Notes to Unaudited Condensed Consolidated
Financial Statements
1. Basis of Presentation and Summary of Significant Accounting
Policies
The unaudited condensed consolidated financial
statements of Patriot Scientific Corporation (the “Company”, “PTSC”, “Patriot”, “we”,
“us” or “our”) presented herein have been prepared pursuant to the rules of the Securities and Exchange
Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnotes required
by accounting principles generally accepted in the United States of America. These unaudited condensed consolidated financial statements
should be read in conjunction with our audited consolidated financial statements and notes thereto included in our Report on Form
10-K for our fiscal year ended May 31, 2017.
In the opinion of management, the interim
condensed consolidated financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation
of the results for the interim period presented. Operating results for the six month period ended November 30, 2017 are not necessarily
indicative of the results that may be expected for the year ending May 31, 2018.
Basis of Consolidation
The condensed consolidated balance sheets
at November 30, 2017 and May 31, 2017 and condensed consolidated statements of operations and condensed consolidated statements
of cash flows for the six months ended November 30, 2017 and 2016 include our accounts and those of our inactive subsidiaries:
Patriot Data Solutions Group, Inc. (“PDSG”) which includes Crossflo Systems, Inc. (“Crossflo”), and Plasma
Scientific Corporation. All significant intercompany accounts and transactions have been eliminated.
Liquidity and Management’s Plans
Cash shortfalls currently experienced by
Phoenix Digital Solutions, LLC (“PDS”) will have an adverse effect on our liquidity. To date, we have determined that
it is in the best interests of the Moore Microprocessor Patent (“MMP”) licensing program that we provide our 50% share
of capital to provide for PDS expenses including legal retainers, and litigation related payments in the event license revenues
received by PDS are insufficient to meet these needs. We believe it is likely that contributions to PDS to fund working capital
will continue to be required.
PDS had been incurring significant third-party
costs for expert testimony, depositions and other related litigation costs. We could be required to make capital contributions
to PDS for any future litigation related costs in the event that PDS does not receive sufficient licensing revenues to pay these
expenses.
Our current liquid cash resources are expected
to provide the funds necessary to support our operations through at least the next twelve months from the date of this report.
The cash flows from our interest in PDS represent our only significant source of cash generation. In the event of a
continued decrease or interruption in MMP portfolio licensing we will incur a significant reduction to our cash position. It is
highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and cash equivalents
and short-term investment position.
On March 20, 2013, Technology
Properties Limited, Inc. (“TPL”) filed a petition under Chapter 11 of the United States Bankruptcy Code. We have
been appointed to the creditors’ committee. A Joint Plan of Reorganization (the “Joint Plan”) between TPL
and the creditor’s committee was confirmed by the Bankruptcy Court on February 11, 2015 with the entered
confirmation order becoming final on April 2, 2015. In the event we are required to provide funding to PDS that is not
reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling financial interest in PDS,
in which case, we will consolidate PDS in our condensed consolidated financial statements.
Investments in Marketable Securities
We determine the appropriate classification
of our investments at the time of purchase and reevaluate such designation at each balance sheet date. Our investments in marketable
securities have been classified and accounted for as held-to-maturity based on management’s investment intentions relating
to these securities. Held-to-maturity marketable securities are stated at amortized cost. Unrealized gains and losses, net of deferred
taxes, are recorded as a component of other comprehensive income (loss). We follow the authoritative guidance to assess whether
our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in fair
value judged to be other than temporary are determined based on the specific identification method and are reported in other income
(expense), net in the condensed consolidated statements of operations.
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Investment in Affiliated Company
We have a 50% interest in PDS (see Note
3). We account for our investment using the equity method of accounting since the investment provides us the ability to exercise
significant influence, but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership
interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee’s
Board of Directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method
of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the
investee and is recognized in the condensed consolidated statements of operations in the caption “Equity in earnings (loss)
of affiliated company” and also is adjusted by contributions to and distributions from PDS.
