Mosaic ImmunoEngineering Inc. - Quarter Report: 2007 August (Form 10-Q)

patriot_10q-083107.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2007

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to _______________

Commission File Number 0-22182

PATRIOT SCIENTIFIC CORPORATION

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of

incorporation or organization)

84-1070278

(I.R.S. Employer Identification No.)

6183 Paseo Del Norte, Suite 180, Carlsbad, California

(Address of principal executive offices)

92011

(Zip Code)

(Issuer’s telephone number): (760) 547-2700

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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

On October 5, 2007, 391,272,101 shares of common stock, par value $.00001 per share (the issuer’s only class of voting stock) were outstanding.

INDEX

	Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed consolidated Balance Sheets as of August 31, 2007 (unaudited) and May 31, 2007	3
Condensed consolidated Statements of Operations for the three months ended August 31, 2007 and 2006 (unaudited)	4
Condensed consolidated Statements of Cash Flows for the three months ended August 31, 2007 and 2006 (unaudited)	5
Notes to Condensed consolidated Financial Statements (unaudited)	6-20
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	21-29
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk	29
ITEM 4. Controls and Procedures	30
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings	31
ITEM 1A. Risk Factors	32
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds	32
ITEM 3. Defaults Upon Senior Securities	32
ITEM 4. Submission of Matters to a Vote of Security Holders	32
ITEM 5. Other Information	32
ITEM 6. Exhibits and Reports on Form 8-K	33-34

SIGNATURES

PART I- FINANCIAL INFORMATION

Item 1. Financial Statements

Patriot Scientific Corporation

Condensed Consolidated Balance Sheets

	August 31, 2007			May 31, 2007
ASSETS	(Unaudited)

Current assets:
Cash and cash equivalents	$	15,581,878		$	21,605,428
Restricted cash and cash equivalents		102,613			102,346
Marketable securities and short term investments		4,696,302			4,349,314
Accounts receivable		81,520			352,390
Receivable from affiliated company		396,098			-
Note receivable		50,000			-
Inventory		183,765			46,361
Prepaid income taxes		-			2,070,981
Deferred tax assets		926,553			2,439,975
Prepaid expenses and other current assets		300,272			431,840

Total current assets		22,319,001			31,398,635

Property and equipment, net		84,823			85,518

Other assets, net		8,190			8,190

Investment in affiliated company		1,683,427			2,883,969

Patents and trademarks, net of accumulated amortization of $610,451 and $607,657		35,523			38,317
	$	24,130,964		$	34,414,629

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	515,875		$	934,298
Accrued expenses and other		357,349			1,086,496
Income taxes payable		7,677,916			-

Total current liabilities		8,551,140			2,020,794

Deferred tax liabilities		753,701			12,222,944
Total liabilities		9,304,841			14,243,738

Commitments and contingencies

Minority Interest		-			-

Stockholders’ equity:
Preferred stock, $0.00001 par value; 5,000,000 shares authorized: none outstanding		-			-
Common stock, $0.00001 par value: 500,000,000 shares authorized: 407,801,507 shares issued and 389,372,340 shares outstanding at August 31, 2007 and 406,668,661 shares issued and 393,201,134 shares outstanding at May 31, 2007		4,078			4,066
Additional paid-in capital		71,493,980			72,150,581
Accumulated deficit		(45,114,064	)		(43,151,678	)
Common stock held in treasury, at cost - 18,429,167 shares and 13,467,527 shares at August 31, 2007 and May 31, 2007, respectively		(11,557,871	)		( 8,832,078	)
Total stockholders’ equity		14,826,123			20,170,891
	$	24,130,964		$	34,414,629

See accompanying notes to unaudited condensed consolidated financial statements.

Patriot Scientific Corporation

Condensed Consolidated Statements of Operations

(Unaudited)

	Three months ended
	August 31, 2007			August 31, 2006
Revenues
Product sales and other	$	521,369		$	26,375

Cost of sales		151,535			-

Gross profit		369,834			26,375

Operating expenses:
Selling, general and administrative		1,958,190			2,732,524
Settlement and license expense		30,000			-
Total operating expenses		1,988,190			2,732,524
Operating loss		(1,618,356	)		(2,706,149	)
Other income (expense):
Interest and other income		474,525			126,767
Loss on sale of assets		(345	)		(543	)
Interest expense		(237	)		-
Gain on sale of subsidiary interest		150,000			-
Equity in earnings (loss) of affiliated company		(1,200,542	)		12,070,198
Total other income (expense), net		(576,599	)		12,196,422

