-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SDbaHnuVshPmx7kGflxuAWPHSEIGpCGTlTZX0RygcDF71BBwz2fAKFoExlpS2QJb tRH4CeQvrHLtNBhp36EjXQ== 0001144204-04-012648.txt : 20040819 0001144204-04-012648.hdr.sgml : 20040819 20040819165836 ACCESSION NUMBER: 0001144204-04-012648 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20040531 FILED AS OF DATE: 20040819 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PATRIOT SCIENTIFIC CORP CENTRAL INDEX KEY: 0000836564 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 841070278 STATE OF INCORPORATION: DE FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-22182 FILM NUMBER: 04986890 BUSINESS ADDRESS: STREET 1: 10989 VIA FRONTERA CITY: SAN DIEGO STATE: CA ZIP: 92127 BUSINESS PHONE: 8586745000 MAIL ADDRESS: STREET 1: 10989 VIA FRONTERA CITY: SAN DIEGO STATE: CA ZIP: 92127 FORMER COMPANY: FORMER CONFORMED NAME: PATRIOT FINANCIAL CORP DATE OF NAME CHANGE: 19920521 10KSB 1 v07972_form10ksb.txt U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MAY 31, 2004 [_] TRANSITION REPORT UNDER 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 (Name of small business issuer in its charter) Delaware 84-1070278 (State or other jurisdiction of (I.R.S. Empl. Ident. No.) incorporation or organization) 10989 Via Frontera, San Diego, California 92127 ----------------------------------------- ----- (Address of principal executive offices) (Zip Code) (Issuer's telephone number): (858) 674-5000 Securities registered under Section 12(b) of the Exchange Act: NONE Securities registered under Section 12(g) of the Exchange Act: Common Stock, $.00001 par value ------------------------------- (Title of Class) Check whether the issuer (1 ) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 [_] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] State issuer's revenues for it most recent fiscal year. $76,417 The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant on August 12, 2004 was $7,256,203 based on a closing price of $0.04 as reported on the OTC Electronic Bulletin Board system.. At August 12, 2004, 185,958,290 shares of common stock, par value $.00001 per share (the issuer's only class of voting stock) were outstanding. Documents Incorporated By Reference: None Transitional Small Business Disclosure Format (check one): YES [_] NO [X] TABLE OF CONTENTS
Page ---- PART I ITEM 1. Description of Business 3 ITEM 2. Description of Property 12 ITEM 3. Legal Proceedings 12 ITEM 4. Submission of Matters to a Vote of Security Holders 13 PART II ITEM 5. Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities 13 ITEM 6. Management's Discussion and Analysis or Plan of Operation 14 ITEM 7. Financial Statements 24 ITEM 8. Changes in and Disagreements with Accountants on 24 Accounting and Financial Disclosure ITEM 8A. Controls and Procedures 25 ITEM 8B. Other Information 25 PART III ITEM 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act 22 ITEM 10. Executive Compensation 27 ITEM 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 30 ITEM 12. Certain Relationships and Related Transactions 32 ITEM 13. Exhibits 33 ITEM 14. Principal Accountant Fees and Services 42
2 DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-KSB, including all documents incorporated by reference, includes "forward-looking" statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and the Private Securities Litigation Reform Act of 1995, and we desire to take advantage of the "safe harbor" provisions thereof. Therefore, we are including this statement for the express purpose of availing ourselves of the protections of such safe harbor with respect to all of such forward-looking statements. The forward-looking statements in this Report reflect our current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including specifically the absence of significant revenues, a history of losses, no assurance that technology can be completed or that its completion will not be delayed, significant competition, the uncertainty of patent and proprietary rights, uncertainty as to royalty payments and indemnification risks, possible adverse effects of future sales of shares on the market, trading risks of low-priced stocks and those other risks and uncertainties discussed herein, that could cause actual results to differ materially from historical results or those anticipated. In this report, the words "anticipates," "believes," "expects," "intends," "future" and similar expressions identify certain of the forward-looking statements. Readers are cautioned not to place undue reliance on the 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 hereof. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this section. PART I ITEM 1. DESCRIPTION OF BUSINESS THE COMPANY Patriot Scientific Corporation was organized under Delaware law on March 24, 1992, and is the successor by merger to Patriot Financial Corporation, a Colorado corporation incorporated on June 10, 1987. Our address is 10989 Via Frontera, San Diego, California 92127, and our telephone number is (858) 674-5000. Our home page can be located on the World Wide Web at http://www.ptsc.com. We develop, market, and sell microprocessors, our technology behind the microprocessors, and complementary products which enable computers and other data processing devices to communicate. These products can be used to connect to the Internet or other telecommunication networks. The microprocessor technology product line accounted for approximately 18% of our revenue in fiscal 2004. The balance of our fiscal 2004 revenue was generated from a communications product line that, subsequent to a completed last buy program, is now generating minimal revenue. We also have a patent for special radar technology which, if fully developed, may allow a potential licensee to penetrate the ground or structures to find various objects. We also owned gas plasma antenna technology which we sold for $250,000 in August 1999. In October 2003, we received a final royalty payment of $75,500 from the sale of the gas plasma technology. Our strategy is to exploit our microprocessor technologies through product sales, licensing, strategic alliances and to litigate against those who may be infringing on our patents. In 1997, we emerged from the development stage primarily as a result of the acquisition of Metacomp Inc. There can be no assurance that we can achieve profitable operations, and we may need additional financial resources during the next twelve months. 3 BACKGROUND In February 1989, we completed our initial public offering under a registration statement on Form S-18 under the Securities Act of 1933. This offering raised gross proceeds of $50,000 and net proceeds of approximately $28,640 upon the sale of 2,500,000 units at $.02 per unit. Each unit sold in the public offering consisted of one common share and one Class A common stock purchase warrant exercisable to acquire one share of common stock and one Class B common stock purchase warrant. All Class A and Class B warrants have since been exercised or have lapsed. On May 12, 1992, we redomiciled ourselves from Colorado to Delaware by merging into a wholly owned Delaware subsidiary, Patriot Scientific Corporation, organized for that purpose. The reincorporation resulted in a reverse stock split. Three shares of the Colorado corporation, par value $.00001, were converted into one share of the Delaware corporation, par value $.00001. The reincorporation also effected a change in our charter and bylaws and a name change to Patriot Scientific Corporation. In May 1993, we registered under the Securities Act of 1933 a total of 7,631,606 shares issuable upon the exercise of outstanding Class A and Class B common stock purchase warrants. Upon the exercise of those warrants, we received net proceeds of $3,343,915 and issued 7,538,102 common shares. None of such warrants remain outstanding. Effective May 31, 1994, we entered into an asset purchase agreement and plan of reorganization with nanoTronics Corporation located in Eagle Point, Oregon and Helmut Falk. We issued a total of 8,500,000 restricted common shares to nanoTronics to acquire certain microprocessor technology of nanoTronics. The technology acquired was used to develop a sophisticated yet low cost microprocessor. 5,000,000 of the shares were issued on a non-contingent basis, and the remaining 3,500,000 shares were issued subject to the terms of an earnout escrow arrangement, which concluded on May 31, 1999. Effective December 26, 1996, we acquired 96.9% of the outstanding shares of Metacomp, Inc., a California corporation, from 56 shareholders in exchange for the issuance of 1,272,068 shares of our common stock. Based on the closing price of our common stock of $1.375 on the date of the acquisition, the price of the acquisition was $1,749,094. This business combination was accounted for as a pooling-of-interests. BUSINESS ORGANIZATION AND CORPORATE DEVELOPMENT. Our business involves the following technologies: o Ignite microprocessor technology, and o high-speed data communications technology. The stage of development of each of our technologies is as follows: o Ignite microprocessor. This technology is generating minor amounts of revenue from the sale of development boards, microprocessors and initial license fees related to the microprocessor application. We run the technology on a 0.18-micron microprocessor, which is in current production. We have ported the WindRiver VxWorks operating system and the Sun Microsystems personalJava virtual machine to the microprocessor. In addition, the technology is available for sale as intellectual property, which enables the prospective customer to incorporate the microprocessor functions with other parties' applications to arrive at a system on a chip solution. Although we anticipate the Ignite technology to be our main product line, it accounted for only about 18% of our revenue in fiscal year 2004. o High-speed data communications. Revenue from this technology was phased out during fiscal year 2002 as a result of the products reaching the end of their life cycles. During fiscal 2002 we initiated a last time buy program and, except for minor repeat orders, have discontinued this product line. We have decided to concentrate our efforts on the Ignite microprocessor technology. Although the communications product line accounted for approximately 82% of our fiscal year 2004 revenue, we anticipate that the Ignite microprocessor will be our main product line in the future. Due to our small size and staffing overlaps among the technologies, certain personnel may work on any or all of our technologies from time to time. 4 During at least the last three years, we have focused the majority of our efforts on the Ignite technology. The Ignite technology is targeted for the embedded controller and Java language processor marketplaces. INTERNET GROWTH AND THE EMERGENCE OF THE JAVA PROGRAMMING LANGUAGE. The Internet is a global web of computer networks. This "network of networks" allows computers connected to the Internet to "talk" to one another. The Internet provides organizations and individuals with new means to conduct business. Commercial uses of the Internet include business-to-business and business-to-consumer transactions, product marketing, advertising, entertainment, electronic publishing, electronic services and customer support. We believe that organizations will also increasingly use the Internet and private Intranet networks to improve communications, distribute information, lower operating costs and change operations. Use of the Internet has grown rapidly and has had an impact on many industries, including computer hardware, software and peripheral industries. The rapid growth in popularity of the Internet is in part due to continuing penetration of computers and modems into U.S. households, growth of the informational, entertainment and commercial applications and resources of the Internet, the growing awareness of such resources among individuals, and the increasing availability of user-friendly navigational and utility tools which enable easier access to the Internet's resources. The growth of the Internet and corporate Intranets is creating a demand for hardware, software and peripherals. Software, such as Java, has been developed to serve the requirements of Internet users. Java is a programming language that was originally developed for personal digital assistant devices and television set top boxes. It was formally announced as an object-oriented language for the Internet in May 1995 by Sun Microsystems Inc. A large number of major computer, software, browser and on-line service provider companies have licensed the Java language. Accordingly, Java is a fundamental platform for Internet related applications. A significant number of Java applications, or applets, are now available on the Internet. These applications not only enhance web pages but also perform many functions of traditional computer software programs. Our Ignite technology lends itself to potential markets in which the use of Java is prevalent. With Java, data and programs do not have to be stored on the user's computer but can reside anywhere on the Internet to be called upon as needed. Among its various attributes, two key features of Java are (1) its ability to run on a variety of computer operating systems thus avoiding the problem of incompatibility across networks, and (2) security, because Java enables the construction of virus-resistant, tamper-resistant systems by using resource-access control and public-key encryption. Because of Java's useful features, it has also become a popular programming language for embedded applications. Since Java is designed to run on multiple types of devices and operating systems, it allows developers to write a program once for many types of operating systems, instead of having to write new versions for each type. Java does this by interpreting a program's commands into something that a particular type of computer can understand. This interpretive design runs programs slower than if they were tailored for each type of computer and is resulting in a need for specialized microprocessors and compilers to increase Java's speed. The growth of Java is causing a number of companies to consider it as a basis for a new style of computing tailored to the Internet and not encumbered by the limitations of, or requiring, traditional computer operating systems. The concept is to design inexpensive access devices to communicate via the Internet. OUR MICROPROCESSOR TECHNOLOGY. General Background. In 1991, nanoTronics Corporation was formed and acquired a base technology for an advanced microprocessor integrated on a single computer chip. nanoTronics subsequently engaged in substantial technical development and fabricated a first-generation microprocessor in early 1994. Since the acquisition of the technology from nanoTronics, effective May 31, 1994, we have been engaged in enhancing the microprocessor design, adding additional technical features to further modernize the design, and improving and testing the new design. We initially fabricated a prototype 0.8-micron microprocessor in May 1996. The next generation was a 0.5-micron microprocessor that was delivered in September 1997. The 0.5-micron microprocessor was employed in demonstrations for prospective customers and was shipped in limited numbers to customers as an embedded microprocessor. In 1998 we introduced a 0.35-micron microprocessor whose features included a reduction in size and improved performance. In addition, in September 2000 we completed a VHDL model of this technology which enables customers to purchase intellectual property incorporating microprocessor functions with other parties' applications to 5 arrive at a system on a chip solution. By purchasing this software model, customers can significantly reduce their time to market by simulating results as opposed to trial and error commitments to silicon production. In 2003 we further reduced the size of our silicon production to 0.18-microns. Industry Background. The semiconductor logic market has three major sectors: o standard logic products, o application specific standard products, and o application specific integrated circuits. Standard logic products, such as the Intel's X86 and Pentium and Motorola's 680X0 microprocessor families, are neither application nor customer specific. They are intended to be utilized by a large group of systems designers for a broad range of applications. Because they are designed to be used in a broad array of applications, they may not be cost effective for specific applications. Application specific integrated circuits are designed to meet the specific application of one customer. While cost effective for that application, application specific integrated circuits require large sales volumes of that application to recover their development costs. Application specific standard processors are developed for one or more applications but are not generally proprietary to one customer. Examples of these applications include modems, cellular telephones, other wireless communications devices, multimedia applications, facsimile machines and local area networks. We have designed our microprocessor to be combined with application specific software to serve as an embedded control product for the application specific standard processor market sector. Application specific standard processors are typically used in embedded control systems by manufacturers to provide an integrated solution for application specific control requirements. Such systems usually contain a microprocessor or microcontroller, logic circuitry, memory and input/output circuitry. Electronic system manufacturers combine one or more of these elements to fit a specific application. The microprocessor provides the intelligence to control the system. The logic circuitry provides functions specific to the end application. The input/output circuitry may also be application specific or an industry standard component. The memory element, if not on the microprocessor, is usually a standard product used to store program instructions and data. In the past, these functions have been executed through multiple integrated circuits assembled on a printed circuit board. The requirements for reduced cost and improved system performance have created market opportunities for semiconductor suppliers to integrate some or all of these elements into a single application specific standard processor or chip set, such as the Ignite family of microprocessors. The Ignite family provides close integration of the microprocessor and input/output function with the logic circuitry, thereby providing an advanced application specific standard processor. Embedded control systems enable manufacturers to differentiate their products, replace less efficient electromechanical control devices, add product functionality and reduce product costs. In addition, embedded control systems facilitate the emergence of completely new classes of products. Embedded control systems have been incorporated into thousands of products and subassemblies worldwide, including automotive systems, remote controls, appliances, portable computers and devices, cordless and cellular telephones, motor controls and many other systems. Microprocessors are generally available in 4-bit through 64-bit architectures, which refers to the amount of data they can process. 4-bit microprocessors are relatively inexpensive, typically less than $1.00 each. Although they lack certain performance and features, they account for more than 40% of worldwide microcontroller volume. Also in general use today are 8-bit architectures, generally costing $1.00 to $10.00 each and accounting for an additional 40% of worldwide microcontroller volume. To date 16-bit, 32-bit and 64-bit architectures, with typical costs of over $10.00 each, have offered very high performance, but are generally considered to be expensive for high-volume embedded control applications. The use of 16-bit, 32-bit and 64-bit architectures offers fewer internal limitations, making programming easier and providing higher performance. Although generally more expensive per unit and requiring more support logic and memory, these devices offer many advantages for more sophisticated embedded control systems. Electronic system designers, driven by competitive market forces, seek semiconductor products with more intelligence, functionality and control that can be used to reduce system costs and improve performance. For these needs, the Ignite product family was designed to be a sophisticated 32-bit microprocessor with advanced features. The Ignite product family uses a smaller number of transistors compared to other RISC (reduced instruction set computor) processors, which results in less power consumption and more economical prices compared to other embedded control applications. This creates the opportunity for the development of new, cost-effective applications. 6 Technology Description. Conventional high-performance microprocessors are register-based with large register sets. These registers are directly addressable storage locations requiring a complex architecture that consumes costly silicon. This conventional architecture provides processing power for computer applications but complicates and slows the execution of individual instructions and increases silicon size, thereby increasing the microprocessor cost. Our technology is fundamentally different from most other microprocessors, in that the data is stored in groups and certain information is known to be at the top of a stack as opposed to being stored in a register. Our microprocessor employs certain features of both register and stack designs. The resultant merged stack-register architecture improves program execution for a wide range of embedded applications. Our design combines two processors in one highly integrated package, a microprocessing unit for performing conventional processing tasks, and an input-output processor for performing input-output functions. This replaces many dedicated peripheral functions supplied with other processors. The microprocessor's design simplifies the manipulation of data. Our architecture employs instructions that are shrunk from 32-bits to 8-bits. This simplified instruction scheme improves execution speed for computer instructions. Our architecture incorporates many on-chip system functions, thus eliminating the requirement of support microprocessors and reducing system cost to users. The 0.8-micron microprocessor was designed to operate at a speed of 50Mhz; the 0.5-micron microprocessor at a speed of 100Mhz; the 0.35-micron microprocessor at 150MHz; and the 0.18-micron to operate at speeds in excess of 300Mhz. They are all compatible with a wide range of memory technology from low cost dynamic random access memory to high-speed static random access memory. The microprocessors can be packaged in various surface-mount and die-form packaging. There can be no assurance that the designed speed will be achieved with the production model of the 0.18-micron microprocessor or future versions or that all of the desired functions will perform as anticipated. Our technology is not designed or targeted to compete with high-end processors for use in personal computers. It is targeted for embedded control applications. We believe that the features described above differentiate the Ignite family from other 8-bit to 64-bit microprocessors targeted for embedded control applications. Considering the reduced requirement for support microprocessors, the Ignite family is intended to be available at a high volume price that should be price competitive with high-end 8-bit microprocessor and general 16-bit microprocessor systems but with higher performance (speed and functional capability). The Ignite family has been designed to allow high-speed and high-yield fabrication using generally available wafer fabrication technology and facilities. The Ignite Microprocessor as a Java Processor. We believe the Ignite microprocessor architecture is capable of being an efficient and cost effective Java programming language processor, because Java is designed to run on a stack-oriented architecture and the Ignite architecture executes the virtual stack machine internal to Java efficiently. Many Java operation codes or instructions require only a single 8-bit Ignite family instruction to be executed, providing a performance advantage over other more expensive processors that require six or more 32-bit instructions to do the same task. This feature allows the execution of Java programs with increased speed and reduced code size thereby enabling lower system memory costs. In addition, the incorporation of many on-chip system functions is expected to allow the Ignite family to perform most of the other functions required of an Internet computer device or Java accelerator, thereby eliminating components. Since Internet computers are designed to be inexpensive appliances for Internet access, cost, speed and performance are expected to be key requirements for designers. We believe the Ignite technology can compete favorably on the basis of such requirements, although there can be no assurance we can successfully exploit Java related applications or that competitors will not create superior Java processors. We have ported the Java operating environment to the Ignite family, which currently uses the C programming language for software support. We are a licensee of Sun Microsystems Inc. This enables us to develop and distribute products based on Sun's personalJava, a platform on which to run Java applications. We have also licensed from Wind River an operating system, VxWorks, and entered into a relationship with Forth Inc. whereby Forth will provide software support and operating system development tools for the Forth Programming language. We believe this solution is competitive in the Java virtual machine and embedded applications markets. We believe that, if the implementation is successfully completed, the Ignite family will be competitive with Java microprocessors announced by competitors. However, there can be no assurance of successful implementation of this package of software or of a market for an Ignite family Java microprocessor. Stage of Development. In early 1994, nanoTronics initiated production of a first generation of wafers at a contract fabrication facility using 6 inch wafers employing 0.8-micron double-metal CMOS technology. After the May 31, 1994 acquisition, we improved the original design, added new features and performed simulations and tests of the improved designs. In October 1995, a run of six wafers of second generation 0.8-micron microprocessors was fabricated by a 7 contract fabrication facility. Subsequently, we tested these microprocessors, while completing a C computer language compiler and preparing application development tools. The compiler and application development tools are necessary to enable system designers to program the Ignite family for specific applications. We made corrections to the design suggested by the testing of prototype units and produced an additional run of second generation microprocessors from remaining wafers in May 1996. In July 1996, we employed these microprocessors in demonstration boards for use by developers and prospective