PDS, as an unconsolidated equity investee,
recognizes revenue from technology license agreements at the time a contract is entered into, the license method is determined
(paid-in-advance or on-going royalty), performance obligations under the license agreement are satisfied, and the realization of
revenue is assured, which is generally upon the receipt of the license proceeds. PDS may at times enter into license agreements
whereby contingent revenues are recognized as one or more contractual milestones are met.
We review our investment in PDS to determine
whether events or changes in circumstances indicate that the carrying amount may not be recoverable. The primary factors we consider
in our determination are the financial condition, operating performance and near term prospects of PDS. If a decline in value
is deemed to be other than temporary, we would recognize an impairment loss.
Earnings (Loss) Per Share
Basic earnings per share includes no dilution
and is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an
entity.
For the three and six months ended November
30, 2017, potential common shares of 2,600,000 related to our outstanding options were not included in the calculation of diluted
loss per share as we recorded a loss. Had we reported net income for the three and six months ended November 30, 2017, no shares
of common stock would have been included in the calculation of diluted income per share using the treasury stock method.
For the three and six months ended November
30, 2016, potential common shares of 2,600,000 related to our outstanding options were not included in the calculation of diluted
income per share as their inclusion would be anti-dilutive. For the three and six months ended November 30, 2016, we included the
PDSG escrow shares of 2,844,630 in the calculation of diluted income per share.
In connection with our acquisition of Crossflo,
which is part of PDSG, we issued escrow shares that are contingent upon certain representations and warranties made by Crossflo
at the time of the merger agreement (see Note 6). We excluded these escrow shares from the basic loss per share calculations and
would have included the escrowed shares in the diluted income per share calculations if we reported net income for the three and
six months ended November 30, 2017.
Income Taxes
We follow authoritative guidance in accounting
for uncertainties in income taxes. This authoritative guidance prescribes a recognition threshold and measurement requirement for
the financial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and also provides
guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Under
this guidance we may only recognize tax positions that meet a “more likely than not” threshold.
We follow authoritative guidance to evaluate
whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available
evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence
that can be objectively verified. We assess our deferred tax assets annually under more likely than not scenarios in which they
may be realized through future income.
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Income Taxes (continued)
We have determined that it was more likely
than not that all of our deferred tax assets will not be realized in the future due to our continuing pre-tax and taxable losses.
As a result of this determination we have recorded a full valuation allowance against our deferred tax assets.
We follow authoritative guidance to adjust
our effective tax rate each quarter to be consistent with the estimated annual effective tax rate. We are also required to record
the tax impact of certain discrete items, unusual or infrequently occurring, including changes in judgment about valuation allowances
and effects of changes in tax laws or rates, in the interim period in which they occur. In addition, jurisdictions with a projected
loss for the year or a year-to-date loss where no tax benefit can be recognized are excluded from the estimated annual effective
tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based
upon the mix and timing of actual earnings or losses versus annual projections.
On December 22, 2017, the United
States Government passed new tax legislation that, among other provisions, will lower the corporate tax rate from 35% to 21%.
In addition to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income we may have, the
legislation affects the way we can use and carryforward net operating losses previously accumulated and results in a
revaluation of deferred tax assets and liabilities recorded on our condensed consolidated balance sheet. Given that our
current deferred tax assets are offset by a full valuation allowance, these changes will have no net impact on our condensed
consolidated balance sheet. However, if we become profitable, we will receive a reduced benefit from such deferred tax
assets.
Assessment of Contingent Liabilities
We are involved in various legal matters,
disputes, and patent infringement claims which arise in the ordinary course of our business. We accrue for any estimated losses
at the time when we can make a reliable estimate of such loss and it is probable that it has been incurred. By their very nature,
contingencies are difficult to estimate. We continually evaluate information related to all contingencies to determine that the
basis on which we have recorded our estimated exposure is appropriate.