Income (loss) before income taxes		(2,194,955	)		9,490,273

Provision (benefit) for income taxes		(232,569	)		3,500,000

Minority interest		-			-

Net income (loss)	$	(1,962,386	)	$	5,990,273

Basic income (loss) per common share	$	(0.01	)	$	0.02

Diluted income (loss) per common share	$	(0.01	)	$	0.01

Weighted average number of common shares outstanding - basic		390,455,132			368,837,051

Weighted average number of common shares outstanding - diluted		390,455,132			420,646,769

See accompanying notes to unaudited condensed consolidated financial statements.

Patriot Scientific Corporation

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Three months ended
	August 31, 2007			August 31, 2006

Operating activities:
Net income (loss)	$	(1,962,386	)	$	5,990,273
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Amortization and depreciation		11,322			10,635
Expense related to extension of expiration date of stock options		-			324
Non cash compensation relating to issuance of stock options and vesting of warrants		282,913			1,584,451
Accrued interest income added to investments		(267	)		(634	)
Equity in (earnings) loss of affiliated company		1,200,542			(12,070,198	)
Loss on sale of assets		345			543
Deferred income taxes		(9,955,821	)		-
Gain on VIE sale of portion of subsidiary interest		(150,000	)		-
Reversal of tax effect of exercise of options		(25,645	)		-
Changes in operating assets and liabilities:
Accounts receivable		(125,228	)		(4,200	)
Inventory		(137,404	)		-
Prepaid and other assets		131,568			63,668
Prepaid income taxes		2,070,981			-
Accounts payable and accrued expenses		(1,147,570	)		(321,297	)
Accrued contested fee payable		-			(340,000	)
Income taxes payable		7,677,916			3,457,600
Net cash used in operating activities		(2,128,734	)		(1,628,835	)

Investing activities:
Proceeds from sales of short-term investments		2,725,793			1,839,085
Purchases of short-term investments		(3,072,781	)		(4,314,223	)
Purchases of property and equipment		(8,178	)		(5,667	)
Proceeds from VIE sale of portion of subsidiary interest		100,000			-
Distributions from affiliated company		-			11,578,672
Net cash provided by (used in) investing activities		(255,166	)		9,097,867

Financing activities:
Proceeds from exercise of common stock warrants and options		8,000			65,500
Repurchase of warrants		(921,857	)		-
Repurchase of common stock for treasury		(2,725,793	)		(1,839,085	)
Net cash used in financing activities		(3,639,650	)		(1,773,585	)

Net increase (decrease) in cash and cash equivalents		(6,023,550	)		5,695,447
Cash and cash equivalents, beginning of period		21,605,428			3,984,240
Cash and cash equivalents, end of period	$	15,581,878		$	9,679,687

Supplemental Disclosure of Cash Flow Information:

Cash payments for interest	$	237		$	-
Cash payments for income taxes	$	-		$	42,400

Supplemental Disclosure of Non-Cash Investing and Financing Activities:
Cashless exercise of warrants	$	-		$	30
Cashless exercise of stock options	$	10		$	-
Note receivable issued in connection with VIE sale of portion of subsidiary interest	$	50,000		$	-

See accompanying notes to unaudited condensed consolidated financial statements.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation and Summary of Significant Accounting Policies

The unaudited condensed consolidated financial statements of Patriot Scientific Corporation (the “Company”, “we”, “us” or “our”) presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in Form 10-K for our fiscal year ended May 31, 2007.

In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the results for the interim periods presented. Operating results for the three month period ended August 31, 2007 are not necessarily indicative of the results that may be expected for the year ending May 31, 2008.

Basis of Consolidation

The condensed consolidated statement of operations for the three months ended August 31, 2006 includes our accounts and those of our majority owned subsidiaries, Metacomp, Inc. and Plasma Scientific Corporation. The condensed consolidated balance sheet at May 31, 2007 and the condensed consolidated financial statements as of and for the three months ended August 31, 2007 include our accounts, those of our majority owned subsidiaries that are not considered variable interest entities (“VIE”s) and all VIEs for which we are the primary beneficiary. All significant intercompany accounts and transactions have been eliminated.

