ITEM 15.
|
EXHIBITS, FINANCIAL STATEMENT
SCHEDULES
|
(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 Public Accounting Firm
are included starting on page F-1 of this Report:
Patriot Scientific Corporation
Report of KMJ Corbin & Company LLP, Independent Registered
Public Accounting Firm
Consolidated Balance Sheets as of May 31, 2013 and 2012
Consolidated Statements of Operations for the Years Ended May
31, 2013 and 2012
Consolidated Statements of Stockholders’ Equity for the
Years Ended May 31, 2013 and 2012
Consolidated Statements of Cash Flows for the Years Ended May
31, 2013 and 2012
Notes to Consolidated Financial Statements
Phoenix Digital Solutions, LLC
Report of KMJ Corbin & Company LLP, Independent Registered
Public Accounting Firm
Balance Sheets as of May 31, 2013 and 2012
Statements of Operations for the Years Ended May 31, 2013 and
2012
Statement of Members’ Equity (Deficit) for the Years Ended
May 31, 2013 and 2012
Statements of Cash Flows for the Years Ended May 31, 2013 and
2012
Notes to Financial Statements
|
|
2.
|
Financial Statement Schedules
. All financial statement schedules have been omitted since the information is either not applicable or required or is included in the consolidated financial statements or notes thereof.
|
|
3.
|
Exhibits
. Those exhibits marked with a (*) refer to exhibits filed herewith. The other exhibits are incorporated herein by reference, as indicated in the following list. Those exhibits marked with a (†) refer to management contracts or compensatory plans or arrangements.
|
Exhibit No.
|
Document
|
2.1
|
Agreement and Plan of Merger dated August
4, 2008, among the Company, PTSC Acquisition 1 Corp, Crossflo Systems, Inc. and the Crossflo principal officers, incorporated by
reference to Exhibit 99.1 to Form 8-K filed August 11, 2008 (Commission file No. 000-22182)
|
3.1
|
Original Articles of incorporation
of the Company’s predecessor, Patriot Financial Corporation, incorporated by reference to Exhibit 3.1 to registration
statement on Form S-18, (Commission file No. 33-23143-FW)
|
3.2
|
Articles of Amendment of Patriot Financial
Corporation, as filed with the Colorado Secretary of State on July 21, 1988, incorporated by reference to Exhibit 3.2
to registration statement on Form S-18, (Commission file No. 33-23143-FW)
|
3.3
|
Certificate of Incorporation of the Company,
as filed with the Delaware Secretary of State on March 24, 1992, incorporated by reference to Exhibit 3.3 to Form 8-K
dated May 12, 1992 (Commission file No. 33-23143-FW)
|
3.3.1
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as 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 (Commission file No. 000-22182)
|
3.3.2
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as filed with the Delaware Secretary of State on June 24, 1997, incorporated by reference
to Exhibit 3.3.2 to Form 10-KSB for the fiscal year ended May 31, 1997, filed July 18, 1997 (Commission file
No. 000-22182)
|
3.3.3
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as filed with the Delaware Secretary of State on April 28, 2000, incorporated by reference
to Exhibit 3.3.3 to Registration Statement on Form S-3 filed May 5, 2000 (Commission file No. 333-36418)
|
3.3.4
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as filed with the Delaware Secretary of State on May 6, 2002, incorporated by reference to
Exhibit 3.3.4 to Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No.
000-22182)
|
3.3.5
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as filed with the Delaware Secretary of State on October 16, 2003, incorporated by reference
to Exhibit 3.3.5 to Registration Statement on Form SB-2 filed May 21, 2004 (Commission file No. 333-115752)
|
3.3.6
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as filed with the Delaware Secretary of State on April 29, 2005, incorporated by reference to
Exhibit 3.3.6 to Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No.
000-22182)
|
3.3.7
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as filed with the Delaware Secretary of State on November 14, 2005, incorporated by reference
to Exhibit 3.3.7 to Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file
No. 000-22182)
|
3.3.8
|
Certificate of Amendment to the Certificate
of Incorporation of the Company, as filed with the Delaware Secretary of State on March 18, 2009, incorporated by reference
to Exhibit 3.3.8 to Form 10-K for the fiscal year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)
|
3.4
|
Articles and Certificate of Merger
of Patriot Financial Corporation into the 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 (Commission file No. 33-23143-FW)
|
3.5
|
Certificate of Merger issued by the Delaware
Secretary of State on May 8, 1992, incorporated by reference to Exhibit 3.5 to Form 8-K dated May 12, 1992 (Commission
file No. 33-23143-FW)
|
3.6
|
Certificate of Merger issued by the Colorado
Secretary of State on May 12, 1992, incorporated by reference to Exhibit 3.6 to Form 8-K dated May 12, 1992 (Commission
file No. 33-23143-FW)
|
3.7
|
Bylaws of the Company, incorporated by
reference to Exhibit 3.7 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)
|
3.7.1
|
Amendment to bylaws of the Company, incorporated
by reference to Exhibit 3.7.1 to our Current Report on Form 8-K dated November 4, 2010 (Commission file No. 000-22182)
|
4.1
|
Specimen common stock certificate, incorporated
by reference to Exhibit 4.1 Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)
|
4.2†
|
2006 Stock Option Plan of the Company as
amended and restated, incorporated by reference to Appendix C to the Company Proxy Statement filed September 22, 2008 (Commission
file No. 000-22182)
|
10.1
|
Master Agreement, dated as of June 7,
2005, by and among the Company, Technology Properties Limited Inc., a California corporation and Charles H. Moore, an individual,
incorporated by reference to Exhibit 10.40 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)
|
10.2
|
Commercialization Agreement dated as of
June 7, 2005 by and among the JV LLC, Technology Properties Limited Inc., a California corporation, and the Company, incorporated
by reference to Exhibit 10.41 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)
|
10.3
|
Limited Liability Company Operating Agreement
of JV LLC, a Delaware limited liability company, dated as of June 7, 2005, incorporated by reference to Exhibit 10.42
to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)
|
10.4†
|
Employment Agreement dated September 17,
2007 by and between the Company and Clifford L. Flowers, incorporated by reference to Exhibit 10.1 to Form 8-K filed September
19, 2007 (Commission file No. 000-22182)
|
10.5
|
Form of Indemnification Agreement by and
between the Company and the Board of Directors, incorporated by reference to Exhibit 10.6 to Form 10-K filed August 29, 2011 (Commission
file No. 000-22182)
|
10.6
|
Licensing Program Services Agreement effective
July 11, 2012 among Phoenix Digital Solutions, LLC, Alliacense Limited, LLC, Technology Properties Limited, LLC and the Company,
incorporated by reference to Exhibit 10.7 to Form 8-K filed July 17, 2012 (Commission file No. 000-22182) (Confidential treatment
has been requested with respect to portions of this agreement.)
|
10.7
|
Agreement effective July 11, 2012 between
Technology Properties Limited, LLC and the Company, incorporated by reference to Exhibit 10.8 to Form 8-K filed July 17, 2012 (Commission
file No. 000-22182) (Confidential treatment has been requested with respect to portions of this agreement.)
|
10.8
|
Agreement effective July 17, 2012 among
Phoenix Digital Solutions, LLC, Alliacense Limited, LLC, Technology Properties Limited, LLC and the Company, incorporated by reference
to Exhibit 10.9 to Form 8-K filed July 17, 2012 (Commission file No. 000-22182) (Confidential treatment has been requested with
respect to portions of this agreement.)
|
14.1
|
Code of Ethics for Senior Financial Officers
incorporated by reference to Exhibit 14.1 to Form 10-K for the fiscal year ended May 31, 2003, filed August 29,
2003 (Commission file No. 000-22182)
|
21*
|
List of subsidiaries of the Company
|
23.1*
|
Consent of Independent Registered Public Accounting Firm
|
31.1*
|
Certification of Clifford L. Flowers, Interim CEO, pursuant to Rule 13a-15(e) or Rule 15d-15(e)
|
31.2*
|
Certification of Clifford L. Flowers, CFO, pursuant to Rule 13a-15(e) or Rule 15d-15(e)
|
32.1*
|
Certification of Clifford L. Flowers, Interim CEO and CFO, pursuant to 18 U.S.C. Section 1350
|
99.1
|
Form of Incentive Stock Option Agreement
to the Company’s 2006 Stock Option Plan incorporated by reference to Exhibit 99.10 on Form 10-K for the fiscal year ended
May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)
|
99.2
|
Form of Non-Qualified Stock Option Agreement
to the Company’s 2006 Stock Option Plan incorporated by reference to Exhibit 99.11 on Form 10-K for the fiscal year ended
May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)
|
101.INS
|
XBRL Instance Document
|
101.SCH
|
XBRL Schema Document
|
101.CAL
|
XBRL Calculation Linkbase Document
|
101.DEF
|
XBRL Definition Linkbase Document
|
101.LAB
|
XBRL Label Linkbase Document
|
101.PRE
|
XBRL Presentation Linkbase Document
|
Patriot Scientific Corporation
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
Page
|
|
|
|
Report of Independent Registered Public Accounting Firm
|
|
F-2
|
Financial Statements:
|
|
|
Consolidated Balance Sheets
|
|
F-3
|
Consolidated Statements of Operations
|
|
F-4
|
Consolidated Statements of Stockholders’ Equity
|
|
F-5
|
Consolidated Statements of Cash Flows
|
|
F-6
|
Notes to Consolidated Financial Statements
|
|
F-7
|
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
To the Stockholders and Board of Directors
Patriot Scientific Corporation
We have audited the accompanying consolidated
balance sheets of
Patriot Scientific Corporation
and subsidiaries (the “Company”)
as of May 31, 2013 and 2012, and the related consolidated statements of operations, stockholders’ equity and cash flows for
the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility
is to express an opinion on these consolidated 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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.
The Company is not required to have, nor were we engaged to perform, an audit on its internal control over financial reporting.
Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As described in Notes 5 and 9, the Company
has extensive transactions with Technology Properties Limited, LLC and Alliacense Limited, LLC both related parties. Accordingly,
the accompanying consolidated financial statements may not be indicative of the financial position or results of operations that
would have occurred had the Company operated without such related party relationships.
In our opinion, the consolidated financial
statements referred to above present fairly, in all material respects, the consolidated financial position of
Patriot
Scientific Corporation
and subsidiaries as of May 31, 2013 and 2012, and the consolidated results of their operations and
their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of
America.