Intellectual Property Rights
PDS, our investment in affiliated company,
relies on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements
to protect our intellectual property rights. We have seven U.S., nine European, and three Japanese patents all of which expired
between August 2009 and October 4, 2016. These patents, while expired, may have certain retrospective statutory benefits that will
fully diminish six years after the patent expiration dates. The patent useful life for purposes of negotiating licenses is finite
and these patents are subject to legal challenges, which in combination with the limited life, could adversely impact the stream
of revenues. A successful challenge to the ownership of the technology or the proprietary nature of the intellectual property would
materially damage business prospects. Any issued patent may be challenged and invalidated.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards
Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with
Customers,” which was subsequently amended by ASUs 2015-14, 2016-08, 2016-10, 2016-12, and 2016-20. ASU 2014-09, as amended,
supersedes the revenue recognition requirements in ASC Topic 605, “Revenue Recognition”, and creates a new ASC Topic
606 (“ASC 606”). ASU 2014-09, as amended, implements a five-step process for customer contract revenue recognition
that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures
regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions
include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction
price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances.
Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption.
The new revenue standards are effective for annual reporting periods beginning after December 15, 2017, including interim reporting
periods within that reporting period (fiscal year 2019 for the Company). Early adoption is permitted. We are currently assessing
the potential impact of this standard on the revenues generated by PDS.
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Recent Accounting Pronouncements (continued)
In August 2016, the FASB issued ASU No.
2016-15, “Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments.” ASU 2016-15 provides
guidance intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The
issue addressed in ASU 2016-15 that will affect the Company is classifying distributions received from equity method investments.
The guidance provides an accounting policy election for classifying distributions received from equity method investments using
either a cumulative earnings approach or a nature of distributions approach. ASU 2016-15 is effective for financial statements
issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years (fiscal 2019 for the Company).
Early adoption is permitted. We have not yet determined the potential effects of the adoption of ASU 2016-15 on our condensed consolidated
financial statements.
In November 2016, the FASB issued ASU No.
2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. ASU 2016-18 requires that a statement of cash flows
explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash
or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should
be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the
statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within
those fiscal years (fiscal 2019 for the Company), with early adoption permitted. We are currently evaluating the effect ASU 2016-18
will have on our condensed consolidated statements of cash flows.
On December 22, 2017, the date the Tax
Cuts and Jobs Act (“Tax Cuts Act”) was signed into law, the Securities and Exchange Commission staff issued Staff Accounting
Bulletin No. 118 (“SAB 118”) which provides guidance regarding accounting for the income tax effects of the Tax Cuts
Act, including the impact of the Tax Cuts Act on deferred tax assets and liabilities for financial statements issued in the reporting
period that includes the enactment date of December 22, 2017. Given that our current deferred tax assets are offset by a full valuation
allowance, these changes will have no net impact on our condensed consolidated financial statements. However, if we become profitable,
we will receive a reduced benefit from such deferred tax assets.
2. Cash, Cash Equivalents, Restricted Cash and Marketable
Securities
We consider all highly liquid investments
acquired with a maturity of three months or less from the purchase date to be cash equivalents.
Restricted cash and cash equivalents at
November 30, 2017 and May 31, 2017 consist of a savings account held as collateral for our corporate credit card account.
At November 30, 2017 and May 31, 2017,
our short-term marketable securities in the amount of $2,256,105 and $2,203,396, respectively, consist of certificates of deposit
with various financial institutions, with maturity dates between three months and twelve months from the purchase date.
We follow authoritative guidance to
account for our marketable securities as held-to-maturity. Under this authoritative guidance we are required to maximize the
use of observable inputs and minimize the use of unobservable inputs when measuring fair value. We determine fair value based
on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows
using market interest rates commensurate with the credit quality and duration of the investment or valuations by third party
professionals. The three levels of inputs that we may use to measure fair value are:
Level 1: Unadjusted quoted prices in active
markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2: Quoted prices in markets that
are not active or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability;
and
Level 3: Prices or valuation techniques
that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market
activity).
