Mosaic ImmunoEngineering Inc. - Quarter Report: 2002 November (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

PATRIOT SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)

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

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

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PATRIOT SCIENTIFIC CORPORATION
INDEX

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

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PATRIOT SCIENTIFIC CORPORATION

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

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PATRIOT SCIENTIFIC CORPORATION

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

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PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.     BASIS OF PRESENTATION

The consolidated financial statements of Patriot Scientific Corporation (“Patriot”) presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission for quarterly reports on Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended May 31, 2002.

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

Loss Per Share

We follow Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings per Share.” Under SFAS No. 128, basic loss per share is calculated as loss available to common stockholders divided by the weighted average number of common shares outstanding. Diluted loss per share is calculated as net loss divided by the diluted weighted average number of common shares. The diluted weighted average number of common shares is calculated using the treasury stock method for common stock issuable pursuant to outstanding stock options and common stock warrants. Common stock options and warrants of 48,744,320 and 13,450,923 for the three and six months ended November 30, 2002 and 2001, respectively, were not included in diluted loss per share for the periods as the effect was antidilutive due to our recording losses in each of those periods. See Notes 5 and 7 for discussion of commitments to issue additional shares of common stock and warrants.

Sale of Accounts Receivable

We follow SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” a replacement of SFAS No. 125. SFAS No. 140 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. A $400,000 factoring line we established with a bank enables us to sell selected accounts receivable invoices to the bank with full recourse against us. These transactions qualify for a sale of assets since (1) we have transferred all of our rights, title and interest in the selected accounts receivable invoices to the bank, (2) the bank may pledge, sell or transfer the selected accounts receivable invoices, and (3) we have no effective control over the selected accounts receivable invoices since we are not entitled to or obligated to repurchase or redeem the invoices before their maturity and we do not have the ability to unilaterally cause the bank to return the invoices. Under SFAS No.140, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. During the first six months of fiscal 2003, we sold $14,846 of our accounts receivable to a bank under the factoring agreement for $11,877. Pursuant to the provisions of SFAS No. 140, we reflected the transactions as sales of assets and established a receivable from the bank for the retained amount less the costs of the transactions and less any anticipated future loss in the value of the retained asset. The retained amount was equal to 20% of the total accounts receivable invoices sold to the bank less 1% of the total invoices as an administrative fee and 1.75% per month of the total outstanding accounts receivable invoices as a finance fee. The estimated future loss reserve for each receivable included in the estimated value of the retained asset was based on the payment history of the accounts receivable customer. As of November 30, 2002, there were no qualifying accounts receivable invoices available to factor resulting in no balance outstanding under the factoring line and $400,000 remaining available for future factoring of accounts receivable invoices.

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

Reclassifications

Certain items in the unaudited November 30, 2001 consolidated financial statements have been reclassified to conform to the current presentation.

2.     RECENT ACCOUNTING PRONOUNCEMENTS

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

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

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

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

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 requires the fair value of a liability for an asset retirement obligation to be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for the fiscal year ending May 31,

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

2003. The adoption of this statement had no material impact on our consolidated financial statements.

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

In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. The statement also contains other nonsubstantive corrections to authoritative accounting literature. The changes related to the debt extinguishment are effective for fiscal years beginning after May 15, 2002. Adoption of this standard did not have any effect on the Company’s consolidated financial statements.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. Adoption of this standard will not have any effect on the Company’s consolidated financial statements.

3.     CONTINUED EXISTENCE AND MANAGEMENT’S PLAN

Our consolidated financial statements are presented on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Our ability to continue as a going concern is contingent upon our obtaining sufficient financing to sustain our operations. We incurred a net loss of $2,020,729, $5,487,051 and $4,968,903 and negative cash flow from operations of $1,108,120, $3,632,534 and $4,839,180 in the six months ended November 30, 2002 and the years ended May 31, 2002 and 2001, respectively. At November 30, 2002, we had deficit working capital of $1,267,935 and cash and cash equivalents of $2,210. We have historically funded our operations primarily through the issuance of securities and debt financings. Cash and cash equivalents decreased $85,898 during the six months ended November 30, 2002.

We estimate our current cash requirements to sustain our operations for the next twelve months through November 2003 to be $2.4 million. Since we are no longer supporting the communications product line, we are assuming that there will be no communications product revenue. We have a note payable to Swartz Private Equity, LLC

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

(“Swartz”) of $635,276 at November 30, 2002 which was originally due in January 2003 and subsequent to the end of the quarter has been extended to April 2003. We also have convertible debentures with a group of investors as of November 30, 2002 aggregating $1,280,000. At the option of the debenture holders, they may purchase additional debentures up to $1 million at any time during the next two years as long as the price of our common stock is in excess of $0.20 per share. During the first six months ended November 30, 2002, we obtained $50,000 from the sale of equity to several private investors and $150,000 from short term notes entered into with a related party. Subsequent to November 30, 2002, we obtained an additional $28,350 from the sale of equity to several private investors, $200,000 from the issuance of additional convertible debentures and $30,000 from a short term note entered into with a related party. In addition, we are negotiating the terms of a $12 million equity line of credit.