/s/ KMJ Corbin & Company LLP
Costa Mesa, California
August 22, 2013
Patriot Scientific Corporation
Consolidated Balance Sheets
May 31,
|
|
2013
|
|
|
2012
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
7,572,887
|
|
|
$
|
4,699,174
|
|
Restricted cash and cash equivalents
|
|
|
21,018
|
|
|
|
20,913
|
|
Current portion of marketable securities
|
|
|
194,463
|
|
|
|
2,907,106
|
|
Accounts receivable – affiliated company
|
|
|
16,538
|
|
|
|
–
|
|
Prepaid expenses and other current assets
|
|
|
194,901
|
|
|
|
225,077
|
|
Current assets of discontinued operations
|
|
|
40,682
|
|
|
|
7,273
|
|
Total current assets
|
|
|
8,040,489
|
|
|
|
7,859,543
|
|
|
|
|
|
|
|
|
|
|
Marketable securities, net of current portion
|
|
|
–
|
|
|
|
229,045
|
|
Property and equipment, net
|
|
|
5,078
|
|
|
|
7,536
|
|
Other assets
|
|
|
3,036
|
|
|
|
–
|
|
Investment in affiliated company
|
|
|
366,304
|
|
|
|
–
|
|
Non-current assets of discontinued operations
|
|
|
–
|
|
|
|
42,000
|
|
Total assets
|
|
$
|
8,414,907
|
|
|
$
|
8,138,124
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
219,213
|
|
|
$
|
239,546
|
|
Accrued expenses and other
|
|
|
58,521
|
|
|
|
64,643
|
|
Income tax payable
|
|
|
–
|
|
|
|
2,513
|
|
Total current liabilities
|
|
|
277,734
|
|
|
|
306,702
|
|
|
|
|
|
|
|
|
|
|
Cumulative losses in excess of investment in affiliated company
|
|
|
–
|
|
|
|
740,824
|
|
Total liabilities
|
|
|
277,734
|
|
|
|
1,047,526
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
|
|
|
|
|
|
|
|
|
Preferred stock, $0.00001 par value; 5,000,000 shares authorized: none outstanding
|
|
|
–
|
|
|
|
–
|
|
Common stock, $0.00001 par value: 600,000,000 shares authorized: 438,242,618 shares issued and 405,247,405 shares outstanding at May 31, 2013 and 438,167,618 shares issued and 405,735,958 shares outstanding at May 31, 2012
|
|
|
4,382
|
|
|
|
4,381
|
|
Additional paid-in capital
|
|
|
77,338,434
|
|
|
|
77,330,935
|
|
Accumulated deficit
|
|
|
(54,801,249
|
)
|
|
|
(55,897,464
|
)
|
Common stock held in treasury, at cost – 32,995,213 shares at May 31, 2013 and 32,431,660 shares at May 31, 2012
|
|
|
(14,404,394
|
)
|
|
|
(14,347,254
|
)
|
Total stockholders’ equity
|
|
|
8,137,173
|
|
|
|
7,090,598
|
|
Total liabilities and stockholders’ equity
|
|
$
|
8,414,907
|
|
|
$
|
8,138,124
|
|
See accompanying
notes to consolidated financial statements
Patriot Scientific Corporation
Consolidated Statements of Operations
Years Ended May 31,
|
|
2013
|
|
|
2012
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
$
|
1,381,430
|
|
|
$
|
1,994,784
|
|
Total operating expenses
|
|
|
1,381,430
|
|
|
|
1,994,784
|
|
|
|
|
|
|
|
|
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
17,494
|
|
|
|
16,591
|
|
Other income
|
|
|
217,618
|
|
|
|
1,555
|
|
Realized recovery on marketable securities
|
|
|
55,873
|
|
|
|
347,452
|
|
Equity in earnings (loss) of affiliated company
|
|
|
2,174,395
|
|
|
|
(1,828,375
|
)
|
Total other income (expense), net
|
|
|
2,465,380
|
|
|
|
(1,462,777
|
)
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations before income taxes
|
|
|
1,083,950
|
|
|
|
(3,457,561
|
)
|
|
|
|
|
|
|
|
|
|
Benefit for income taxes
|
|
|
(113
|
)
|
|
|
(875
|
)
|
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
|
1,084,063
|
|
|
|
(3,456,686
|
)
|
|
|
|
|
|
|
|
|
|
Income (loss) from discontinued operations, net
|
|
|
12,152
|
|
|
|
(1,363,719
|
)
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
1,096,215
|
|
|
$
|
(4,820,405
|
)
|
|
|
|
|
|
|
|
|
|
Basic and diluted income (loss) per common share:
|
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
|
$
|
–
|
|
|
$
|
(0.01
|
)
|
Income (loss) from discontinued operations
|
|
$
|
–
|
|
|
$
|
–
|
|
Net income (loss)
|
|
$
|
–
|
|
|
$
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average number of common shares outstanding – basic
|
|
|
402,522,925
|
|
|
|
403,626,888
|
|
Weighted average number of common shares outstanding – diluted
|
|
|
405,425,823
|
|
|
|
403,626,888
|
|
See accompanying
notes to consolidated financial statements.
Patriot Scientific Corporation
Consolidated Statements of Stockholders’
Equity
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Amounts
|
|
|
Additional Paid-in Capital
|
|
|
Accumulated Deficit
|
|
|
Treasury Stock
|
|
|
Stockholders’ Equity
|
|
Balance, June 1, 2011
|
|
|
407,526,799
|
|
|
$
|
4,381
|
|
|
$
|
77,314,301
|
|
|
$
|
(51,077,059
|
)
|
|
$
|
(14,223,037
|
)
|
|
$
|
12,018,586
|
|
Share-based compensation
|
|
|
–
|
|
|
|
–
|
|
|
|
16,634
|
|
|
|
–
|
|
|
|
–
|
|
|
|
16,634
|
|
Purchase of common stock for treasury
|
|
|
(1,790,841
|
)
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(124,217
|
)
|
|
|
(124,217
|
)
|
Net loss
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(4,820,405
|
)
|
|
|
–
|
|
|
|
(4,820,405
|
)
|
Balance, May 31, 2012
|
|
|
405,735,958
|
|
|
|
4,381
|
|
|
|
77,330,935
|
|
|
|
(55,897,464
|
)
|
|
|
(14,347,254
|
)
|
|
|
7,090,598
|
|
Exercise of options at $0.10 per share
|
|
|
75,000
|
|
|
|
1
|
|
|
|
7,499
|
|
|
|
–
|
|
|
|
–
|
|
|
|
7,500
|
|
Purchase of common stock for treasury
|
|
|
(563,553
|
)
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
(57,140
|
)
|
|
|
(57,140
|
)
|
Net income
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
1,096,215
|
|
|
|
–
|
|
|
|
1,096,215
|
|
Balance, May 31, 2013
|
|
|
405,247,405
|
|
|
$
|
4,382
|
|
|
$
|
77,338,434
|
|
|
$
|
(54,801,249
|
)
|
|
$
|
(14,404,394
|
)
|
|
$
|
8,137,173
|
|
See accompanying
notes to consolidated financial statements.
Patriot Scientific Corporation
Consolidated Statements of Cash Flows
Years Ended May 31,
|
|
2013
|
|
|
2012
|
|
Operating activities:
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
1,096,215
|
|
|
$
|
(4,820,405
|
)
|
Less: Net income (loss) from discontinued operations
|
|
|
12,152
|
|
|
|
(1,363,719
|
)
|
Net income (loss) from continuing operations
|
|
|
1,084,063
|
|
|
|
(3,456,686
|
)
|
Adjustments to reconcile net income (loss) before discontinued operations to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
2,590
|
|
|
|
3,191
|
|
Accrued interest income added to investments
|
|
|
(8,270
|
)
|
|
|
(5,641
|
)
|
Equity in (earnings) loss of affiliated company
|
|
|
(2,174,395
|
)
|
|
|
1,828,375
|
|
Realized recovery on sale of marketable securities
|
|
|
(55,873
|
)
|
|
|
(347,452
|
)
|
Loss on sale of assets
|
|
|
2,036
|
|
|
|
736
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable – affiliated company
|
|
|
120,730
|
|
|
|
(7,923
|
)
|
Prepaid expenses and other current assets
|
|
|
27,140
|
|
|
|
613
|
|
Accounts payable, accrued expenses, and other
|
|
|
(26,456
|
)
|
|
|
(55,564
|
)
|
Income taxes payable
|
|
|
(2,513
|
)
|
|
|
–
|
|
Net cash used in operating activities of continuing operations
|
|
|
(1,030,948
|
)
|
|
|
(2,040,351
|
)
|
Net cash provided by (used in) operating activities of discontinued operations
|
|
|
20,744
|
|
|
|
(361,774
|
)
|
Net cash used in operating activities
|
|
|
(1,010,204
|
)
|
|
|
(2,402,125
|
)
|
|
|
|
|
|
|
|
|
|
Investing activities:
|
|
|
|
|
|
|
|
|
Proceeds from sales of marketable securities
|
|
|
7,651,525
|
|
|
|
4,616,847
|
|
Purchases of marketable securities
|
|
|
(4,645,799
|
)
|
|
|
(5,193,000
|
)
|
Purchases of property and equipment
|
|
|
(2,168
|
)
|
|
|
(1,996
|
)
|
Investment in affiliated company
|
|
|
(1,097,809
|
)
|
|
|
(650,000
|
)
|
Distributions from affiliated company
|
|
|
2,027,808
|
|
|
|
–
|
|
Net cash provided by (used in) investing activities
|
|
|
3,933,557
|
|
|
|
(1,228,149
|
)
|
|
|
|
|
|
|
|
|
|
Financing activities:
|
|
|
|
|
|
|
|
|
Repurchase of common stock for treasury
|
|
|
(57,140
|
)
|
|
|
(124,217
|
)
|
Exercise of stock options
|
|
|
7,500
|
|
|
|
–
|
|
Net cash used in financing activities
|
|
|
(49,640
|
)
|
|
|
(124,217
|
)
|
Net increase (decrease) in cash and cash equivalents
|
|
|
2,873,713
|
|
|
|
(3,754,491
|
)
|
Cash and cash equivalents, beginning of year
|
|
|
4,699,174
|
|
|
|
8,453,665
|
|
Cash and cash equivalents, end of year
|
|
$
|
7,572,887
|
|
|
$
|
4,699,174
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information:
|
|
|
|
|
|
|
|
|
Cash payments for income taxes
|
|
$
|
2,400
|
|
|
$
|
–
|
|
Cash receipts from income tax refunds
|
|
$
|
–
|
|
|
$
|
907,588
|
|
See accompanying
notes to consolidated financial statements.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements
1. Organization and Business
Patriot Scientific Corporation (the “Company”,
“PTSC”, “we”, “us”, or “our”), 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
.
In June 2005, we entered into a joint venture agreement with Technology Properties Limited, Inc. (“TPL”) to
form Phoenix Digital Solutions, LLC (“PDS”). In September 2008, we acquired Patriot Data Solutions Group, Inc. formerly
known as Crossflo Systems, Inc. (“PDSG”) which engaged in data-sharing services and products primarily in the public
safety/government sector. I
n January 2010, we sold
the assets of Verras Medical, Inc. and in August 2010 we sold the Vigilys business line both formerly associated with PDSG. D
uring
April 2012, we sold substantially all of the assets of PDSG.
Through our joint venture PDS we pursue
the commercialization of our patented microprocessor technologies through broad and open licensing and by litigating against those
who may be infringing on our patents.
Reclassification
Certain amounts presented in the prior
periods’ consolidated financial statements related to discontinued operations, recovery on marketable securities, and interest
and other income have been reclassified to conform to the current period’s presentation.
Liquidity and Management’s Plans
Cash shortfalls currently experienced by
PDS will have an adverse effect on our liquidity. During the fiscal year ended May 31, 2012 we and TPL each contributed $650,000
in additional capital to PDS, in order to fund a portion of a legal retainer. During the fiscal year ended May 31, 2013 we and
TPL each contributed $1,097,809 in additional capital to fund the operations of PDS. 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 retainer payments, as well as licensing and litigation support payments to Alliacense
Limited, LLC (“Alliacense”, an affiliate of TPL), 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.
As the litigation with HTC Corporation
and Acer, Inc., in the U.S. District Court, and the actions with the ITC Investigation No. 337-TA-853 progress, PDS is incurring
significant third-party costs for expert testimony, depositions and other related legal costs. We will be required to make capital
contributions to PDS for these costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.
Our current liquid cash resources as of
May 31, 2013, are expected to provide the funds necessary to support our operations through at least the next twelve months. The
cash flows from our interest in PDS 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 of $7,767,350 at May 31, 2013.