Consolidation of Affiliate

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46”). In December 2003, the FASB modified FIN 46. FIN 46 provides a new framework for identifying VIEs and determining when a company should include the assets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements.

A VIE is a corporation, partnership, limited liability corporation, trust or any other legal structure used to conduct activities or hold assets that either (1) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (2) has a group of equity owners that are unable to make significant decisions about its activities, or (3) has a group of equity owners that do not have the obligation to absorb losses or the right to receive returns generated by its operations.

FIN 46 requires a VIE to be consolidated if a party with an ownership, contractual or other financial interest in the VIE is obligated to absorb a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the VIE’s residual returns (if no party absorbs a majority of the VIE’s losses), or both. A variable interest holder that consolidates the VIE is called the primary beneficiary. Upon consolidation, the primary beneficiary generally must initially record all of the VIE’s assets, liabilities, and noncontrolling interests at fair value and subsequently account for the VIE as if it were consolidated based on majority voting interest.

FIN 46 was effective immediately for VIEs created after January 31, 2003. The provisions of FIN 46, as revised, were adopted as of December 31, 2003, for our interests in all VIEs. During the quarter ended May 31, 2007, we consolidated Scripps Secured Data, Inc. (“SSDI”) as SSDI was deemed a VIE and we determined that we were the primary beneficiary of SSDI.

Investment in Affiliated Company

We have a 50% interest in Phoenix Digital Solutions, LLC (see Note 4). This investment is accounted for 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

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company, continued

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”.

We review our investment in affiliated company to determine whether events or changes in circumstances indicate that its 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 investee. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.

Revenue Recognition

We recognize revenue from the sale of our product upon shipment to the customer, at which time title transfers and we have no further obligations. Fees for maintenance or support are recorded on a straight-line basis over the underlying period of performance. Revenue from technology license agreements is recognized at the time we enter into a contract and provide the customer with the licensed technology. At this point, we have performed all of our obligations under contract, the rights to our technology have been transferred and no significant performance obligations remain.

SSDI recognizes revenue upon shipment of its product and recognizes revenue on its short-term installation contracts as time and materials costs are incurred.

SSDI maintains an agreement with a distributor which accounts for the majority of SSDI’s product sales. This agreement provides for a limited product warranty for a period of one year from the date of sale to the end user. The warranty does not cover damage to the product after it has been delivered to the distributor. SSDI’s agreement with the distributor also allows the distributor the right to stock rotation whereby the distributor, on a six month basis, may return product for replacement products of the distributor’s choosing provided that the aggregate price of the replacement products is equal to the price of the original products returned. Such stock rotations shall not exceed 10% of the distributor’s purchases from SSDI in the prior twelve month period for any year and any single rotation shall not exceed 6% of the total rotational allowance for that year. The first stock rotation shall not occur before February 2008.

Shipping and Handling

Emerging Issues Task Force ("EITF") Issue No. 00-10, Accounting for Shipping and Handling Fees and Costs, requires shipping and handling fees billed to customers to be classified as revenue and shipping and handling costs to be classified as either cost of sales or disclosed in the notes to the financial statements. SSDI includes shipping and handling fees billed to customers in net sales. Shipping and handling costs associated with inbound freight are included in cost of sales.

Net Income (Loss) Per Share

We apply Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share, for the calculation of "Basic" and "Diluted" earnings per share. Basic earnings per share includes no dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities that could share in the earnings of an entity. At August 31, 2007, all potential common shares related to our outstanding warrants and options totaling 9,820,871 shares were not included in the calculation of diluted loss per share as they had an anti-dilutive effect. At August 31, 2006, potential common shares of 135,000 related to our outstanding warrants and options were not included in the calculation of diluted loss per share as they had an anti-dilutive effect.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Net Income (Loss) Per Share, continued

	Three Months Ended August 31, 2007
	Numerator (Loss)			Denominator (Shares)		Per Share Amount
Basic EPS:
Net loss	$	(1,962,386	)		390,455,132	$	(0.01	)
Diluted EPS:
Effect of dilutive securities:
Options and warrants		-			-
Loss available to common shareholders	$	(1,962,386	)		390,455,132	$	0.01

	Three Months Ended August 31, 2006
	Numerator (Loss)		Denominator (Shares)		Per Share Amount
Basic EPS:
Net income	$	5,990,273		368,837,051	$	0.02
Diluted EPS:
Effect of dilutive securities:
Options and warrants		-		51,809,718
Income available to common shareholders	$	5,990,273		420,646,769	$	0.01

Minority Interest

Minority interest in our consolidated financial statements results from the accounting for the acquisition of a noncontrolling interest in SSDI. Noncontrolling interest represents a partially owned subsidiary’s income, losses, and components of other comprehensive income which should be attributed to the controlling and noncontrolling interests or other parties with a right or obligation that affects the attribution of comprehensive income or loss, on the basis of their contractual rights or obligations, if any, otherwise, on the basis of ownership interests.