customers and licensees. In December 1997, we completed development of and started shipping a 0.5-micron microprocessor based on the Ignite technology and found that 0.5-micron double-metal CMOS technology improved operating speed, reduced power requirements, reduced physical size and reduced fabrication cost. In May 1998, we began a production run of a 0.35-micron microprocessor that further increased operating speed and cost performance over the previous generations of the Ignite family of microprocessors. At each stage of development, microprocessors require extensive testing to ascertain performance limitations and the extent and nature of errors (bugs), if any. When significant limitations or errors are discovered, additional rounds of design modifications and fabrication are required prior to having functional and demonstrable microprocessors for prospective customers and licensees. Although our 0.5 and 0.35-micron microprocessors have been sent to prospective customers in anticipation of production orders, there can be no assurance that we, during our continued testing of these products, will not identify errors requiring additional rounds of design and fabrication prior to commercial production. Additional delays could have an adverse effect on the marketability of our technology and financial condition. In September 2000, we completed the VHDL soft-core version of the Ignite microprocessor family. The hardware design inside a microprocessor, or silicon device, can be represented as a software program. This, in essence, replaces the old style of designing microprocessors using schematics. VHDL is the predominant software language used to design semiconductors. In addition to the design aspects, VHDL also contains sophisticated simulation tools that allow the designer to simulate the functionality of the entire design before committing to silicon. Also VHDL enables a designer to easily modify and enhance the design. A design represented in VHDL goes through a synthesis process whereby it is converted to the most basic element of a design, logical gates. This gate level representation in turn is used with computer aided engineering tools to translate the design into the most fundamental component of semiconductors, transistors. The characteristics of the transistors can be given as a library to a foundry. Therefore, a design represented in VHDL is technology and foundry independent and can be targeted for any given transistor geometry (such as 0.18, 0.25, or 0.35- micron) for any foundry of choice. We have developed marketing materials, product manuals and application development tools for use by licensees and customers. The manuals and tools are necessary to enable system designers to quickly and easily program the Ignite family for specific applications. We believe that the Ignite family is ready for licensing or sale and that any additional changes encountered in current testing will be minor and can be made during subsequent production runs of Ignite family microprocessors for customers, when and if orders are obtained. We also believe the core technology is ready for licensing for use by others to develop custom microprocessors. Business Strategy. The increasing demand for embedded control has helped to make the market for microprocessors one of the largest segments of the semiconductor logic market. This demand will drive the need for embedded processors. Our strategy does not entail competing directly with suppliers who have multiple microprocessor types addressing all parts of the embedded systems market, but on identifying certain market niches that the Ignite microprocessor would best address due to its low cost, low power consumption, small number of transistors and higher performance. Because of the above factors, we intend to focus the majority of our efforts on the embedded microprocessor business, a market without an established base of microprocessor products and for which we believe the Ignite microprocessor has desirable technical and market advantages. We believe that our architecture is suited for controller applications requiring high performance and low system cost, such as smart cards, cell phones, printers, video terminals, robotics, motion controllers, industrial controllers, digital communication devices, video games, kiosks, cable and satellite modems and TV set top boxes. We expect that early licensing of the technology and product applications will focus on embedded control. 8 We have two international representatives for foreign markets and are addressing the domestic market with an in-house business development person. We also have a strategic alliance with an outside microprocessor design house. We believe the appropriate approach for us initially lies in a balanced effort of cultivating licensees and developing specific product enhancement partnerships, producing original equipment manufactured products, and providing technical support to third parties on a contract basis. The overall balance of these approaches will be monitored and modified as we attempt to ascertain and capitalize on the highly dynamic and competitive embedded microprocessor market. There can be no assurance that we can successfully exploit our microprocessor technology. Subject to the availability of financial and personnel resources, while we are commercializing the Ignite family and the core technology, our strategy is to also design and develop future versions of the microprocessor with more demanding sub-micron technology and with more features. However, our resources are limited, and there can be no assurance that we will be able to continue microprocessor enhancement. Initial fabrications of the 0.8-micron and 0.5-micron processors were performed by contract fabrication facilities. The 0.35-micron microprocessor was fabricated by a contract fabrication facility that had agreed to provide production quantities for our customers. We have completed work with a contract fabrication facility and our design house partner to produce a 0.18-micron version of the Ignite family. There can be no assurance fabrication facilities will be available to produce the Ignite family in the future. However, since there are a large number of fabrication facilities with the capability to produce the Ignite family of microprocessors, we believe microprocessors can be produced on a contract basis. Industry shortages of fabrication facilities that may exist and are predicted to exist in the future are generally limited to the more demanding architectures. If a shortage of fabrication facilities develops, it could have a material adverse effect on our financial condition. Competition. The semiconductor industry is intensely competitive and has been characterized by price erosion, rapid technological change and foreign competition in many markets. The industry consists of major domestic and international semiconductor companies, most of which have greater financial, technical, marketing, distribution, development and other resources than we do. The market for microprocessors and for embedded control applications is at least as competitive. While our strategy is to target high-volume licensees and microprocessor customers requiring more sophisticated but low-cost, low-power consumption devices, we can still expect significant competition. We may also elect to develop embedded control system products utilizing our own architecture or by contract for other manufacturers. We expect that the Ignite family, if successfully commercialized in the embedded controller market, will compete with a variety of 16/64-bit microprocessors including those based on intellectual property from ARM and MIPS and microprocessors from Hitachi, Motorola and IBM. As a Java processor, we expect our Ignite family will compete with a broad range of microprocessors including those incorporating co-processor accelerator technology. The producers of these microprocessors have significantly greater resources than we do. A new entrant, such as ours, is at a competitive disadvantage compared to these and other established producers. A number of factors contribute to this, including: o the lack of product performance experience, o lack of experience by customers in using application development systems, o no record of technical service and support, and o limited marketing and sales capabilities. HIGH SPEED DATA COMMUNICATIONS PRODUCTS. The communication products that reached the end of their life cycles are: VME Product Line - a line of high-speed communications products developed under European standards. Some of our customers for these products included the military as well as large satellite based data communications companies. 9 Atcomm2/4 Product Line - an intelligent two or four channel product that was used for high-speed data communications. Except for minor repeat orders, we no longer support this product line. We have disposed of or fully reserved the communication product line inventory and are concentrating our efforts and resources on Ignite. RESEARCH AND DEVELOPMENT. Our current development efforts are focused on improvement of, and additional features for, the Ignite family of microprocessors. The development of this technology has taken longer than anticipated and could be subject to additional delays. Therefore, there can be no assurance of timely or successful marketing of this technology. We incurred research and development expenditures of $549,756 and $723,287 for our fiscal years ended May 31, 2004 and 2003, respectively. The majority of these expenditures have been devoted to our microprocessor technology. We believe that technical advances are essential to our success and expect that we will, conditioned on the availability of funds, continue to expend substantial amounts on research and development of our technology. However, there can be no assurance that such research and development efforts will result in the design and development of a competitive technology in a timely manner. LICENSES, PATENTS, TRADE SECRETS AND OTHER PROPRIETARY RIGHTS. We rely on a combination of patents, copyright and trademark laws, trade secrets, software security measures, license agreements and nondisclosure agreements to protect our proprietary technologies. Our policy is to seek the issuance of patents that we consider important to our business to protect inventions and technology that support our microprocessor technology. We have seven U.S. patents issued dating back to 1989 on our microprocessor technology. We have one microprocessor technology patent issued in five European countries and one patent issued in Japan and may file additional applications under international treaties depending on an evaluation of the costs and anticipated benefits that may be obtained by expanding possible patent coverage. In addition, we have one U.S. patent issued on ground penetrating radar technology and one U.S. patent issued on one of the communications products. In addition to such factors as innovation, technological expertise and experienced personnel, we believe that a strong patent position is becoming increasingly important to compete effectively in the semiconductor industry. It may become necessary or desirable in the future for us to obtain patent and technology licenses from other companies relating to certain technology that may be employed in future products or processes. To date, we have not received notices of claimed infringement of patents based on our existing processes or products; but, due to the nature of the industry, we may receive such claims in the future. We believe that we may have claims against numerous companies that use semiconductors with capabilities in excess of 125 MHz in their products. In December 2003, we initiated legal actions against five companies to enforce our patents. In February 2004, Intel initiated a legal action against us and we filed a counterclaim against them related to the initial five lawsuits. There can be no assurance that we will be successful in enforcing any potential patent claims against these or other companies. Also in February 2004, we initiated a legal action against several entities, one of which was a co-inventor for some of the technology, to clarify the inventorship and ownership of each of our granted patents. See Legal Proceedings. Based on the asset purchase agreement and plan of reorganization between Patriot, nanoTronics and Mr. Falk, we were the recipients of a number of warranties and indemnities. We believe nanoTronics has been liquidated and, due to Mr. Falk's death in July 1995, we may be limited in our ability to obtain satisfaction should we have any future claims against nanoTronics or its successor, the Falk Family Estate. We have entered into the following licenses related to the microprocessor technology: o Sierra Systems. In June 1994, we entered into an agreement with Sierra Systems whereby we could provide the C programming language on the Ignite microprocessor. We currently provide development boards with the C programming language. o Sun Microsystems Inc. In June 1997, we entered into an agreement with Sun Microsystems, Inc., which enabled us to develop and distribute products based on Sun's Java technology. In June 1998, we exercised an option under that agreement to license from Sun, personalJava, a smaller platform on which to run Java applications that did not 10 include an operating system. We determined that personalJava is better suited to the markets available to the Ignite microprocessor. We have ported personalJava to the Ignite microprocessor. o Wind River. In July 1997, we entered into an agreement with Wind River that provided us with a license for an operating system, VxWorks, to be used in conjunction with personalJava. We have ported VxWorks to the Ignite. o Forth Inc. In July 1997, we entered into a license agreement with Forth Inc. whereby Forth will provide software support and operating system development tools for the Forth programming language. We have one U.S. patent on our ground penetrating radar technology. No foreign application has been made. There are a large number of patents owned by others in the radar field generally and in the field of ground penetrating radar specifically. Accordingly, although we are not aware of any possible infringement and have not received any notices of claimed infringement, we may receive such claims in the future. There can be no assurance that any patents will be issued from pending or future applications or that any patents that are issued will provide meaningful protection or other commercial advantages to us. Although we intend to protect our rights vigorously, there can be no assurance that these measures will be successful. We generally require all of our employees and consultants, including our management, to sign a non-disclosure and invention assignment agreement upon employment with us. MARKETING AND DISTRIBUTION. Our products are marketed through a combination of direct sales and distributors. Approximate sales by principal geographic area (as a percentage of sales) for fiscal years ended May 31 were as follows: 2004 2003 ---- ---- Domestic sales 92% 91% Foreign sales Europe 8% 9% ---- ---- Total sales 100% 100% ==== ==== All of our operating assets are located within the United States. While sales to certain geographic areas generally vary from year to year, we do not expect that changes in the geographic composition of sales will have a material adverse effect on operations. DEPENDENCE UPON SINGLE CUSTOMERS. Ten percent (10%) or more of our consolidated net sales were derived from shipments to the following customers for the fiscal years ended May 31as follows: 2004 2003 ------- ------- nTelesis $25,000 $ -- Blue Tech Inc. 18,000 -- Litton Systems 9,000 -- Long Wave, Inc. -- 43,000 General Dynamics -- 23,000 Centratech -- 15,000 Advanced Relay -- 15,000 All of the above sales were shipped against multiple purchase orders from each customer. nTelesis is owned by an executive officer of the company. We had no backlog as of May 31, 2004 or 2003. 11 EMPLOYEES. We currently have six personnel. Two people are employed in research and development, one in marketing and sales and three are engaged in general and administrative activities. We also engage additional consultants and part-time persons as needed from time to time. Our future success depends in significant part upon the continued services of our key technical and senior management personnel. The competition for highly qualified personnel is intense, and there can be no assurance that we will be able to retain our key managerial and technical employees or that we will be able to attract and retain additional highly qualified technical and managerial personnel in the future. None of our employees is represented by a labor union, and we consider our relations with our employees to be good. None of our employees is covered by key man life insurance policies. GOVERNMENT REGULATION. To our knowledge, our products are not subject to governmental regulation by any federal, state or local agencies that would affect the manufacture, sale or use of our products, other than occupational health and safety laws and labor laws which are generally applicable to most companies. We cannot, of course, predict what sort of regulations of this type may be imposed in the future but do not anticipate any unusual difficulties in complying with governmental regulations which may be adopted in the future. We have not incurred costs associated with environmental laws and do not anticipate such laws will have any significant effect on our future business. ITEM 2. DESCRIPTION OF PROPERTY We have one 10,300 square foot office located at 10989 Via Frontera, San Diego, California. The facility is leased through July 2006. In July 2002, we sublet approximately 5,000 square feet of our facility to an independent third party. The term of the sublease coincides with the remaining term of our lease. The reduced floor space provides adequate and suitable facilities for all of our corporate functions. ITEM 3. LEGAL PROCEEDINGS In December 2003, we filed several lawsuits in United States District Courts against companies we contend are infringing on our patent number 5,809,336 entitled "High Performance Microprocessor Having Variable Speed Clock." The defendants and suits are as follows: Defendant U.S. District Court Case Number - --------- ------------------- ----------- Sony Corporation of America Southern District of New York 03CV10142 Fujitsu Northern District of California C035787 Toshiba America, Inc. Southern District of New York 03CV10180 NEC USA, Inc. Eastern District of New York CV036432 Matsushita District of New Jersey 03CV06210 We are requesting the courts to enjoin the defendants from making use of our patent and are requesting damages for past infringements. In February, with the consent of the defendants and ourselves, the above five actions were consolidated into the Fujitsu action in the Northern District of California under case number C035787. In February 2004, Intel Corporation filed a lawsuit against us in the United States District Court- Northern District of California, case number C040439, in which they are requesting a declaratory judgment that their microprocessors, used by the defendants in our consolidated suit, do not infringe our patent. We filed a counterclaim against Intel contending that they also are infringing on our patent, and Intel asserted an affirmative defense that our 5,809,336 patent is invalid. Also in February 2004, we filed a lawsuit in the United States District Court- Northern District of California, case number C040618, against Charles H. Moore, Technology Properties Limited, and Daniel E. Leckrone. We are requesting 12 the court to declare inventorship and ownership on each of our granted patents related to the suits discussed above and other unasserted claims of infringement Patriot believes it has. The Intel lawsuit has been stayed pending the results of the Moore lawsuit. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES Our Common Stock is traded in the over-the-counter market and is quoted on the NASD OTC Bulletin Board system maintained by the National Association of Securities Dealers, Inc. Prices reported represent prices between dealers, do not include markups, markdowns or commissions and do not necessarily represent actual transactions. The market for our shares has been sporadic and at times very limited. The following table sets forth the high and low closing bid quotations for the Common Stock for the fiscal years ended May 31, 2004 and 2003. BID QUOTATIONS ---------------- HIGH LOW Fiscal Year Ended May 31, 2004 First Quarter $0.07 $0.04 Second Quarter $0.08 $0.04 Third Quarter $0.17 $0.03 Fourth Quarter $0.15 $0.08 Fiscal Year Ended May 31, 2003 First Quarter $0.08 $0.06 Second Quarter $0.14 $0.04 Third Quarter $0.09 $0.04 Fourth Quarter $0.09 $0.04 We have approximately 550 shareholders of record as of May 31, 2004. Because most of our common stock is held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these record holders. We have never paid a cash dividend on our common stock and do not expect to pay one in the foreseeable future. RECENT SALE OF UNREGISTERED SECURITIES During the fourth fiscal quarter ended May 31, 2004, we offered and sold the following 1) a convertible debenture and associated warrant in exchange for a previously issued secured promissory note and 2) warrants associated with the sale of 8% convertible debentures all 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 will be taken, including, should the debenture be converted or the warrants exercised into common stock, the placing of a restrictive legend on the certificates evidencing such securities. The sales were effected without the aid of underwriters, and no sales commissions were paid. 13
CONVERTIBLE DEBENTURE Amount of Initial Conversion Debenture Holder Date of Sale Convertible Debenture Price Per Share Consideration ---------------- ------------ --------------------- --------------- ------------- Swartz Private Equity March 23, 2004 $ 723,167 $0.090 Note conversion WARRANTS Initial Exercise Expiration Warrant Holder Date of Issuance Number of Shares Price Per Share Date -------------- ---------------- ----------------- --------------- ---- Swartz Private Equity March 23, 2004 8,035,192 $0.090 April 1, 2011 Lincoln Ventures LLC March 24, 2004 3,366,727 $0.094 April 1, 2011 Swartz Private Equity April 1, 2004 5,240,211 $0.081 April 1, 2009 Lincoln Ventures LLC May 11, 2004 6,951,428 $0.070 April 1, 2011
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATON OVERVIEW Patriot Scientific Corporation ("the Company") develops, markets, and sells microprocessors, the technology behind the microprocessors, and complementary products which enable computers and other data processing devices to communicate. These products can be used to connect to the Internet or other telecommunication networks. The microprocessor technology product line accounted for approximately 18% of our revenue in fiscal 2004. The balance of our fiscal 2004 revenue was generated from a communications product line that, subsequent to a completed last buy program, is now generating minimal revenue. We also have a patent for special radar technology which, if fully developed, may allow a potential licensee to penetrate the ground or structures to find various objects. We also owned gas plasma antenna technology which we sold for $250,000 in August 1999. In fiscal 2004 we received a final royalty payment of $75,500 from the sale of the gas plasma technology. Our strategy is to exploit our microprocessor technologies through product sales, licensing, strategic alliances and to litigate against those who may be infringing on our patents. Management's discussion and analysis of results of operations and financial condition are based upon the Company's financial statements. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require management to make certain estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. CRITICAL ACCOUNTING POLICIES AND ESTIMATES We have identified nine accounting principles that we believe are key to an understanding of our financial statements. These important accounting policies require management's most difficult, subjective judgments. 14 1. Going Concern These financial statements are presented on the basis that the Company is a going concern. Going concern contemplates the realization of assets and the satisfaction of liabilities in the normal course of business over a reasonable length of time. The Company has incurred significant operating losses and has had negative cash flows from operating activities for each of the years ended May 31, 2004 and 2003, had negative working capital and a stockholders' deficit for the year ended May 31, 2003 and used convertible debentures for raising substantially all of its working capital. These factors raise substantial doubt as to the Company's ability to continue as a going concern. Management's plans to eliminate the going concern situation include, but are not limited to, the following: 1. Obtain additional equity or debt financing from investors including the exercise of outstanding warrants. 2. Obtain revenue producing contracts by successfully negotiating licensing, development and product opportunities within the microprocessor market place. 3. Aggressively pursue patent infringement opportunities by litigating with companies alleged to be infringing on our issued patents. 4. If funds are not satisfactorily available to continue operations at our current level, put in place cost reduction programs. Such reduction programs could include a scale back in the support of the microprocessor technology with total emphasis being placed on patent infringement activity. If, in the future, there is patent infringement success, additional funds would be available for the microprocessor technology. 2. Marketable Securities As part of the sale of our gas plasma antenna technology we received restricted securities in a company that is traded on the OTC bulletin board. The securities can be traded under Rule 144 after July 2004. We reflect the value of those securities based on the closing price as of the end of our reporting period. Any unrealized gain or loss between reporting periods is reflected in our consolidated statement of operations as non-operating income or loss. 3. 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 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. 4. 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. 