On March 20, 2013, TPL filed a petition
under Chapter 11 of the United States Bankruptcy Code. We have been appointed to the creditors’ committee and will be closely
monitoring the progress in this matter as it relates to our interest in PDS. If we 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 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.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
2. Summary of Significant Accounting
Policies
Basis of Consolidation
The consolidated balance sheets at May
31, 2013 and 2012 and consolidated statements of operations for the fiscal years ended May 31, 2013 and 2012 includes our accounts
and those of our wholly owned subsidiary PDSG which includes Crossflo Systems, Inc. (“Crossflo”), and our inactive
subsidiary Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated.
PDSG is being presented as discontinued
operations in the consolidated statements of operations for all periods presented. See “Discontinued Operations” below
for additional information.
Discontinued Operations
On February 17, 2012 our board of directors
authorized management to sell the assets of PDSG due to the inability of PDSG to meet its business plan and continuing projected
negative cash flows. In accordance with authoritative guidance we have classified the assets, liabilities, operations and cash
flows of PDSG as discontinued operations for all periods presented. During March 2012, we entered into an interim agreement with
the purchaser of the assets of PDSG which required the purchaser to pay PDSG $93,450 to subsidize the April 2012 expenses of PDSG
during the sale transaction negotiations. On April 30, 2012, we negotiated a sale transaction in which we sold substantially all
of the assets of PDSG in exchange for a royalty on PDSG revenues for a period of three years. From April 30, 2012 to May 31, 2013,
the gain on the asset sale of PDSG is approximately $4,000.
Summarized operating results of discontinued
operations for the fiscal years ended May 31, 2013 and 2012 are as follows:
|
|
May 31, 2013
|
|
|
May 31, 2012
|
|
Revenues
|
|
$
|
–
|
|
|
$
|
179,871
|
|
Gross profit
|
|
$
|
–
|
|
|
$
|
132,277
|
|
Operating loss from discontinued operations
|
|
$
|
(3,224
|
)
|
|
$
|
(1,446,690
|
)
|
Other income from discontinued operations
|
|
$
|
–
|
|
|
$
|
93,959
|
|
Gain (loss) on sale of discontinued operations
|
|
$
|
15,376
|
|
|
$
|
(10,988
|
)
|
Income (loss) before income taxes
|
|
$
|
12,152
|
|
|
$
|
(1,363,719
|
)
|
Income (loss) from discontinued operations
|
|
$
|
12,152
|
|
|
$
|
(1,363,719
|
)
|
PDSG activity for the fiscal year ended
May 31, 2013 consists of operating expenses for: legal, insurance, taxes and bank fees offset by PDSG royalty revenues.
The following table summarizes the carrying
amount of the major classes of assets and liabilities of PDSG classified as discontinued operations at May 31, 2013 and May 31,
2012:
|
|
May 31, 2013
|
|
|
May 31, 2012
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Other current assets
|
|
$
|
40,682
|
|
|
$
|
7,273
|
|
|
|
$
|
40,682
|
|
|
$
|
7,273
|
|
Long-lived assets:
|
|
|
|
|
|
|
|
|
Other receivable
|
|
$
|
–
|
|
|
$
|
42,000
|
|
|
|
$
|
–
|
|
|
$
|
42,000
|
|
Financial Instruments and Concentrations
of Credit Risk
Financial instruments that potentially
subject us to concentrations of credit risk consist principally of cash, cash equivalents, and investments in marketable securities.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Financial Instruments and Concentrations
of Credit Risk (continued)
At times, our balance of cash maintained
with our bank may exceed the Federal Deposit Insurance Corporation’s (“FDIC”) insured limit of $250,000. At May
31, 2013, our cash and cash equivalents balances subject to FDIC insurance exceeded the FDIC limit by $35,084. At May 31, 2013
and 2012, our cash and cash equivalents balance consisting of money market accounts not subject to FDIC insurance was $5,225,176
and $2,559,456, respectively. We limit our exposure of loss by maintaining our cash with financially stable financial institutions.
When we have excess cash, our cash equivalents are placed in certificates of deposit and high quality money market accounts with
major financial institutions. We believe this investment policy limits our exposure to concentrations of credit risk.
At May 31, 2013 and 2012, investments in
marketable securities consist of certificates of deposit with maturities greater than three months. Each certificate of deposit
is invested with a financial institution for $245,000 or less so as not to exceed the FDIC insurance limit.
Fair Value of Financial Instruments
Our financial instruments consist principally
of cash and cash equivalents, investments in marketable securities, accounts payable and accrued expenses. The carrying value of
these financial instruments approximates fair value because of the immediate or short-term maturity of the instruments. T
he
fair value of our cash equivalents and investments in marketable securities is determined based on quoted prices in active markets
for identical assets or Level 1 inputs. We believe that the carrying values of all other financial instruments approximate
their current fair values due to their nature and respective durations.
Cash Equivalents, Restricted Cash, and
Short-Term Marketable Securities
We consider all highly liquid investments
acquired with a maturity of three months or less to be cash equivalents.
Restricted cash and cash equivalents at
May 31, 2013 and 2012 consist of a savings account held as collateral for our corporate credit card account.
At May 31, 2013 and 2012 our short-term
marketable securities in the amount of $194,463 and $2,907,106 consist of certificates of deposit with various financial institutions,
with maturity dates of twelve months or less.
Investments in Marketable Securities
We determine the appropriate classification
of our investments at the time of purchase and reevaluate such designation at each balance sheet date. Our investments in marketable
securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating
to these securities. Available-for-sale marketable securities are stated at fair market value. Unrealized gains and losses, net
of deferred taxes, are recorded as a component of other comprehensive income (loss). We follow the authoritative guidance to assess
whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines
in 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 consolidated statements of operations.
Property, Equipment and Depreciation
Property and equipment are stated at cost
and are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to five years.
Major betterments and renewals are capitalized, while routine repairs and maintenance are charged to expense when incurred.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Investment
in Affiliated Company
We have a 50% interest in PDS. We account
for our investment using the equity method of accounting since the investment provides us the ability to exercise significant influence,
but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership
interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee’s
Board of Directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method
of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the
investee and is recognized in the 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 the PDS. If a decline in
value is deemed to be other than temporary, we would recognize an impairment loss.
Treasury Stock
We account for treasury stock under the
cost method and include treasury stock as a component of stockholders’ equity.
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.
We have determined that it was not more
likely than not that all of our deferred tax assets will be realized in the future due to our continuing pre-tax and taxable losses.
As a result of this determination we have placed 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.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
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.
Earnings (Loss) Per Share
Basic earnings per share for continuing
and discontinued operations 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 for continuing and discontinued operations
reflect the potential dilution of securities that could share in the earnings of an entity.
For the fiscal year ended May 31, 2013
potential common shares of 175,000 related to our outstanding options were not included in the calculation of diluted income per
share for continuing and discontinued operations. For the fiscal year ended May 31, 2013, we included the PDSG escrow shares of
2,844,630 in the calculation of diluted income per share for continuing and discontinued operations.
At May 31, 2012 potential common shares
of 2,360,838 related to our outstanding options were not included in the calculation of diluted loss per share for continuing and
discontinued operations as we recorded a loss. Had we reported net income for the year ended May 31, 2012 an additional 0 shares
of common stock would have been included in the calculation of diluted income per share for continuing and discontinued operations.
In connection with our acquisition of Crossflo,
which became a part of PDSG, we issued escrow shares that are contingent upon certain representations and warranties made by Crossflo
at the time of the merger agreement (see Note 9). We exclude these escrow shares from the basic loss per share calculations and
include the escrowed shares in the diluted loss per share calculations.
Use of Estimates
The preparation of financial statements
in accordance with accounting principles generally accepted in the United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent
assets and liabilities in the consolidated financial statements and accompanying footnotes. Actual results could differ from those
estimates. On an ongoing basis we evaluate our estimates, including, but not limited to: fair values of investments in marketable
securities, the use, recoverability, and /or realizability of certain assets, including investments in affiliated companies, deferred
tax assets, and stock-based compensation.
Share-Based Compensation
Share-based compensation expense recognized
during the year is based on the grant date fair value of the portion of share-based payment awards ultimately expected to vest
during the year. As share-based compensation expense recognized in the consolidated statements of operations is based on awards
ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeiture rates are based on historical
forfeiture experience and estimated future employee forfeitures.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Intellectual Property Rights
PDS, our investment in affiliate, relies
on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to
protect our intellectual property rights. PDS currently licenses four unexpired U.S. patents issued dating back to 1997 on our
microprocessor technology in addition to three European and two Japanese patents. The U.S. patents will expire between 2014 and
2015 and the European and Japanese patents will expire in 2016. PDS also licenses three U.S. patents, six European,
and one Japanese patent all of which expired between August 2009 and June 2013. These patents, while expired, may have certain
retrospective statutory benefits that will fully diminish six years after the patent expiration date (e.g. for the expired U.S.
patents). 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.
3.
C
ash, Cash Equivalents, Restricted Cash and Marketable Securities
We consider all highly liquid investments
with original maturities of three months or less to be cash equivalents.
Restricted cash and cash equivalents at
May 31, 2013 and 2012 consist of deposits in a savings account required to be held as collateral for our corporate credit card.
At May 31, 2013 and 2012, our current portion
of marketable securities in the amount of $194,463 and $2,907,106, respectively, consists of the par value plus accrued interest
of our time deposits. At May 31, 2012, our non-current portion of marketable securities in the amount of $229,045 consists of the
par value plus accrued interest of time deposits. These marketable securities are classified as available for sale and are reported
at fair market value.