The noncontrolling interest in SSDI, which we are required to consolidate as we are the primary beneficiary, has been reduced to zero due to the initial allocation of losses prior to the period in which we were required to consolidate. If a noncontrolling interest has been reduced to zero, the primary beneficiary must absorb any losses that are in excess of the value of the noncontrolling interest’s equity. For the period in which we are required to consolidate, March 27, 2007 through August 31, 2007 we absorbed $165,164 of SSDI’s losses as we are the primary beneficiary. The noncontrolling interest in any future profits will not be presented until all prior losses have been recovered.

Stock-Based Compensation

On June 1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payment, which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period. Stock-based awards to non-employees are accounted for using the fair value method in accordance with SFAS No. 123, Accounting for Stock Based Compensation.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Stock-Based Compensation, continued

In November 2005, FASB issued FASB Staff Position No. FAS 123R-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (“FAS 123R-3”). We have elected to adopt the alternative transition method provided in FAS 123R-3. The alternative transition method includes a simplified method to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R).

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in our condensed consolidated statement of operations for the three months ended August 31, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of May 31, 2006 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to May 31, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Stock-based compensation expense recognized in our condensed consolidated statement of operations for the three months ended August 31, 2007 included compensation expense for share-based payment awards granted subsequent to May 31, 2007 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). As stock-based compensation expense recognized in the condensed consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate for the three months ended August 31, 2007 and 2006, of approximately 5% was based on historical forfeiture experience and estimated future employee forfeitures. The estimated pricing term of option grants for the three months ended August 31, 2007 and 2006 was five years.

Summary of Assumptions and Activity

The fair value of stock-based awards to employees and directors is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the pricing term of the grant effective as of the date of the grant. The expected volatility for the three months ended August 31, 2007 and 2006 is based on the historical volatilities of our common stock. These factors could change in the future, affecting the determination of stock-based compensation expense in future periods.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Stock-Based Compensation, continued

	Three Months Ended			Three Months Ended
	August 31, 2007 (Unaudited)			August 31, 2006 (Unaudited)

Expected term		5	years		5	years
Expected volatility		127 - 128	%		156	%
Risk-free interest rate		4.26 - 4.96	%		5.00	%
Expected dividends		2.82	%		-

A summary of option activity as of August 31, 2007 and changes during the three months then ended, is presented below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Options outstanding at June 1, 2007		7,245,000		$	0.40
Options granted		2,225,000		$	0.48
Options exercised		(1,007,846	)	$	0.16
Options forfeited		(1,017,154	)	$	0.16
Options outstanding at August 31, 2007		7,445,000		$	0.49		3.88	$	619,300
Options vested and expected to vest at August 31, 2007		7,370,000		$	0.49		3.88	$	619,300
Options exercisable at August 31, 2007		5,945,000		$	0.49		3.66	$	619,300

The weighted average grant date fair value of options granted during the three months ended August 31, 2007 and 2006 was $0.36 and $1.02 per option, respectively. The total intrinsic value of options exercised during the three months ended August 31, 2007 and 2006 was $478,750 and $40,500, respectively, based on the differences in market prices on the dates of exercise and the option exercise prices.

The aggregate intrinsic value represents the differences in market price at the close of the quarter ($0.47 per share on August 31, 2007) and the exercise price of outstanding, in the money options (those options with exercise prices below $0.47) on August 31, 2007.