15 5. Revenue Recognition We recognize revenue on the shipment to our customers of communication products, microprocessor integrated chips and evaluation boards. We also derive revenue from fees for the transfer of proven and reusable intellectual property components or the performance of engineering services. We enter into licensing agreements that will provide licensees the right to incorporate our intellectual property components in their products with terms and conditions that will vary by licensee. Generally, these payments will include a nonrefundable technology license fee, which will be payable upon the transfer of intellectual property, or a nonrefundable engineering service fee, which generally will be payable upon achievement of defined milestones. In addition, we anticipate these agreements will include royalty payments, which will be payable upon sale of a licensee's product, and maintenance and limited support fees. We will classify all revenue that involves the future sale of a licensee's products as royalty revenue. Royalty revenue will be generally recognized in the quarter in which a report is received from a licensee detailing the shipments of products incorporating our intellectual property components (i.e., in the quarter following the sale of licensed product by the licensee). We will classify all revenue that does not involve the future sale of a licensee's products, primarily license fees and engineering service fees and maintenance and support fees, as contract revenue. License fees will be recognized upon the execution of the license agreement and transfer of intellectual property, provided no further significant performance obligations exist and collectibility is deemed probable. Fees related to engineering services contracts, which will be performed on a best efforts basis and for which we will receive periodic milestone payments, will be recognized as revenue over the estimated development period, using a cost-based percentage of completion method. Annual maintenance and support fees, which will be renewable by the licensee, will be classified as contract revenue and will be amortized over the period of support, generally 12 months. 6. Research and Development Costs Research and development costs are expensed as incurred. 7. Stock Options The Company applies Accounting Principles Board ("APB") Opinion 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for all stock option plans. Under APB Opinion 25, compensation cost has been recognized for stock options granted to employees when the option price is less than the market price of the underlying common stock on the date of grant. SFAS No. 123, "Accounting for Stock-Based Compensation," and SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and disclosure," require the Company to provide pro forma information regarding net income as if compensation cost for the Company's stock option plans had been determined in accordance with the fair value based method prescribed in SFAS No. 123. To provide the required pro forma information, the Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model. SFAS No. 148 also provides for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company has elected to continue to account for stock based compensation under APB No. 25. The Company applies SFAS No. 123 in valuing options granted to consultants and estimates the fair value of such options using the Black-Scholes option-pricing model. The fair value is recorded as consulting expense as services are provided. Options granted to consultants for which vesting is contingent based on future performance are measured at their then current fair value at each period end, until vested. 8. Income Taxes Deferred income taxes are provided for by recognizing temporary differences in certain income and expense items for financial and tax reporting purposes. Deferred tax assets consist primarily of income tax benefits from net operating loss carry-forwards. A valuation allowance has been recorded to fully offset the deferred tax asset as it is more likely than not that the assets will not be utilized. The valuation allowance increased approximately $441,000 for the year ended May 31, 2004, from $14,291,000 at May 31, 2003 to $14,732,000 at May 31, 2004. 9. Debt Discount We issue warrants as part of our convertible debentures and other financings. We value the warrants using the Black-Scholes pricing model based on expected fair value at issuance and the estimated fair value is recorded as debt discount. The debt discount is amortized to non-cash interest over the life of the debenture assuming the debenture will be held to maturity which is normally 2 years. If the debenture is converted to common stock previous to its maturity date, any debt discount not previously amortized is expensed to non-cash interest. 16 SELECTED FINANCIAL INFORMATION
Year Ended Increase 5/31/2004 5/31/2003 (Decrease) % Statements of Operations Revenue $ 76,417 $ 123,903 $ (47,486) -38.3% Cost of revenue 10,472 18,660 (8,188) -43.9% % of revenue 14% 15% -1% -9.0% Gross profit 65,945 105,243 (39,298) -37.3% % of revenue 86% 85% 1% 1.6% Operating expenses Research and development 549,756 723,287 (173,531) -24.0% General and administrative 1,253,559 1,821,902 (568,343) -31.2% Total operating expenses 1,803,315 2,545,189 (741,874) -29.1% Gain on sale of technology 75,500 -- 75,500 NM Loss on marketable securities (45,354) -- (45,354) NM Interest expense (2,443,024) (1,448,544) 994,480 68.7% Interest income 270 191 79 41.4% Net loss (4,149,978) (3,888,299) 261,679 6.7% Net loss per share basic and diluted (0.03) (0.04) (0.01) -25.0%
RESULTS OF OPERATIONS Year ended May 31, 2004, compared to year ended May 31, 2003. Revenues Our revenue decrease of $47,486, or 38.3%, was due to a continuing lack of significant revenue producing contracts. Although our bid and proposal activity remains high, our microprocessor product line has failed to generate any significant contracts. We continue to receive minor follow-on orders for the communication products that have reached the end of their life cycle. We no longer market these products but do fill follow-on orders when economically feasible. During fiscal 2004, we had an engineering design contract for approximately $25,000 with a company owned by one of our executive officers. We anticipate that future revenue will be derived from successful microprocessor technology efforts in the form of licensing and royalties and the successful collection of patent infringement proceeds from litigation and settlement. Cost of Revenue Our cost of revenue decrease of $8,188, or 43.9%, was commensurate with the reduction in revenue. We fully reserved our inventory in fiscal 2002 and, therefore, minor amounts of existing inventory can be resold at a zero cost basis. However, in order to fulfill the minor follow-on orders for communication products, we normally must procure a portion of additional components and assemblies. We anticipate that future cost of revenue will be commensurate with the success of receiving microprocessor licenses and royalties and patent infringement proceeds. 17 Research and Development
Year Ended Increase 5/31/2004 5/31/2003 (Decrease) % Research and Development Personnel (including consultants) $ 480,967 $ 610,416 $(129,449) -21.2% Facilities 66,294 104,832 (38,538) -36.8% Other research and development expenses 2,495 8,039 (5,544) -69.0% --------- --------- ---------
The $173,531, or 24%, reduction in research and development was attributed to a reduction in personnel costs, primarily consulting costs, as the development of our softcore microprocessor technology has reached a leveling off point. In addition, there has been no significant increase in depreciable equipment related to research and development for the past three years resulting in a lower depreciation amount charged to facilities expense. When and if funds become available, we anticipate an increase in research and development to upgrade the tools which are used by our potential customers to implement the microprocessor technology and to expand our offerings on which our microprocessor can run to include additional operating systems. General and Administrative
Year Ended Increase 5/31/2004 5/31/2003 (Decrease) % General and Administrative Personnel (including consultants) $ 491,898 $ 891,851 $ (399,953) -44.8% Professional fees 228,935 272,296 (43,361) -15.9% Facilities 308,207 324,726 (16,519) -5.1% Other general and administrative expenses 224,519 333,029 (108,510) -32.6% ----------- ----------- ----------- $ 1,253,559 $ 1,821,902 $ (568,343) -31.2% $ 549,756 $ 723,287 $ (173,531) -24.0%
The $568,343, or 31.2%, reduction in general and administrative expenses was attributed to a reduction in personnel costs, including consulting ($87,000), prior employee legal settlement costs ($76,000), and non-cash compensation related to investor relations ($207,000). Professional fees decreased as a result of fewer registration statements being filed during fiscal 2004. Other general and administrative expenses decreased as a result of a one time write off of prepaid royalties in fiscal 2003 ($48,000), a one time write off of impaired patent costs in fiscal 2003 ($77,000), and reduced insurance costs ($35,000) partially offset by an increase in shareholder costs ($112,000) which includes annual meeting expenses and investor relations. We anticipate general and administrative expenses to remain stable at the fiscal 2004 levels until such time as contract revenue and patent litigation proceeds are recognized at which time additional personnel and other fees would be expected to increase. 18 Other income (expense)
Year Ended 5/31/2004 5/31/2003 Change % Other income (expense) Sale of technology $ 75,500 $ -- $ 75,500 NM Loss on marketable securities (45,354) -- (45,354) NM Interest income 270 191 79 41.4% Interest expense, paid in cash or accrued (149,102) (143,587) (5,515) 3.8% Non-cash interest expense (2,293,922) (1,304,957) (988,965) 75.8% ----------- ----------- ----------- $(2,412,608) $(1,448,353) $ (964,255) 66.6%
The increase in other expenses, net of other income, of $964,255, or 66.6%, was primarily attributable to the non-cash interest expense recognized on the amortization and cancellation of debt discounts related to our convertible debentures and the recognition of expense on the issuance of warrants related to our financings. We anticipate that the non-cash interest expense will increase over the fiscal 2004 amount due to a large debt discount remaining on our books as of May 31, 2004 ($2,075,146) which will be recognized as expense via amortization over 24 months if the underlying debentures are not converted or written off in their entirety on the conversion of the underlying debentures. CAPITAL RESOURCES Working Capital Year Ended Increase 5/31/2004 5/31/2003 (Decrease) Current assets $ 701,879 $ 129,559 $ 572,320 Current liabilities 548,042 1,586,562 (1,038,520) ----------- ----------- ----------- Working capital (deficit) $ 153,837 $(1,457,003) $ 1,610,840 =========== =========== =========== Long-term debt $ 230,007 $ 290,436 $ (60,429) =========== =========== =========== Stockholders' equity (deficit) $ 148,179 $(1,411,764) $ 1,559,943 =========== =========== =========== Statements of Cash Flows Select Information Year Ended Increase 5/31/2004 5/31/2003 (Decrease) Net cash provided (used) by: Operating activities $(2,075,972) $(1,885,762) $ (190,210) Investing activities $ (28,623) $ (2,194) $ (26,429) Financing activities $ 2,427,872 $ 1,832,511 $ 595,361 19 Balance Sheet Select Information Year Ended Increase 5/31/2004 5/31/2003 (Decrease) Cash and cash equivalents $ 355,940 $ 32,663 $ 323,277 =========== =========== =========== Prepaid expenses $ 322,068 $ 93,030 $ 229,038 =========== =========== =========== Accounts payable and accrued expesnes $ 294,702 $ 643,002 $ (348,300) =========== =========== =========== The increase in working capital of $1,610,840 and stockholders' equity of $1,559,943 was attributable to the continued financing of the company by issuing convertible debentures ($2,175,000), the issuance of common stock ($50,440), and the exercise of common stock warrants and options ($175,237). The proceeds from these financings were used, in addition to funding our operating needs, to increase our cash balances ($323,277), create a legal fund for anticipated protracted legal fees related to the patent enforcement litigation ($240,719), and reduce our outstanding accounts payable and accrued expenses ($348,300). LIQUIDITY We estimate our current cash requirements to sustain our operations for the next twelve months through May 2005 to be $1.8 million. Since we are no longer supporting the communications product line, we are assuming that there will be no communications product revenue. We have issued 8% convertible debentures as our primary source of funding since 2002. At the option of the debenture holders, they may purchase additional debentures up to $1 million at any time during the two years following their purchase as long as the price of our common stock is in excess of $0.20 per share. During the year ended May 31, 2004, we obtained $2,175,000 from the issuance of convertible debentures, $50,440 from the sale of equity to several private investors, $175,237 from the exercise of warrants and $12,320 from short term notes entered into with a related party. If the optional amounts under the convertible debentures are not raised in sufficient amounts, then we may not have funds sufficient to meet our cash requirements. In such circumstances, we would need to secure additional debt and/or equity financings with individual or institutional investors. In addition, we would be required to make additional cost reductions if our cash requirements cannot be met from external sources. We expect that the $1.8 million requirement will be provided by: o additional debt and/or equity financings; o proceeds from the exercise of outstanding stock options and warrants; and o proceeds from revenue contracts and patent enforcement activities. In addition, we have formulated additional cost reduction plans which can be implemented if the required funds are not obtainable. As of May 31, 2004, we also have remaining $400,000 under an accounts receivable factoring agreement with our bank. We anticipate our future revenue to be derived primarily from the sale of licenses, royalties and the proceeds from litigation of patent infringement cases. 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 and to fund the expenses of protracted patent enforcement litigation. Product introductions such as those currently underway for the Ignite microprocessor 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. 20 If we are unable to obtain the necessary funds, we could be forced to substantially curtail or cease operations, which would have a material adverse effect on our business. Further, there can be no assurance 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. NEW ACCOUNTING PRONOUNCEMENTS In April 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 requires that contracts with comparable characteristics be accounted for similarly. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this statement did not impact our financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. The adoption of this statement did not impact our financial position or results of operations. RISK FACTORS You should consider the following discussion of risks as well as other information regarding our common stock. The risks and uncertainties described below are not the only ones. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business could be harmed. RELATED TO OUR BUSINESS PATRIOT'S MICROPROCESSOR TECHNOLOGIES HAVE RESULTED IN LIMITED REVENUES AND SEVERAL RELATED PRODUCTS ARE STILL IN THE DEVELOPMENT STAGE We are in the development stage on several components of our microprocessor technology product line, and the products which have been commercialized have resulted in limited revenues. Our other product lines have not generated enough revenue to support our company. Therefore, we have limited financial results upon which you may judge our potential. We may not become profitable. We have experienced in the past and may experience in the future many of the problems, delays and expenses encountered by any early stage business, many of which are beyond our control. These include: o substantial delays and expenses related to testing and development of our new products, o production and marketing problems encountered in connection with our new and existing products and technologies, o competition from larger and more established companies, and o lack of market acceptance of our new products and technologies. PATRIOT HAS A HISTORY OF LOSSES, EXPECTS FUTURE LOSSES AND MAY NOT ACHIEVE OR SUSTAIN ANNUAL PROFITABILITY We expect to incur operating losses in the future. Sales of our products may never generate sufficient revenues to fund our continuing operations. We may never generate positive cash flow or attain profitability. To date, we have incurred significant losses. As of May 31, 2004, our accumulated deficit was $49,844,018. For the fiscal years ended May 31, 2004 and 2003, we incurred net 21 losses of $4,149,978 and $3,888,299. Because of this record of losses, there is substantial doubt about our ability to continue as a going concern. These losses have resulted primarily from: o significant costs associated with the development of our products, o costs associated with the marketing of those products, and o the interest charges and expenses related to equity and debt financings. Should our losses continue and should we be unable to fund our operations from external sources, we would need to cease doing business and/or liquidate or sell our assets. PATRIOT'S LIMITED SALES AND MARKETING EXPERIENCE HAS AFFECTED OUR REVENUE Our operating results depend to a large extent on our ability to successfully market and sell our products. We currently have limited marketing capabilities and need to hire additional sales and marketing personnel. In part as a consequence of our limited resources, we may not be able to recruit, train, or retain qualified personnel to sell and market our products and may not be able to develop a successful sales and marketing strategy. We also have very limited marketing experience. There can be no assurance that any marketing efforts undertaken by us will be successful or will result in any significant sales of our products. A continued lack of significant revenues from the sale of our products would require us to cease doing business and/or liquidate or sell our assets. PATRIOT MAY EXPERIENCE DIFFICULTIES IN THE INTRODUCTION OF NEW PRODUCTS THAT COULD RESULT IN PATRIOT HAVING TO INCUR SIGNIFICANT UNEXPECTED EXPENSES OR DELAY THE LAUNCH OF NEW PRODUCTS Our technologies and products are in various stages of development. Our development stage products may not be completed in time to allow production or marketing due to the inherent risks of new product and technology development, limitations on financing, competition, obsolescence, loss of key personnel and other factors. Although we may license some of our technology at its current stage of development, there can be no assurance that we will be able to do so or that any revenues generated from licensing would be sufficient to support operations at their current level. Unanticipated technical obstacles can arise at any time and result in lengthy and costly delays or in a determination that further development is not feasible. Discovery of microprocessor design errors, frequent in the industry prior to and after production, could result in lengthy and costly redesign, fabrication (production) and testing in an industry where new technology rapidly eclipses prior innovations. The development of our technologies has taken longer than anticipated and could be additionally delayed. Therefore, there can be no assurance of timely completion and introduction of improved products on a cost-effective basis, or that such products, if introduced, will achieve market acceptance such that, in combination with existing products, they will sustain us or allow us to achieve profitable operations. RELATED TO OUR INDUSTRY INTENSE COMPETITION IN THE MARKET FOR MICROPROCESSORS COULD PREVENT PATRIOT FROM INCREASING OR SUSTAINING REVENUE AND PREVENT PATRIOT FROM ACHIEVING OR SUSTAINING ANNUAL PROFITABILITY Our products could be rendered noncompetitive or obsolete. Technological competition from larger and more established microprocessor companies is significant and expected to increase. Most of the companies with which we compete and expect to compete have far greater capital resources and more significant research and development staffs, marketing and distribution programs and facilities, and many of them have substantially greater experience in the production and marketing of products. Staff cut backs by us, which have been occasioned by financial constraints, have increased the differences in capacity between us and certain of our competitors. Our ability to compete effectively may be adversely affected by the ability of these competitors to devote greater resources to the sale and marketing of their products than we can. In addition, one or more of our competitors may succeed or may already have succeeded in developing technologies and products that are more effective than any of those we currently offer or are developing. PATRIOT'S LIMITED ABILITY TO PROTECT ITS INTELLECTUAL PROPERTY MAY INADVERTENTLY ADVERSELY AFFECT ITS ABILITY TO COMPETE A successful challenge to our ownership of our technology could materially damage our business prospects. Our technologies may infringe upon the proprietary rights of others. Licenses required by us from others may not be 22 available on commercially reasonable terms, if at all. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We currently have eight U.S., one European and one Japanese patents issued. Any issued patent may be challenged and invalidated. Patents may not issue from any of our pending applications. Any claims allowed from existing or pending patents may not be of sufficient scope or strength to provide significant protection for our products. Patents may not be issued in all countries where our products can be sold so as to provide meaningful protection or any commercial advantage to us. Our competitors may also be able to design around our patents. Vigorous protection and pursuit of intellectual property rights or positions characterize the fiercely competitive semiconductor industry, which has resulted in significant and often protracted and expensive litigation. Therefore, our competitors may assert that our technologies or products infringe on their patents or proprietary rights. Problems with patents or other rights could increase the cost of our products or delay or preclude new product development and commercialization by us. If infringement claims against us are deemed valid, we may not be able to obtain appropriate licenses on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our future patent and/or technology license positions or to defend against infringement claims. Also, we have initiated legal actions against companies we believe are infringing on our patents. See Legal Proceedings. We did not develop the technology which is the basis for our products. This technology, which was originally known as the ShBoom technology, was acquired through a series of agreements from one of two co- inventors. We have been, and may again be, subject to claims from such prior parties related to the technology. Such parties may also attempt to exploit the technology independently of our rights to do so. The asset purchase agreement and plan of reorganization between Patriot, nanoTronics Corporation and Helmut Falk was the agreement under which we acquired the basic ShBoom technology. The agreement also contained a number of warranties and indemnities related to the ownership of the technology and other matters. We believe nanoTronics Corporation has been liquidated and, due to Mr. Falk's death in July 1995, our ability to obtain satisfaction for any future claims as a result of a breach of the agreement may be limited. PATRIOT MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED SECURITY MEASURES IN RESPONSE TO TERRORISM Our business depends on the free flow of products and services through the channels of commerce. Recently, in response to terrorists' activities and threats aimed at the United States, transportation, mail, financial and other services have been slowed or at certain times stopped altogether. Further delays or stoppages in transportation, mail, financial or other services could have a material adverse effect on our business, results of operations and financial condition. Furthermore, we may experience an increase in operating costs, such as costs for transportation, insurance and security, as a result of these activities and potential activities. We may also experience delays in receiving payments from payers that have been affected by terrorist activities and potential activities. The U.S. economy in general is being adversely affected by terrorist activities and potential activities, and any economic downturn could adversely impact our results of operations, impair our ability to raise capital or otherwise adversely affect our ability to grow our business. RELATED TO OUR DEBT AND EQUITY OFFERINGS AND SHARE PRICE PATRIOT MAY NOT BE ABLE TO OBTAIN ADDITIONAL CAPITAL TO FUND ITS OPERATIONS WHEN NEEDED A lack of additional funding could force us to substantially curtail or cease our operations, which would have a material adverse effect on our business. Our ability to raise additional funds under the debenture agreement is subject to certain conditions. These conditions include the effectiveness of a registration statement covering the resale of the shares sold on the conversion of the debentures or the exercise of the warrants issued concurrently with the debentures. We estimate our current annual cash requirements to sustain our operations to be $1.8 million. There can be no assurance that any future funds required will be generated from operations or from other potential sources. Further, any such required funds may only be available on unattractive terms and may significantly dilute the value of our existing shares. IF A LARGE NUMBER OF PATRIOT SHARES ARE SOLD ALL AT ONCE OR IN BLOCKS, THE MARKET PRICE OF OUR SHARES WOULD MOST LIKELY DECLINE Our debenture holders are are not restricted in the price at which they can sell common stock acquired through the conversion of the debentures or exercise of warrants issued with the debentures. Shares sold at a price below the current market price at which the common stock is trading may cause the 23 market price to decline. The shares of common stock that are issuable on the conversion of debentures or exercise of the warrants issued concurrently with the debentures represent a significant portion of our outstanding shares. Should the price of our stock drop, the number of common shares issuable on the conversion of these debentures would be subject to reset provisions which would substantially increase the number of common shares to be issued. To the extent the debenture holders, and shareholders of currently outstanding common stock, convert and sell their common stock, the common stock price may decrease due to the additional shares in the market. This could allow remaining debenture holders to convert their convertible debentures into even greater amounts of common stock, the sales of which would further depress the stock price. Accordingly, we do not know the exact number of shares that will be issued on the conversions of the debentures. In addition, at the option of the debenture holder, interest accruing at the annual rate of 8% can be converted into shares of our common stock at the same time and at the same conversion price as the principal portion of the debenture. Should the debenture holders accumulate interest, a larger number of shares would be issued on conversion; and if the price of the common stock declines, the reset provisions which allow greater amounts of shares to be issued would also be in effect for the interest portion of the debenture. THE MARKET FOR PATRIOT'S STOCK IS SUBJECT TO RULES RELATING TO LOW-PRICED STOCK WHICH LIMITS OUR ABILITY TO ATTRACT COMPETITIVE FUNDING Our common stock is currently listed for trading in the NASD Over-The-Counter Bulletin Board Market and is subject to the "penny stock rules" adopted pursuant to Section 15 (g) of the Securities Exchange Act of 1934, as amended. In general, the penny stock rules apply to non-NASDAQ or non-national stock exchange companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years). Such rules require, among other things, that brokers who trade "penny stock" to persons other than "established customers" complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document, quote information, broker's commission information and rights and remedies available to investors in penny stocks. Many brokers have decided not to trade "penny stock" because of the requirements of the penny stock rules, and as a result, the number of broker-dealers willing to act as market makers in such securities is limited. The "penny stock rules," therefore, may have an adverse impact on the market for our common stock and may effect our ability to attract competitive funding. OUR SHARE PRICE COULD BE LOWERED AS A RESULT OF SHORT SALES The downward pressure on the price of our common stock as the debenture holders convert and sell material amounts of common stock could encourage short sales by the debenture holders or others. When an investor sells stock that he does not own, it is known as a short sale. The seller, anticipating that the price of the stock will go down, will buy the stock at a later date. If the price of the stock goes down, the seller will profit to the extent of the difference between what he originally sold it for less what he later had to buy it for. Short sales enable the seller to profit in a down market. Short sales could place significant downward pressure on the price of our common stock. ON A SIGNIFICANT DROP IN THE PRICE OF OUR STOCK, WE COULD BE SUBJECT TO A CHANGE IN CONTROL There is a possibility that a significant number of shares, the exact number of which we do not know, of our common stock could be issued on the conversion of the debentures. This possibly could result in a change in control of our company. Such a change in control could have a material adverse effect on our operations and business plans. We are unable to determine the impact such a change in control could have on our company. ITEM 7. FINANCIAL STATEMENTS The financial statements required by this item begin on page F-1 with the index to consolidated financial statements. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 24 ITEM 8A. CONTROLS AND PROCEDURES Our President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer conducted an evaluation of our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-14 and 15d-14) as of July 1, 2004. Based on their evaluation, they concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of this evaluation. ITEM 8B. OTHER INFORMATION None. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT The following table and biographical summaries set forth information, including principal occupation and business experience, about our directors and the executive officers at June 1, 2004:
NAME AGE POSITION AND OFFICES DIRECTOR SINCE - ---- --- -------------------- -------------- Donald R. Bernier 62 Chairman and Director January 1995 David H. Pohl 66 Director April 2001 Jeffrey Wallin 56 President and CEO n/a Lowell W. Giffhorn 57 Executive Vice President, CFO, August 1999 Secretary and Director Carlton M. Johnson, Jr. 44 Director August 2001 Helmut Falk, Jr. 47 Director December 1997 Gloria Felcyn 57 Director October 2002 Joey Maitra 54 Vice President Engineering n/a Patrick Nunally 40 Vice President and CTO n/a
BIOGRAPHICAL INFORMATION DONALD R. BERNIER. Mr. Bernier was appointed Chairman of the Board on August 5, 2001. Since 1971, Mr. Bernier has been the owner and President of Compunetics Incorporated, a Troy, Michigan-based electronics firm of which he is the founder. Compunetics engages in contract research and development, specializing in microelectronics primarily for the automotive industry. DAVID H. POHL. Mr. Pohl has served on our board of directors since April 2001, and served as an officer of the Company from January 2001 to March 2002. Except for his service with PTSC, Mr. Pohl has been in the private practice of law counseling business clients since 1997, and from 1995 to 1996 was Special Counsel to the Ohio Attorney General. Previously, he was a senior attorney with a large U.S. law firm, and held positions as a senior officer and general counsel in large financial services corporations. Mr. Pohl earned a J.D. degree in 1962 from the Ohio State University College of Law, and also holds a BS in Administrative Sciences from Ohio State. JEFFREY E. WALLIN. Mr. Wallin has served as our Chief Executive Officer and President since March 2002. Since 1999, Mr. Wallin was president of SDMC Inc., a consulting company serving the multimedia system integration and communications markets. From 1996 to 1999, Mr. Wallin was President and CEO of 25 TV/COM International, a division of Hyundai that developed and manufactured end-to-end digital communications systems. Previously Mr. Wallin held senior level management positions with Snell & Wilcox, General Instrument, now a major division of Motorola, and Teledyne Corporation. Mr. Wallin obtained a B.S. degree from Bemidji State University in 1970. LOWELL W. GIFFHORN. Mr. Giffhorn was the principal in his own financial management consulting firm from August 1996 until joining Patriot as Chief Financial Officer (CFO) in May 1997. Mr. Giffhorn has served on our board of directors since August 1999. From June 1992 to August 1996 and from September 1987 to June 1990 he was the CFO of Sym-Tek Systems, Inc. and Vice President of Finance for its successor, Sym-Tek Inc., a major supplier of capital equipment to the semiconductor industry. Mr. Giffhorn obtained a M.B.A. degree from National University in 1975 and he obtained a B.S. in Accountancy from the University of Illinois in 1969. Mr. Giffhorn is also a director and chairman of the audit committee of DND Technologies, Inc., a publicly held company. CARLTON M. JOHNSON, JR. Mr. Johnson was appointed a Director on August 5, 2001. Mr. Johnson is in-house legal counsel for Swartz Investments, LLC, a position he has held since June 1996. Mr. Johnson has practiced law in Alabama since 1986, Florida since 1988, and Georgia since 1997. He has been a shareholder in the Pensacola, Florida AV rated law firm of Smith, Sauer, DeMaria & Johnson and as President-Elect of the 500 member Escambia-Santa Rosa Bar Association. He also served on the Florida Bar Young Lawyers Division Board of Governors. Mr. Johnson earned a degree in History/Political Science at Auburn University and Juris Doctor at Samford University - Cumberland School of Law. Mr. Johnson is also a director and member of the audit committee of Peregrine Pharmaceuticals, Inc., a publicly held company. HELMUT FALK, JR. Since 1992, Dr. Falk has been the Director of Anesthesia for the Johnson Memorial Hospital in Franklin, Indiana. Dr. Falk received his D.O. from the College of Osteopathic Medicine of the Pacific in 1987 and his B.S. in Biology from the University of California, Irvine in 1983. Dr. Falk is the son of the late Helmut Falk, who was the sole shareholder of nanoTronics and the Chairman and CEO of Patriot until his death in July 1995. Dr. Falk is also an heir to the Helmut Falk Estate, which is the beneficial owner of the Company's shares held by the Helmut Falk Family Trust. GLORIA FELCYN. Ms. Felcyn was appointed a Director and chairman of our audit committee on October 10, 2002. Since 1982 Ms. Felcyn has been the principal in her own public accounting firm. Ms. Felcyn received a B.S. degree in Business Economics for Trinity University in 1968. PATRICK O. NUNALLY. Dr. Nunally joined us as Vice President of Business Development and Chief Technical Officer in June 2001, previous to which he had been providing consulting services to us since May 2000. Dr. Nunally has more than 20 years of entrepreneurial experience in semiconductor and embedded processor design. From December 1998 to May 2000, he was President and CEO of Intertech, a company he founded specializing in intellectual property development for embedded processor and communications systems. From June 1998 to December 1998, he was President and CEO of Gruppe Telekom, Inc., a licensee of Interactive Video and Data Service Spectrum. From April 1996 to June 1998, he served as Chief Technical Officer and co-founder of Aristo, now PlayNet Inc., a Java-based games company. Dr. Nunally also held other senior management positions with Wave Interactive Network, Sensormatic Video Products Division, Intellisys Automation Inc., E-Metrics Inc., General Dynamics Corporation and Interstate Electronics. Dr. Nunally received his PhD in Electrical Engineering from the Pacific Western University in 1996, a MBA from the University of LaVerne in 1993 and a BS in Electrical and Electronics Engineering from California State Polytechnic University in 1987. JOEY MAITRA. Mr. Maitra was Vice President of Engineering for Metacomp since 1990 and was appointed Vice President of Engineering of Patriot in December 1996 through February 2001. Mr. Maitra was reappointed to the same position in November 2001. Previously Mr. Maitra held various engineering positions with several computer related technology companies. Mr. Maitra obtained a B.S. in Electrical Engineering from the Indian Institute of Technology in 1972 and a M.S. in Electrical Sciences at State University of New York in 1973. There is no family relationship between any of our executive officers and directors. COMMITTEES OF THE BOARD OF DIRECTORS Our Board has standing Audit and Compensation Committees. 26 Audit Committee. The Audit Committee is responsible for assisting the Board of Directors in monitoring and oversight of (1) the integrity of the Company's financial statements and its systems of internal accounting and financial controls and (2) the independence and performance of the Company's independent auditors. The Audit Committee, which met four times during fiscal 2004, is composed of two directors, both of whom were determined by the Board to be independent directors. During fiscal 2004 and to date, the Audit Committee consists of Ms. Felcyn (Chairman) and Mr. Johnson. The Board of Directors has determined that Ms. Felcyn is an audit committee financial expert as defined in Item 401 of Regulation S-B promulgated by the Securities and Exchange Commission. The Board's conclusions regarding the qualifications of Ms. Felcyn as an audit committee financial expert were based on her standing as a certified public accountant and her degree in business economics. Compensation Committee. The Compensation Committee establishes the compensation philosophy for the company and has all the authority of the Board of Directors to act or exercise corporate powers with respect to the compensation of the executive officers and the administration of the company's equity compensation plans. The Compensation Committee is composed of Mr. Johnson, as Chairman, Ms. Felcyn and Mr. Falk. Each member of the Audit Committee and Compensation Committee is independent as defined under the National Association of Securities Dealers' listing standards. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Section 16(a) of the Exchange Act requires our directors, executive officers and persons who beneficially own 10% or more of a class of securities registered under Section 12 of the Exchange Act to file reports of beneficial ownership and changes in beneficial ownership with the Securities and Exchange Commission. Directors, executive officers and greater than 10% shareholders are required by the rules and regulations of the Commission to furnish us with copies of all reports filed by them in compliance with Section 16(a). Based solely on our review of copies of the reports we received from persons required to make such filings and our own records, we believe that from the period June 1, 2003 through May 31, 2004, all persons subject to the Section 16(a) reporting requirements timely filed the required reports. ITEM 10. EXECUTIVE COMPENSATION There is shown below information concerning the compensation of our chief executive officer and the most highly compensated executive officers whose salary and bonus exceeded $100,000 (each a "Named Officer") for the fiscal years ended May 31, 2004, 2003, and 2002. 27 SUMMARY COMPENSATION TABLE
Annual Cash Compensation Long-Term Compensation Name and Fiscal Repriced All Other Principal Position Year Salary Bonus (# of Shares) Options Compensation ------------------ ---- ------ ----- ------------- ------- ------------ Jeff Wallin 2004 $145,933 (1) Nil 673,000 None None President and CEO 2003 $127,650 (1) Nil 250,000 None None 2002 $68,800 (1) Nil 1,000,000 None None Lowell W. Giffhorn 2004 $148,800 (1) Nil 239,000 None None Exec. V.P., CFO and Secy. 2003 $150,779 (1) Nil 115,000 None None 2002 $139,908 (1) Nil 255,000 None None Joey Maitra (3) 2004 $131,040 (1) Nil 125,000 None None VP Engineering 2003 $131,040 (1) Nil 100,000 None None 2002 $125,058 (1) Nil 335,000 None None Patrick O. Nunally 2004 $180,000 (1) Nil 173,000 None None VP and CTO 2003 $189,521 (1) Nil 400,000 None $52,500 (2) 2002 $173,046 (1) Nil 250,000 None $105,000 (2)
(1) Included in Mssr. Wallin, Giffhorn, Maitra and Nunally is cash compensation of $400 per month for car allowance. (2) Payments through November 30, 2002 to Dr. Nunally for assignments to the Company of intellectual property rights. The rights were returned to Dr. Nunally in April 2003. (3) Mr. Maitra's employment was terminated in July 2004 per the terms of his employment contract. The Company maintains employee benefits that are generally available to all of its employees, including medical, dental and life insurance benefits and a 401(k) retirement savings plan. The Company did not make any matching contributions under the 401(k) plan for any of the above named officers during the fiscal years ended May 31, 2004, 2003 and 2002. OPTION GRANTS Shown below is information on grants of stock options pursuant to the Company's 1992, 1996, 2001 and 2003 Stock Option Plans to the Named Officers reflected in the Summary Compensation Table shown above. OPTION GRANTS TABLE FOR FISCAL YEAR ENDED MAY 31, 2004
Potential Realizable Value Percent of Total of Assumed Annual Rates Options Granted of Stock Price Appreciation Number of to Employees in Exercise Expiration for Option Term (1) Name Options Granted Fiscal Year Prices Dates 5% ($) 10% ($) ---- --------------- ----------- ------ ----- ------ ------- Jeffrey E. Wallin 673,000 30.5% $0.035-$0.11 12/18/08-3/18/09 $ 16,844 $ 37,222 Lowell W. Giffhorn 239,000 10.8% $0.035-$0.05 10/23/08-12/18/08 $ 2,706 $ 5,981 Joey Maitra 125,000 5.7% $ 0.035 12/18/2008 $ 1,191 $ 2,633 Patrick Nunally 173,000 7.8% $ 0.035 12/18/2008 $ 1,649 $ 3,644
28 (1) These amounts represent certain assumed rates of appreciation only. Actual gains, if any, on stock option exercises are dependent upon the future performance of the company's common stock, overall market conditions and the executive's continued involvement with the company. The amounts represented in this table will not necessarily be achieved. AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES There were no exercises of stock options for the fiscal year ended May 31, 2004 by any of the officers reflected in the Summary Compensation Table shown above. Shown below is information on fiscal year-end values under the Company's 1992, 1996, 2001 and 2003 Stock Option Plans to the officers reflected in the Summary Compensation Table shown above.
Number of Unexercised Value of Unexercised Options Held At In-The-Money Options At May 31, 2004 May 31, 2004 ------------ ------------ Name Exercisable Unexercisable Exercisable Unexercisable ---- ----------- ------------- ----------- ------------- Jeffrey E. Wallin 1,520,000 423,000 $ 7,875 $ 6,834 Lowell W. Giffhorn 565,000 169,000 $ 2,740 $ 5,541 Joey Maitra 385,000 175,000 $ 750 $ 5,688 Patrick Nunally 950,000 173,000 $12,600 $ 6,834
The fair market value of the unexercised in-the-money options at May 31, 2004 was determined by subtracting the option exercise price from the last sale price as reported on the over the counter bulletin board on May 31, 2004, $0.074. The Company has not awarded stock appreciation rights to any of its employees. The Company has no long-term incentive plans. COMPENSATION OF DIRECTORS No direct or indirect remuneration has been paid or is payable by us to the directors in their capacity as directors other than the granting of stock options. We expect that, during the next twelve months, we will not pay any direct or indirect remuneration to any directors of ours in their capacity as directors other than in the form of stock option grants or the reimbursement of expenses of attending directors' or committee meetings. EMPLOYMENT CONTRACTS The Company entered into a consulting agreement dated as of March 18, 2004, with SDMC, Inc. whereby SDMC will provide the services of Mr. Wallin to be the President and Chief Executive Officer of the Company. The agreement is for a term through March 18, 2005 providing for payments of $145,200 per annum and provides for automatic one year renewals unless either party gives a notice at least 30 days but not more than 60 days previous to any anniversary date. The agreement provides for a bonus up to 50% of the annual base consideration for the applicable year. The agreement also provides for potential bonuses to be paid based on the increase in the price of the Company's common stock. Should the price of the common stock reach $0.25 for twenty consecutive days, SDMC would receive a cash payment of $10,000. Additional payments will be made to SDMC in the following amounts if the price of the Company's common stock reaches the following thresholds: $0.40- $20,000, $0.50- $20,000, $0.60- $30,000, $0.80- $30,000, and $1.00- $50,000. The Company may terminate SDMC's agreement with or without cause, but termination without cause (other than disability or death) would result in severance payments equal to the lesser of (i) four months of the then current compensation or (ii) the balance remaining of the current compensation for the term of his agreement. If a change in control, as defined in the agreement, occurs during the term of his agreement, and if Mr. Wallin refuses to accept or voluntarily resigns from a position other than a qualified position, as that term is defined in the agreement, then SDMC will receive a lump sum severance payment equal to twelve months of the then current compensation. Under the agreement, the Company granted SDMC options to purchase 500,000 common shares, 250,000 vesting on March 18, 2004 and 250,000 vesting on September 18, 2004. The Company also placed in escrow four months of payments which shall be released to SDMC on the termination of Mr. Wallin's services for any reason other than cause or his resignation. 29 The Company entered into an employment agreement dated as of November 17, 2001, with Mr. Giffhorn providing for his employment as Executive Vice President and Chief Financial Officer. The agreement is for a term through September 4, 2004, providing for a base salary of $144,000 per annum. The base salary may be increased at the discretion of the Board of Directors. The agreement provides for a bonus up to 50% of the annual base salary for the applicable year. The agreement also provides Mr. Giffhorn a monthly car allowance of $400. The Company may terminate Mr.Giffhorn's employment with or without cause, but termination without cause (other than disability or death) would result in severance payments equal to the lesser of (i) four months of the then current base salary or (ii) the balance remaining of the current base salary for the term of his agreement. If a change in control, as defined in the agreement, occurs during the term of his agreement, and if Mr. Giffhorn refuses to accept or voluntarily resigns from a position other than a qualified position, as that term is defined in the agreement, then he will receive a lump sum severance payment equal to twelve months of his then current salary. The Company entered into an employment agreement dated as of January 2, 2004, with Mr. Maitra providing for his employment as Vice President of Engineering. The agreement is for a term through January 2, 2005 providing for a base salary initially of $126,240. The base salary may be increased at the discretion of the Board of Directors. The agreement provides for a bonus up to 50% of the annual base salary for the applicable year. The agreement also provides Mr. Maitra a monthly car allowance of $400. The Company may terminate Mr.Maitra's employment with or without cause, but termination without cause (other than disability or death) would result in severance payments equal to the lesser of (i) two months of the then current base salary or (ii) the balance remaining of the current base salary for the term of his agreement. If a change in control, as defined in the agreement, occurs during the term of his agreement, and if Mr. Maitra refuses to accept or voluntarily resigns from a position other than a qualified position, as that term is defined in the agreement, then he will receive a lump sum severance payment equal to twelve months of his then current salary. Under the agreement, the Company granted Mr. Maitra options to purchase 125,000 common shares with vesting tied to the Company's customer billings. The Company entered into employment agreement dated June 1, 2004, as amended on July 12, 2004, with Dr. Nunally providing for his employment as the Chief Technical Officer of the Company. The agreement is for a term through June 1 2005, providing for a base salary initially of $124,800. The base salary may be increased at the discretion of the Board of Directors. The agreement provides for a bonus up to 50% of the annual base salary for the applicable year. The agreement also provides Dr. Nunally a monthly car allowance of $400. The Company may terminate Dr. Nunally's employment with or without cause, but termination without cause (other than disability or death) would result in severance payments equal to the lesser of (i) two months of the then current base salary or (ii) the balance remaining of the current base salary for the term of his agreement. If a change in control, as defined in the agreement, occurs during the term of his agreement, and if Dr. Nunally refuses to accept or voluntarily resigns from a position other than a qualified position, as that term is defined in the agreement, then he will receive a lump sum severance payment equal to the lesser of (i) two months of the then current base salary or (ii) the balance remaining of the current base salary for the term of his agreement. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth, as of August 12, 2004, the stock ownership of each officer and director of the Company, of all officers and directors of the Company as a group, and of each person known by the Company to be a beneficial owner of 5% or more of its Common Stock. Except as otherwise noted, each person listed below is the sole beneficial owner of the shares and has sole investment and voting power over such shares. No person listed below has any option, warrant or other right to acquire additional securities of the Company, except as otherwise noted. 30 Name and Address Amount & Nature Title of Beneficial of Beneficial Percent of Class Owner Ownership of Class -------- ----- --------- -------- Common stock Gloria Felcyn, CPA 1,650,000 (1) * par value 10989 Via Frontera $0.00001 San Diego, CA 92127 SAME Donald R. Bernier 725,000 (2) * 10989 Via Frontera San Diego, CA 92127 SAME Helmut Falk, Jr. 2,628,231 (3) 1.4% 10989 Via Frontera San Diego, CA 92127 SAME Lowell W. Giffhorn 789,948 (4) * 10989 Via Frontera San Diego, CA 92127 SAME SDMC, Inc. 1,520,000 (5) * 10989 Via Frontera San Diego, CA 92127 SAME David H. Pohl 425,000 (6) * 10989 Via Frontera San Diego, CA 92127 SAME Patrick O. Nunally 962,700 (7) * 10989 Via Frontera San Diego, CA 92127 SAME Joey Maitra 562,342 (8) * 10989 Via Frontera San Diego, CA 92127 SAME Carlton M. Johnson, Jr. 175,000 (9) * 10989 Via Frontera San Diego, CA 92127 All directors & officers 9,438,221 (10) 4.9% as a group (9 persons) * Less than 1% 1) As trustee of the Helmut Falk Family Trust and executor of the Helmut Falk estate, Ms. Felcyn effectively controls the shares which were subject to an escrow arrangement (as described in "Certain Transactions" below) originally issued to nanoTronics in connection with the ShBoom technology acquisition and shares that remain from 5,000,000 non-escrowed shares that were originally issued to nanoTronics in connection with the ShBoom technology acquisition and were subsequently transferred to the Helmut Falk Family Trust. Includes 150,000 shares issuable upon the exercise of outstanding stock options. 2) Includes 500,000 shares issuable upon the exercise of outstanding stock options. 3) Includes 215,000 shares issuable upon the exercise of outstanding stock options. 31 4) Includes 565,000 shares issuable upon the exercise of outstanding stock options. 5) Includes 1,520,000 shares issuable upon the exercise of outstanding stock options. 6) Includes 425,000 shares issuable upon the exercise of outstanding stock options. 7) Includes 950,000 shares issuable upon the exercise of outstanding stock options. 8) Includes 385,000 shares issuable upon the exercise of outstanding stock options. 9) Includes 175,000 shares issuable upon the exercise of outstanding stock options. 10) Includes 4,553,221 shares issued and outstanding and 4,885,000 shares issuable upon exercise of stock options. EQUITY COMPENSATION PLAN INFORMATION
Plan category Number of securities Weighted average Number of securities to be issued upon exercise price of remaining available exercise of outstanding options, for future issuance outstanding options, warrants and rights under equity warrants and rights compensation plans (excluding securities reflected in column (a) (a) (b) (c) - ------------------------------------------------------------------------------------------------------------------------ Equity compensation plans approved by security holders 7,003,000 $0.22 4,196,188 Equity compensation plans not approved by security holders 121,349,420 $0.05 None --------------------------------------------------------------------------------- Total 128,352,420 $0.06 4,196,188 =================================================================================