We follow authoritative guidance
to
account for our marketable securities as available for sale. 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 Consolidated Financial Statements (Continued)
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 May 31, 2013 Using
|
|
|
|
|
|
|
Quoted Prices
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Other
|
|
|
Significant
|
|
|
|
Fair Value at
|
|
|
Markets for
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
May 31,
|
|
|
Identical Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
2013
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
197,862
|
|
|
$
|
197,862
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Money market funds
|
|
|
5,225,176
|
|
|
|
5,225,176
|
|
|
|
–
|
|
|
|
–
|
|
Certificates of deposit
|
|
|
2,149,849
|
|
|
|
–
|
|
|
|
2,149,849
|
|
|
|
–
|
|
Restricted cash
|
|
|
21,018
|
|
|
|
21,018
|
|
|
|
–
|
|
|
|
–
|
|
Marketable securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
194,463
|
|
|
|
–
|
|
|
|
194,463
|
|
|
|
–
|
|
Total
|
|
$
|
7,788,368
|
|
|
$
|
5,444,056
|
|
|
$
|
2,344,312
|
|
|
$
|
–
|
|
|
|
|
|
|
Fair Value Measurements at May 31, 2012 Using
|
|
|
|
|
|
|
Quoted Prices
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Other
|
|
|
Significant
|
|
|
|
Fair Value at
|
|
|
Markets for
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
May 31,
|
|
|
Identical Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
|
2012
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
77,745
|
|
|
$
|
77,745
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Money market funds
|
|
|
2,559,456
|
|
|
|
2,559,456
|
|
|
|
–
|
|
|
|
–
|
|
Certificates of deposit
|
|
|
2,061,973
|
|
|
|
–
|
|
|
|
2,061,973
|
|
|
|
–
|
|
Restricted cash
|
|
|
20,913
|
|
|
|
20,913
|
|
|
|
–
|
|
|
|
–
|
|
Marketable securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
2,907,106
|
|
|
|
–
|
|
|
|
2,907,106
|
|
|
|
–
|
|
Long-term:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
229,045
|
|
|
|
–
|
|
|
|
229,045
|
|
|
|
–
|
|
Total
|
|
|
7,856,238
|
|
|
|
2,658,114
|
|
|
|
5,198,124
|
|
|
|
–
|
|
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Cash, Cash Equivalents, Restricted Cash
and Marketable Securities (continued)
Beginning in fiscal 2011, we purchased
certificates of deposit with varying maturity dates greater than three months. The following table summarizes the maturities, gross
unrealized gains or losses and fair value of the certificates of deposit as of May 31, 2013:
|
|
May 31, 2013
|
|
|
|
Cost
|
|
|
Gross Unrealized Gains/(Losses)
|
|
|
Fair
Value
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in three months or less
|
|
$
|
2,149,849
|
|
|
$
|
–
|
|
|
$
|
2,149,849
|
|
Due in one year or less
|
|
$
|
194,463
|
|
|
$
|
–
|
|
|
$
|
194,463
|
|
The following table summarizes the maturities,
gross unrealized gains or losses and fair value of the certificates of deposit as of May 31, 2012:
|
|
May 31, 2012
|
|
|
|
Cost
|
|
|
Gross Unrealized Gains/(Losses)
|
|
|
Fair
Value
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in three months or less
|
|
$
|
2,061,973
|
|
|
$
|
–
|
|
|
$
|
2,061,973
|
|
Due in one year or less
|
|
$
|
2,907,106
|
|
|
$
|
–
|
|
|
$
|
2,907,106
|
|
Due in one year or more
|
|
$
|
229,045
|
|
|
$
|
–
|
|
|
$
|
229,045
|
|
4. Property and Equipment
Property and equipment consisted of the following at May 31,
2013 and 2012:
|
|
2013
|
|
|
2012
|
|
Computer equipment and software
|
|
$
|
28,741
|
|
|
$
|
28,658
|
|
Furniture and fixtures
|
|
|
21,176
|
|
|
|
23,545
|
|
|
|
|
49,917
|
|
|
|
52,203
|
|
Less: accumulated depreciation
|
|
|
(44,839
|
)
|
|
|
(44,667
|
)
|
Net property and equipment
|
|
$
|
5,078
|
|
|
$
|
7,536
|
|
Depreciation expense related to property
and equipment was $2,590 and $3,191 for the years ended May 31, 2013 and 2012, respectively.
5. Investment in Affiliated Company
Phoenix Digital Solutions,
LLC
On June 7, 2005, we entered into a Master
Agreement (the “Master Agreement”) with TPL, and Charles H. Moore (“Moore”), the co-inventor of the technology
which is the subject of the MMP Portfolio of microprocessor patents, pursuant to which the parties resolved all legal disputes
between them. Pursuant to the Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of PDS
(the “LLC Agreement”) into which we and Moore contributed our rights to certain of our technologies.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Investment in Affiliated Company (continued)
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 has not been a third management committee
member since May 2010. 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. Since there
is currently not a third member of the management committee, working capital contributions made to PDS require the approval of
both management committee members. On December 14, 2011 we contributed $200,000 and TPL forfeited rights to $200,000 of special
litigation support payments due it pursuant to the October 6, 2011 settlement agreement for an in-kind capital contribution of
$200,000 in order to fund a portion of a retainer due to newly engaged counsel. On March 23, 2012, April 13, 2012, and May 15,
2012 we and TPL each contributed $150,000, $150,000, and $150,000 to PDS to fund a portion of a retainer due to such counsel. During
the fiscal year ended May 31, 2013 we and TPL each contributed $1,097,809 to fund the remaining portions of the legal retainer
and the operations of PDS. Distributable cash and allocation of profits and losses have been allocated to the members in the priority
defined in the LLC Agreement.
Pursuant to our June 7, 2005 agreement
with PDS and TPL to license the MMP Portfolio (“Commercialization Agreement”), PDS had committed to pay a quarterly
amount ranging between $500,000 and $1,000,000 (based upon a percentage of the working capital fund balance of PDS) for supporting
efforts to secure licensing agreements by TPL on behalf of PDS. During the fiscal years ended May 31, 2013 and 2012, PDS expensed
$185,000 and $2,000,000, respectively, pursuant to this commitment. These expenses are recorded in the accompanying PDS statements
of operations presented below. These expenses concluded with the execution of the July 11, 2012 Licensing Program Services Agreement
(the “Program Agreement”).
PDS reimburses TPL for payment of all legal
and third-party expert fees and other related third-party costs and expenses, and certain internally generated costs as approved
on August 17, 2009 and more fully described below. During the fiscal years ended May 31, 2013 and 2012, PDS expensed $3,367,294
and $5,563,594, respectively, to TPL pursuant to the agreement. These expenses are recorded in the accompanying PDS statements
of operations presented below net of $376,049 and $491,124, respectively, of legal fee reversals previously expensed and recorded
as accounts payable to TPL during the fiscal years ended May 31, 2013 and 2012 as the statute of limitations had expired.
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 continues 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 17, 2012, we entered into an Agreement
with PDS, TPL, and Alliacense whereby we agreed to certain additional allocations of obligations relating to the Program Agreement.
Pursuant to the Program Agreement, PDS
has committed to Alliacense a quarterly amount of $500,000 which represents the licensing services fees due Alliacense, subject
to a contingency arrangement which provides for a percentage on future revenues, for its efforts to secure licensing agreements
on behalf of PDS. These payments can be capped at $2,000,000 pursuant to six-month notice from PDS, at which time the PDS management
committee will review and decide the warranting of future payments. These payments replace the quarterly amounts previously paid
to TPL pursuant to the Commercialization Agreement. During the fiscal year ended May 31, 2013, Alliacense earned $1,858,647 pursuant
to this commitment. This expense is recorded in
the accompanying PDS statement of operations for the fiscal year ended May 31, 2013 presented below.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Investment in Affiliated Company (continued)
Pursuant to the Program Agreement, PDS
has committed to pay Alliacense litigation support fees relating to Alliacense’s special work and effort regarding internal
costs related to MMP maintenance and litigation support including support in the U.S. District Court and the complaints filed on
behalf of TPL, PDS and us with the ITC. During the fiscal year ended May 31, 2013, PDS expensed $1,786,414 pursuant to this commitment.
Future litigation support payments to Alliacense relating to the ITC litigation are subject to a contingency arrangement which
provides for a percentage of future recoveries in these actions. This expense is recorded in the accompanying PDS statement of
operations for the fiscal year ended May 31, 2013 presented below.
During January 2013, TPL and Moore settled
their litigation. Terms of the settlement include 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 comes first. Per terms of the agreement PDS paid Moore $150,000
on the settlement date and will pay Moore $16,667 per month from August 2013 through January 2014 and $20,833 per month beginning
February 2014 through January 2017.
We are accounting for our investment in
PDS under the equity method of accounting, and accordingly have recorded our share of PDS’ net income during the fiscal year
ended May 31, 2013 of $2,174,395 as an increase in our investment and net loss of $1,828,375 during the fiscal year ended May 31,
2012 as a decrease in our investment. Cash distributions of $2,027,808 received from PDS during the year ended May 31, 2013 have
been recorded as a reduction in our investment. We received no cash distributions from PDS during the fiscal year ended May 31,
2012. Cash contributions of $1,097,809 and $650,000 made during the fiscal years ended May 31, 2013 and 2012, respectively, have
been recorded as in increase in our investment. We have recorded our share of PDS’ net income and net loss as “Equity
in earnings (loss) of affiliated company” in the accompanying consolidated statements of operations for the years ended May
31, 2013 and 2012, respectively.
During the fiscal year ended May 31, 2012
we accounted for an advance of $227,268 for legal services, which was reimbursable by PDS as equity in loss of PDS, under the equity
method of accounting given that this amount remained unreimbursed at May 31, 2012. During the fiscal year ended May 31, 2012 we
advanced PDS $10,000 for legal services and received $100,000 in payment on previous advances.
During the fiscal year ended May 31, 2012,
our share of loss in PDS exceeded our investment in PDS by $740,824. Such amount has been recorded as “Cumulative losses
in excess of investment in affiliated company” on our consolidated balance sheet at May 31, 2012, due to our and TPL’s
intent to fund the working capital of PDS.
During the fiscal year ended May 31, 2013,
PDS entered into licensing agreements with third parties, pursuant to which PDS recognized revenues of $10,620,000.
During the fiscal year ended May 31, 2013,
PDS recognized revenues of $1,500,000 for license agreements previously entered into by TPL.
During the fiscal years ended May 31, 2013
and 2012, TPL entered into licensing agreements with third parties, pursuant to which PDS recorded license revenues of approximately
$450,000 and $4,029,000, respectively.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Investment in Affiliated Company (continued)
At May
31, 2013, PDS had a prepaid balance to Alliacense of approximately $456,000 for advance payment of the June 1, 2013 quarterly payment
less license fees earned. At May 31, 2013, PDS had accounts payable balances of approximately $1,494,000, $34,000, and $17,000
to TPL, Alliacense, and PTSC, respectively. At May 31, 2012, PDS had accounts payable and accrued expenses balances of approximately
$2,611,000 and $137,000 to TPL and PTSC, respectively.
Variable Interest Entity Disclosures
At August 16, 2013, PDS’ cash balance
was $206,605.
For the fiscal years ended May 31, 2013
and 2012, we and TPL have each contributed $1,097,809 and $650,000, respectively, to fund the operations of PDS.
Our variable interest in PDS consists of
50% of PDS’ Members Equity of $366,304 as well as the accounts payable balance due us of $16,538 for a total of $349,766
at May 31, 2013.
On March 20, 2013, TPL filed a petition
under Chapter 11 of the United States Bankruptcy Code. We have been appointed to the creditors’ committee and will be closely
monitoring the progress in this matter as it relates to our interest in PDS. If we 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 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’ balance sheets at May 31, 2013
and 2012 and statements of operations for the years ended May 31, 2013 and 2012 are as follows:
Balance Sheets
Assets:
|
|
2013
|
|
|
2012
|
|
Cash and cash equivalents
|
|
$
|
1,320,932
|
|
|
$
|
1,003,489
|
|
Prepaid expenses
|
|
|
717,540
|
|
|
|
–
|
|
Licenses receivable
|
|
|
250,000
|
|
|
|
–
|
|
Total assets
|
|
$
|
2,288,472
|
|
|
$
|
1,003,489
|
|
Liabilities and Members’ Equity:
|
|
2013
|
|
|
2012
|
|
Related party payables and accrued expenses
|
|
$
|
1,544,075
|
|
|
$
|
2,747,883
|
|
Income tax payable
|
|
|
11,790
|
|
|
|
11,790
|
|
Members’ equity (deficit)
|
|
|
732,607
|
|
|
|
(1,756,184
|
)
|
Total liabilities and members’ equity
|
|
$
|
2,288,472
|
|
|
$
|
1,003,489
|
|
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Investment in Affiliated Company (continued)
Statements of Operations
|
|
2013
|
|
|
2012
|
|
Revenues
|
|
$
|
12,570,000
|
|
|
$
|
4,029,300
|
|
Expenses
|
|
|
7,548,619
|
|
|
|
7,673,461
|
|
Operating income (loss)
|
|
|
5,021,381
|
|
|
|
(3,644,161
|
)
|
Income (loss) before income taxes and foreign taxes
|
|
|
5,021,381
|
|
|
|
(3,644,161
|
)
|
Provision for income taxes and foreign taxes
|
|
|
672,590
|
|
|
|
12,590
|
|
Net income (loss)
|
|
$
|
4,348,791
|
|
|
$
|
(3,656,751
|
)
|
PDS Related Party Balances And Transactions
Balances with related parties as of May
31, 2013 and 2012 are summarized as follows:
|
|
May 31, 2013
|
|
|
May 31, 2012
|
|
Assets:
|
|
|
|
|
|
|
|
|
Prepaid expenses (Advances to Alliacense)
|
|
$
|
456,353
|
|
|
$
|
–
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
Related party payables and accrued expenses (TPL) (1)
|
|
$
|
1,493,775
|
|
|
$
|
2,610,615
|
|
Related party payables (PTSC)
|
|
|
16,538
|
|
|
|
137,268
|
|
Related party payables (Alliacense)
|
|
|
33,762
|
|
|
|
–
|
|
Total liabilities
|
|
$
|
1,544,075
|
|
|
$
|
2,747,883
|
|
Transactions with related parties for the
fiscal years ended May 31, 2013 and 2012 are as follows:
|
|
May 31, 2013
|
|
|
May 31, 2012
|
|
|
|
|
|
|
|
|
Expenses paid or accrued (TPL)
|
|
$
|
3,552,294
|
|
|
$
|
7,563,594
|
|
Expenses paid or accrued (Alliacense)
|
|
$
|
3,645,061
|
|
|
$
|
–
|
|
|
(1)
|
Pursuant to the terms of the Commercialization Agreement, PDS will reimburse TPL for the payment
of all legal and third party expert fees and other related third party costs and expenses upon TPL’s submission of documentation
supporting that payment by them has occurred.
|
Significant Contractual Legal Relationship
PTSC through its unconsolidated affiliate,
PDS has incurred legal fees from an unrelated law firm and legal subcontractors to provide substantial legal services for the commercialization
of the MMP portfolio of microprocessor patents.