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Cash, Cash Equivalents, Restricted Cash
and Marketable Securities (continued)
The following tables detail the fair value
measurements within the fair value hierarchy of our cash, cash equivalents and investments in marketable securities:
|
|
|
|
|
Fair Value Measurements at
November 30, 2017 Using
|
|
|
|
Fair Value at
November 30,
|
|
|
Quoted Prices in Active Markets for Identical Assets
|
|
|
Significant Other Observable Inputs
|
|
|
Significant Unobservable Inputs
|
|
|
|
2017
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
97,564
|
|
|
$
|
97,564
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Money market funds
|
|
|
347,630
|
|
|
|
347,630
|
|
|
|
–
|
|
|
|
–
|
|
Restricted cash and cash equivalents
|
|
|
21,497
|
|
|
|
21,497
|
|
|
|
–
|
|
|
|
–
|
|
Marketable securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
2,256,105
|
|
|
|
–
|
|
|
|
2,256,105
|
|
|
|
–
|
|
Total
|
|
$
|
2,722,796
|
|
|
$
|
466,691
|
|
|
$
|
2,256,105
|
|
|
$
|
–
|
|
|
|
|
|
|
Fair Value Measurements at May 31, 2017 Using
|
|
|
|
Fair Value at May 31,
|
|
|
Quoted Prices in Active Markets for Identical Assets
|
|
|
Significant Other Observable Inputs
|
|
|
Significant Unobservable Inputs
|
|
|
|
2017
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
93,321
|
|
|
$
|
93,321
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Money market funds
|
|
|
435,899
|
|
|
|
435,899
|
|
|
|
–
|
|
|
|
–
|
|
Certificates of deposit
|
|
|
450,421
|
|
|
|
–
|
|
|
|
450,421
|
|
|
|
–
|
|
Restricted cash and cash equivalents
|
|
|
21,443
|
|
|
|
21,443
|
|
|
|
–
|
|
|
|
–
|
|
Marketable securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
2,203,396
|
|
|
|
–
|
|
|
|
2,203,396
|
|
|
|
–
|
|
Total
|
|
$
|
3,204,480
|
|
|
$
|
550,663
|
|
|
$
|
2,653,817
|
|
|
$
|
–
|
|
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Cash, Cash Equivalents, Restricted
Cash and Marketable Securities (continued)
We purchase certificates of deposit with
varying maturity dates. The following table summarizes the purchase date maturities, gross unrealized gains or losses and fair
value of the certificates of deposit as of November 30, 2017:
|
|
November 30, 2017
(Unaudited)
|
|
|
|
Cost
|
|
|
Gross Unrealized Gains/(Losses)
|
|
|
Fair
Value
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year or less
|
|
$
|
2,256,105
|
|
|
$
|
–
|
|
|
$
|
2,256,105
|
|
We purchase certificates of deposit with
varying maturity dates. The following table summarizes the purchase date maturities, gross unrealized gains or losses and fair
value of the certificates of deposit as of May 31, 2017:
|
|
May 31, 2017
|
|
|
|
Cost
|
|
|
Gross Unrealized Gains/(Losses)
|
|
|
Fair
Value
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in three months or less
|
|
$
|
450,421
|
|
|
$
|
–
|
|
|
$
|
450,421
|
|
Due in one year or less
|
|
$
|
2,203,396
|
|
|
$
|
–
|
|
|
$
|
2,203,396
|
|
3. Investment in Affiliated Company
On June 7, 2005, we entered into a Master
Agreement (the “Master Agreement”) with TPL, and Charles H. Moore (“Moore”), the co-inventor of the technology
which is the subject of the MMP Portfolio of microprocessor patents, pursuant to which the parties resolved all legal disputes
between them. Pursuant to the Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of PDS
(the “LLC Agreement”) into which we and Moore contributed our rights to certain of our technologies.
We and TPL each own 50% of the membership
interests of PDS, and each member has the right to appoint one member of the three member management committee. The two appointees
are required to select a mutually acceptable third member of the management committee. There had not been a third management committee
member since May 2010; however, as a result of our initiation of arbitration seeking the appointment of a third member, on December
16, 2014, an independent manager to the PDS management committee was selected by the arbitrator. Pursuant to the LLC Agreement,
we and TPL initially agreed to establish a working capital fund for PDS of $4,000,000, of which our contribution was $2,000,000.