Common shares issuable on the exercise of stock warrants have not been approved by the security holders and, accordingly, have been segregated in the above table. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS There were no transactions, or series of transactions, during fiscal 2004 and 2003, nor are there any currently proposed transactions, or series of transactions, to which the Company is a party, in which the amount exceeds $60,000, and in which to its knowledge any director, executive officer, nominee, five percent or greater shareholder, or any member of the immediate family of any of the foregoing persons, has or will have any direct or indirect material interest other than as described below. In June 2000, we entered into a three-year, $80,000 secured promissory note receivable with James T. Lunney, a previous Chairman, President and CEO. The note bore interest at the rate of 6% with interest payments due semi-annually and the principal due at the maturity of the note. Mr. Lunney pledged 100,000 shares of Patriot's common stock that he held on the date of issuance as security for this note. In April 2003, we negotiated an early payment discount and Mr. Lunney paid $60,000 to retire this note. From June 10, 2002 through August 23, 2002, we issued to Gloria Felcyn, Trustee of the Helmut Falk Family Trust, two 8% Convertible Debentures with accumulative principal balances of $275,000 due June 10, 2004 through August 23, 2004. The initial exercise prices ranged from $0.0727 to $0.08616 and were subject to a downward revisions if the price of our stock was lower on any three month anniversary of the debentures or on the date that a statement registering 32 the resale of the common stock issuable upon conversion of the debentures became effective. Also, in conjunction with the debentures, we issued five year warrants to purchase up to 4,102,431 shares of our common stock at initial exercise prices ranging from $0.0727 to $0.08616 subject to reset provisions on each six month anniversary of the issuance of the warrants. If the price of our common stock is in excess of $0.20 per share, Ms. Felcyn has a two year option to purchase up to an additional $275,000 of 8% Convertible Debentures on the same terms. Ms. Felcyn converted the debentures into 6,810,102 shares of common stock in July and November 2003 and exercised the warrants into 4,102,431 shares of common stock in July 2003 and January 2004. During October 2002 through December 2002, we entered into three 8% short-term notes with Gloria Felcyn, the trustee for the Falk Family Trust, aggregating $180,000 with initial maturity dates ranging from January 1 to January 31, 2003. In July 2003 we issued a new 8% short-term note in the amount of $200,354 with a maturity date of October 7, 2003 in exchange for cancellation of the three 8% short term notes issued in October through December 2002, the accrued interest on the cancelled notes and an additional $10,000 in cash. In January 2004, as part of the exercise of the warrants, the $200,354 note was exchanged for four $25,000 6% notes and shares of common stock which were issued to the beneficiaries of the trust. The 6% notes have a one year maturity date of January 9, 2005. ITEM 13. EXHIBITS (a) The following documents are filed as a part of this Report: 1. Financial Statements. The following consolidated financial statements and Report of Independent Registered Certified Public Accounting Firm are included in Part II of this Report: Report of Nation Smith Hermes Diamond, Independent Certified Public Accounting Firm Consolidated Balance Sheets- As of May 31, 2004 and 2003 Consolidated Statements of Operations- Years Ended May 31, 2004 and 2003 Consolidated Statement of Stockholders' Equity (Deficit)- Years Ended May 31, 2004 and 2003 Consolidated Statements of Cash Flows- Years Ended May 31, 2004 and 2003 Notes to Consolidated Financial Statements 2. Exhibits. The following Exhibits are filed as part of, or incorporated by reference into, this Report:
Exhibit No. Document No. - ----------- -------- --- 2.0 PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION. 2.1 Agreement to Exchange Technology for Stock in Patriot Scientific Corporation, (1) incorporated by reference to Exhibit 2.1 to Form 8-K dated August 10, 1989 2.2 Assets Purchase Agreement and Plan of Reorganization dated June 22, 1994, among (1) the Company, nanoTronics Corporation and Helmut Falk, incorporated by reference to Exhibit 10.4 to Form 8-K dated July 6, 1994 2.2.1 Amendment to Development Agreement dated April 23, 1996 between the Company and (1) Sierra Systems, incorporated by reference to Exhibit 2.2.1 to Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2 dated April 29, 1996
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Exhibit No. Document No. - ----------- -------- --- 2.3 Form of Exchange Offer dated December 4, 1996 between the Company and certain (1) shareholders of Metacomp, Inc. incorporated by reference to Exhibit 2.3 to Form 8-K dated January 9, 1997 2.4 Letter of Transmittal to Accompany Shares of Common Stock of Metacomp, Inc. (1) Tendered Pursuant to the Exchange Offer Dated December 4, 1996 incorporated by reference to Exhibit 2.4 to Form 8-K dated January 9, 1997 3.0 ARTICLES AND BYLAWS. 3.1 Original Articles of Incorporation of the Company's predecessor, Patriot Financial (1) Corporation, incorporated by reference to Exhibit 3.1 to registration statement on Form S-18, file no. 33-23143-FW 3.2 Articles of Amendment of Patriot Financial Corporation, as filed with the Colorado (1) Secretary of State on July 21, 1988, incorporated by reference to Exhibit 3.2 to registration statement on Form S-18, File No. 33-23143-FW 3.3 Certificate of Incorporation of the Company, as filed with the Delaware Secretary (1) of State on March 24, 1992, incorporated by reference to Exhibit 3.3 to Form 8-K dated May 12, 1992 3.3.1 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1) filed with the Delaware Secretary of State on April 18, 1995, incorporated by reference to Exhibit 3.3.1 to Form 10-KSB for the fiscal year ended May 31, 1995 3.3.2 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1) filed with the Delaware Secretary of State on June 19,1997, incorporated by reference to Exhibit 3.3.2 to Form 10-KSB for the fiscal year ended May 31, 1997 3.3.3 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1) filed with the Delaware Secretary of State on April 28, 2000, incorporated by reference to Exhibit 3.3.3 to Registration Statement on Form S-3 dated May 5, 2000 3.3.4 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1) filed with the Delaware Secretary of State on May 6, 2002, incorporated by reference to Exhibit 3.3.4 to Registration Statement on Form S-3 dated June 27, 2002 3.3.5 Certificate of Amendment to the Certificate of Incorporation of the Company, as (1) filed with the Delaware Secretary of State on October 16, 2003, incorporated by reference to Exhibit 3.3.5 to Registration Statement on Form SB-2 dated May 21, 2004+B96 3.4 Articles and Certificate of Merger of Patriot Financial Corporation into the (1) Company dated May 1, 1992, with Agreement and Plan of Merger attached thereto as Exhibit A, incorporated by reference to Exhibit 3.4 to Form 8-K dated May 12, 1992 3.5 Certificate of Merger issued by the Delaware Secretary of State on May 8, 1992, (1) incorporated by reference to Exhibit 3.5 to Form 8-K dated May 12, 1992 3.6 Certificate of Merger issued by the Colorado Secretary of State on May 12, 1992, (1) incorporated by reference to Exhibit 3.6 to Form 8-K dated May 12, 1992
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Exhibit No. Document No. - ----------- -------- --- 3.7 Bylaws of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K dated (1) May 12, 1992 4.0 INSTRUMENTS ESTABLISHING RIGHTS OF SECURITY HOLDERS. 4.1 Specimen common stock certificate, incorporated by reference to Exhibit 4.1 Form (1) 8-K dated May 12, 1992 4.2 Form of Stock Purchase Warrant (Labway Corporation) dated February 29, 1996, (1) exercisable to purchase 253,166 common shares at $1.58 per share until August 31, 1996, granted to investors in connection with an offering of securities made in reliance upon Regulation S, incorporated by reference to Exhibit 4.2 to Form 10-QSB for fiscal quarter ended February 29, 1996 4.3 Form of 6% Convertible Subordinated Promissory Note due September 30, 1998 (1) aggregating $1,500,000 to six investors incorporated by reference to Exhibit 4.3 to Form 10-QSB for fiscal quarter ended August 31, 1996 4.4 Form of 5% Convertible Term Debenture (CC Investments, LDC) due June 2, 1999 (1) aggregating $2,000,000 to two investors incorporated by reference to Exhibit 4.4 to Form 8-K dated June 16, 1997 4.5 Form of Stock Purchase Warrant (CC Investments, LDC) dated June 2, 1997 (1) exercisable to purchase an aggregate of 400,000 common shares at $1.69125 per share until June 2, 2002, granted to two investors in connection with the offering of securities in Exhibit 4.4 incorporated by reference to Exhibit 4.5 to Form 8-K dated June 16, 1997 4.6 Registration Rights Agreement dated June 2, 1997 by and among the Company and CC (1) Investments, LDC and the Matthew Fund, N.V. related to the registration of the common stock related to Exhibits 4.4 and 4.5 incorporated by reference to Exhibit 4.6 to Form 8-K dated June 16, 1997 4.7 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, L.P.) dated (1) June 2, 1997 exercisable to purchase an aggregate of 211,733 common shares at $1.69125 per share until June 2, 2002, granted to a group of investors in connection with the offering of securities in Exhibit 4.4 incorporated by reference to Exhibit 4.7 to Form 8-K dated June 16, 1997 4.8 Registration Rights Agreement dated June 2, 1997 by and among the Company and (1) Swartz Investments, LLC related to the registration of the common stock related to Exhibit 4.7 incorporated by reference to Exhibit 4.8 to Form 8-K dated June 16, 1997 4.9 Form of 5% Convertible Term Debenture (CC Investments, LDC) due June 2, 1999 (1) aggregating $1,000,000 to two investors incorporated by reference to Exhibit 4.9 to Form 10-KSB for the fiscal year ended May 31, 1998 4.10 Form of Stock Purchase Warrant (CC Investments, LDC) dated November 24, 1997 (1) exercisable to purchase an aggregate of 200,000 common shares at $1.50 per share until June 2, 2002, granted to two investors in connection with the offering of securities described in Exhibit 4.9 incorporated by reference to Exhibit 4.10 to Form 10-KSB for the year ended May 31, 1998
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Exhibit No. Document No. - ----------- -------- --- 4.11 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, L.P.) dated (1) November 24, 1997 exercisable to purchase an aggregate of 105,867 common shares at $1.50 per share until June 2, 2002, granted to a group of investors in connection with the offering of securities described in Exhibit 4.9 incorporated by reference to Exhibit 4.11 to Form 10-KSB for the year ended May 31, 1998 4.12 Form of Warrant to Purchase Common Stock (Investor Communications Group, Inc.) (1) dated June 16, 1997 exercisable to purchase an aggregate of 130,000 common shares at prices ranging from $2.50 to $7.50 per share until June 15, 1999 incorporated by reference to Exhibit 4.12 to Form 10-KSB for the year ended May 31, 1998 4.13 Warrant to Purchase Common Stock issued to Spellcaster Telecommunications, Inc. (1) dated April 28, 1998 exercisable to purchase an aggregate of 100,000 common shares at $1.25 per share until April 28, 2000 incorporated by reference to Exhibit 4.13 to Form 10-KSB for the year ended May 31, 1998 4.14 Investment agreement dated February 24, 1999 by and between the Company and Swartz (1) Private Equity, LLC for a maximum aggregate amount of $5,000,000 incorporated by reference to Exhibit 4.14 to Form 10-QSB/A for the fiscal quarter ended November 30, 1998 4.15 Registration Rights Agreement dated February 24, 1999 by and between the Company (1) and Swartz Private Equity, LLC related to the registration of the common stock related to Exhibit 4.14 incorporated by reference to Exhibit 4.15 to Form 10-QSB/A for the fiscal quarter ended November 30, 1998 4.16 Form of Warrant to Purchase Common Stock (Swartz Private Equity, LLC) dated (1) February 24, 1999 exercisable to purchase common shares in connection with the offering of securities in Exhibit 4.14 incorporated by reference to Exhibit 4.16 to Form 10-QSB/A for the fiscal quarter ended November 30, 1998 4.17 Amended and Restated Investment Agreement dated July 12, 1999 by and between the (1) Company and Swartz Private Equity, LLC for a maximum aggregate amount of $5,000,000 incorporated by reference to Exhibit 4.17 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated July 14, 1999 4.18 Investment Agreement dated April 28, 2000 by and between the Company and Swartz (1) Private Equity, LLC for a maximum aggregate amount of $30,000,000 incorporated by reference to Exhibit 4.18 to Registration Statement on Form S-3 dated May 5, 2000 4.18.1 Waiver and Agreement dated September 24, 2001 amending the Investment Agreement (1) dated April 28, 2000 by and between the Company and Swartz Private Equity, LLC for a maximum aggregate amount of $30,000,000 incorporated by reference to Exhibit 4.18.1 to Registration Statement on Form S-1 dated October 11, 2001 4.19 2001 Stock Option Plan of the Company dated February 21, 2001 incorporated by (1) reference to Exhibit 4.19 to Registration Statement on Form S-8 dated March 26, 2001
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Exhibit No. Document No. - ----------- -------- --- 4.20 Investment agreement dated September 17, 2001 by and between the Company and (1) Swartz Private Equity, LLC for a maximum aggregate amount of $25,000,000 incorporated by reference to Exhibit 4.20 to Registration Statement on Form S-1 dated October 11, 2001 4.21 Registration Rights Agreement dated September 17, 2001 by and between the Company (1) and Swartz Private Equity, LLC related to the registration of the common stock related to Exhibit 4.20 incorporated by reference to Exhibit 4.21to Registration Statement on Form S-1 dated October 11, 2001 4.22 Warrant to Purchase Common Stock dated September 17, 2001 exercisable to purchase (1) common shares in connection with the Offering of securities in Exhibit 4.20 incorporated by reference to Exhibit 4.22 to Registration Statement on Form S-1 dated October 11, 2001 4.23 Financial Consulting Services Agreement between the Company and M. Blaine Riley, (1) Randall Letcavage and Rosemary Nguyen incorporated by reference to Exhibit 4.23 to Registration Statement on Form S-8 dated January 22, 2002 4.24 Form of 8% Convertible Debenture (Lincoln Ventures, LLC) due June 10, 2004 (1) aggregating $1,000,000 to six investors incorporated by reference to Exhibit 4.24 to Registration Statement on Form S-3 dated June 27, 2002 4.25 Form of Stock Purchase Warrant (Lincoln Ventures, LLC) dated June 10, 2002 (1) exercisable to purchase an aggregate of 12,859,175 common shares at initial exercise prices ranging form $0.08616 to $0.10289 per share until June 10, 2007, granted to six investors in connection with the offering of securities described in Exhibit 4.24 incorporated by reference to Exhibit 4.25 to Registration Statement on Form S-3 dated June 27, 2002 4.26 Form of Registration Rights Agreement (Lincoln Ventures, LLC) dated June 10, 2002 (1) by and among the Company and six investors related to the registration of the common stock related to Exhibit 4.24 incorporated by reference to Exhibit 4.26 to Registration Statement on Form S-3 dated June 27, 2002 4.27 2003 Stock Option Plan of the Company dated July 2, 2003 incorporated by reference (1) to Exhibit 4.27 to Registration Statement on Form S-8 dated September 4, 2003 10.0 MATERIAL CONTRACTS. 10.1 1992 Incentive Stock Option Plan of the Company, incorporated by reference to (1) Exhibit 10.1 to Form 8-K dated May 12, 1992 10.1.1 Amendment to 1992 Incentive Stock Option Plan dated January 11, 1995, incorporated (1) by reference to Exhibit 10.1.1 to Form S-8 dated July 17, 1996 10.2 1992 Non-Statutory Stock Option Plan of the Company, incorporated by reference to (1) Exhibit 10.2 to Form 8-K dated May 12, 1992 10.2.1 Amendment to 1992 Non-Statutory Stock Option Plan dated January 11, 1995 (1) incorporated by reference to Exhibit 10.2.1 to Form 10-KSB for fiscal year ended May 31, 1996
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Exhibit No. Document No. - ----------- -------- --- 10.3 Lease Agreement between the Company's subsidiary Metacomp, Inc. and Clar-O-Wood (1) Partnership, a California limited partnership dated April 11, 1991 as amended November 11, 1992 and November 2, 1995 incorporated by reference to Exhibit 10.3 to Form 10-KSB for fiscal year ended May 31, 1997 10.4 Stock Purchase Agreement dated November 29 and 30, 1995, between the Company and (1) SEA, Ltd., incorporated by reference to Exhibit 10.4 to Form 8-K dated December 11, 1995 10.4.1 Letter Amendment to Stock Purchase Agreement dated February 21, 1996, between the (1) Company and SEA, Ltd., incorporated by reference to Exhibit 10.4.1 to Form 10-QSB for fiscal quarter ended 2/29/96 10.5 1995 Employee Stock Compensation Plan of the Company, incorporated by reference to (1) Exhibit 10.5 to Form 10-QSB for fiscal quarter ended 11/30/95 10.6 Letter Stock and Warrant Agreement dated January 10, 1996 between the Company and (1) Robert E. Crawford, Jr., incorporated by reference to Exhibit 10.6 to Form 10-QSB for fiscal quarter ended February 29, 1996 10.7 Non-Exclusive Manufacturing and Line of Credit Agreement dated February 28, 1996, (1) between the Company and Labway Corporation, incorporated by reference to Exhibit 10.7 to Form 10-QSB for fiscal quarter ended February 29, 1996 10.8 Distribution and Representation Agreement dated February 28, 1996, between the (1) Company and Innoware, Inc., incorporated by reference to Exhibit 10.8 to Form 10-QSB for fiscal quarter ended February 29, 1996 10.9 Employment Agreement dated November 20, 1995 between the Company and Elwood G. (1) Norris, incorporated by reference to Exhibit 10.9 to Registration Statement on Form SB-2 dated March 18, 1996 10.9.1 First Amendment to Employment Agreement dated May 17, 1996 between the Company and (1) Elwood G. Norris, incorporated by reference to Exhibit 10.9.1 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 10.10 Employment Agreement dated November 20, 1995 between the Company and Robert (1) Putnam, incorporated by reference to Exhibit 10.10 to Registration Statement on Form SB-2 dated March 18, 1996 10.11 Sales Contractual Agreement dated March 19, 1996 between the Company and Evolve (1) Software, Inc., incorporated by reference to Exhibit 10.11 to Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2 dated April 29, 1996 10.11.1 Two Year Stock Purchase Warrant dated March 19, 1996 Granted to Evolve Software, (1) Inc. Providing for the Purchase of up to 50,000 Common Shares at $2.85, incorporated by reference to Exhibit 10.11.1 to Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2 dated April 29, 1996
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Exhibit No. Document No. - ----------- -------- --- 10.12 Employment Agreement dated as of May 8, 1996 between the Company and Michael A. (1) Carenzo, including Schedule A - Stock Option Agreement, incorporated by reference to Exhibit 10.12 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 10.12.1 First Amendment to Employment Agreement dated as of May 8, 1996 between the (1) Company and Michael A. Carenzo dated September 23, 1996, incorporated by reference to Exhibit 10.12.1 to Form 10-KSB for the fiscal year ended May 31, 1997 10.13 1996 Stock Option Plan of the Company dated March 25, 1996 and approved by the (1) Shareholders on May 17, 1996, incorporated by reference to Exhibit 10.13 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 10.14 Sales Contractual Agreement dated June 20, 1996 between the Company and (1) Compunetics Incorporated incorporated by reference to Exhibit 10.14 to Form 10-KSB for fiscal year ended May 31, 1996 10.15 Sales Contractual Agreement dated July 31, 1996 between the Company and Premier (1) Technical Sales, Inc. incorporated by reference to Exhibit 10.15 to Form 10-KSB for fiscal year ended May 31, 1996 10.16 Employment Agreement dated January 1, 1997 between the Company and Norman J. (1) Dawson incorporated by reference to Exhibit 10.16 to Form 10-KSB for fiscal year ended May 31, 1997 10.17 Employment Agreement dated January 1, 1997 between the Company and Jayanta K. (1) Maitra incorporated by reference to Exhibit 10.17 to Form 10-KSB for fiscal year ended May 31, 1997 10.18 Technology License and Distribution Agreement dated June 23, 1997 between the (1) Company and Sun Microsystems, Inc. incorporated by reference to Exhibit 10.18 to Form 10-KSB for the fiscal year ended May 31, 1997 10.19 Employment Agreement dated March 23, 1998 between the Company and James T. Lunney (1) incorporated by reference to Exhibit 10.19 to Form 10-KSB for the fiscal year ended May 31, 1998 10.20 Employment Agreement dated July 28, 1997 between the Company and Phillip Morettini (1) incorporated by reference to Exhibit 10.20 to Form 10-KSB for the fiscal year ended May 31, 1998 10.21 Employment Agreement dated July 23, 1998 between the Company and Lowell W. (1) Giffhorn incorporated by reference to Exhibit 10.21 to Form 10-KSB for the fiscal year ended May 31, 1998 10.22 Secured Promissory Note dated June 12, 2000 between the Company and James T. (1) Lunney incorporated by reference to Exhibit 10.22 to Form 10-KSB for the fiscal year ended May 31, 2000 10.23 Purchase Agreement dated June 29, 2000 between the Company and 4S 37/38, LLC (1) incorporated by reference to Exhibit 10.23 to Form 10-KSB for the fiscal year ended May 31, 2000
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Exhibit No. Document No. - ----------- -------- --- 10.24 Employment Agreement dated October 2, 2000 between the Company and Miklos B. (1) Korodi incorporated by reference to Exhibit 10.24 to Form 10-QSB for the fiscal quarter ended November 30, 2000 10.25 Employment Agreement dated December 1, 2000 between the Company and Richard G. (1) Blum incorporated by reference to Exhibit 10.25 to Form 10-QSB for the fiscal quarter ended November 30, 2000 10.26 Employment Agreement dated January 29, 2001 between the Company and Serge J. (1) Miller incorporated by reference to Exhibit 10.26 to Form 10-KSB for the fiscal year ended May 31, 2001 10.27 Lease Agreement dated February 23, 2001 between the Company and Arden Realty (1) Finance IV, LLC incorporated by reference to Exhibit 10.27 to Form 10-KSB for the fiscal year ended May 31, 2001 10.28 Employment Agreement dated January 1, 2001 between the Company and David H. Pohl (1) incorporated by reference to Exhibit 10.28 to Form 10-KSB for the fiscal year ended May 31, 2001 10.29 Employment Agreement dated April 26, 2001 between the Company and David H. Pohl (1) incorporated by reference to Exhibit 10.29 to Form 10-KSB for the fiscal year ended May 31, 2001 10.30 Employment Agreement dated November 17, 2001 between the Company and Lowell W. (1) Giffhorn incorporated by reference to Exhibit 10.30 to Registration Statement on Form S-3 dated June 27, 2002 10.31 Employment Agreement dated December 20, 2001 between the Company and Jayanta (1) Maitra incorporated by reference to Exhibit 10.31 to Registration Statement on Form S-3 dated June 27, 2002 10.32 Consulting Agreement dated March 7, 2002 between the Company and SDMC, Inc. (1) incorporated by reference to Exhibit 10.32 to Registration Statement on Form S-3 dated June 27, 2002 10.33 Employment Agreement dated January 2, 2004 between the Company and Jayanta Maitra (1) incorporated by reference to Exhibit 10.33 to Registration Statement on Form SB-2 dated May 21, 2004 10.34 Consulting Agreement dated March 18, 2004 between the Company and SDMC, Inc. (1) incorporated by reference to Exhibit 10.34 to Registration Statement on Form SB-2 dated May 21, 2004 10.35 Employment Agreement dated June 1, 2004 between the Company and Patrick Nunally (2) 10.36 Amendment No. 1 to Employment Agreement dated July 12, 2004 between the Company (2) and Patrick Nunally 14.0 CODE OF ETHICS. 14.1 Code of Ethics for Senior Financial Officers incorporated by reference to Exhibit (1) 14.1 to Form 10-K for the fiscal year ended May 31, 2003
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Exhibit No. Document No. - ----------- -------- --- 21.0 SUBSIDIARIES OF THE SMALL BUSINESS ISSUER. 21.1 Subsidiaries of the small business issuer (2) 23.0 CONSENTS OF EXPERTS AND COUNSEL. 23.1 Consent of Nation Smith Hermes Diamond, LLP independent registered certified (2) public accounting firm 31.0 CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002. 31.1 Certification of Jeffrey E. Wallin, CEO (2) 31.2 Certification of Lowell W. Giffhorn, CFO (2) 32.0 CERTIFICATIONS PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002. 321.1 Certification of Jeffrey E. Wallin, CEO (2) 32.2 Certification of Lowell W. Giffhorn, CFO (2) 99.0 ADDITIONAL EXHIBITS. 99.1 Form of ISO Plan Option (Gaspar) dated May 29, 1992, incorporated by reference to (1) Exhibit 28.2 to registration statement on Form SB-2, file no. 33-57858 99.2 Form of NSO Plan Option (Berlin) dated May 29, 1992, incorporated by reference to (1) Exhibit 28.3 to registration statement on Form SB-2, file no. 33-57858 99.3 Form of Incentive Stock Option Agreement to the Company's 1996 Stock Option Plan (1) (individual agreements differ as to number of shares, dates, prices and vesting), incorporated by reference to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 99.4 Form of NonQualified Stock Option Agreement to the Company's 1996 Stock Option (1) Plan (individual agreement differ as to number of shares, date, prices and vesting), incorporated by reference to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 dated May 23, 1996 99.5 Press Release of the Company dated November 4, 1996 incorporated by reference to (1) Exbibit 99.5 to Form 8-K dated January 9, 1997 99.6 Form of Incentive Stock Option Agreement to the Company's 2001 Stock Option Plan (1) incorporated by reference to Exhibit 99.6 to Registration Statement on Form S-8 filed March 26, 2001 99.7 Form of Non-Qualified Stock Option Agreement to the Company's 2001 Stock Option (1) Plan incorporated by reference to Exhibit 99.7 to Registration Statement on Form S-8 filed March 26, 2001
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Exhibit No. Document No. - ----------- -------- --- 99.8 Form of Incentive Stock Option Agreement to the Company's 2003 Stock Option Plan (1) incorporated by reference to Exhibit 99.8 to Registration Statement on Form S-8 filed September 4, 2003 99.9 Form of Non-Qualified Stock Option Agreement to the Company's 2003 Stock Option (1) Plan incorporated by reference to Exhibit 99.9 to Registration Statement on Form S-8 filed September 4, 2003
(1) Previously filed in indicated registration statement or report. (2) Exhibit filed herewith this Annual Report on Form 10-KSB for the fiscal year ended May 31, 2004 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Nation Smith Hermes Diamond was our principal accountant during the years ended May 31, 2004 and May 31, 2003. BDO Seidman, LLP was our principal accountant for previous fiscal years and for the review of quarterly reports and registration statements through May 20, 2002. Presented below are the fees billed during the fiscal years ended May 31, 2004 and 2003.