If we are not successful at obtaining and drawing down on the $12 million equity line of credit or if the optional amounts under the convertible debentures are not raised in sufficient amounts, then we may not have funds sufficient to meet our cash requirements. In such circumstances, we may need to receive additional advances from Swartz, secure additional short-term debt, private placement debt and/or equity financings with individual or institutional investors. In addition, we may need to make additional cost reductions if our cash requirements cannot be met from external sources. We expect that the $2.4 million requirement will be provided by:

In addition, we have formulated additional cost reduction plans which can be implemented if the required funds are not obtainable. We also have remaining a $400,000 accounts receivable factoring agreement with our bank; however, we have no eligible accounts receivable to factor as of November 30, 2002.

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

If we are unable to obtain the necessary funds, we could be forced to substantially curtail or cease operations which would have a material adverse effect on our business. Further, there can be no assurance that we will be able to timely receive shareholder approval to increase the number of authorized shares or that required funds, if available, will be available on attractive terms or that they will not have a significantly dilutive effect on our existing shareholders. As such, there is substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our possible inability to continue as a going concern.

4.     SECURED NOTE PAYABLE

On March 12, 2002, we replaced and superceded a previously issued Secured Promissory Note with Swartz with an Amended Secured Promissory Note and Agreement with an effective date of October 9, 2001 and an Addendum to

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

Amended Secured Promissory Note dated March 12, 2002. The amended note, which originally was to mature on January 9, 2003, has been extended to April 2003 and amounts outstanding under the note bear interest at the rate of 5% per annum. Per the addendum to the amended note, principal and interest payments are deferred until April 2003.

As part of the consideration for entering into the above amended note, we agreed to issue warrants to Swartz related to each advance against the note. In connection with each advance, we issued to Swartz a warrant to purchase a number of shares of common stock equal to the amount of the advance multiplied by 8.25 at an initial exercise price equal to the lesser of (a) the factor of the average of the volume weighted average price per share, as defined by Bloomberg L.P., for each trading day in the period beginning on the date of the previous advance and ending on the trading day immediately preceding the date of the current advance multiplied by .70 or (b) the volume weighted average price per share minus $0.05. In addition, if after March 12, 2002, we issue common stock to any parties other than Swartz, we are obligated to issue to Swartz warrants equal to 20% of the common stock so issued. The amended note also gives to Swartz the right of first refusal and rights to participate in subsequent debt or equity transactions entered into by us through March 15, 2003.

As of November 30, 2002 we issued warrants to purchase up to 14,817,481 shares of our common stock in accordance with the amended note agreements. The warrants issued were valued using the Black-Scholes pricing model based on the expected fair value at issuance and the estimated fair value was also recorded as debt discount. See Note 7 to the consolidated financial statements for discussion of the terms of the warrants

The note is secured by our assets.

All debt discounts are to be amortized as additional interest expense over the term of the note payable. As of November 30, 2002, $1,107,238 had been reflected as debt discount of which $917,722, $86,781 and $189,516 was amortized to interest expense during the year ended May 31, 2002 and the three and six months ended November 30, 2002, respectively.

On November 9, 2001, an offset of $227,800 from the sale of 2,500,000 shares of common stock was applied against the final put under the $30 million equity line of credit discussed below.

On May 30, 2002, an offset of $926,924 from the sale of 14,100,000 shares of common stock was applied against the first and only put under the $25 million equity line of credit discussed below.

5.     8% CONVERTIBLE DEBENTURES

Overview. From April 23, 2002 through November 30, 2002, we sold an aggregate of $1,355,000 of 8% convertible debentures to a group of eleven investors. The convertible debentures entitle the debenture holder to convert the principal and unpaid accrued interest into our common stock for two years from the date of closing. In addition, the debenture holders received warrants exercisable into a number of our common shares.

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

Number of Shares Debentures May Be Converted Into. The debentures can be converted into a number of our common shares at conversion prices that initially equaled $0.05126 to $0.10289 per share.

Resets of Conversion Price and Conversion Shares. A reset date occurs on each three month anniversary of the closing date of each debenture and on the date the registration statement becomes effective, October 29, 2002 for the first $1,000,000 of principal. If the volume weighted average price for our common stock for the ten days previous to the reset date is less than the conversion price in effect at the time of the reset date, then the number of common shares issuable to the selling shareholder on conversion will be increased. If the conversion price is reset, the debenture can be converted into a number of our common shares based on the following calculation: the amount of the debenture plus any unpaid accrued interest divided by the reset conversion price which shall equal the volume weighted average price for our common stock for the ten days previous to the reset date. On October 29, 2002, the date the registration statement for the first $1,000,000 of principal became effective, the conversion price for debentures dated April 23, 2002 in an amount of $225,000 and June 10, 2002 in amounts accumulating $775,000 were reset to $0.04457 from initial conversion prices of $0.10289 and $0.08616.