The working capital fund was increased to a maximum of $8,000,000 as license revenues are achieved. We and TPL are obligated to
fund future working capital requirements at the discretion of the management committee of PDS in order to maintain working capital
of not more than $8,000,000. If the management committee determines that additional capital is required, neither we nor TPL are
required to contribute more than $2,000,000 in any fiscal year. No such contributions were made during the three and six months
ended November 30, 2017 and 2016. Distributable cash and allocation of profits and losses have been allocated to the members in
the priority defined in the LLC Agreement.
On July 11, 2012, we entered into the
Program Agreement with PDS, TPL, and Alliacense, and an Agreement (the “TPL Agreement”) with TPL. Pursuant to the
Program Agreement, PDS engaged Alliacense to negotiate MMP portfolio licenses and to pursue claims against violators of the MMP
portfolio on behalf of PDS, TPL, and the Company. The Program Agreement continued through the useful life of the MMP portfolio
patents. Pursuant to the TPL Agreement, we and TPL agreed to certain allocations of obligations in connection with the engagement
of Alliacense. On July 24, 2014, the Program Agreement was amended with PDS and Alliacense entering into the Amended Alliacense
Services and Novation Agreement (the “Novation Agreement”). Pursuant to the Novation Agreement certain performance
goals and incentives were established for Alliacense. The Novation Agreement also provided for the addition of a second licensing
company, which was engaged on October 10, 2014, to complement the MMP licensing commercialization. However, Alliacense fulfilled
only a portion of its obligations under the Novation Agreement associated with the deployment of the second licensing company
and on May 11, 2015, Alliacense was terminated by PDS.
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Investment in Affiliated Company (continued)
On August 10, 2016, PDS entered into an
agreement with Alliacense and MMP Licensing, LLC to settle matters relating to Alliacense’s non-performance under terms of
the Novation Agreement. The August 10, 2016 agreement requires Alliacense to provide PDS’s second licensing company with
certain materials and to cooperate with reasonable discovery requests relating to infringement litigation currently pending in
the U.S. District Court for the Northern District of California. MMP Licensing, LLC will provide commercialization services to
PDS for the MMP portfolio with respect to certain companies. PDS and Alliacense have agreed to cause the arbitration between the
parties to be dismissed with prejudice. The August 10, 2016 agreement will expire on October 4, 2022. Terms of the settlement agreement
required PDS to pay Alliacense $84,000 within 24 hours after delivery of materials to PDS’s second licensing agent and to
pay Alliacense $84,000 out of subsequent recoveries. On August 11, 2016, PDS paid Alliacense $84,000.
During January 2013, TPL and Moore settled
their litigation. Terms of the settlement included the payment by PDS to Moore of a consulting fee of $250,000 for four years or
until the completion of all outstanding MMP litigation whichever came first. Per terms of the agreement PDS paid Moore $150,000
on the settlement date and paid Moore $16,667 per month from August 2013 through January 2014 and paid $20,833 per month from February
2014 through January 2017. During the three and six months ended November 30, 2016, PDS expensed $62,499 and $124,998, respectively,
pursuant to this commitment. These expenses are recorded in the accompanying PDS statements of operations presented below.
Based on our analysis of current authoritative
accounting guidance with respect to our investment in PDS, we continue to account for our investment in PDS under the equity method
of accounting, and accordingly have recorded our share of PDS’s net loss during the three and six months ended November 30,
2017 of $104,690 and $117,892, respectively, as a decrease in our investment. We have recorded our share of PDS’s net income
during the three and six months ended November 30, 2016 of $1,247,280 and $1,191,885, respectively, as an increase in our investment.
We have recorded our share of PDS’s
net income and loss for the three and six months ended November 30, 2017 and 2016 as “Equity in earnings (loss) of affiliated
company” in the accompanying condensed consolidated statements of operations.