Accounts payable balances due this law
firm and legal subcontractors as of May 31, 2013 and 2012 were $518,694 and $0, respectively.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Investment in Affiliated Company (continued)
Transactions with this law firm and legal
subcontractors for the fiscal years ended May 31, 2013 and 2012 were as follows:
|
|
May 31, 2013
|
|
|
May 31, 2012
|
|
Legal costs
|
|
$
|
3,689,419
|
|
|
$
|
2,474,072
|
|
Contractual Commitments
In January 2013, PDS entered into a contractual
commitment with a related party entity to provide consulting services at a cost of $250,000 per year for a duration of four years
or the completion of all outstanding MMP litigation, whichever comes first.
For the fiscal year ended May 31, 2013,
PDS expensed $150,000 related to this agreement.
In connection with the Program Agreement,
PDS is required to make payments to Alliacense of $500,000 no later than three days prior to the start of each calendar quarter.
Such payments are non-accountable and non-recoupable, but are offset against the licensing series fees owed to Alliacense pursuant
to the Program Agreement. Upon six months notice to Alliacense, and in conjunction with a proportionate reduction in the scope
of the Project Description, as defined, PDS may determine to implement a maximum of advances not-yet-offset of $2,000,000.
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 the PDS. If a decline in
value is deemed to be other than temporary, we would recognize an impairment loss.
6. Accrued Expenses and Other
At May 31, 2013 and 2012, accrued expenses
and other consisted of the following:
|
|
2013
|
|
|
2012
|
|
Accrued lease obligation
|
|
$
|
1,814
|
|
|
$
|
2,889
|
|
Compensation and benefits
|
|
|
56,707
|
|
|
|
61,754
|
|
|
|
$
|
58,521
|
|
|
$
|
64,643
|
|
7. Stockholders’ Equity
Share Repurchases
During July 2006, we commenced our Board
of Director approved stock buyback program in which we repurchase our outstanding common stock from time to time on the open market.
The repurchase plan has no maximum number of shares and is solely at the discretion of the Board of Directors. The repurchase plan
has no set expiration date.
The following table summarizes share repurchases during the
years ended May 31, 2013 and 2012:
|
|
2013
|
|
|
2012
|
|
Number of shares repurchased
|
|
|
563,553
|
|
|
|
1,790,841
|
|
Aggregate cost
|
|
$
|
57,140
|
|
|
$
|
124,217
|
|
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Stockholders’ Equity
(continued)
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. No
stock options were granted during the fiscal years ended May 31, 2013 and 2012.
A summary of option
activity as of May 31, 2013 and changes during the fiscal year then ended, is presented below:
|
|
Shares
|
|
|
Weighted Average
Exercise
Price
|
|
|
Weighted Average Remaining Contractual Term (Years)
|
|
|
Aggregate
Intrinsic
Value
|
|
Options outstanding at June 1, 2012
|
|
|
2,360,838
|
|
|
$
|
0.26
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
Options exercised
|
|
|
(75,000
|
)
|
|
$
|
0.10
|
|
|
|
|
|
|
|
|
|
Options forfeited
|
|
|
(1,535,838
|
)
|
|
$
|
0.34
|
|
|
|
|
|
|
|
|
|
Options outstanding at May 31, 2013
|
|
|
750,000
|
|
|
$
|
0.10
|
|
|
|
1.70
|
|
|
$
|
–
|
|
Options vested and expected to vest at May 31, 2013
|
|
|
750,000
|
|
|
$
|
0.10
|
|
|
|
1.70
|
|
|
$
|
–
|
|
Options exercisable at May 31, 2013
|
|
|
750,000
|
|
|
$
|
0.10
|
|
|
|
1.70
|
|
|
$
|
–
|
|
The aggregate
intrinsic value in the table above represents the differences in market price at the close of the fiscal year ($0.10 per share
on May 31, 2013) and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.10) on
May 31, 2013.
The following
table summarizes employee and director stock-based compensation expense for PTSC and employee stock-based compensation expense
for PDSG for the fiscal years ended May 31, 2013 and 2012, which was recorded as follows:
|
|
Year Ended
|
|
|
Year Ended
|
|
|
|
May 31, 2013
|
|
|
May 31, 2012
|
|
Research and development - PDSG
|
|
$
|
–
|
|
|
$
|
1,541
|
|
Selling, general and administrative expense - PDSG
|
|
|
–
|
|
|
|
15,093
|
|
Selling, general and administrative expense - PTSC
|
|
|
–
|
|
|
|
–
|
|
Total
|
|
$
|
–
|
|
|
$
|
16,634
|
|
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Stockholders’ Equity
(continued)
2003 Stock Option Plan
The 2003 Stock Option Plan, which expired
in July 2013, provided for the granting of options to acquire up to 6,000,000 shares of our common stock to either full or part
time employees, directors and our consultants 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). There were no grants made under the 2003 Stock Option Plan during
the fiscal years ended May 31, 2013 and 2012. As of May 31, 2013, there are no options outstanding under the 2003 Stock Option
Plan.
2006 Stock Option Plan
The 2006 Stock Option Plan, as amended,
which expires in March 2016, provides for the granting of options to acquire up to 10,000,000 shares, with a limit of 8,000,000
Incentive Stock Option (“ISO”) shares of our common stock to either full or part time employees, directors and our
consultants at a price not less than the fair market value on the date of grant. 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 2006 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case
of a significant stockholder). There were no grants made under the 2006 Stock Option Plan during the fiscal years ended May 31,
2013 and 2012. As of May 31, 2013, options to purchase 750,000 shares of common stock are outstanding under the 2006 Stock Option
Plan.
8. Income Taxes
The provision (benefit) for income taxes from continuing operations
is as follows for the years ended May 31:
|
|
2013
|
|
|
2012
|
|
Current:
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
(2,513
|
)
|
|
$
|
(4,075
|
)
|
State
|
|
|
2,400
|
|
|
|
3,200
|
|
Total current
|
|
|
(113
|
)
|
|
|
(875
|
)
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Federal
|
|
|
571,104
|
|
|
|
(1,531,321
|
)
|
State
|
|
|
146,377
|
|
|
|
(398,831
|
)
|
Total deferred
|
|
|
717,481
|
|
|
|
(1,930,152
|
)
|
Valuation allowance
|
|
|
(717,481
|
)
|
|
|
1,930,152
|
|
Total deferred
|
|
|
–
|
|
|
|
–
|
|
Total benefit
|
|
$
|
(113
|
)
|
|
$
|
(875
|
)
|
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Income Taxes (continued)
The reconciliation of the effective income
tax rate to the Federal statutory rate is as follows for the years ended May 31:
|
|
2013
|
|
|
2012
|
|
Statutory federal income tax rate
|
|
|
35.0%
|
|
|
|
35.0%
|
|
State income tax rate, net of Federal effect
|
|
|
0.2%
|
|
|
|
-%
|
|
Change in tax rate
|
|
|
(1.0%
|
)
|
|
|
(1.0%
|
)
|
Stock option expense
|
|
|
7.6%
|
|
|
|
(2.2%
|
)
|
Tax exempt interest
|
|
|
-%
|
|
|
|
0.2%
|
|
FIN 48 liability
|
|
|
(0.2%
|
)
|
|
|
-%
|
|
Other
|
|
|
7.0%
|
|
|
|
0.4%
|
|
Change in valuation allowance
|
|
|
(48.6%
|
)
|
|
|
(32.4%
|
)
|
Effective income tax rate
|
|
|
0.0%
|
|
|
|
0.0%
|
|
Deferred tax assets and liabilities reflect the net tax effect
of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and amounts used
for income tax purposes. Significant components of our deferred tax assets from continuing operations are as follows as of May
31:
|
|
2013
|
|
2012
|
|
Current deferred tax assets:
|
|
|
|
|
|
|
|
State taxes
|
|
$
|
815
|
|
$
|
815
|
|
Accrued expenses
|
|
|
14,751
|
|
|
24,949
|
|
Less: valuation allowance
|
|
|
(15,566
|
)
|
|
(25,764
|
)
|
Total net current deferred tax asset
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Long-term deferred tax assets (liabilities):
|
|
|
|
|
|
|
|
Investment in affiliated company
|
|
|
(106,419
|
)
|
|
536,480
|
|
Basis difference in property and equipment
|
|
|
(2,166
|
)
|
|
(2,371
|
)
|
Basis difference in intangibles
|
|
|
18,334
|
|
|
9,943
|
|
Stock based compensation expense
|
|
|
227,284
|
|
|
374,131
|
|
Impairment of note receivable
|
|
|
331,896
|
|
|
331,896
|
|
Capital loss carryover
|
|
|
643,144
|
|
|
775,942
|
|
Net operating loss carryforwards
|
|
|
9,491,977
|
|
|
9,285,312
|
|
Credit carryover
|
|
|
107,017
|
|
|
107,017
|
|
Valuation allowance
|
|
|
(10,711,067
|
)
|
|
(11,418,350
|
)
|
Total net long-term deferred tax asset
|
|
|
-
|
|
|
-
|
|
Net deferred tax asset
|
|
$
|
-
|
|
$
|
-
|
|
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Income Taxes (continued)
We have federal and state net operating
loss carryforwards available to offset future taxable income of approximately $21,515,000 and $24,626,000, respectively, at May
31, 2013. These carryforwards begin to expire in the years ending May 31, 2023 and 2013, respectively. The state of California
has suspended NOL deductions for taxable years beginning in 2008 or 2009 for taxpayers with business income of $300,000 or more.
On
June 1, 2007, we adopted authoritative guidance which
defines criteria that an individual tax position must meet for any
part of the benefit of that position to be recognized in a company’s financial statements and also provides guidance on measurement,
derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of
this guidance did not result in any cumulative effect adjustment to retained earnings. Interest and penalties, if any, related
to unrecognized tax benefits are recorded in income tax expense. As of May 31, 2013, we are subject to U.S. Federal income tax
examinations for the tax years May 31, 1996 through May 31, 2012, and we are subject to state and local income tax examinations
for the tax years May 31, 2004 through May 31, 2012 due to the carryover of net operating losses related to PDSG from previous
years.