Warrants. Concurrent with the issuance of the convertible debentures, we issued to the debenture holders warrants to purchase up to 19,665,438 shares of our common stock. These warrants are exercisable for five years from the date of issuance at initial exercise prices equal to 115% of the volume weighted average price for our common stock for the ten days previous to the debenture date. The warrant exercise price is subject to being reset on each six month anniversary of its issuance. On October 23, 2002, the six month anniversary for a debenture dated April 23, 2002 in an amount of $225,000, the warrant exercise price was reset to $0.04685 from an initial exercise price of $0.10289.

Options to Purchase Additional Debentures. Subject to the price of our common stock being equal to or greater than $0.20 per share and a two year limitation, the debenture holders may purchase additional debentures equal to the value of their initial debentures. The price at which the optional additional debentures could be converted would initially equal 115% of the volume weighted average price for our common stock for the ten days previous to the date on which the optional additional debentures were closed. The optional additional debentures would carry the same warrant amounts and reset privileges as the initial debentures.

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

Restrictive Covenants. For a period of 18 months from the date of the debentures, we are prohibited from certain transactions. These include the issuance of any debt or equity securities in a private transaction which are convertible or exercisable into shares of common stock at a price based on the trading price of the common stock at any time after the initial issuance of such securities; the issuance of any debt or equity securities with a fixed conversion or exercise price subject to adjustment; and any private equity line type agreements without obtaining the debenture holders’ prior written approval.

Right of First Refusal. The debenture holders have a right of first refusal to purchase or participate in any equity securities offered by us in any private transaction which closes on or prior to the date that is two years after the issue date of each debenture.

Registration Rights. We are responsible for registering the resale of the shares of our common stock which will be issued on the conversion of the debentures. On October 29, 2002, a registration statement covering the first $1,000,000 of debentures was declared effective by the Securities and Exchange Commission.

As of November 30, 2002 we issued warrants to purchase up to 19,665,438 shares of our common stock in accordance with the convertible debentures. The warrants issued were valued using the Black-Scholes pricing

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

model based on the expected fair value at issuance and the estimated fair value was also recorded as debt discount. See Note 7 to the consolidated financial statements for discussion of the terms of the warrants. Debt discounts related to the warrant valuations are to be amortized as additional interest expense over the term of the convertible debenture. As of November 30, 2002, $950,268 has been reflected as debt discount of which $108,689, $203,104 and $8,383 was amortized to interest expense during the three and six months ended November 30, 2002 and the year ended May 31, 2002, respectively.

In addition, the convertible debentures contain beneficial conversion features. Such features require us to allocate the proceeds received to both the warrants and the debt and to calculate an intrinsic value for the debt portion if the per share price allocated to debt is less than the fair market per share price as of the first date the debenture is sold. Accordingly, during the three and six months ended November 30, 2002, we recorded $58,842 and $404,732 to additional paid in capital to reflect the intrinsic value of the convertible debentures. The intrinsic value of the beneficial conversion feature of the convertible debenture is amortized to non-cash interest expense over the life of the convertible debenture. Accordingly, we amortized to non-cash interest expense $45,688 and $71,139 during the three and six months ended November 30, 2002.

During November 2002, holders converted debentures accumulating $75,000 of principal and $394 of accrued interest into 1,691,597 shares of our common stock. The balance of unamortized debt discount related to the beneficial conversion features and debt discount on the date of conversion of $57,288 was charged to additional paid in capital.

The convertible debentures are secured by our assets.

6.     INVESTMENT AGREEMENTS

$5 Million Equity Line of Credit Agreement

In February 1999, the Company entered into an investment agreement with Swartz. The investment agreement entitled the Company, at the Company’s option, to issue and sell its common stock for up to an aggregate of $5 million from time to time during a three-year period through February 24, 2002, subject to certain conditions including (1) an effective registration statement must be on file with the SEC registering the resale of the common shares, and (2) a limitation on the number of common shares which could be sold to Swartz within a 30 day time period based on the trading volume of the stock, among others. Swartz could purchase the common stock from the Company at a discount ranging from 10% to 20% depending on the price of the common stock. In addition to the common stock purchased, Swartz received warrants to purchase an additional 15% of the common stock equal to 110% of the market price as determined during the pricing period, subject to further semi-annual price adjustments if the price of the common stock goes down.

In July 1999, the Company amended and restated the investment agreement with Swartz to eliminate the discretion

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

of Swartz as to the timing of its purchase of the Company’s common stock.

The amended and restated investment agreement required Swartz, after the Company put shares of common stock to it, to purchase the Company’s common stock on the twentieth day following the put. The previous agreement enabled Swartz, in its sole discretion, to purchase the Company’s common stock at any time during a twenty-day period following the Company’s put to it.

The registration statement went effective on October 5, 1999. As a result of an increase in the market price and trading volume of the Company’s common stock, the Company completed the $5 million placement of shares in February 2000. The total number of shares placed with Swartz was 13.9% of the total number of shares outstanding at the time or 7,014,796 common shares at prices ranging from $0.248 to $0.9775. The average price per share paid by Swartz was $0.71 compared to the average closing price during the twenty day pricing periods of $1.34 per share.