On March 20, 2013, TPL filed a petition
under Chapter 11 of the United States Bankruptcy Code. A Joint Plan of Reorganization (the “Joint Plan”) between TPL
and the creditor’s committee was confirmed by the Bankruptcy Court on February 11, 2015 with the entered confirmation
order becoming final on April 2, 2015. We have been appointed to the creditors’ committee. In the event we are required
to provide funding to PDS that is not reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling
financial interest in PDS, in which case, we will consolidate PDS in our condensed consolidated financial statements. If we determine
that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their
fair values at the date that we have the controlling financial interest.
PDS’s balance sheets at November
30, 2017 and May 31, 2017 and statements of operations for the three and six months ended November 30, 2017 and 2016 are as follows:
Balance Sheets
Assets:
|
|
November 30, 2017
|
|
|
May 31, 2017
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
Cash
|
|
$
|
650,858
|
|
|
$
|
864,180
|
|
Prepaid expenses
|
|
|
23,884
|
|
|
|
26,378
|
|
Total assets
|
|
$
|
674,742
|
|
|
$
|
890,558
|
|
Liabilities and Members’ Equity:
|
|
November 30, 2017
|
|
|
May 31, 2017
|
|
|
|
(Unaudited)
|
|
|
(Audited)
|
|
Payables
|
|
$
|
26,550
|
|
|
$
|
6,582
|
|
Members’ equity
|
|
|
648,192
|
|
|
|
883,976
|
|
Total liabilities and members’ equity
|
|
$
|
674,742
|
|
|
$
|
890,558
|
|
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Investment in Affiliated Company (continued)
Statements of Operations
|
|
Three
Months Ended
|
|
|
Six
Months Ended
|
|
|
|
November
30, 2017
|
|
|
November
30, 2016
|
|
|
November
30, 2017
|
|
|
November
30, 2016
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
3,000,000
|
|
|
$
|
–
|
|
|
$
|
3,000,000
|
|
Expenses
|
|
|
209,381
|
|
|
|
505,441
|
|
|
|
229,785
|
|
|
|
616,020
|
|
Income (loss) before provision for income taxes
|
|
|
(209,381
|
)
|
|
|
2,494,559
|
|
|
|
(229,785
|
)
|
|
|
2,383,980
|
|
Provision for income taxes
|
|
|
–
|
|
|
|
–
|
|
|
|
6,000
|
|
|
|
210
|
|
Net income (loss)
|
|
$
|
(209,381
|
)
|
|
$
|
2,494,559
|
|
|
$
|
(235,785
|
)
|
|
$
|
2,383,770
|
|
We review our investment in PDS to
determine whether events or changes in circumstances indicate that the carrying amount may not be recoverable. The primary
factors we consider in our determination are the financial condition, operating performance and near term prospects of PDS.
If a decline in value is deemed to be other than temporary, we would recognize an impairment loss.
4
.
Income Taxes
We have determined that it was more likely
than not that all of our deferred tax assets will not be realized in the future due to our continuing pre-tax and taxable losses.
As a result of this determination we have recorded a full valuation allowance against our deferred tax assets. There have been
no changes to our determination during the current fiscal year.
On December 22, 2017, the United States
Government passed new tax legislation that, among other provisions, will lower the corporate tax rate from 35% to 21%. In addition
to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income we may have, the legislation affects
the way we can use and carryforward net operating losses previously accumulated and results in a revaluation of deferred tax assets
and liabilities recorded on our condensed consolidated balance sheet. Given that our current deferred tax assets are offset by
a full valuation allowance, these changes will have no net impact on our condensed consolidated balance sheet. However, if we become
profitable, we will receive a reduced benefit from such deferred tax assets.
5. Stockholders’ Equity
Share-based Compensation
Summary of Assumptions and Activity
The fair value of share-based awards to
employees and directors is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate
the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our
stock options.
The Black-Scholes model also requires subjective
assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.
The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination
behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the
pricing term of the grant effective as of the date of the grant. The expected volatility is based on the historical volatilities
of our common stock. These factors could change in the future, affecting the determination of share-based compensation expense
in future periods.