The table below summarizes our liability
relating to unrecognized tax benefits under the authoritative guidance for the fiscal years ended May 31, 2013 and 2012:
Balance at June 1, 2011
|
|
$
|
6,588
|
|
Increase in unrecognized tax benefit liability
|
|
|
–
|
|
Decrease in unrecognized tax benefit liability
|
|
|
(4,075
|
)
|
Accrual of interest related to unrecognized tax benefits
|
|
|
–
|
|
Balance at May 31, 2012
|
|
$
|
2,513
|
|
Increase in unrecognized tax benefit liability
|
|
|
–
|
|
Decrease in unrecognized tax benefit liability
|
|
|
(2,513
|
)
|
Accrual of interest related to unrecognized tax benefits
|
|
|
–
|
|
Balance at May 31, 2013
|
|
$
|
–
|
|
Our liability
relating to unrecognized tax benefits has been presented net of our prepaid income taxes on our consolidated balance sheet at May
31, 2012.
Our continuing
practice is to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. This
policy did not change as a result of our adoption of the authoritative guidance on June 1, 2007. We do not expect our unrecognized
tax benefits to change significantly over the next twelve months.
9. Commitments and Contingencies
Litigation
Patent Litigation
On February 8, 2008, we, TPL and Alliacense
Ltd. were named as defendants in separate lawsuits filed in the United States District Court for the Northern District of California
by HTC Corporation, and Acer, Inc., and affiliated entities of each of them. (Those cases are deemed related and are referred to
herein as the “N.D. Cal. Case”). HTC and Acer
seek declaratory relief that their products do not infringe enforceable
claims of the '336 patent. We allege counterclaims for patent infringement of the '336 and '890 patents as to certain of their
products.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Commitments
and Contingencies (continued)
The Court issued a first claim construction
ruling in the N.D. Cal. Case on June 12, 2012, which preserved our ability to proceed on our infringement claims against Acer and
HTC. Thereafter, Chief District Judge James Ware retired and the N.D. Cal. case was reassigned to Magistrate Judge Paul S. Grewal,
who held a supplemental claim construction hearing on November 30, 2012. Judge Grewal then issued a supplemental claim construction
ruling on December 5, 2012, which preserved our ability to proceed with our infringement claims. Judge Grewal considered a number
of motions challenging our claims on August 13, 2013 but has not yet ruled on them. The N.D. Cal. case is set for a jury trial
starting on September 23, 2013.
On July 24, 2012 complaints were filed
on behalf of us, TPL, and PDS against Acer, Inc., Amazon.com, Inc., Barnes & Noble, Inc., Garmin, Ltd., HTC Corporation, Huawei
Technologies Co., Ltd., Kyocera Corporation, LG Electronics, Nintendo C., Ltd., Novatel Wireless, Inc., Samsung Electronics Co.,
Ltd., Sierra Wireless, Ltd. and ZTE Corporation with the U.S. International Trade Commission ("ITC") (ITC Investigation
No. 337-TA-853, or the “853 Investigation”) alleging infringement of the ‘336 patent. We also filed new parallel
proceedings in the U.S. District Court for the Northern District of California alleging infringement of the ‘749, ‘890
and ‘336 patents 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 subsequently reached a settlement with Sierra Wireless, Inc. Trial proceedings before the ITC began on June 3, 2013 and concluded
the following week. An initial determination is expected from the ITC by September 6, 2013. The target date in the ITC proceeding,
in which the ITC could potentially issue an importation ban on infringing products, is January 6, 2014. All of the district
court actions against the new parties (i.e., all respondents other than Acer and HTC) are currently stayed pending resolution of
the 853 Investigation.
Licensing Fee Dispute
In February 2013, PDS received a license
fee installment attributable to the January 2013 satisfaction of a contingency contained in an MMP license agreement entered into
in May 2012. Alliacense has asserted a claim against PDS for $300,000 under the premise that it is owed a percentage of the license
fee installment pursuant to the Program Agreement it entered into with PDS, TPL and us in July 2012. TPL has also asserted a claim
against PDS for $225,000 under the premise that it is owed a percentage of the license fee installment pursuant to the terms of
the June 2005 Commercialization Agreement between PDS, TPL and us. Our position is that no percentage is due Alliacense as it had
not been engaged for services at the time the May 2012 license agreement was entered into, and that it had no role in the satisfaction
of the contingency that triggered the installment fee. Regarding TPL, our position is that a percentage to TPL could be justified,
subject to, and fully offset by, advances previously made to it by PDS. We intend to vigorously defend our interest in PDS against
the assertions made by Alliacense and TPL. While no amounts have been accrued in regards to these matters, we believe pursuant
to the criteria defined in Accounting Standards Codification 450-20-50
Disclosure of Certain Loss Contingencies
, it is reasonably
possible PDS could recognize a charge to earnings in the range of $0 to $300,000.
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 fiscal years ended May 31, 2013 and 2012 were
$10,801 and $15,504, respectively.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
Commitments
and Contingencies (continued)
PDSG had a retirement plan that complied
with Section 401(k) of the Internal Revenue Code. All employees were eligible to participate in the plan and PDSG did not match
participant voluntary contributions. On April 30, 2012 substantially all of the assets of PDSG were sold and the PDSG 401(k) plan
was transferred to the purchaser’s 401(k) plan.
Employment Contracts
In connection with Mr. Flowers’
appointment as the Chief Financial Officer, and commencing on September 17, 2007, we entered into an employment agreement
with Mr. Flowers for an initial 120-day term if not terminated pursuant to the agreement, with an extension period of one
year and on a continuing basis thereafter. Pursuant to the agreement, if Mr. Flowers is terminated without cause or resigns
with good reason any time after two years of continuous employment, he is entitled to receive an amount equal to twelve months
of his annual base salary. Mr. Flowers is also entitled to certain payments upon a change of control of the Company if the
surviving corporation does not retain him. All such payments are conditional upon the execution of a general release.
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. In connection with our facility lease, we have
indemnified our lessor for certain claims arising from the use of the facility. 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 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.
Operating Lease
We lease our facility through an operating
lease that expires in January 2014. Rental expense is presented in the following table:
|
|
Year Ended
|
|
|
Year Ended
|
|
|
|
May 31, 2013
|
|
|
May 31, 2012
|
|
Rental expense
|
|
$
|
34,791
|
|
|
$
|
35,279
|
|
Future minimum payments under our operating
lease commitment as of May 31, 2013 amount to $23,581.
Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)
10. 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 consolidated financial statements or disclosure in the notes thereto other than as disclosed
in the accompanying notes.
On June 4, 2013, we issued 760,000 stock
options from our 2006 Stock Option Plan with an exercise price of $0.12 to our employees and directors. The options vested immediately
upon issuance.
Phoenix Digital Solutions, LLC
INDEX TO FINANCIAL STATEMENTS
|
|
Page
|
Report of Independent Registered Public Accounting Firm
|
|
F-28
|
Financial Statements:
|
|
|
Balance Sheets
|
|
F-29
|
Statements of Operations
|
|
F-30
|
Statements of Members’ Equity (Deficit)
|
|
F-31
|
Statements of Cash Flows
|
|
F-32
|
Notes to Financial Statements
|
|
F-33
|
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
To the Members
Phoenix Digital Solutions, LLC
We have audited the accompanying balance
sheets of Phoenix Digital Solutions, LLC (the "Company") as of May 31, 2013 and 2012, and the related statements of operations,
members' equity (deficit) and cash flows for the years then ended. 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits
included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate
in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting. Accordingly, we express no such opinion. 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.
As described in Notes 6, 8, and 9, the
Company has extensive transactions with Technology Properties Limited, LLC and Alliacense Limited LLC both related parties. Accordingly,
the accompanying financial statements may not be indicative of the financial position or results of operations that would have
occurred had the Company operated without such related party relationships.
In our opinion, the financial statements
referred to above, present fairly, in all material respects, the financial position of Phoenix Digital Solutions, LLC as of May 31,
2013 and 2012, and the results of their operations and their cash flows for the years then ended, in conformity with accounting
principles generally accepted in the United States of America.
The accompanying
financial statements have been prepared assuming the Company will continue as a going concern. As more fully described in Note
1 to the financial statements,
because of the uncertain nature of the negotiations that lead to license revenues, there
is no assurance that the Company will receive any future revenues from license agreements, or if it does, that such license revenues
in the future will be consistent with amounts received in the past
. These factors raise substantial
doubt about the Company’s 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.
Our opinion is not modified with respect to this matter.
/s/ KMJ Corbin & Company LLP
Costa Mesa, California
August 22, 2013
Phoenix Digital Solutions, LLC
Balance Sheets
May 31,
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
1,320,932
|
|
|
$
|
1,003,489
|
|
Prepaid expenses
|
|
|
717,540
|
|
|
|
–
|
|
Licenses receivable
|
|
|
250,000
|
|
|
|
–
|
|
Total assets
|
|
$
|
2,288,472
|
|
|
$
|
1,003,489
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND MEMBERS’ EQUITY (DEFICIT)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Related party payables and accrued expenses
|
|
$
|
1,544,075
|
|
|
$
|
2,747,883
|
|
Income tax payable
|
|
|
11,790
|
|
|
|
11,790
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
1,555,865
|
|
|
|
2,759,673
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Members’ equity (deficit)
|
|
|
732,607
|
|
|
|
(1,756,184
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities and members’ equity (deficit)
|
|
$
|
2,288,472
|
|
|
$
|
1,003,489
|
|
See accompanying notes to financial statements.
Phoenix Digital
Solutions, LLC
Statements of Operations
Years Ended May 31,
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
License revenues
|
|
$
|
12,570,000
|
|
|
$
|
4,029,300
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
7,548,619
|
|
|
|
7,673,461
|
|
Operating income (loss)
|
|
|
5,021,381
|
|
|
|
(3,644,161
|
)
|
|
|
|
|
|
|
|
|
|
Income (loss) before provision for income taxes and foreign taxes
|
|
|
5,021,381
|
|
|
|
(3,644,161
|
)
|
|
|
|
|
|
|
|
|
|
Provision for income taxes and foreign taxes
|
|
|
672,590
|
|
|
|
12,590
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
4,348,791
|
|
|
$
|
(3,656,751
|
)
|
See accompanying notes to financial statements.
Phoenix Digital Solutions, LLC
Statements of Members’ Equity (Deficit)
Years Ended May 31, 2013 and 2012
Balance June 1, 2011
|
|
$
|
600,567
|
|
Contributions
|
|
|
1,300,000
|
|
Net loss
|
|
|
(3,656,751
|
)
|
Balance May 31, 2012
|
|
|
(1,756,184
|
)
|
Contributions
|
|
|
2,195,617
|
|
Distributions
|
|
|
(4,055,617
|
)
|
Net income
|
|
|
4,348,791
|
|
Balance May 31, 2013
|
|
$
|
732,607
|
|
See accompanying notes to financial statements.