An additional 1,052,219 shares of common stock at exercise prices ranging initially from $0.341 to $1.265 are issuable to Swartz upon the exercise of warrants issued under the investment agreement. The warrants contain a reset provision which may reduce the exercise price if the price, as defined in the agreement, is lower on any subsequent six month anniversary. As a result of the reset provision, the exercise prices have been reduced to a range of $0.066 to $0.077 as of November 30, 2002. None of the warrants had been exercised as of November 30, 2002.

$30 Million Equity Line of Credit Agreement

In May 2000, we entered into an investment agreement with Swartz. The investment agreement entitled us , at our option, to issue and sell our common stock for up to an aggregate of $30 million from time to time during a three- year period, subject to certain conditions including among other items (1) an effective registration statement being on file with the SEC registering the resale of the common shares, and (2) a limitation on the number of common shares that could have been sold to Swartz within a 30 day time period based on the trading volume of the stock. Swartz could purchase the common stock from us at a discount. If the market price was less than $1.00 per share, the discount was $.10 per share; if the market price was between $1.00 to $1.99 per share, the discount was 10%; and if the market price was $2.00 or greater, the discount was 7%. In addition to the common stock purchased, Swartz received warrants to purchase an additional 15% of the common stock equal to 110% of the market price as determined during the pricing period, subject to further semi-annual price adjustments if the price of our common stock goes down.

The registration statement went effective on June 23, 2000 and we received a total of $4,381,601 from the sale of 12,000,000 shares of common stock . Per the terms of the investment agreement, we issued ten five-year warrants for 1,800,000 shares of common stock exercisable initially at prices ranging from $0.091 to $1.562. The warrants contain a reset provision which may reduce the exercise price if the price, as defined in the agreement, is lower on any subsequent six month anniversary. As a result of the reset provision, the exercise prices have been reduced to a range of $0.0385 to $0.0858 as of November 30, 2002. None of the warrants had been exercised as of November 30, 2002.

On September 17, 2001, we entered into a $25 million equity line of credit agreement with Swartz, thereby, effectively concluding the $30 million equity line of credit at the conclusion of the put in effect on that date.

On September 24, 2001, we entered into a waiver and agreement with Swartz whereby Swartz was able to advance us $227,800 prior to the close of the final put under the $30 million equity line of credit. The waiver and agreement extended the time of the put beyond twenty days and redefined the price of the put to be the lesser of the factor of (a) the volume weighted average price per share, as defined by Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume weighted average price per share minus $0.05 multiplied by 20% of the acceptable daily volume as defined in the waiver. At the discretion of Swartz the 20% daily volume limitation could be increased up to 30% of the daily volume. In addition, the waiver included the issuance of a purchase warrant to purchase

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

2,125,000 shares of common stock at an initial exercise price of $0.0911. The purchase warrant shares were issued to Swartz as restricted shares subject to “piggyback” registration rights and are subject to repricings on each six month anniversary if 110% of the lowest closing bid price for the five days previous to the anniversary date is less than the initial or subsequent reset exercise prices. As a result of the reset provision, the exercise price has been reduced to $0.0858 as of November 30, 2002. None of the warrants had been exercised as of November 30, 2002. See Note 7 for further information on the warrants.

$25 Million Equity Line of Credit Agreement

On September 17, 2001, we entered into an investment agreement with Swartz. The investment agreement entitled us to issue and sell our common stock to Swartz for up to an aggregate of $25 million from time to time during a three-year period following the effective date of the registration statement. We filed a registration statement on Form S-1 that was declared effective on November 5, 2001 for 15,000,000 shares of our common stock. We issued the 15,000,000 shares of common stock to Swartz during the fiscal year ended May 31, 2002 to be applied against a note payable that Swartz had issued to us.

We issued to Swartz a commitment warrant to purchase up to 900,000 shares of our common stock concurrent with the execution of the investment agreement. This warrant is exercisable through September 17, 2006 at an initial exercise price of $0.22. The commitment warrant exercise price is subject to being reset on each six month anniversary of its issuance. As a result of the reset provision, the exercise price has been reduced to $0.0858 as of November 30, 2002. None of the warrants had been exercised as of November 30, 2002.

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

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

Waiver and Agreement. On March 12, 2002, we entered into an amended waiver and agreement with Swartz which replaced and superseded all previous waivers and agreements. This amended waiver and agreement extended the time of the put beyond twenty days and redefined the price of the put to be the lesser of the factor of (a) the volume weighted average price per share, as defined by Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume weighted average price per share minus $0.05 multiplied by 20% of the acceptable daily volume as defined in the waiver. At the discretion of Swartz, the 20% daily volume limitation could be increased up to 30% of the daily volume. In addition, the amended waiver and agreement increased the intended put share amount for the first put to 14,100,000 shares, which is the total number of shares we had registered under the $25 million equity line of credit. On May 30, 2002 we closed the first put and effectively the $25 million equity line of credit by applying the proceeds of $926,924 to the secured note payable discussed below.