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Stockholders’ Equity (continued)
A summary of
option activity as of November 30, 2017 and changes during the six months then ended, is presented below:
|
|
Shares
|
|
|
Weighted Average Exercise Price
|
|
|
Weighted Average Remaining Contractual Term (Years)
|
|
|
Aggregate Intrinsic Value
|
|
Options outstanding at June 1, 2017
|
|
|
2,600,000
|
|
|
$
|
0.06
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
Options exercised
|
|
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
Options forfeited/expired
|
|
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
Options outstanding at November 30, 2017
|
|
|
2,600,000
|
|
|
$
|
0.06
|
|
|
|
1.87
|
|
|
$
|
–
|
|
Options vested and expected to vest at November 30, 2017
|
|
|
2,600,000
|
|
|
$
|
0.06
|
|
|
|
1.87
|
|
|
$
|
–
|
|
Options exercisable at November 30, 2017
|
|
|
2,600,000
|
|
|
$
|
0.06
|
|
|
|
1.87
|
|
|
$
|
–
|
|
The aggregate
intrinsic value represents the differences in market price at the close of the quarter ($0.008 per share on November 30, 2017)
and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.008 per share) on November
30, 2017.
6. Commitments and Contingencies
Litigation
Patent Litigation
We, TPL, and PDS (collectively referred
to as “Plaintiffs”) are Plaintiffs in ongoing proceedings in the U.S. District Court for the Northern District of California
where the Plaintiffs allege infringement of the US 5,809,336 patent (the “‘336 patent”) by: Huawei Technologies
Co. Ltd., LG Electronics, Nintendo Co. Ltd., Samsung Electronics Co. Ltd., and ZTE Corporation. This litigation is proceeding in
front of District Court Judge Vince Chhabria.
These ongoing proceedings relate to the
proceedings filed by the Plaintiffs in February 2008 in the U.S. District Court for the Northern District of California alleging
infringement of the US 5,440,749 patent (the “‘749 patent”), the US 5,530,890 patent (the “‘890
patent”) and the ‘336 patent against Amazon.com Inc., Barnes & Noble Inc., Garmin Ltd., Huawei Technologies Co.
Ltd., Kyocera Corporation, LG Electronics, Nintendo Co. Ltd., Novatel Wireless Inc., Samsung Electronics Co. Ltd., Sierra Wireless
Inc., and ZTE Corporation. We have settled with all defendants except those named in the first paragraph to this footnote.
On September 18, 2015, a Markman hearing
was held before U.S. Magistrate Judge Grewal and, on September 22, 2015, he issued a claim construction report and recommendation.
On September 25, 2015, as a result of the claim construction report and recommendation, Plaintiffs and defendants, with the exception
of Huawei Technologies Co. Ltd., (“Huawei”) agreed to stay all proceedings pending resolution of Plaintiffs’
objections to the claim construction report and recommendation. Plaintiffs further stipulated that, under the claim construction
provided by the report and recommendation, defendants’ products do not infringe the ‘336 patent, and, in the event
that the Court does not materially modify the claim construction, Plaintiffs and defendants ask that the Court enter a final judgment
of non-infringement. After Plaintiffs and Huawei filed opposing letter briefs with the Court, U.S. Magistrate Judge Grewal stayed
the action against Huawei pending resolution of Plaintiffs’ objections to the claim construction. On October 6, 2015, Plaintiffs
filed objections to the claim construction with District Court Judge Chhabria. Judge Chhabria rejected those objections on November
9, 2015. Based on that order, the parties stipulated to a judgment of non-infringement as to the ‘336 patent and such judgment
was entered on November 13, 2015.
On December 7, 2015, Plaintiffs filed notices
of appeal with the U.S. Federal Circuit appealing the district court’s claim construction. Plaintiffs filed their opening
appellate brief on March 10, 2016. Defendants filed their response brief on May 23, 2016, with Plaintiffs filing their reply brief
on June 23, 2016. On March 3, 2017, the U.S. Court of Appeals for the Federal Circuit rendered its decision modifying the claim
construction that was issued in September 2016 by the U.S. District Court for the Northern District of California and has remanded
the matter to the District Court for further proceedings.