Nation Smith Hermes Diamond BDO Seidman ------------------------------- ----------------------------- 2004 2003 2004 2003 --------------- ------------- ------------- ------------- Audit fees $ 78,000 $ 72,902 $ 5,500 $ - Audit-related fees 22,908 40,099 7,200 20,000 Tax fees 13,000 635 - - All other fees (57) 57 - - --------------- ------------- ------------- ------------- Total $ 113,851 $ 113,693 $ 12,700 $ 20,000 =============== ============= ============= =============
Audit Fees. Represents fees for professional services provided for the audit of Patriot Scientific's annual financial statements and review of Patriot Scientific's quarterly financial statements, and audit services provided in connection with other statutory or regulatory filings. Audit-related Fees. Represents fees for assurance services related to the audit of Patriot Scientific's financial statements. The fees are primarily for review of registration and proxy statements. Tax Fees. Represents fees for professional services provided primarily for compliance, advice and tax return preparation. All Other Fees. Represents fees for products and services not otherwise included in the categories above. To help ensure the independence of our independent auditor, the Audit Committee of the Board of Directors of Patriot Scientific has approved and adopted a Policy on Engagement of Independent Auditor, which is available on Patriot Scientific's Web site at http:/www.ptsc.com. Pursuant to the Policy on Engagement of Independent Auditor, the Audit Committee is directly responsible for the appointment, compensation and oversight of the independent auditor. The Audit Committee preapproves all audit services and non-audit services to be provided by our independent auditor. The Audit Committee may delegate to one or more of its members the authority to grant the required approvals, provided that any exercise of such authority is presented at the next Audit Committee meeting. 42 Each audit, non-audit or tax service that is approved by the Audit Committee will be reflected in a written engagement letter or writing specifying the services to be performed and the cost of such services, which will be signed by either a member of the Audit Committee or by an officer of Patriot Scientific authorized by the Audit Committee to sign on behalf of Patriot Scientific. The Audit Committee will not approve any prohibited non-audit service or any non-audit service that individually or in the aggregate may impair, in the Audit Committee's opinion, the independence of our independent auditor. In addition, beginning on January 1, 2003, our independent auditor may not provide any services to Patriot Scientific officers or Audit Committee members, including financial counseling and tax services. 43 Patriot Scientific Corporation Index to Consolidated Financial Statements Report of Nation Smith Hermes Diamond, Independent Registered Certified Public Accounting Firm.............................F-2 Consolidated Balance Sheets as of May 31, 2004 and 2003................F-3 Consolidated Statements of Operations for the Years Ended May 31, 2004 and 2003........................................................F-4 Consolidated Statement of Stockholders' Equity (Deficit) for the Years Ended May 31, 2004 and 2003....................................F-5 Consolidated Statements of Cash Flows for the Years Ended May 31, 2004 and 2003............................................... F-6 Summary of Accounting Policies.........................................F-7- F-11 Notes to Consolidated Financial Statements.............................F-12- F-26 F-1 REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors Patriot Scientific Corporation San Diego, California We have audited the accompanying consolidated balance sheets of Patriot Scientific Corporation as of May 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the years in the two year period ended May 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above, present fairly, in all material respects, the consolidated financial position of Patriot Scientific Corporation at May 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the years in the two year period ended May 31, 2004, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses from operations, has negative cash flows and has negative working capital that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Nation Smith Hermes Diamond San Diego, California July 8, 2004 F-2 PATRIOT SCIENTIFIC CORPORATION Consolidated Balance Sheets
May 31, 2004 2003 - -------------------------------------------------------------------------------------------------------------------- ASSETS (Notes 4 and 5) CURRENT ASSETS: Cash and cash equivalents $ 355,940 $ 32,663 Marketable securities 22,646 -- Accounts receivable, net of allowance of none and $10,000 for uncollectible accounts 1,225 3,866 Prepaid expenses 322,068 93,030 - -------------------------------------------------------------------------------------------------------------------- Total current assets 701,879 129,559 PROPERTY AND EQUIPMENT, net (Note 2) 68,389 153,530 OTHER ASSETS 41,221 53,220 PATENTS AND TRADEMARKS, net of accumulated amortization of $501,235 and $450,926 114,739 128,925 - -------------------------------------------------------------------------------------------------------------------- $ 926,228 $ 465,234 - -------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Secured note payable (Note 4) $ -- $ 635,276 Current portion of 8% Convertible Debentures, net of debt discount of $27,180 and $103,121 (Note 5) 145,320 121,879 Secured notes payable to shareholders 100,000 180,000 Accounts payable 134,600 397,180 Accrued liabilities 160,102 245,822 Current portion of capital lease obligation 8,020 6,405 - -------------------------------------------------------------------------------------------------------------------- Total current liabilities 548,042 1,586,562 8% CONVERTIBLE DEBENTURES, net of debt discount of $2,047,966 and $709,890 (Note 227,701 280,110 LONG TERM PORTION OF CAPITAL LEASE OBLIGATION 2,306 10,326 COMMITMENTS AND CONTINGENCIES (Notes 1, 6 and 10) STOCKHOLDERS' EQUITY (DEFICIT) (Notes 5 and 6): Preferred stock, $.00001 par value; 5,000,000 shares authorized: none outstanding -- -- Common stock, $.00001par value; 400,000,000 shares authorized: 171,156,363 and 106,547,807 issued and outstanding at May 31, 2004 and 2003, respectively 1,712 1,066 Additional paid-in capital 49,990,485 44,281,210 Accumulated deficit (49,844,018) (45,694,040) - -------------------------------------------------------------------------------------------------------------------- Total stockholders' deficit 148,179 (1,411,764) - -------------------------------------------------------------------------------------------------------------------- $ 926,228 $ 465,234 - --------------------------------------------------------------------------------------------------------------------
See accompanying report of independent registered certified public accounting firm, summary of accounting policies and notes to consolidated financial statements. F-3 PATRIOT SCIENTIFIC CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended May 31, 2004 2003 - -------------------------------------------------------------------------------- Net sales (Note 11): Product $ 74,017 $ 108,403 Licenses and royalties 2,400 15,500 - -------------------------------------------------------------------------------- Net sales 76,417 123,903 - -------------------------------------------------------------------------------- Cost of sales 10,472 18,660 - -------------------------------------------------------------------------------- Gross profit 65,945 105,243 Operating expenses: Research and development 549,756 723,287 Selling, general and administrative 1,253,559 1,821,902 - -------------------------------------------------------------------------------- Operating expenses 1,803,315 2,545,189 - -------------------------------------------------------------------------------- Operating loss (1,737,370) (2,439,946) - -------------------------------------------------------------------------------- Other income (expenses): Sale of technology 75,500 -- Loss on marketable securities (45,354) -- Interest income 270 191 Interest expense (Notes 4, 5 and 6) (2,443,024) (1,448,544) - -------------------------------------------------------------------------------- Other income (expenses) (2,412,608) (1,448,353) - -------------------------------------------------------------------------------- Net loss $ (4,149,978) $ (3,888,299) - -------------------------------------------------------------------------------- Basic and diluted loss per common share (Note 7) $ (0.03) $ (0.04) - -------------------------------------------------------------------------------- Weighted average number of common shares outstanding during the period (Note 7) 139,767,276 93,791,470 - --------------------------------------------------------------------------------
See accompanying report of independent registered certified public accounting firm, summary of accounting policies and notes to consolidated financial statements. F-4 PATRIOT SCIENTIFIC CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
- ------------------------------------------------------------------------------------------------------------------------------------ Years Ended May 31, 2004 and 2003 Common Stock ---------------------- Additional Accumulated Stockholders' Shares Amount Paid-in Capital Deficit Equity (Deficit) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, June 1, 2002 81,465,757 $ 815 $ 41,360,101(1) $(41,805,741) $ (444,825) Issuance of common stock at $.03 to $.05 per share (Note 6) 3,765,266 38 120,312 -- 120,350 Collection of note receivable (Note 3) -- -- 80,000 -- 80,000 Issuance of common stock for services at $.04 to $.06 per share 2,780,000 28 148,772 -- 148,800 Conversion of debentures payable plus accrued interest at $.04 to $.05 per share (Note 4) 18,536,784 185 836,375 -- 836,560 Value of warrants issued -- -- 1,735,650 -- 1,735,650 Net loss -- -- -- (3,888,299) (3,888,299) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, May 31, 2003 106,547,807 $ 1,066 $ 44,281,210 $(45,694,040) $ (1,411,764) - ------------------------------------------------------------------------------------------------------------------------------------ Issuance of common stock at $.025 to $.034 per share (Note 6) 1,800,752 18 50,422 -- 50,440 Exercise of warrants and options at $.0172 to $.04 per 11,184,175 112 285,832 -- 285,944 Issuance of common stock for services at $.043 to $.117 per share 1,126,496 11 59,841 -- 59,852 Conversion of debentures payable plus accrued interest at $.017 to $.064 per share (Note 5) 50,497,133 505 1,757,123 -- 1,757,628 Value of warrants issued -- -- 3,556,057 -- 3,556,057 Net loss -- -- -- (4,149,978) (4,149,978) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, May 31, 2004 171,156,363 $ 1,712 $ 49,990,485 $(49,844,018) $ 148,179 - ------------------------------------------------------------------------------------------------------------------------------------
See accompanying report of independent registered certified public accounting firm, summary of accounting policies and notes to consolidated financial statements. (1) Additional Paid-In Capital included a note receivable of $80,000 and additional paid-in capital of $41,440,101 at June 1, 2002. F-5 PATRIOT SCIENTIFIC CORPORATION Consolidated Statements of Cash Flows
- -------------------------------------------------------------------------------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS Years Ended May 31, 2004 2003 - -------------------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net loss $(4,149,978) $(3,888,299) Adjustments to reconcile net loss to cash used in operating activities: Amortization and depreciation 135,450 258,915 Provision for doubtful accounts -- 24,000 Non -cash interest expense related to convertible debentures, notes payable and warrants 2,293,922 1,304,957 Gain on sale of technology (75,500) -- Unrealized loss on marketable securities 45,354 -- Common stock, options and warrants issued for services 59,852 148,800 Changes in: Accounts receivable (18,639) (33,346) Prepaid and other assets (217,039) 216,195 Accounts payable and accrued expenses (149,394) 83,016 - -------------------------------------------------------------------------------------------- Net cash used in operating activities (2,075,972) (1,885,762) - -------------------------------------------------------------------------------------------- INVESTING ACTIVITIES: Note receivable (Note 3) -- 60,000 Proceeds from sale of technology 7,500 -- Purchase of property, equipment and patents, net (36,123) (62,194) - -------------------------------------------------------------------------------------------- Net cash used in investing activities (28,623) (2,194) - -------------------------------------------------------------------------------------------- FINANCING ACTIVITIES: Proceeds from issuance of secured notes payable 12,320 180,000 Payments for capital lease obligations (6,405) (5,116) Proceeds from issuance of convertible debentures 2,175,000 1,507,000 Proceeds from issuance of common stock 50,440 120,350 Proceeds from exercise of common stock warrants and options 175,237 -- Proceeds from sale of accounts receivable 21,280 30,277 - -------------------------------------------------------------------------------------------- Net cash provided by financing activities 2,427,872 1,832,511 - -------------------------------------------------------------------------------------------- NET DECREASE IN CASH AND CASH EQUIVALENTS 323,277 (55,445) CASH AND CASH EQUIVALENTS, beginning of year 32,663 88,108 - -------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, end of year $ 355,940 $ 32,663 - -------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash payments for interest $ 17,220 $ 15,083 Convertible debentures, notes payable and accrued interest exchanged for common stock $ 1,757,628 $ 836,560 Debt discount $ 2,873,167 $ 1,763,816 - --------------------------------------------------------------------------------------------
See accompanying report of independent registered certified public accounting firm, summary of accounting policies and notes to consolidated financial statements. F-6 PATRIOT SCIENTIFIC CORPORATION SUMMARY OF ACCOUNTING POLICIES ORGANIZATION AND BUSINESS Patriot Scientific Corporation (the "Company") is engaged in the development, marketing, and sale of patented microprocessor technology and the sale of high-performance high-speed data communication products. The Company also owns innovative radar technology. The Company sold its antenna technology in August 1999. BASIS OF PRESENTATION AND CONSOLIDATION The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of the Company, its majority owned subsidiaries, Metacomp, Inc. ("Metacomp") and Plasma Scientific Corporation. All material intercompany transactions and balances have been eliminated in consolidation. RECLASSIFICATIONS Certain reclassifications have been made to the 2003 financial statements in order for them to conform to the 2004 presentation. Such reclassifications have no impact on the Company's financial position or results of operations. FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade accounts receivable. When the Company has excess cash, the Company's cash equivalents are placed in high quality money market accounts with major financial institutions and high grade short-term commercial paper. The investment policy limits the Company's exposure to concentrations of credit risk. Money market accounts are federally insured; however, commercial paper is not insured. The Company has not experienced any losses in such accounts. Concentrations of credit risk with respect to accounts receivable are limited due to the wide variety of customers and markets which comprise the Company's customer base, as well as their dispersion across many different geographic areas. The Company routinely assesses the financial strength of its customers and, as a consequence, believes that its accounts receivable credit risk exposure is limited. Generally, the Company does not require collateral or other security to support customer receivables. The carrying value of financial instruments including cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value because of the immediate or short-term maturity of these instruments. With respect to long-term debt, the carrying amounts approximate fair value due to the relative consistency in interest rates and the short term nature of the debt, with all debt maturing within two years of issuance. MARKETABLE SECURITIES As part of the sale of our gas plasma antenna technology we received restricted securities in a company that is traded on the OTC bulletin board. The securities can be traded under Rule 144 after July 2004. We reflect the value of those securities based on the closing price as of the end of our reporting period. Any unrealized gain or loss between reporting periods is reflected in our consolidated statement of operations as non-operating income or loss. F-7 PATRIOT SCIENTIFIC CORPORATION SUMMARY OF ACCOUNTING POLICIES (CONTINUED) 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. The Company follows the provisions of the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment of Long-lived Assets." 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. The Company continuously evaluates the recoverability of its long-lived assets based on estimated future cash flows and the estimated fair value of such long-lived assets, and provides 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 individual intangible assets is less than its carrying value determined based on the provisions of SFAS No. 144 as discussed above. REVENUE RECOGNITION We recognize revenue on the shipment to our customers of communication products, microprocessor integrated chips and evaluation boards. We also derive revenue from fees for the transfer of proven and reusable intellectual property components or the performance of engineering services. We enter into licensing agreements that will provide licensees the right to incorporate our intellectual property components in their products with terms and conditions that will vary by licensee. Generally, these payments will include a nonrefundable technology license fee, which will be payable upon the transfer of intellectual property, or a nonrefundable engineering service fee, which generally will be payable upon achievement of defined milestones. In addition, we anticipate these agreements will include royalty payments, which will be payable upon sale of a licensee's product, and maintenance and limited support fees. We will classify all revenue that involves the future sale of a licensee's products as royalty revenue. Royalty revenue will be generally recognized in the quarter in which a report is received from a licensee detailing the shipments of products incorporating our intellectual property components (i.e., in the quarter following the sale of licensed product by the licensee). We will classify all revenue that does not involve the future sale of a licensee's products, primarily license fees and engineering service fees and maintenance and support fees, as contract revenue. License fees will be recognized upon the execution of the license agreement and transfer of intellectual property, provided no further significant performance obligations exist and collectibility is deemed probable. Fees related to engineering services contracts, which will be performed on a best efforts basis and for which we will receive periodic milestone payments, will be recognized as revenue over the estimated development period, using a cost-based percentage of completion method. Annual maintenance and support fees, which will be renewable by the licensee, will be classified as contract revenue and will be amortized over the period of support, generally 12 months. RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred. F-8 PATRIOT SCIENTIFIC CORPORATION SUMMARY OF ACCOUNTING POLICIES (CONTINUED) ADVERTISING The Company expenses advertising costs as incurred. Advertising expenses were approximately none and $3,400 for the years ended May 31, 2004 and 2003. INCOME TAXES The Company accounts for income taxes under SFAS No. 109, "Accounting for Income Taxes". Deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the combination of the tax payable for the year and the change during the year in deferred tax assets and liabilities. NET LOSS PER SHARE The Company applies SFAS No. 128, "Earnings Per Share" for the calculation of "Basic" and "Diluted" earnings (loss) per share. Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflect the potential dilution of securities that could share in the earnings (loss) of an entity. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles 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. INVENTORIES Inventories consist of raw materials, work in process and finished goods and are valued at the weighted average cost method, which approximates cost on a first-in, first-out basis, not in excess of market value. As of May 31, 2004 and 2003 both inventory amounts were fully reserved. SALE OF ACCOUNTS RECEIVABLE The Company has adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"). SFAS 140 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. A $400,000 factoring line established by the Company with a bank enables the Company to sell selected accounts receivable invoices to the bank with full recourse against the Company. These transactions qualify for a sale of assets since (1) the Company has transferred all of its right, 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) the Company has no effective control over the selected accounts receivable invoices since it is not entitled to or obligated to repurchase or redeem the invoices before their maturity and it does not have the ability to unilaterally cause the bank to return the invoices. Under SFAS 140, after a transfer of financial F-9 PATRIOT SCIENTIFIC CORPORATION SUMMARY OF ACCOUNTING POLICIES (CONTINUED) 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 fiscal 2004 and 2003, the Company sold approximately $27,000 and $38,000, respectively, of its accounts receivable to a bank under a factoring agreement for approximately $21,000 and $30,000, respectively. Pursuant to the provisions of SFAS 140, the Company reflected the transaction as a sale of assets and established an accounts receivable from the bank for the retained amount less the costs of the transaction and less any anticipated future loss in the value of the retained asset. The retained amount is equal to 20% of the total accounts receivable invoice sold to the bank less 1% of the total invoice 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 is based on the payment history of the accounts receivable customer. At May 31, 2004, there was no outstanding balance and $400,000 was available for future factoring of accounts receivable invoices. STOCK OPTIONS The Company applies Accounting Principles Board ("APB") Opinion 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for all stock option plans. Under APB Opinion 25, compensation cost has been recognized for stock options granted to employees when the option price is less than the market price of the underlying common stock on the date of grant. SFAS No. 123, "Accounting for Stock-Based Compensation," and SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and disclosure," require the Company to provide pro forma information regarding net income as if compensation cost for the Company's stock option plans had been determined in accordance with the fair value based method prescribed in SFAS No. 123. To provide the required pro forma information, the Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model. SFAS No. 148 also provides for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company has elected to continue to account for stock based compensation under APB No. 25. The Company applies SFAS No. 123 in valuing options granted to consultants and estimates the fair value of such options using the Black-Scholes option-pricing model. The fair value is recorded as consulting expense as services are provided. Options granted to consultants for which vesting is contingent based on future performance are measured at their then current fair value at each period end, until vested. Under the accounting provisions for SFAS No. 123, the Company's net loss per share would have been increased by the pro forma amounts indicated below: F-10 PATRIOT SCIENTIFIC CORPORATION SUMMARY OF ACCOUNTING POLICIES (CONTINUED) 2004 2003 - ----------------------------------------------------------------------- Net loss as reported $(4,149,978) $(3,888,299) Compensation expense (152,074) (289,023) ----------- ----------- Net loss pro forma $(4,302,052) $(4,177,322) =========== =========== As reported per share Basic and diluted loss $ (0.03) $ (0.04) =========== =========== Pro forma per share Basic and diluted loss $ (0.03) $ (0.04) =========== =========== RECENT ACCOUNTING PRONOUNCEMENTS In April 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 requires that contracts with comparable characteristics be accounted for similarly. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of this statement did not impact our financial position or results of operations. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. The adoption of this statement did not impact our financial position or results of operations. F-11 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. CONTINUED EXISTENCE AND 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 $4,149,978 and $3,888,299 and negative cash flow from operations of $2,171,896 and $1,885,762 in the years ended May 31, 2004 and 2003. At May 31, 2004, we had cash and cash equivalents of $355,940. We have historically funded our operations primarily through the issuance of securities and debt financings. Cash and cash equivalents increased $323,277 during the year ended May 31, 2004. We estimate our current cash requirements to sustain our operations for the next twelve months through May 2005 to be $1.8 million. Since we are no longer supporting the communications product line, we are assuming that there will be no communications product revenue. We have issued 8% convertible debentures as our primary source of funding since 2002. At the option of the debenture holders, they may purchase additional debentures up to $1 million at any time during the two years following their purchase as long as the price of our common stock is in excess of $0.20 per share. During the year ended May 31, 2004, we obtained $2,175,000 from the issuance of convertible debentures, $50,440 from the sale of equity to several private investors, $183,270 from the exercise of warrants and $12,320 from short term notes entered into with a related party. If the optional amounts under the convertible debentures are not raised in sufficient amounts, then we may not have funds sufficient to meet our cash requirements. In such circumstances, we would need to secure additional debt and/or equity financings with individual or institutional investors. In addition, we would be required to make additional cost reductions if our cash requirements cannot be met from external sources. We expect that the $1.8 million requirement will be provided by: o additional debt and/or equity financings; o proceeds from the exercise of outstanding stock options and warrants; and o proceeds from revenue contracts and patent enforcement activities. In addition, we have formulated additional cost reduction plans which can be implemented if the required funds are not obtainable. As of May 31, 2004, we also have remaining $400,000 under an accounts receivable factoring agreement with our bank. We anticipate our future revenue to be derived primarily from the sale of licenses, royalties and the proceeds from litigation or settlements of patent infringement cases. 