Warrants. In connection with closing the $25 million equity line of credit, we issued to Swartz a commitment warrant to purchase 900,000 shares of our common stock as discussed further in Note 7 to the consolidated financial statements. This warrant was valued on the issuance date using the Black-Scholes pricing model and the value was recorded as a debt discount.

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

7.     STOCKHOLDERS’ DEFICIT

The following table summarizes equity transactions during the six months ended November 30, 2002:

Stock Options

At November 30, 2002, we had 17,500 options outstanding pursuant to our 1992 ISO Stock Option Plan exercisable at $1.325 per share expiring in 2005; 50,000 options outstanding pursuant to our 1992 NSO Stock Option Plan exercisable at $1.325 per share expiring in 2005; 2,204,405 options outstanding pursuant to our 1996 Stock Option Plan exercisable at a range of $0.0575 to $1.41 per share expiring beginning in 2002 through 2007; and 2,305,000 options outstanding pursuant to our 2001 Stock Option Plan exercisable at a range of $0.07 to $0.70 per share expiring beginning in 2002 through 2007.

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

Warrants

At November 30, 2002, we had warrants outstanding exercisable into 44,167,415 common shares at exercise prices ranging from $0.033 to $1.12 per share expiring beginning in 2002 through 2007. During the six months ended November 30, 2002, we issued warrants to purchase 17,150,629 shares of common stock which are subject to repricings at the six month anniversary of the issuance of the warrant. At each anniversary date the warrants will be repriced to the lesser of the initial exercise price or 110% of the lowest closing bid price of our common stock for the five trading days ending on such six month anniversary date. During the six months ended November 30, 2002, warrants to purchase 14,202,869 shares of common stock with initial or reset exercise prices ranging from $0.0657 to $0.1320 have been repriced to exercise prices ranging from $0.033 to $0.077.

During the six months ended November 30, 2002, we issued to two individuals warrants exercisable for five years into 1,000,000 common shares at an exercise price of $0.05 per share. These individuals are acting as our marketing representatives and the warrants are scheduled to vest based on sales activity as defined in their contracts.

Also, during the six months ended November 30, 2002, we issued to Swartz snap shot warrants exercisable for five years into 1,929,331 common shares at exercise prices ranging from $0.047 to $0.068 per share. These snap shot

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

warrants were issued under an agreement with Swartz whereby we will issue to Swartz warrants to purchase common shares equal to 20% of any common stock or warrants we issue to parties other than Swartz or their affiliates after March 12, 2002.

Common Stock

During the six months ended November 30, 2002, we sold to a group of individual private investors a total of 1,932,000 shares of common stock at prices ranging from $0.025 to $0.0301 for an accumulated total of $50,000. The investors have agreed to hold these shares for a minimum of one year.

In October 2002, we entered into an agreement with Barry Clark whereby he will provide consulting services through April 2003 to help structure financing, provide innovative capital resources and advise us on other strategic decisions. In October 2002 we issued to Mr. Clark 2,000,000 shares of our common stock as compensation for the consulting services. We recorded $110,000, the value of the common stock on the day it was issued, as a prepaid expense and additional paid-in capital of which, during the six months ended November 30, 2002, we amortized to expense $36,667 as non-cash compensation.

In October 2002, we entered into a settlement agreement with a former executive officer of the Company. As part of the agreement, we issued to him 400,000 shares of our common stock. During the six months ended November 30, 2002, we recorded $16,000, the value of the common stock on the day of the settlement, as litigation expense. The shares are subject to registration and will be included in our next registration statement.

In December 2001, we entered into a series of agreements with iCapital Corporation (“iCapital”) and several principals of iCapital whereby they provided consulting services through December 2002 to help structure financing, provide innovative capital resources, identify and assist with merger and acquisition opportunities and advise us on other strategic decisions. In January 2002, based on meeting several performance criteria, we issued to iCapital and the principals of iCapital 2,200,000 shares of our common stock as compensation for the consulting services. During our previous fiscal year, we recorded $198,000, the value of the common stock on the day it was issued, as a prepaid expense and additional paid-in capital of which, during the six months ended November 30, 2002, we amortized to expense $99,000 as non-cash compensation.

8.     NOTE RECEIVABLE

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

9.     LEGAL PROCEEDINGS

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

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Patriot Scientific Corporation
Notes to Consolidated Financial Statements (Continued)

In September 2001, an action was filed against us in the Superior Court of San Diego County, California by Richard G. Blum, our former Chairman, President and Chief Executive Officer. Mr. Blum contended that he was wrongfully terminated on August 5, 2001 in violation of his employment agreement dated December 1, 2000. He sought damages for the alleged breach of his employment agreement, age discrimination, as well as other related claims. In October 2002, we entered into a settlement agreement with Mr. Blum whereby we agreed to pay him $60,000 over twelve months and to issue him 400,000 shares of our common stock. This liability has been recorded in our consolidated financial statements for the six months ended November 30, 2002.