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated
Financial Statements
Commitments and Contingencies (continued)
On May 23, 2017, a case management conference
was held in front of District Court Judge Chhabria, who ordered that Plaintiffs amend their infringement contentions on or before
June 16, 2017. Judge Chhabria further ordered that Defendants submit any motion for summary judgment based on the amended infringement
contentions and the modified claim construction by August 1, 2017. On June 5, 2017, the law firm of Banys, P.C., who had served
as local counsel for PDS, withdrew as counsel. PDS continued to be represented by the law firm of Nelson Bumgardner, P.C. On June
16, 2017, Plaintiffs timely amended their infringement contentions. On July 13, 2017, all remaining counsel for each of Patriot,
TPL, and PDS moved to withdraw as counsel and further moved to extend all currently pending case deadlines by 60 days for Plaintiffs
to seek new counsel.
On September 13, 2017, the law firm of
Bunsow De Mory LLP was entered before the U.S. District Court for the Northern District of California as successor counsel in representation
of Patriot, PDS, and TPL.
The Defendants moved for summary
judgment of non-infringement on September 29, 2017, and the Court held a hearing on Defendants’ motion on November 30,
2017. The Court granted Defendants’ motion and entered judgment of non-infringement on December 13, 2017.
Plaintiffs’ filed notices of appeal
in these district court matters on January 5, 2018. An appellate briefing schedule would then be set in accordance with the
rules and calendar of the United States Court of Appeals for the Federal Circuit.
Defendant Samsung submitted a Bill of Costs
seeking $30,170 in costs. On January 9, 2018, Plaintiffs filed an objection to virtually all of the submitted costs. The
company does not consider the reimbursement of these costs to the defendant to be probable.
401(k) Plan
We have a retirement plan that complies
with Section 401(k) of the Internal Revenue Code. All employees are eligible to participate in the plan. We match 100% of elective
deferrals subject to a maximum of 4% of the participant’s eligible earnings. Our participants vest 33% per year over a three
year period in their matching contributions. Our matching contributions during the three months ended November 30, 2017 and 2016
were $5,414, respectively. Our matching contributions during the six months ended November 30, 2017 and 2016 were $10,055 and $10,828,
respectively.
Guarantees and Indemnities
We have made certain guarantees and indemnities,
under which we may be required to make payments to a guaranteed or indemnified party. We indemnify our directors, officers, employees
and agents to the maximum extent permitted under the laws of the State of Delaware. The duration of the guarantees and indemnities
varies, and in many cases is indefinite. These guarantees and indemnities do not provide for any limitation of the maximum potential
future payments we could be obligated to make. Historically, we have not been obligated to make any payments for these obligations
and no liabilities have been recorded for these guarantees and indemnities in the accompanying condensed consolidated balance sheets.
Escrow Shares
On August 31, 2009, we gave notice to the
former shareholders of Crossflo and Union Bank of California (the “Escrow Agent”) under Section 2.5 of the Agreement
and Plan of Merger between us and Crossflo (the “Agreement”), outlining damages incurred by us in conjunction with
the acquisition of Crossflo, and seeking the return of 2,844,630 shares of our common stock held by the Escrow Agent. Subsequently,
former shareholders of Crossflo representing a majority of the escrowed shares responded in protest to our claim, delaying the
release of the escrowed shares until a formal resolution is reached. In the event we fail to prevail in our claim against
the escrowed shares, we may be obligated to deposit into escrow approximately $256,000 of cash consideration due to the decline
in our average stock price over the one year escrow period, calculated in accordance with the Section 2.5 of the Agreement.
We have evaluated the potential for loss regarding our claim and believe that it is probable that the resolution of this issue
will not result in a material obligation to the Company, although there is no assurance of this. Accordingly, we have not
recorded a liability for this matter.
7. Subsequent Events
We have evaluated subsequent events after
the balance sheet date and based on our evaluation, management has determined that no subsequent events have occurred that would
require recognition in the accompanying condensed consolidated financial statements or disclosure in the notes thereto other than
as disclosed in the accompanying notes.