Phoenix Digital Solutions, LLC
Statements of Cash Flows
Years Ended May 31,
|
|
2013
|
|
|
2012
|
|
Operating activities:
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
4,348,791
|
|
|
$
|
(3,656,751
|
)
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Forgiveness of accounts payable
|
|
|
(376,049
|
)
|
|
|
(491,124
|
)
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaid expenses
|
|
|
(717,540
|
)
|
|
|
600,000
|
|
Licenses receivable
|
|
|
(250,000
|
)
|
|
|
–
|
|
Related party payables and accrued expenses
|
|
|
(827,759
|
)
|
|
|
1,555,711
|
|
Net cash provided by (used in) operating activities
|
|
|
2,177,443
|
|
|
|
(1,992,164
|
)
|
|
|
|
|
|
|
|
|
|
Financing activities:
|
|
|
|
|
|
|
|
|
Contributions from members
|
|
|
2,195,617
|
|
|
|
1,100,000
|
|
Distributions to members
|
|
|
(4,055,617
|
)
|
|
|
–
|
|
Net cash (used in) provided by financing activities
|
|
|
(1,860,000
|
)
|
|
|
1,100,000
|
|
Net increase (decrease) in cash
|
|
|
317,443
|
|
|
|
(892,164
|
)
|
Cash , beginning of year
|
|
|
1,003,489
|
|
|
|
1,895,653
|
|
Cash , end of year
|
|
$
|
1,320,932
|
|
|
$
|
1,003,489
|
|
Supplemental Disclosure of Cash Flow Information:
|
|
|
|
|
|
|
|
|
Cash payments for income taxes
|
|
$
|
672,590
|
|
|
$
|
12,590
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosure of Non-Cash Financing Activities:
|
|
|
|
|
|
|
|
|
In-kind capital contribution
|
|
$
|
–
|
|
|
$
|
200,000
|
|
See accompanying notes to financial statements.
Phoenix Digital Solutions, LLC
Notes to Financial Statements
1. Organization and Business
Phoenix Digital Solutions, LLC (the “Company”
or “PDS”) is a Delaware limited liability company organized on June 7, 2005. Through a commercialization agreement
dated June 7, 2005 as amended in July 2012, the Company holds the rights to certain patents of its members. The Company receives
license fees from license agreements entered into between licensees and the Company and distributes license fee proceeds to its
members.
Basis of Presentation
The Company’s financial statements
have been prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United
States of America (“GAAP”) and have been prepared on a going concern basis, which contemplates the realization of assets
and the settlement of liabilities in the normal course of business.
Going Concern and Management’s Plans
At August 16, 2013, the Company’s
cash balance was $206,605. The ability of PDS to continue as a going concern is dependent on its ability to generate or obtain
sufficient cash to meet its obligations on a timely basis. The Company will need to generate proceeds from new license agreements
or obtain equity or debt financing from its members to fund its planned operating expenses and working capital requirements for
the foreseeable future. Currently, the Company has no commitments to obtain additional capital from sources outside of that which
may be contributed by the members, and there can be no assurance that financing will be available in amounts or on terms acceptable
to the Company, if at all.
Because of the uncertain nature of the
negotiations that lead to license revenues, pending litigation with companies which the members believe have infringed on their
patent portfolio, the possibility of legislative action regarding patent rights, and the possible effect of new judicial interpretations
of patent laws, there is no assurance that the Company will receive any future revenues from license agreements, or if it does,
that such license revenues in the future will be consistent with amounts received in the past.
In the event the Company is unable to successfully
generate proceeds from license agreements at historical levels or obtain additional capital, it is unlikely that the Company will
have sufficient cash flows and liquidity to finance its business operations as currently contemplated. Accordingly, in the event
new financing is not obtained, the Company will likely reduce general and administrative expenses, including legal fees, litigation
activity and other licensing costs, until it is able to obtain sufficient financing to do so.
On March 20, 2013, Technology Properties
Limited Inc. (“TPL”) filed a petition under Chapter 11 of the United States Bankruptcy Code. Patriot Scientific Corporation
(“PTSC”) has been appointed to the creditors’ committee and will be closely monitoring the progress in this matter
as it relates to PTSC’s interest in PDS.
The accompanying financial statements have
been prepared assuming that the Company will continue as a going concern. As discussed, the above conditions raise sufficient doubt
about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
2. Summary of Significant Accounting
Policies
Limited Liability Company Operating
Agreement
As a limited liability company, each member’s
liability is limited to the capital invested. Allocation of profits, losses and distributions is in accordance with the terms as
defined in the operating agreement.
Phoenix Digital Solutions, LLC
Notes to Financial Statements (Continued)
Summary of Significant Accounting Policies
(continued)
The Company is treated as a partnership
for federal income tax purposes. Consequently, federal income taxes are not payable by the Company. The Company’s net income
or loss is allocated among the members in accordance with the operating agreement of the Company and members are taxed individually
on their share of the Company’s earnings. The State of California assesses a limited liability company fee based on the Company’s
income in addition to a flat limited liability company tax. Accordingly the financial statements reflect a provision for these
California taxes.
Use of Estimates
The preparation of financial statements
in conformity with accounting principles generally accepted in the United States of America requires management to make estimates
and assumptions that affect the reported amounts and disclosures. Accordingly, actual results could differ from those estimates.
Revenue Recognition
The Company 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. The Company may at times enter into license agreements whereby contingent revenues are
recognized as one or more contractual milestones are met.
Financial Instruments and Concentration
of Credit Risk
Financial instruments that potentially
subject the Company to concentrations of credit risk consist principally of cash.
At times, the Company’s balance of
cash maintained with its bank may exceed the Federal Deposit Insurance Corporation’s (“FDIC”) insured limit of
$250,000. At May 31, 2013, the Company’s cash balance subject to FDIC insurance exceeded the FDIC limit by $1,070,932. The
Company limits its exposure of loss by maintaining its cash with financially stable financial institutions.
Legal Fees
For the year ended May 31, 2012, one legal
service provider accounted for $2,609,573 of legal costs associated with the litigation of the Moore Microprocessor Patent (“MMP”)
portfolio, this provider had no such costs for the year ended May 31, 2013. For the years ended May 31, 2013 and 2012 another
legal service provider accounted for $2,082,638 and $2,474,072, respectively, of legal costs associated with the litigation of
the MMP patent portfolio. These amounts are included in general and administrative expense in the accompanying statements of operations.
Intellectual Property Rights
The Company relies on a combination of
patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual
property rights. The Company currently licenses four unexpired U.S. patents issued dating back to 1997 on PTSC’s microprocessor
technology in addition to three European and two Japanese patents. The U.S. patents will expire between 2014 and 2015 and the European
and Japanese patents will expire in 2016. The Company also licenses three U.S. patents, six European, and one Japanese patent all
of which expired between August 2009 and June 2013. These patents, while expired, may have certain retrospective statutory benefits
that will fully diminish six years after the patent expiration date (e.g. for the expired U.S. patents). 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 its ownership of the technology or the proprietary
nature of the intellectual property would materially
damage the Company’s business prospects. Any issued patent may be challenged and invalidated.
Phoenix Digital Solutions, LLC
Notes to Financial Statements (Continued)
3. Fair Value of Financial Instruments
The Company’s financial instruments
consist of cash, licenses receivable and certain of its accounts payable and accrued expenses. The carrying value of these financial
instruments approximates fair value because of the immediate or short-term maturity of the instruments.
4. Prepaid Expenses
At May 31, 2013, prepaid expenses
consist of:
|
|
May 31, 2013
|
|
Prepaid Expenses
|
|
$
|
506,291
|
|
Retainers
|
|
|
211,249
|
|
Total
|
|
$
|
717,540
|
|
Prepaid expenses in the table
above consist of the amount advanced to Alliacense Limited, LLC (“Alliacense”, an affiliate of TPL) in May 2013 for
licensing services fees, less the amount of license fees earned for the quarter ended May 31, 2013. Also included in prepaid expenses
are fees paid for the court reporter services for the U.S. International Trade Commission (“ITC”) trial held in June
2013.
Retainers
in the table above consist of the balances with the court appointed Special Master and Technical Advisor in the United States District
Court for the Northern District of California (“U.S. District Court”) and the amount the Company advanced to its current
patent litigation firm for the ITC and U.S. District Court cases.
5. Licenses Receivable
The Company 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.
At May 31, 2013, the balance in licenses
receivable consists of a license agreement entered into during May 2013, for which payment was received by the Company during June
and July 2013.
6. Formation of Joint Venture and Commercialization Agreement
The Company, a joint venture has two members:
TPL, and PTSC. Each member owns 50% of the membership interests of the Company. 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 has not been a third management committee member since May 2010.
Phoenix Digital Solutions, LLC
Notes to Financial Statements (Continued)
Formation
of Joint Venture and Commercialization Agreement
(continued)
Contribution Requirements
Pursuant to the Company’s Limited
Liability Company Operating Agreement (the “LLC Agreement”), the members agreed to establish a working capital fund
for the Company of $4,000,000, of which each member contributed $2,000,000. The working capital fund increases to a maximum of
$8,000,000 as license revenues are achieved. The members are obligated to fund future working capital requirements at the discretion
of the management committee of the Company in order to maintain working capital of not more than $8,000,000. If the management
committee determines that additional capital is required, neither member is required to contribute more than $2,000,000 in any
fiscal year. Since there is currently not a third member of the management committee, working capital contributions made to the
Company require the approval of both management committee members. During the fiscal years ended May 31, 2013 and 2012 PTSC and
TPL each contributed $1,097,809 and $650,000, respectively, to the Company for working capital requirements. Distributable cash
and allocation of profits and losses are allocated to the members in the priority defined in the LLC Agreement.
Joint Venture Contractual Agreements
On June 7, 2005, the Company entered into
a Commercialization Agreement (the “Commercialization Agreement”) with TPL and PTSC. This Commercialization Agreement
allows TPL to commercialize the patent portfolio by entering into settlement and/or license agreements, litigating in the name
of TPL, PTSC, the Company and Charles Moore (“Moore”), and manage the use of the patent portfolio by third parties.
On July 11, 2012, the Company entered into
a Licensing Program Services Agreement (the “Program Agreement”) with PTSC, TPL, and Alliacense creating an amendment
to the Commercialization Agreement, and an Agreement (the “TPL Agreement”) between TPL and PTSC. Pursuant to the Program
Agreement, the Company engaged Alliacense to negotiate MMP portfolio licenses and to pursue claims against violators of the MMP
portfolio on behalf of the Company, TPL, and PTSC. The Program Agreement continues through the useful life of the MMP portfolio
patents.
On July 17, 2012, the Company entered into
an Agreement with PTSC, TPL, and Alliacense whereby the parties agreed to certain additional allocations of obligations relating
to the Program Agreement.
Under terms of the Commercialization Agreement,
the Company was required to pay a quarterly amount ranging between $500,000 and $1,000,000 (based upon a percentage of the working
capital fund balance) to TPL for TPL’s supporting efforts to secure licensing agreements for the Company. During the years
ended May 31, 2013 and 2012 the Company expensed $185,000 and $2,000,000, respectively, pursuant to the agreement. The Company
is also required to reimburse TPL for payment of all legal and third-party expert fess and other related third party costs and
expenses. During the years ended May 31, 2013 and 2012 the Company expensed $3,367,294 and $5,563,594, respectively, pursuant to
the agreement.
Pursuant to the Program Agreement effective
July 11, 2012, the Company has committed to Alliacense a quarterly amount of $500,000 which represents the licensing services fees
due Alliacense, subject to a contingency arrangement which provides for a percentage on future revenues, for its efforts to secure
licensing agreements on behalf of the Company. These payments can be capped at $2,000,000 pursuant to six-month notice from the
Company, at which time the management committee will review and decide on future payments, if any. These payments replace the quarterly
amounts previously paid to TPL pursuant to the Commercialization Agreement. During the fiscal year ended May 31, 2013, the Company
expensed $1,815,000 pursuant to this contractual obligation.