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

THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, “FUTURE PERFORMANCE AND RISK FACTORS.” SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31, 2002.

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

Critical Accounting Policies

We believe that the following represent our critical accounting policies:

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

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

Revenue Recognition

We recognize revenue on the shipment to our customers of communication products, microprocessor integrated chips and evaluation boards. We anticipate that in the future we will also derive revenue from fees for the transfer of proven and reusable intellectual property components or the performance of engineering services. We anticipate to enter into licensing agreements that will provide licensees the right to incorporate our intellectual property components in their products with terms and conditions that we anticipate to vary by licensee. Generally,

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we anticipate these payments will include a nonrefundable technology license fee, which will be payable upon the transfer of intellectual property, or a nonrefundable engineering service fee, which generally will be payable upon achievement of defined milestones. In addition, we anticipate these agreements will include royalty payments, which will be payable upon sale of a licensee’s product, and maintenance and limited support fees. We will classify all revenue that involves the future sale of a licensee’s products as royalty revenue. Royalty revenue will be generally recognized in the quarter in which a report is received from a licensee detailing the shipments of products incorporating our intellectual property components (i.e., in the quarter following the sale of licensed product by the licensee). We will classify all revenue that does not involve the future sale of a licensee’s products, primarily license fees and engineering service fees and maintenance and support fees, as contract revenue. License fees will be recognized upon the execution of the license agreement and transfer of intellectual property, provided no further significant performance obligations exist and collectibility is deemed probable. Fees related to engineering services contracts, which will be performed on a best efforts basis and for which we will receive periodic milestone payments, will be recognized as revenue over the estimated development period, using a cost-based percentage of completion method. Annual maintenance and support fees, which will be renewable by the licensee, will be classified as contract revenue and will be amortized over the period of support, generally 12 months.

Research and Development Costs
Research and development costs are expensed as incurred.

Stock Options
The Company applies Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for all stock option plans. Under APB Opinion 25, compensation cost has been recognized for stock options granted to employees when the option price is less than the market price of the underlying common stock on the date of grant.

Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” requires the Company to provide pro forma information regarding net income as if compensation cost for the Company’s stock option plans had been determined in accordance with the fair value based method prescribed in SFAS No. 123. To provide the required pro forma information, the Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model.

Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Results of Operations for the Three months Ended November 30, 2002 and November 30, 2001

Net sales. Total net sales for the second fiscal quarter ended November 30, 2002 decreased 30.2% to $5,160 from $7,389 for the corresponding period of the previous fiscal year. This decrease was due to the final buys on our matured communication products having been substantially completed the previous fiscal year. We are currently expending our efforts on marketing and sale of our microprocessor technology. The microprocessor technology generated minimal revenue during the second fiscal quarter ended November 30, 2002. We anticipate that future revenue will be derived from up front license fees and royalties as a result of the shift in focus to the commercialization of our microprocessor and related technology intellectual property. Previously we focused primarily on the sale of silicon products. We cannot estimate when significant revenue will be generated from the microprocessor technology.

Cost of sales. Cost of sales as a percentage of net sales decreased to 137.2% in the second fiscal quarter ended November 30, 2002 compared to 2,515.1% for the corresponding period of the previous fiscal year. This significant decrease was due to minor sales during the second quarter of 2003 not having associated costs due to our having written off the communication product inventory during the second quarter of the previous fiscal year. We wrote-

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off $149,433, the remaining balance, during the second quarter ended November 30, 2001. We decided on writing off the inventory as a result of not being able to find a buyer for the communication product line and our decision to focus future company revenue on the sale of licenses and intellectual property related to our microprocessor technology versus the sale of microprocessor silicon and related products. The winding down of the communication product line did not impair any of our other assets. Also, as a result of eliminating the communication product line, overhead expenses charged to cost of sales the previous fiscal year are now being charged to general and administrative expenses.

Research and development expenses decreased 56.3% from $375,439 for the second fiscal quarter ended November 30, 2001 compared to $164,218 for the second fiscal quarter ended November 30, 2002. This decrease was due to a reduction in consulting services compared to the previous fiscal year related to the development of a new soft core version of the microprocessor technology in the amount of $17,213 and a reduction in payroll expense as a result of downsizing the department by six individuals during the second and third fiscal quarters of the previous fiscal year in an amount of $170,949.

Selling, general and administrative expenses decreased 21.9% to $577,133 for the second fiscal quarter ended November 30, 2002 compared to $738,672 for the second fiscal quarter of the previous fiscal year. This decrease was due primarily to a reduction in executive, marketing and sales personnel in the amount of $124,298 as a result of downsizing the company during the second and third fiscal quarters of the previous fiscal year partially offset by an increase in professional fees related to financings and litigation.

Other expenses for the second fiscal quarter ended November 30, 2002, were $334,017 compared to other expenses of $266,038 for the corresponding period of the previous fiscal year. This change resulted primarily from the recognition of non-cash interest expense of $296,199 related to the amortization of the debt discount associated with the issuance of warrants under a secured note payable and convertible debentures coupled with interest expense of $37,828 related to the note and debentures for the current fiscal period compared to $261,068 and $5,029, respectively for the same fiscal period of the previous fiscal year.