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 and to fund the expenses of protracted patent enforcement litigation. Product introductions such as those currently underway for the Ignite I may require significant product launch, marketing personnel and other expenditures that cannot be currently estimated. Further, if expanded development is F-12 PATRIOTSCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. If we are unable to obtain the necessary funds, we could be forced to substantially curtail or cease operations, which would have a material adverse effect on our business. Further, there can be no assurance 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. 2. PROPERTY AND Property and equipment consisted of the following: EQUIPMENT May 31, ------------------------------- 2004 2003 - -------------------------------------------------------------------------------- Computer equipment and software $1,660,707 $1,660,707 Furniture and fixtures 499,274 499,274 Laboratory equipment 205,594 205,594 ---------- ---------- ---------- ---------- 2,365,575 2,365,575 Less accumulated depreciation and amortization 2,297,186 2,212,045 ---------- ---------- ---------- ---------- Net property and equipment $ 68,389 $ 153,530 - -------------------------------------------------------------------------------- Depreciation expense was $85,141 and $131,958 for the years ended May 31, 2004 and 2003. 3. NOTE RECEIVABLE In June 2000, the Company 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 the Company. The note had an interest 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 the Company's common stock that he held on the date of issuance as security for this note. In April 2003, the Company negotiated an early payment discount and the individual paid $60,000 to retire this note. The balance of $20,000 was written off to bad debt expense during the year ended May 31, 2003. F-13 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. SECURED NOTES PAYABLE We previously replaced and superceded a previously issued Secured Promissory Note with Swartz with an Amended Secured Promissory Note and Agreement with an effective date of October 9, 2001, an Addendum to Amended Secured Promissory Note dated March 12, 2002 and an Antidilution Agreement and Addendum to Warrants dated March 19, 2003. On March 23, 2004, the amended note, which had a principal balance of $635,276 plus accrued interest of $87,891, was exchanged for an 8% convertible debenture for $723,167 with a maturity date of March 23, 2006. As part of the consideration for entering into the original amended note, we agreed to issue warrants to Swartz related to each advance against the note. In connection with each advance, we issued 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 (a) the factor of 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. In addition, we were obligated under the addendum to the note to issue to Swartz warrants equal to 20% of the common stock issued between March 12, 2002 and April 1, 2003 and we are obligated under the antidilution agreement to issue to Swartz warrants equal to 30% of the common stock issued subsequent to April 1, 2003 to any parties other than Swartz. In addition, we agreed to extend the expiration date to December 31, 2006 on certain warrants that were to expire previous to December 31, 2006. In exchange for these concessions, Swartz agreed to extend the due date to March 1, 2004 on a note for $635,276 net of accrued interest and allowed us to unreserve 20,007,350 shares that had been reserved for the exercise of warrants for a period the sooner of 1) March 19, 2004, or 2) 90 days after the date on which our common stock exceeded $0.375 for 10 consecutive trading days. As of May 31, 2004 we issued warrants to purchase up to 28,286,208 shares of our common stock in accordance with the amended note agreements and antidilution agreement. The warrants issued 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. As part of the consideration for exchanging the note for an 8% convertible debenture, we agreed to extend the expiration dates on certain outstanding warrants to April 1, 2011. In January 2004, a note held by an affiliate for $200,353 plus accrued interest of $8,033 was partially used to exercise a warrant with the balance of $100,000 converted into four one year $25,000 notes due January 9, 2005 issued to four heirs of the estate over which the affiliate is a trustee. The interest rate on the four notes is 6% and the notes are secured by the assets of the company. F-14 5. CONVERTIBLE DEBENTURES Overview. From April 23, 2002 through May 11, 2004, we sold an aggregate of $4,913,167 of convertible debentures, ranging from 8% to 12%, to a group of twenty-four investors. The PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) convertible debentures entitle the debenture holder to convert the principal and unpaid accrued interest into our common stock for two years from the date of closing. Number of Shares Debentures May Be Converted Into. The debentures can be converted into a number of our common shares at conversion prices that initially equaled $0.0172 to $0.10289 per share. Resets of Conversion Price and Conversion Shares. A reset date occurs on each three month anniversary of the closing date of each debenture and on the date the registration statement becomes effective. If the volume weighted average price for our common stock for the ten days previous to the reset date is less than the conversion price in effect at the time of the reset date, then the number of common shares issuable to the selling shareholder on conversion will be increased. If the conversion price is reset, the debenture can be converted into a number of our common shares based on the following calculation: the amount of the debenture plus any unpaid accrued interest divided by the reset conversion price which shall equal the volume weighted average price for our common stock for the ten days previous to the reset date. Warrants. Concurrent with the issuance of the convertible debentures, we issued to the debenture holders warrants to purchase shares of our common stock. These warrants are exercisable for five years from the date of issuance at either initial negotiated exercise prices or prices equal to 115% of the volume weighted average price for our common stock for the ten days previous to the debenture date. The warrant exercise price is generally subject to being reset on each six month anniversary of its issuance, however, if the warrant holder elects to have the warrant shares registered, then the exercise price is fixed at the price in effect on the date of the election. Options to Purchase Additional Debentures. Subject to the price of our common stock being equal to or greater than $0.20 per share and a two year limitation, the debenture holders may purchase additional debentures equal to the value of their initial debentures. The price at which the optional additional debentures could be converted would initially equal 115% of the volume weighted average price for our common stock for the ten days previous to the date on which the optional additional debentures were closed. The optional additional debentures would carry the same warrant amounts and reset privileges as the initial debentures. Shareholder Approval. We may currently issue more than 20% of our outstanding shares under the convertible debentures. 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. Restrictive Covenants. For a period of 18 months from the date of the debentures, 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; the issuance of any debt or equity securities with a fixed conversion or exercise price subject to adjustment; and any private equity line type agreements without obtaining the debenture holders' prior written approval. F-15 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Right of First Refusal. The debenture holders have a right of first refusal to purchase or participate in any equity securities offered by us in any private transaction which closes on or prior to the date that is two years after the issue date of each debenture. Registration Rights. Except for one debenture issued on March 23, 2004, we are responsible for registering the resale of the shares of our common stock which will be issued on the conversion of the debentures. As of May 31, 2004, there have been five registration statements (designated A through E). Security Interest. The convertible debentures are secured by our assets. The following tables present the status, as of May 31, 2004, of our convertible debentures:
Principal Effective Shares Warrant Dates of Aggregate Balance Conversion Prices Registration Converted at Shares ------------------------- Series Issuance cc Principal at 5/31/04 Initial Reset Date May 31, 2004 Issued ------ -------- --------- ---------- ------- ----- ---- ------------- ------ A 4/23/2002- $ 1,000,000 $ 25,000 $0.08616- $0.04190- 10/29/2002 23,441,662 12,859,175 6/10/2002 $0.10289 $0.04457 B 8/23/2002- $ 605,000 $ 107,500 $0.05126- $0.04381- 3/7/2003 11,620,528 11,234,835 1/24/2003 $0.0727 $0.04722 C 3/24/2002- $ 510,000 $ 10,000 $0.041- $0.041- 6/26/2003 10,179,007 9,377,943 6/9/2003 $0.065 $0.065 D 8/1/2003- $ 547,500 $ 55,000 $0.0172- $0.0172- 11/18/2003 23,792,725 22,455,355 10/21/2003 $0.048 $0.0477 E 12/1/2003- $ 1,527,500 $ 1,527,500 $0.0267- $0.0267- 6/7/2004 -- 30,395,392 5/11/2004 $0.10 $0.10 F 3/23/2004 $ 723,167 $ 723,167 $0.09 $0.09 Not Registered -- 8,035,192 ----------- ----------- ---------- ---------- Totals $ 4,913,167 $ 2,448,167 69,033,922 94,357,892
F-16 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Convertible debentures issued since April 23, 2002 $ 4,913,167 Less amounts converted to common stock (2,465,000) ----------- 2,448,167 Less debt discount (2,075,146) ----------- Convertible debentures at May 31, 2004 373,021 Less current portion 145,320 ----------- Long term portion $ 227,701 =========== Maturity dates of outstanding convertible debentures June 10, 2004 $ 25,000 October 29, 2004 107,500 April 15, 2005 10,000 August 1, 2005 25,000 September 30, 2005 30,000 December 1, 2005 25,000 January 23, 2006 275,000 February 2, 2006 325,000 March 23, 2006 723,167 March 24, 2006 315,900 April 26, 2006 100,000 May 11, 2006 486,600 ----------- $ 2,448,167 =========== 6. STOCKHOLDERS' EQUITY (DEFICIT) During fiscal 2004, the Company's shareholders approved an increase in the authorized number of common shares from 200,000,000 to 400,000,000. PRIVATE STOCK OFFERINGS During fiscal 2004, 1,800,752 restricted shares of common stock were issued to a group of individual investors for $50,440 and 1,126,496 shares of common stock were issued to a vendor in satisfaction of $59,852 of trade accounts payable. During fiscal 2003, 3,765,266 restricted shares of common stock were issued to a group of individual investors for $120,350; 2,000,000 shares of common stock were issued to a consultant in exchange for services valued at $110,000; and 400,000 shares valued at $16,000 were issued to a former executive of the company as partial settlement of a legal action. The fair value (as determined by the quoted market price) for the consulting services and legal settlement were recorded as additional general and administrative expense during the year ended May 31, 2003. Also, during fiscal 2003, the Company issued 380,000 shares of common stock to a vendor in satisfaction of $22,800 of trade accounts payable. WARRANTS At May 31, 2004, the Company had warrants outstanding to purchase 121,349,420 shares of common stock at exercise prices ranging from $0.0172 to $0.65 per share expiring beginning in F-17 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2004 through 2011. During fiscal 2004, the Company issued warrants to purchase 73,436,127 shares of common stock at exercise prices ranging from $0.0172 to $0.10 per share and issued 11,079,175 shares of common stock on the exercise of warrants at exercise prices ranging from $0.0172 to $0.04 per share. At May 31, 2003, the Company had warrants outstanding to purchase 58,992,468 shares of common stock at exercise prices ranging from $0.033 to $1.12 per share expiring beginning in 2004 through 2008. During fiscal 2003, the Company issued warrants to purchase 35,005,013 shares of common stock at exercise prices ranging from $0.04 to $0.065 per share. The following table presents the outstanding warrants at May 31: 2004 2003 ----------- ----------- Issued in conjunction with Convertible debentures 83,278,716 31,164,260 Anti-dilution agreements 15,398,058 5,355,562 Equity lines of credit 18,765,369 18,765,369 Other 3,907,277 3,707,277 ----------- ----------- Total warrants outstanding 121,349,420 58,992,468 =========== =========== 1992 INCENTIVE STOCK OPTION PLAN ("ISO") The Company has an ISO Plan which expired March 20, 2002. The ISO Plan provided for grants to either full or part time employees, at the discretion of the board of directors, to purchase common stock of the Company at a price not less than the fair market value of the shares on the date of grant. In the case of a significant stockholder, the option price of the share could not be less than 110 percent of the fair market value of the share on the date of grant. Any options granted under the ISO Plan must be exercised within ten years of the date they were granted (five years in the case of a significant stockholder). At May 31, 2004, options to purchase up to 17,500 shares of common stock remained outstanding and will expire in July 2004. 1992 NON-STATUTORY STOCK OPTION PLAN("NSO") The Company has an NSO Plan which expired March 20, 2002. The NSO Plan provided, at the discretion of the board of directors, for grants to either full or part time employees, directors and consultants of the Company to purchase common stock of the Company at a price not less than the fair market value of the shares on the date of grant. Any options granted under the NSO Plan must be exercised within ten years of the date they were granted. At May 31, 2004, options to purchase up to 50,000 shares of common stock remained outstanding and will expire in 2005. 1996 STOCK OPTION PLAN Effective March 1996, the Company adopted the 1996 Stock Option Plan, which was amended by the Stockholders in December 1997, expiring March 24, 2006, reserving for issuance 4,000,000 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) F-18 shares of the Company's common stock. The 1996 Stock Option Plan provides, at the discretion of the board of directors, for grants to either full or part time employees, directors and consultants of the Company to purchase common stock of the Company at a price not less than the fair market value on the date of grant for incentive stock options or not less than 85% of the fair market value on the date of grant for non-qualified stock options. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 1996 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). During the fiscal years ended May 31, 2004 and 2003, the Company granted options to purchase none and 340,500 shares of stock at market value. 2001 STOCK OPTION PLAN Effective February 2001, the Company adopted the 2001 Stock Option Plan, expiring February 21, 2011, reserving for issuance 3,000,000 shares of the Company's common stock. The 2001 Stock Option Plan provides, at the discretion of the board of directors, for grants to either full or part time employees, directors and consultants of the Company to purchase common stock of the Company at a price not less than the fair market value on the date of grant for incentive stock options or not less than 85% of the fair market value on the date of grant for non-qualified stock options. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2001 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). During the fiscal years ended May 31, 2004 and 2003, the Company granted options to purchase none and 875,000 shares of stock at market value. 2003 STOCK OPTION PLAN Effective July 2003, the Company adopted the 2003 Stock Option Plan, expiring July 2, 2013, reserving for issuance 6,000,000 shares of the Company's common stock. The 2003 Stock Option Plan provides, at the discretion of the board of directors, for grants to either full or part time employees, directors and consultants of the Company to purchase common stock of the Company at a price not less than the fair market value on the date of grant for incentive stock options or not less than 85% of the fair market value on the date of grant for non-qualified stock options. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2003 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). During the fiscal year ended May 31, 2004, the Company granted options to purchase 2,210,000 shares of stock at market value. SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to provide pro forma information regarding net loss and net loss per share as if compensation costs for the Company's stock option plans and other stock awards had been determined in accordance with the fair value based method prescribed in SFAS No. 123. The Company estimates the fair value of each stock award at the grant date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for the two years ended May 31, 2004 and 2003, respectively: dividend yield of zero percent for both years; expected volatility of 107 to 127 and 100 to PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) F-19 120, risk-free interest rates of 2.1 to 3.9 and 2.3 to 4.3; and expected lives of 3 to 5 years for both years. A summary of the status of the Company's stock option plans and warrants as of May 31, 2004, 2003 and 2002 and changes during the years ending on those dates is presented below:
Options Warrants --------------------------------- --------------------------------------- Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price - ---------------------------------------------------------------------------------------------------------------------------- Outstanding, June 1, 2002 4,249,739 $ 0.39 24,477,724 $ 0.11 - ---------------------------------------------------------------------------------------------------------------------------- Granted 1,215,500 0.05 35,005,013 0.05 Cancelled (411,239) 0.81 (490,269) 0.30 Exercised -- 0 -- -- - ---------------------------------------------------------------------------------------------------------------------------- Outstanding, May 31, 2003 5,054,000 $ 0.28 58,992,468 $ 0.06 - ---------------------------------------------------------------------------------------------------------------------------- Granted 2,210,000 0.06 73,436,127 0.05 Cancelled (156,000) 0.13 -- -- Exercised (105,000) 0.05 (11,079,175) 0.03 - ---------------------------------------------------------------------------------------------------------------------------- Outstanding, May 31, 2004 7,003,000 $ 0.21 121,349,420 $ 0.05 - ---------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------- Exercisable, May 31, 2003 4,138,633 $ 0.29 57,992,468 $ 0.06 - ---------------------------------------------------------------------------------------------------------------------------- Exercisable, May 31, 2004 5,904,434 $ 0.24 120,149,420 $ 0.05 - ---------------------------------------------------------------------------------------------------------------------------- Weighted average fair value of options and warrants granted during the year ended May 31, 2003 $ 0.04 $ 0.05 Weighted average fair value of options and warrants granted during the year ended May 31, 2004 $ 0.05 $ 0.06 - ----------------------------------------------------------------------------------------------------------------------------
Included in the above table are certain options for which vesting is contingent based on various future performance measures. The following table summarizes information about stock options and warrants outstanding at May 31, 2004: F-20 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Outstanding Exercisable ---------------------------------------------- ------------------------------- Weighted Average Weighted Weighted Range of Remaining Average Average Exercise Number Contractual Exercise Number Exercise Prices Outstanding Life Price Exercisable Price - ----------------------------------------------------------------------------------------------------- OPTIONS $ 0.0345-0.059 2,380,000 4.24 $ 0.04 1,370,000 $ 0.05 0.07-0.09 1,365,500 2.96 0.08 1,526,934 0.08 0.11-0.1325 2,340,000 2.93 0.11 2,090,000 0.11 0.61-1.18 525,000 1.02 0.93 525,000 0.93 1.325 392,500 1.00 1.33 392,500 1.33 - --------------------------------------------------- -------------------------------- ---------- $ 0.0345-1.325 7,003,000 3.13 $ 0.21 5,904,434 $ 0.24 WARRANTS $ 0.0172-0.039 29,634,938 6.79 $ 0.03 29,634,938 $ 0.03 0.04-0.044 39,156,429 6.26 0.04 39,156,429 0.04 0.045-0.049 21,057,218 5.95 0.05 21,057,218 0.05 0.05-0.094 27,793,558 6.32 0.08 26,593,558 0.08 0.10-0.65 3,707,277 2.87 0.13 3,707,277 0.13 - --------------------------------------------------- -------------------------------- ---------- $ 0.0172-0.65 121,349,420 6.25 $ 0.05 120,149,420 $ 0.05
7. NET LOSS PER SHARE The Company has implemented Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 provides for the calculation of "Basic" and "Diluted" earnings per share ("EPS"). Basic EPS includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of an entity. The Company's net losses for the periods presented cause the inclusion of potential common stock instruments outstanding to be antidilutive and, therefore, in accordance with SFAS No. 128, the Company is not required to present a diluted EPS. During the years ended May 31, 2004 and 2003, common stock options and warrants convertible or exercisable into approximately 128,352,420 and 64,046,468 shares of common stock were not included in diluted loss per share as the effect was antidilutive due to the Company recording losses in each of those years. F-21 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. INCOME TAXES The net deferred tax asset recorded and its approximate tax effect consisted of the following: May 31, - -------------------------------------------------------------------------------- 2004 2003 - -------------------------------------------------------------------------------- Net operating loss carryforwards $12,873,000 $12,073,000 Purchased technology 371,000 420,000 Depreciation and amortization 1,434,000 1,607,000 Other, net 54,000 191,000 - -------------------------------------------------------------------------------- 14,732,000 14,291,000 Valuation allowance 14,732,000 14,291,000 - -------------------------------------------------------------------------------- Net deferred tax asset $ -- $ -- - -------------------------------------------------------------------------------- A reconciliation of the income taxes at the federal statutory rate to the effective tax rate is as follows:
May 31, 2004 2003 - ----------------------------------------------------------------------------------------------------------------- Federal income tax benefit computed at the Federal statutory rate $(1,411,000) $(1,322,000) State income tax benefit net of Federal benefit (242,000) (139,000) Other- permanent differences 1,212,000 521,000 Expiration of state net operating loss carryforwards -- 95,000 Change in valuation allowance 441,000 845,000 - ----------------------------------------------------------------------------------------------------------------- Income tax benefit $ -- $ -- - -----------------------------------------------------------------------------------------------------------------