Phoenix Digital Solutions, LLC
Notes to Financial Statements (Continued)
Formation
of Joint Venture and Commercialization Agreement
(continued)
Pursuant to the Program Agreement effective
July 11, 2012, the Company is contractually obligated to pay Alliacense litigation support fees relating to Alliacense’s
special work and effort regarding internal costs related to MMP maintenance and litigation support including support in the U.S.
District Court and the complaints filed on behalf of TPL, PTSC and the Company with the ITC. During the fiscal year ended May 31,
2013, the Company expensed $1,786,414 pursuant to this contractual obligation. Future litigation support payments to Alliacense
relating to the ITC litigation are subject to a contingency arrangement which provides for a percentage of future recoveries in
these actions.
During January 2013, TPL and Moore settled
their litigation. Terms of the settlement include payment by the Company to Moore of a consulting fee of $250,000 for four years
or until the completion of all outstanding MMP litigation whichever comes first. Per terms of the agreement the Company paid Moore
$150,000 on the settlement date and will pay Moore $16,667 per month from August 2013 through January 2014 and $20,833 per month
beginning February 2014 through January 2017.
Significant Contractual Legal Relationship
The Company has incurred legal fees from
an unrelated law firm and legal subcontractors to provide substantial legal services for the commercialization of the MMP portfolio
of microprocessor patents.
Accounts payable balances due this law
firm and legal subcontractors as of May 31, 2013 and 2012 were $518,694 and $0, respectively.
Transactions with this law firm and legal
subcontractors for the fiscal years ended May 31, 2013 and 2012 were as follows:
|
|
May 31,
2013
|
|
|
May 31,
2012
|
|
Legal costs
|
|
$
|
3,689,419
|
|
|
$
|
2,474,072
|
|
7. Delinquent Accounts Payable
During the fiscal years ended May 31, 2013
and 2012, the Company reversed approximately $376,000 and $491,000, respectively, of legal fees previously expensed and recorded
as accounts payable to TPL as the statute of limitations had expired. This reversal is recorded as a reduction of legal expenses
in general and administrative expense in the accompanying statements of operations.
8. Commitments and Contingencies
Member Litigation
On October 6, 2011, PTSC settled a legal
action. Pursuant to the executed settlement agreement with TPL, the Company agreed to pay TPL
$172,000
for June 2011, and $86,000 per month thereafter until 60 days after the Markman hearing
relating to TPL’s special
work and effort regarding internal costs related to litigation support. Accordingly, the Company recognized $946,000 through May
31, 2012 pursuant to the executed settlement agreement. This amount has been recorded in general and administrative expense for
the year ended May 31, 2012 in the accompanying statements of operations.
Phoenix Digital Solutions, LLC
Notes to Financial Statements (Continued)
Commitments and Contingencies (continued)
Licensing Fee Dispute
In February 2013, the Company received
a license fee installment attributable to the January 2013 satisfaction of a contingency contained in an MMP license agreement
entered into in May 2012. Alliacense has asserted a claim against the Company for $300,000 under the premise that it is owed a
percentage of the license fee installment pursuant to the Program Agreement it entered into with Patriot, TPL and the Company in
July 2012. TPL has also asserted a claim against the Company for $225,000 under the premise that it is owed a percentage of the
license fee installment pursuant to the terms of the June 2005 Commercialization Agreement between Patriot, TPL and the Company.
The Company’s position is that no percentage is due Alliacense as it had not been engaged for services at the time the May
2012 license agreement was entered into, and that Alliacense had no role in the satisfaction of the contingency that triggered
the installment fee. Regarding TPL, the Company’s position is that a percentage to TPL could be justified, subject to, and
fully offset by, advances previously made to it by the Company. The Company intends to vigorously defend itself against the assertions
made by Alliacense and TPL. While no amounts have been accrued in regards to these matters, the Company believes pursuant to the
criteria defined in Accounting Standards Codification 450-20-50
Disclosure of Certain Loss Contingencies
, it is reasonably
possible the Company could recognize a charge to earnings in the range of $0 to $300,000.
Guarantees and Indemnities
Under the LLC Operating Agreement, the
Company indemnifies its members, managers, officers and employees from any damages and liabilities by reason of their management
or involvement in the affairs of the Company as long as the indemnitee acted in good faith and in the best interests of the Company.
Under the Commercialization Agreement,
the Company and PTSC hold harmless TPL and its representatives with respect to all claims of any nature by or on behalf of the
Company and PTSC related to the preparation, execution and delivery of duties and responsibilities under the Commercialization
Agreement.
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 the Company could be obligated to make. Historically, the Company has not been obligated to make any payments for
these obligations and no liabilities have been recorded for these guarantees and indemnities in the accompanying balance sheets.
Contractual Commitments
In January 2013, the Company entered into
a contractual commitment with a related party entity to provide consulting services at a cost of $250,000 per year for duration
of four years or the completion of all outstanding MMP litigation, whichever comes first.
For the fiscal year ended May 31, 2013,
the Company expensed $150,000 related to this agreement.
In connection with the Program Agreement,
the Company is required to make payments to Alliacense of $500,000 no later than three days prior to the start of each calendar
quarter. Such payments are non-accountable and non-recoupable, but are offset against the licensing fees owed to Alliacense pursuant
to the Program Agreement. Upon six months notice to Alliacense, and in conjunction with a proportionate reduction in the scope
of the Project Description, as defined, the Company may determine to implement a maximum of advances not-yet-offset of $2,000,000.
Phoenix Digital Solutions, LLC
Notes to Financial Statements (Continued)
9. Related Party Transactions
During the fiscal year ended May 31, 2013,
TPL and PTSC each contributed $1,097,809 to the Company for working capital obligations.
During the fiscal year ended May 31, 2012,
TPL contributed $450,000 in cash and forfeited rights to $200,000 of special litigation support payments due it for an in-kind
capital contribution of $200,000 and PTSC contributed $650,000 to the Company for working capital obligations.
Per the Commercialization Agreement, the
Company had committed to pay a quarterly amount ranging between $500,000 and $1,000,000 (based upon a percentage of the working
capital fund balance of the Company) for supporting efforts to secure licensing agreements by TPL on behalf of the Company. During
the fiscal years ended May 31, 2013 and 2012 the Company expensed $185,000 and $2,000,000, respectively, pursuant to this commitment.
During the fiscal year ended May 31, 2012,
the Company expensed $946,000 pursuant to various settlement agreements with TPL (see Note 6) for TPL’s special work and
effort regarding internal costs related to litigation support and patent re-examinations.
During the fiscal years ended May 31, 2013
and 2012, the Company expensed $3,367,294 and $4,617,594, respectively, for reimbursement of legal and related fees incurred by
TPL due to patent litigation. These legal fees are net of $376,049 and $491,124, respectively, of legal fee reversals previously
expensed and recorded as accounts payable to TPL during the fiscal years ended May 31, 2013 and 2012, as the statute of limitations
had expired.
During the fiscal years ended May 31, 2013
and 2012, the Company expensed $194,422 and $104,377, respectively, for reimbursement of legal and related fees incurred by PTSC
due to patent litigation.
Pursuant to the Program Agreement, the
Company has committed to Alliacense a quarterly amount of $500,000 which represents the licensing services fees due Alliacense,
subject to a contingency arrangement which provides for a percentage on future revenues, for its efforts to secure licensing agreements
on behalf of the Company. These payments can be capped at $2,000,000 pursuant to six-month notice from the Company, at which time
the management committee will review and decide the warranting of future payments. These payments replace the quarterly amounts
previously paid to TPL pursuant to the Commercialization Agreement. During the fiscal year ended May 31, 2013 Alliacense earned
$1,858,647 pursuant to this contingency commitment.
Pursuant to the Program Agreement, the
Company has committed to pay Alliacense litigation support fees relating to Alliacense’s special work and effort regarding
internal costs related to MMP maintenance and litigation support including support in the U.S. District Court and the complaints
filed on behalf of TPL, PTSC and the Company with the ITC. During the fiscal year ended May 31, 2013, the Company expensed $1,786,414
pursuant to this commitment
At May
31, 2013, the Company had prepaid expenses (advances to Alliacense) of approximately $456,000.
At May
31, 2013, the Company had accounts payable balances of approximately $1,494,000, $34,000 and $17,000 to TPL, Alliacense, and PTSC,
respectively, for direct expenses and third party fees incurred by TPL, Alliacense, and PTSC.
At May
31, 2012, the Company had accounts payable and accrued expenses balances of approximately $2,611,000 and $137,000 to TPL and PTSC,
respectively, for direct expenses and third party fees incurred by TPL and PTSC.
Phoenix Digital Solutions, LLC
Notes to Financial Statements (Continued)
Related
Party Transactions
(continued)
A summary
of related party transactions described above is as follows:
Related party transactions as of May 31,
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
Advances to Alliacense
|
|
$
|
456,353
|
|
|
$
|
–
|
|
Accounts payable and accrued expenses due TPL
|
|
$
|
1,493,775
|
|
|
$
|
2,610,615
|
|
Accounts payable due Alliacense
|
|
|
33,762
|
|
|
|
–
|
|
Accounts payable due PTSC
|
|
|
16,538
|
|
|
|
137,268
|
|
Total payables and accrued expenses
|
|
$
|
1,544,075
|
|
|
$
|
2,747,883
|
|
|
|
|
|
|
|
|
|
|
Contributions (50% from TPL and PTSC)
|
|
$
|
2,195,617
|
|
|
$
|
1,300,000
|
|
Distributions (50% to TPL and PTSC)
|
|
$
|
4,055,617
|
|
|
$
|
–
|
|
Related party transactions for the years ended May 31,
|
|
2013
|
|
|
2012
|
|
|
|
|
|
|
|
|
|
|
PTSC Commercialization Agreement payments
|
|
$
|
185,000
|
|
|
$
|
2,000,000
|
|
Settlement costs expensed and paid or accrued to TPL
|
|
|
–
|
|
|
|
946,000
|
|
TPL legal fees and reimbursements expensed
|
|
|
3,743,343
|
|
|
|
5,108,718
|
|
Reversal of legal fees previously expensed as accounts payable to TPL
|
|
|
(376,049
|
)
|
|
|
(491,124
|
)
|
Total TPL expenses paid or accrued
|
|
$
|
3,552,294
|
|
|
$
|
7,563,594
|
|
|
|
|
|
|
|
|
|
|
Alliacense litigation support fees
|
|
$
|
1,786,414
|
|
|
$
|
–
|
|
Alliacense license fees earned
|
|
|
1,858,647
|
|
|
|
–
|
|
Total Alliacense expenses paid or accrued
|
|
$
|
3,645,061
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
|
PTSC legal fees and reimbursements expensed
|
|
$
|
194,422
|
|
|
$
|
104,377
|
|
Payments to Charles Moore per TPL and Moore litigation settlement
|
|
$
|
150,000
|
|
|
$
|
–
|
|
10. Subsequent Events
The Company has evaluated subsequent events
after the balance sheet date and based on its evaluation, management has determined that no subsequent events have occurred that
would require recognition in the accompanying financial statements or disclosure in the notes thereto other than as disclosed in
the accompanying notes.
SIGNATURES
Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
DATED: August 22, 2013
|
PATRIOT SCIENTIFIC CORPORATION
|
|
|
|
|
|
/s/
CLIFFORD L. FLOWERS
|
|
|
Clifford L. Flowers
|
|
|
Interim Chief Executive Officer and Chief Financial Officer
(Duly Authorized and Principal Financial Officer)
|
|