Results of Operations for the Six months Ended November 30, 2002 and November 30, 2001

Net sales. Total net sales for the six months ended November 30, 2002 decreased 86.0% to $45,049 from $321,889 for the corresponding period of the previous fiscal year. This decrease was due to the final buys on our matured communication products having been substantially completed the previous fiscal year. We are currently expending our efforts on marketing and sale of our microprocessor technology. The microprocessor technology generated minimal revenue during the six months ended November 30, 2002. We anticipate that future revenue will be derived from up front license fees and royalties as a result of the shift in focus to the commercialization of our microprocessor and related technology intellectual property. Previously we focused primarily on the sale of silicon products. We cannot estimate when significant revenue will be generated from the microprocessor technology.

Cost of sales. Cost of sales as a percentage of net sales decreased to 26.6% in the six months ended November 30, 2002 compared to 121.2% for the corresponding period of the previous fiscal year. This significant decrease was due to minor sales during the first two quarters of 2003 not having associated costs due to having previously written off the communication product line inventory. A $149,433 write-down of the inventory to zero during the previous fiscal year was a result of not being able to find a buyer for the communication product line and our decision to focus future company revenue on the sale of licenses and intellectual property related to our microprocessor technology versus the sale of microprocessor silicon and related products. The winding down of the communication product line did not impair any of our other assets. Also, as a result of eliminating the communication product line, overhead expenses charged to cost of sales the previous fiscal year are now being charged to general and administrative expenses.

Research and development expenses decreased 57.1% from $871,247 for the six months ended November 30, 2001 compared to $373,505 for the six months ended November 30, 2002. This decrease was due to a reduction in consulting services compared to the previous fiscal year related to the development of a new soft core version of the microprocessor technology in the amount of $87,802 and a reduction in payroll expense as a result of downsizing the department by six individuals during the second and third fiscal quarters of the previous fiscal year in an amount

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of $370,625.

Selling, general and administrative expenses decreased 23.6% to $1,064,234 for the six months ended November 30, 2002 compared to $1,392,412 for the six months of the previous fiscal year. This decrease was due primarily to a reduction in executive, marketing and sales personnel in the amount of $309,932 as a result of downsizing the company during the second and third fiscal quarters of the previous fiscal year.

Other expenses for the six months ended November 30, 2002, were $616,050 compared to other expenses of $273,791 for the corresponding period of the previous fiscal year. This change resulted primarily from the recognition of non-cash interest expense of $550,566 related to the amortization of the debt discount associated with the issuance of warrants under a secured note payable and convertible debentures coupled with interest expense of $65,669 related to the note and debentures for the current fiscal period compared to $261,068 and $13,087, respectively for the same fiscal period of the previous fiscal year.

Income Taxes

Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. Deferred tax assets consist primarily of income tax benefits from net operating loss carry-forwards. A valuation allowance has been recorded to fully offset the deferred tax asset as it is more likely than not that the assets will not be utilized. The valuation allowance increased approximately $432,000 in the first six months of 2003, from $13,446,000 at May 31, 2002 to $13,878,000 at November 30, 2002.

Liquidity and Capital Resources

In connection with their report on our consolidated financial statements as of and for the year ended May 31, 2002, Nation Smith Hermes Diamond, our independent certified public accountants, expressed substantial doubt about our ability to continue as a going concern because of recurring net losses and negative cash flow from operations.

At November 30, 2002, we had deficit working capital of $1,267,935 and cash and cash equivalents of $2,210. We have historically funded our operations primarily through the issuance of securities and debt financings. Cash and cash equivalents decreased $85,898 during the six months ended November 30, 2002 due to net cash used in operations of $1,108,120 offset by funds generated primarily from the issuance of convertible debentures of $847,000 and short term notes payable of $150,000. The net cash used in operations was $1,108,120 for the six months ended November 30, 2002 compared to $2,073,812 for the corresponding period of the previous fiscal year. The decrease in cash required in operations was due primarily to a $764,150 reduction in net loss as adjusted to reconcile to cash used in operating activities coupled with a $167,211 change in prepaid expenses and other assets between the two periods. Cash used in investing activities was $34,240 for the six months ended November 30, 2002 compared to $51,348 for the corresponding period of the previous fiscal year. Cash provided by financing activities was $1,056,462 for the six months ended November 30, 2002 compared to $1,703,603 for the corresponding period of the previous fiscal year. This decrease was primarily the result of a reduced issuance of common stock of $761,604 during the current fiscal period compared to the corresponding period of the previous fiscal year.