As of May 31, 2004 and 2003, valuation allowances equal to the net deferred tax asset recognized have been recorded, as management has not determined that it is more likely than not that the deferred tax asset will be realized. No current tax provision was recorded for fiscal 2004 and 2003 due to reported losses. The valuation allowance increased $441,000 for the year ended May 31, 2004 and $845,000 for the year ended May 31, 2003. At May 31, 2004, the Company has federal net operating loss carryforwards of approximately $34,290,000 that expire through 2023 and are subject to certain limitations under the Internal Revenue Code of 1986, as amended. As such, certain federal net operating loss carryforwards may expire unused. At May 31, 2004, the Company has state net operating loss carryforwards of approximately $20,244,000 that expire through 2011. The state of California suspended the utilization of net operating losses for 2002 and 2003. F-22 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. PROFIT-SHARING PLAN Effective July 1, 1993, the Company adopted a savings and profit-sharing plan that allows participants to make contributions by salary reduction pursuant to Section 401(k) of the Internal Revenue Code. At the Company's discretion, the Company may match contributions at 20% of the employee's contribution up to 6% of the employee's salary. The Company contributions are vested 20% per year beginning with the first year of service. The Company made no matching contribution in fiscal 2004 or 2003. 10. COMMITMENTS AND CONTINGENCIES LITIGATION In December 2003, the Company filed several lawsuits in United States District Courts against companies it contends are infringing on its patent number 5,809,336 entitled "High Performance Microprocessor Having Variable Speed Clock." The defendants and suits are as follows: Defendant U.S. District Court Case Number - --------- ------------------- ----------- Sony Corporation of America Southern District of New York 03CV10142 Fujitsu Northern District of California C035787 Toshiba America, Inc. Southern District of New York 03CV10180 NEC USA, Inc. Eastern District of New York CV036432 Matsushita District of New Jersey 03CV06210 The Company is requesting the courts to enjoin the defendants from making use of our patent and are requesting damages for past infringements. In February, with the consent of the defendants and the Company, the above five actions were consolidated into the Fujitsu action in the Northern District of California under case number C035787. In February 2004, Intel Corporation filed a lawsuit against the Company in the United States District Court- Northern District of California, case number C040439, in which they are requesting a declaratory judgment that their microprocessors, used by the defendants in our consolidated suit, do not infringe the Company's patent. The Company filed a counterclaim against Intel contending that they also are infringing on its patent, and Intel asserted an affirmative defense that the Company's 5,809,336 patent is invalid. Also in February 2004, the Company filed a lawsuit in the United States District Court- Northern District of California, case number C040618, against Charles H. Moore, Technology Properties Limited, and Daniel E. Leckrone. The Company is requesting the court to declare inventorship and ownership on each of its granted patents related to the suits discussed above and other unasserted claims of infringement Patriot believes it has. F-23 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Intel lawsuit has been stayed pending the results of the Moore lawsuit. OPERATING AND CAPITAL LEASES The Company is obligated under employment contracts with certain key employees to pay severance upon termination under certain defined conditions. Generally, unless relieved of their duties for cause, the executive officers are entitled to severance pay equal to two to four months of their then current monthly salary. In the case of a change in control, generally, the executive officers are entitled to severance pay equal to twelve months of their then current monthly salary unless they continue to work for the new controlling interest in the same function as previous to the change. The Company granted a lien and security interest in substantially all of its assets to the bank under the accounts receivable factoring line and to investors under its notes payable and convertible debentures. The Company has one capital lease at May 31, 2004. Future minimum lease payments are as follows: Year ending May 31, 2005 $ 9,562 2006 2,391 - ----------------------------------------------------------- Total minimum lease payments 11,953 Amount representing interest 1,627 - ----------------------------------------------------------- Present value of minimum lease payments 10,326 Total obligation 10,326 Less current portion (8,020) - ----------------------------------------------------------- Long-term portion $ 2,306 - ----------------------------------------------------------- Capital leases included in fixed assets at May 31, 2004 and 2003, were $3,471 and $11,803, net of an allowance for depreciation of $21,524 and $13,192. Depreciation expense related to the capitalized lease was $8,332 and $8,332 for the years ended May 31, 2004 and 2003. F-24 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company has a non-cancellabe operating lease for its office and manufacturing facilities located in San Diego, California. Future minimum lease payments required under the operating lease are as follows: Years ending May 31, - -------------------------------------------------------------------------- Gross Sublease Net Payments Income Payments 2005 $ 135,454 $ 70,470 $ 64,984 2006 141,658 72,540 69,118 2007 23,782 12,150 11,632 Thereafter - - - - -------------------------------------------------------------------------- Total minimum lease payments $ 300,894 $ 155,160 $ 145,734 - -------------------------------------------------------------------------- Rent expense for fiscal 2004 and 2003 was $181,135 and $189,423, respectively. 11. SEGMENT INFORMATION EXPORT SALES The Company is engaged in one business segment, the development and marketing of microprocessor technology related products and licenses. Telecommunication products have reached the end of their life cycles and no longer provide any significant sales. During the fiscal years ended May 31, 2004 and 2003, the Company's product sales of high technology computer products and licenses were $13,615 and $31,340 and telecommunication products and licenses were $62,802 and $92,563. For the purpose of allocating revenues by geographic location, the Company uses the physical location of its customers as its basis. During the fiscal years ended May 31, 2004 and 2003, the Company's sales by geographic location consisted of the following: 2004 2003 -------- -------- Domestic sales $ 70,000 $113,000 Foreign sales: Europe 6,000 11,000 -------- -------- Total foreign sales 6,000 11,000 -------- -------- Total net product sales $ 76,000 $124,000 ======== ======== The Company has no foreign assets. F-25 PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SALES TO MAJOR CUSTOMERS During the fiscal years ended May 31, 2004 and 2003, revenues from significant customers consisted of the following: 2004 2003 -------------------------- --------------------------- Customer Sales Percent Sales Percent - -------- ---------- ------------- ------------ ------------ A $ 25,000 33.2% $ - - B 18,000 22.9% - - C 9,000 11.9% - - D - - 43,000 34.3% E - - 23,000 18.6% F - - 15,000 11.9% G - - 15,000 11.9% 12. RELATED PARTY TRANSACTIONS During fiscal year 2004, we sold services totaling $25,352 to a company owned by one of our officers. F-26 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DATED: August 18, 2004 PATRIOT SCIENTIFIC CORPORATION By: /s/ LOWELL W. GIFFHORN ------------------------------------------ Lowell W. Giffhorn Executive Vice President, Chief Financial Officer and Secretary In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/JEFFREY E. WALLIN President and Chief Executive August 18, 2004 -------------------- Jeffrey E. Wallin Officer /s/LOWELL W. GIFFHORN Chief Financial Officer, Principal August 18, 2004 --------------------- Lowell W. Giffhorn Financial Officer, Principal Accounting Officer, Secretary and Director /s/DAVID POHL Director August 18, 2004 ------------- David Pohl /s/CARLTON JOHNSON Director August 18, 2004 ------------------- Carlton Johnson /s/DONALD BERNIER Chairman of the Board and August 18, 2004 ----------------- Director Donald Bernier /s/HELMUT FALK JR. Director August 18, 2004 - ------------------ Helmut Falk Jr. /s/GLORIA FELCYN Director August 18, 2004 - ---------------- Gloria Felcyn F-27 EX-10.35 2 v07972_ex10-35.txt EXHIBIT 10.35 This EMPLOYMENT AGREEMENT ("Agreement") is effective as of June 1, 2004 by and between PATRIOT SCIENTIFIC CORPORATION, a Delaware Corporation (the "Company"), and PATRICK NUNALLY (the "Employee"). The parties agree as follows: 1. Term of Employment. The Company hereby agrees to employ the Employee and the Employee hereby agrees to accept employment as Chief Technology Officer (CTO) of the Company for a one year period commencing June 1, 2004, or for such shorter period as may be mutually agreed by the Company and the Employee (the "Employment Period'), subject to the terms and conditions of this Agreement. In his capacity as CTO of the Company, Employee will be responsible for the general duties associated with his title including, but not limited to the development of the company technology and product roadmaps as well as researching, developing, testing, and monitoring the production of products necessary to enable the Company to successfully market and sell its microprocessor technology and other technology and/or such other duties on behalf of the Company as may be assigned to him from time to time by the Chief Executive Officer ("CEO") of the Company. The Employee agrees that, during the Employment Period, he will serve the Company faithfully and to the best of his abilities, devoting substantially all his time, energy and skill to the activities of the Company and the promotion of its interests. The Employee agrees not to work for or participate in any business that competes in any manner with the business of the Company during his employment with the Company, including after hours, or on weekends, or during vacation time, even if only organizational assistance or limited consultation is involved. 2. Compensation and Benefit Plans. (a) The Employee shall receive a base salary during the Employment Period which shall be payable in installments at such times as other employees are paid but in any case at least monthly as follows: The Employee shall receive a gross base salary of not less than fifteen thousand dollars ($15,000.00) per month for his services as CTO. The base salary may be subject to other upward adjustments as may be recommended by the CEO of the Company to the Board of Directors of the Company (the "Board") and as shall be approved by the Board and Compensation Committee. (b) The Employee may receive, at the sole discretion of the Board of Directors of the Company, an Annual Incentive Bonus up to 50% of the total yearly base compensation for the applicable year (the "Annual Incentive Bonus"). The Annual Incentive Bonus payment will be based upon mutually agreed upon objectives and levels of performance, if any, and shall otherwise be at the discretion of the Board of Directors. (c) The Employee shall be eligible to participate in all employee benefit programs, if any, maintained by the Company, including, but not limited to, group life insurance, medical, dental, retirement and pension plans, any deferred compensation profit sharing plans, 401(k) savings plan, and other such fringe benefits as are or may be available from time to time to senior Employees of the Company, including without limitation a car allowance of $400 per month. The Company reserves the right to modify or eliminate such fringe benefits on a prospective basis, at any time, effective upon 60 days notice to Employee. During the Employment Period, the Employee shall accrue vacation at the rate of 4 weeks per annum. EX-1 (d) The Company will pay or reimburse the Employee during the Employment Period for all expenses normally reimbursed by the Company and reasonably incurred by the Employee in furtherance of his duties hereunder including but not limited to, expenses of entertainment, travel, meals, hotel accommodations and the like upon the submission by the Employee of vouchers or an itemized list thereof and as may be required in order to permit such payments as proper deductions for the Company under the Internal Revenue Code of 1986 and the rules and regulations adopted pursuant thereto now or hereafter in effect. Any and all business expenses exceeding $100.00 shall be pre-approved by the CEO of the Company. 3. Stock Options. (a) The Employee has been granted an option dated December 18, 2003 to purchase up to 173,000 shares of the Company's common stock at an exercise price of $.0345. (b) The Stock Option will vest according to the following schedule: 1. 25% on billings to customers accumulating $200,000 subsequent to December 18, 2003 and previous to December 31, 2004, 50% on billings to customers accumulating $500,000 subsequent to December 18, 2003 and previous to December 31, 2004. 2. 100% on billings to customers accumulating $750,000 subsequent to December 18, 2003 and previous to December 31, 2004. 3. Any shares not vested as of December 31, 2004 shall be cancelled. 4. Termination of Employment. (a) Termination for Cause by Company. The Company may terminate Employee's employment immediately at any time for good cause, including, but not limited to: (a) acts or omissions constituting gross negligence, recklessness, gross misconduct, dishonesty or an act of moral turpitude on the part of Employee; (b) Employee's material breach of this Agreement or any other confidentiality agreement between the Company and Employee; (c) Employee's conviction or entry of a plea of nolo contendere for fraud, misappropriation or embezzlement, or any felony or crime of moral turpitude; (d) Employee's breach of fiduciary duty toward the Company; (e) Employee's inability to perform all of the essential functions and duties of Employee's position, with or without reasonable accommodation; (f) Employee's death; (g) improper actions taken to impair the Company's duly held licenses; (h) a determination or request by an appropriate regulatory authority that the Employee be removed or disqualified from acting as an officer of the Company; (i) Employee's failure to satisfactorily perform his duties to the Company, provided that Employee fails to cure any such failure within 30 days after written notice from the Company of such failure, provided further, however, that such right to cure shall not apply to any repetition of the same failure previously cured hereunder; or (j) Employee's violation of any material rule, regulation or policy of the Company that may be established and made known to the Company's employees from time to time. In the event Employee's employment is terminated in accordance with this subparagraph 4.(a), Employee shall be entitled to receive only the Base Salary then in effect, prorated to the date of termination, and any benefits and expense reimbursements to which Employee is entitled by virtue of his prior employment with the Company through the date of termination (collectively referred to as "Standard Entitlements."). All other company obligations to Employee pursuant to this Agreement will become automatically terminated and completely extinguished. Executive will not be entitled to receive any severance payment or any part thereof. EX-2 (b) Termination Without Cause By The Company. If the Employee's employment is terminated for other than cause by the Company, then the Employee is entitled to severance payments equal to the lesser of: (1) two (2) months of the then current base salary payable in a lump sum payment or (2) the then current base salary for the remaining term of this Agreement payable in a lump sum, providing Employee executes a full general release, releasing all claims, known or unknown, that Employee may have against the Company arising out of or any way related to Employee's employment or termination of employment with the Company. In such event, the Employee shall have the right to continue coverage in accordance with COBRA, at his expense, under group life insurance, medical, and dental healthcare plans of the Company by paying the applicable group premium(s) as if the Employee were still employed. (c) Voluntary Resignation By Employee. Employee may voluntarily resign Employee's position with the Company, at any time, on thirty (30) days advance written notice. The Company reserves the right, exercisable in its sole discretion, to pay Employee his Base Salary and the value of other contractual benefits provided herein, on a pro rata basis in lieu of the required noticed. In the event of Employee's resignation, Employee will be entitled to receive the Standard Entitlements to the date of resignation and no other amount for the remaining term of this Agreement, if any. All other company obligations to Employee pursuant to this Agreement will become automatically terminated and completely extinguished. Employee will not be entitled to receive any severance payment. (d) Change of Control. If within six (6) months of a Change in Control, as that term is defined herein, Employee refuses to accept or voluntarily resigns from a position other than a Qualified Position, as that term is defined herein, Employee shall receive severance compensation equal to the lesser of: (1) two (2) months of the then current base salary payable in a lump sum payment or (2) the then current base salary for the remaining term of this Agreement payable in a lump sum, providing Employee executes a full general release, releasing all claims, known or unknown, that Employee may have against the Company arising out of or any way related to Employee's employment or termination of employment with the Company. A "Change in Control" means the acquisition, directly or indirectly, of more than 40% of the outstanding shares of any class of voting securities of the Company by one person or one entity that is not an existing shareholder as of the date of this Agreement, or a merger, consolidation or sale of all or substantially all of the assets of the Company, such that the individuals constituting the Board of the Company immediately prior to such period shall cease to constitute a majority of the Board, unless the election of each director who was not a director prior thereto was approved by vote of at least two-thirds of the directors then in office who were directors prior to such period. Notwithstanding the foregoing, an acquisition of the requisite percentage of voting securities in connection with a public offering of securities by the Company for the primary purpose of providing capital resources to the Company shall not be considered a "Change in Control" for purposes of this paragraph. "Qualified Position" is an Employee officer position with the entity surviving the Change in Control with substantially the same responsibilities as those held by the Employee on the date of the Change in Control as determined by the Company's compensation committee in its sole discretion. Also, notwithstanding the foregoing, if the Company determines that the amounts payable to Employee under this Agreement, cause such payments to be treated as excess parachute payments within the meaning of Section 280G of the Internal Revenue Code, the Company shall reduce the amount payable to Employee under this Section 4(d) to an amount that will not subject Employee to the imposition of tax under Section 4999 of the Internal Revenue Code; provided, however, that this provision shall apply only to payments to be made under this employment agreement and Employee by the Company. EX-3 5. Trade Secrets of the Company, Patents and Inventions. Employee agrees to read, sign and abide by the Company's Proprietary Information and Inventions Agreement which is attached as Exhibit 1 and incorporated herein by reference. 6. Severability. In the event that any provisions or portion of this Agreement shall be determined to be invalid or unenforceable for any reason, in whole or in part, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect to the fullest extent permitted by law. 7. Assignment. The rights of the Company (but not its obligations) under this Agreement may, without the consent of the Employee, be assigned by the Company to any parent, subsidiary, or a successor of the Company; provided that such parent, subsidiary or successor acknowledges in writing that it is also bound by the terms and obligations of this Agreement. [?] Except as provided for in Section 9 hereunder the Employee may not assign all or any of his rights, duties or obligations hereunder without the prior written consent of the Company. 8. Survival of Certain Provisions. The covenants and agreements set forth in Paragraph 5 through 18 of this Agreement shall survive termination of the Employee's employment and/or this Agreement, and shall remain in full force and effect regardless of the cause of such termination. 9. Beneficiaries: References. The Employee shall be entitled to select (and change) a beneficiary or beneficiaries to receive any accrued compensation or benefit payable, if any, following the Employee's death, and may change such election, in either case, by giving the Company written notice thereof. In the event of the Employee's death or a judicial determination of his incompetence, reference in this Agreement shall be deemed, where appropriate, to refer to the Employee's beneficiary, estate, committee, conservator or other legal representative. 10. Notices. All notices, requests, demands and other communications shall be in writing and shall be defined to have been duly given if delivered or if mailed by registered mail, postage prepaid; (a) If to the Employee, addressed to him at the following address as may be changed in writing from time to time: Patrick Nunally 2227 Villa Verde Road Escondido, CA 92029 EX-4 (b) If to the Company, addressed to: CEO Patriot Scientific Corporation 10989 Via Frontera San Diego, CA 92127 or to such other address as any party may request by notice given as aforesaid to the other parties hereto. 11. Titles and Headings. Titles and headings to paragraphs hereof are for the purposes of references only and shall in no way limit, define or otherwise effect the provisions hereof 12. Governing Law. This Agreement is being executed and delivered and is intended to be performed in the State of California, and shall be governed by and construed in accordance with the laws of the State of California. 13. Agreement to Arbitrate. Employee and Company agree to arbitrate any controversy, claim or dispute between them arising out of or in any way related to this Agreement, the employment relationship between them, and any disputes upon termination of employment in accordance with the Arbitration Agreement attached hereto as Exhibit "2" and incorporated by this reference as though fully set forth herein. 14. Counterparts. This Agreement shall be executed simultaneously in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. It shall not be necessary in making proof of this Agreement to produce or account for more than one original counterpart. 15. Entire Agreement. This Agreement, including the Exhibits attached hereto, contains the entire agreement of the parties hereto and may be modified or amended only by a written instrument executed by the parties hereto. This Agreement supersedes any previous oral or written communications, representations, understandings or agreements with Employer or any officer or agent thereof through the date the Agreement is executed by the parties. Employee understands that no representative of the Company has been authorized to enter into any agreement or commitment with Employee which is inconsistent in any way with the terms of this Agreement. 16. Good Faith. Each of the parties hereto agrees that he or it shall act in good faith in all actions taken under this Agreement. 17. Waiver. No waiver of any of the provisions of this Agreement shall be deemed to be or shall constitute a waiver of any other provision of the Agreement, whether or not similar, nor shall any waiver constitute a continuing waiver. No waiver of any provision of this Agreement shall be binding upon the parties hereto unless it is executed in writing by the party making the waiver. 18. Interpretation; Construction. The headings set forth in this Agreement are for convenience only and shall not be used in interpreting this Agreement. This Agreement has been drafted by legal counsel representing the Company, but Employee has participated in the negotiation of its terms. Furthermore, Employee acknowledges that Employee has had an opportunity to have it reviewed by legal counsel, if desired, and, therefore, the normal rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Agreement. EX-5 IN WITNESS WHEREOF, the parties hereto have executed the Agreement as of the day and year first above written. PATRIOT SCIENTIFIC CORPORATION By: /s/ J.E. WALLIN ------------------ J.E. Wallin, CEO Employee: By: /s/ PATRICK NUNALLY -------------------- Patrick Nunally EX-6 EX-10.36 3 v07972_ex10-36.txt EXHIBIT 10.36 AMENDMENT NUMBER 1 TO EMPLOYMENT AGREEMENT This Amendment Number 1 (the "Amendment") is effective as of July 12, 2004 by and between PATRIOT SCIENTIFIC CORPORATION, a Delaware Corporation (the "Company") and PATRICK NUNALLY (the "Employee"). WITNESSETH: WHEREAS, the Company and the Employee entered into an Employment Agreement dated June 1, 2004 (the "Employment Agreement"). NOW, THEREFORE, in consideration of the covenants and mutual agreements set forth herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties do hereby agree as follows: 1. TERM OF EMPLOYMENT. Section 1of the Employment Agreement is hereby amended by adding said section as paragraph 3: The Employee is classified as a Full -time employee as outlined in the Company Employee Handbook, working a minimum of thirty-five (35) hours per week. The Employee will work a minimum of four (4) hours per day at the Company office between the hours of 8:00 a.m. to 12:00 p.m. These hours will be flexible with a twenty four (24) hour notice provided by employee to the CEO. 2. COMPENSATION AND BENEFIT PLANS. Section 2(a) of the Employment Agreement is hereby amended by deleting the first sentence in its entirety and inserting the following in lieu there of: The Employee shall receive a base salary during the Employment Period which shall be payable in installments at such times as other employees are paid but in any case at least monthly as follows: The Employee shall receive a gross base salary of not less than ten thousand dollars ($10,000.00) per month for his services as CTO. IN WITNESS WHEREOF, the parties have executed the Amendment Number 1 as of the date first above written. COMPANY: PATRIOT SCIENTIFIC CORPORATION By: /s/ J.E. WALLIN ---------------------------------- J.E. WALLIN, President and Chief Executive Officer EMPLOYEE: /S/ PATRICK NUNALLY ---------------------------------- PATRICK NUNALLY EX-7 EX-21.1 4 v07972_ex21-1.txt EXHIBIT 21.1 Subsidiaries of the Registrant Metacomp Inc., a California corporation Plasma Scientific Corp., a Delaware corporation. EX-8 EX-23.1 5 v07972_ex23-1.txt EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM Patriot Scientific Corporation San Diego, California We hereby consent to the incorporation by reference in the previously filed Registration Statements (No. 333-36418, No. 333-57602, No. 333-81156, No. 333-100901 and No. 333-108489) of Patriot Scientific Corporation of our report dated July 8, 2004, relating to the consolidated financial statements of Patriot Scientific Corporation, appearing in the Company's Annual Report on Form 10-KSB for the year ended May 31, 2004. Our report contained an explanatory paragraph regarding the Company's ability to continue as a going concern. /s/ Nation Smith Hermes Diamond San Diego, California August 18, 2004 EX-9 EX-31.1 6 v07972_ex31-1.txt EXHIBIT 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER Section 302 Certification I, Jeffrey E. Wallin, Chief Executive Officer of the registrant, certify that: 1. I have reviewed this annual report on Form 10-KSB of Patriot Scientific Corportion; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial data; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 18, 2004 /s/ Jeffrey E. Wallin -------------------------- Jeffrey E. Wallin Chief Executive Officer EX-31.2 7 v07972_ex31-2.txt EXHIBIT 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER Section 302 Certification I, Lowell W. Giffhorn, Chief Financial Officer of the registrant, certify that: 1. I have reviewed this annual report on Form 10-KSB of Patriot Scientific Corportion; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial data; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Dated: August 18, 2004 /s/ Lowell W. Giffhorn ----------------------- Lowell W. Giffhorn Chief Financial Officer EX-32.1 8 v07972_ex32-1.txt EXHIBIT 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report on Form 10-KSB of Patriot Scientific Corporation (the "Company") for the period ended May 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Jeffrey E. Wallin, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /S/ JEFFREY E. WALLIN ---------------------------- Name: Jeffrey E. Wallin Title: President and CEO Date: August 18, 2004 EX-32.2 9 v07972_ex32-2.txt EXHIBIT 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report on Form 10-KSB of Patriot Scientific Corporation (the "Company") for the period ended May 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Lowell W. Giffhorn, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge: 1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /S/ LOWELL W. GIFFHORN Name: Lowell W. Giffhorn Title: Exec. V.P. and CFO Date: August 18, 2004 -----END PRIVACY-ENHANCED MESSAGE-----