We estimate our current cash requirements to sustain our operations for the next twelve months through November 2003 to be $2.4 million. Since we are no longer supporting the communications product line, we are assuming that there will be no communications product revenue. We have a note payable to Swartz Private Equity, LLC (“Swartz”) of $635,276 at November 30, 2002 which was originally due in January 2003 and subsequent to the end of the quarter has been extended to April 2003. We also have convertible debentures with a group of investors as of November 30, 2002 aggregating $1,280,000. At the option of the debenture holders, they may purchase additional debentures up to $1 million at any time during the next two years as long as the price of our common stock is in excess of $0.20 per share. During the first six months ended November 30, 2002, we obtained $50,000 from the sale of equity to several private investors and $150,000 from short term notes entered into with a related party. Subsequent to November 30, 2002, we obtained an additional $28,350 from the sale of equity to several private investors, $200,000 from the issuance of additional convertible debentures and $30,000 from a short term note entered into with a related party. In addition, we are negotiating the terms of a $12 million equity line of credit.

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If we are not successful at obtaining and drawing down on the $12 million equity line of credit or if the optional amounts under the convertible debentures are not raised in sufficient amounts, then we may not have funds sufficient to meet our cash requirements. In such circumstances, we may need to receive additional advances from Swartz, secure additional short-term debt, private placement debt and/or equity financings with individual or institutional investors. In addition, we may need to make additional cost reductions if our cash requirements cannot be met from external sources. We expect that the $2.4 million requirement will be provided by:

In addition, we have formulated additional cost reduction plans which can be implemented if the required funds are not obtainable. We also have remaining a $400,000 accounts receivable factoring agreement with our bank; however, we have no eligible accounts receivable to factor as of November 30, 2002.

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

If we are unable to obtain the necessary funds, we could be forced to substantially curtail or cease operations which would have a material adverse effect on our business. Further, there can be no assurance that we will be able to timely receive shareholder approval to increase the number of authorized shares or that required funds, if available, will be available on attractive terms or that they will not have a significantly dilutive effect on our existing shareholders. As such, there is substantial doubt about our ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our possible inability to continue as a going concern.

New Accounting Pronouncements

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

In June 2001, the FASB issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 141 requires the use of the purchase method of accounting and

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

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

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

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

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

In April 2002, FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement eliminates the current requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement. Instead, such gains and losses will be classified as extraordinary items only if they are deemed to be unusual and infrequent, in accordance with the current GAAP criteria for extraordinary classification. In addition, SFAS 145 eliminates an inconsistency in lease accounting by requiring that modifications of capital leases that result in reclassification as operating leases be accounted for consistent with sale-leaseback accounting rules. The statement also contains other nonsubstantive corrections to authoritative accounting literature. The changes related to the debt extinguishment are effective for fiscal years beginning after May 15, 2002. Adoption of this standard did not have any effect on the Company’s consolidated financial statements.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for restructuring activities initiated after December 31, 2002. SFAS No. 146 requires that the

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liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs as well as the amount recognized. Adoption of this standard will not have any effect on the Company’s consolidated financial statements.

Future Performance and Risk Factors

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

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

The status of these three major technologies is as follows:

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

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

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unanticipated technical obstacles can arise at any time and result in lengthy and costly delays or result in determination that further development is unfeasible. There can be no assurance that the technologies, if completed, will achieve market acceptance sufficient to sustain us or achieve profitable operations.

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

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

Item 3. Quantitative and Qualitative Disclosure About Market Risk

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

As of November 30, 2002, our notes payable and convertible debentures to corporations and individuals totaling $2.1 million bore interest at fixed rates of 5% to 8%. Our capital lease obligation totaling $19,432 is discounted at a fixed rate of interest of 22.7%.

PART II.     OTHER INFORMATION

Item 1. Legal Proceedings

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

In September 2001, an action was filed against us in the Superior Court of San Diego County, California by Richard G. Blum, our former Chairman, President and Chief Executive Officer. Mr. Blum contended that he was wrongfully terminated on August 5, 2001 in violation of his employment agreement dated December 1, 2000. He sought damages for the alleged breach of his employment agreement, age discrimination, as well as other related claims. In October 2002, we entered into a settlement agreement with Mr. Blum whereby we agreed to pay him $60,000 over twelve months and to issue him 400,000 shares of our common stock. This liability has been recorded in our consolidated financial statements for the six months ended November 30, 2002.

Item 2. Changes in Securities

(a)         We offered and sold the following common stock, either for cash or in consideration of services rendered as indicated below, without registration under the Securities Act of 1933, as amended, and exemption for such sales from registration under the Act is claimed in reliance upon the exemption provided by Section 4(2) thereof on the basis that such offers and sales were transactions not involving any public offering. Appropriate precautions against

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transfer have been taken, including the placing of a restrictive legend on all certificates evidencing such securities. All such sales were effected without the aid of underwriters, and no sales commissions were paid.

Item 6. Exhibits and Reports on Form 8-K

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.

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CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Patriot Scientific Corporation (the “Issuer”) for the period ended November 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Jeffrey E. Wallin, Chief Executive Officer of the Issuer, certify that:

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CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Patriot Scientific Corporation (the “Issuer”) for the period ended November 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Lowell W. Giffhorn, Chief Financial Officer of the Issuer, certify that:

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