As of August 31, 2007, there was approximately $488,415 of total unrecognized compensation cost related to employee stock option compensation arrangements. That cost is expected to be recognized on a straight-line basis over the next 57 months.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Stock-Based Compensation, continued

The following table summarizes employee stock-based compensation expense related to stock options under SFAS No. 123(R) for the three months ended August 31, 2007 and 2006, which was recorded as follows:

	Three Months Ended		Three Months Ended
	August 31, 2007		August 31, 2006
Selling, general and administrative expense	$	282,913	$	1,575,000

Recent Accounting Pronouncements

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). This interpretation clarifies the application of SFAS No. 109, Accounting for Income Taxes, by defining 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. We adopted FIN 48 on June 1, 2007 and did not record any cumulative effect adjustment to retained earnings as a result of adopting FIN 48. Interest and penalties, if any, related to unrecognized tax benefits are recorded in income tax expense. As of June 1, 2007, we are subject to U.S. Federal income tax examinations for the tax years May 31, 1991 through May 31, 2007, and we are subject to state and local income tax examinations for the tax years May 31, 1999 through May 31, 2007 due to the carryover of net operating losses from previous years.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principals and expands disclosures about fair value measurements. The statement does not require new fair value measurements, but is applied to the extent that other accounting pronouncements require or permit fair value measurements. The statement emphasizes that fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. Companies that have assets and liabilities measured at fair value will be required to disclose information that enables the users of its financial statements to access the inputs used to develop those measurements. The reporting entity is encouraged, but not required, to combine the fair value information disclosed under this statement with the fair value information disclosed under other accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We expect to adopt SFAS No. 157 on June 1, 2008. We are currently assessing the impact the adoption of SFAS No. 157 will have on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS No. 159 does not establish requirements for recognizing and measuring dividend income, interest income, or interest expense. This Statement does not eliminate disclosure requirements included in other accounting standards. SFAS No. 159 is effective in fiscal years beginning after November 15, 2007. We are in the process of evaluating the provisions of the statement, but do not anticipate that the adoption of SFAS No. 159 will have a material impact on our consolidated financial statements.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

2. Inventory

Inventory at August 31, 2007, consisted of raw materials of $183,765.

3. License Agreements

In February 2005, we entered into two separate licensing agreements with one customer for our patent portfolio and Ignite microprocessor technology. The aggregate amount of the two licenses was $3,050,000, of which $2,950,000 was for licensing fees and $100,000 was for maintenance services. Maintenance under the agreement is expected to be provided over a period not to exceed four years. Maintenance revenue recognized during the three months ended August 31, 2007 and 2006 was $6,250 and $6,250, respectively. The payment terms of the agreements required aggregate payments of $300,000 at the time of execution, three quarterly payments of $750,000 each on April 1, August 15, and November 15, 2005 and one final payment of $500,000 on February 15, 2006. The $500,000 payment due on February 15, 2006 was paid in March 2006. Total payments received in fiscal 2005 amounted to $1,050,000 and total payments received in fiscal 2006 amounted to $2,000,000. The agreements also provide for the future payment of royalties to us based on sales of product using the Ignite licensed technology. In connection with this license agreement, we became obligated to the co-inventor of the patent portfolio technology, Russell H. Fish III (“Fish”), for $207,600 pursuant to a July 2004 agreement under which we were obligated to pay a percentage of all patent portfolio licensing proceeds to Fish. The amount due under the agreement with Fish was payable in four installments of $51,900. Fish filed a lawsuit against us seeking damages and/or enforcement of the 2004 agreement. We challenged the enforceability of the agreement by counterclaim in that action. On February 14, 2007, a settlement of the litigation was finalized. Terms of the settlement required us to pay $3,400,000 in cash on February 14, 2007 and $3,000,000 on May 1, 2007, which amounted to approximately the debt claimed by Fish to be owed to him under the July 2004 agreement. In addition, the settlement required us to make a donation of $15,000 on February 14, 2007 on behalf of Fish to Maasai Power and Education Project, Inc., and to pay Fish the equivalent of 4% of 50% of the next $100 million of gross license fees as they are collected by Phoenix Digital and as distributions are made to us, after excluding the first $20 million collected by Phoenix Digital after December 1, 2006. Our commitment to make payments to Fish related to such future license revenues will not exceed $2 million. A liability for gross license fees due of $20,000 is included in accrued expenses in the accompanying condensed consolidated balance sheet at August 31, 2007. During the three months ended August 31, 2007, we recorded $30,000 in settlement and license expenses relating to royalty payments due to the Fish parties.

4. Investment in Affiliated Company/License Agreement

On June 7, 2005, we entered into a Master Agreement (the “Master Agreement”) with Technology Properties Limited Inc., a California corporation (“TPL”), and Charles H. Moore (“Moore”), the co-inventor of certain of our technology, pursuant to which we, TPL and Moore resolved all legal disputes between us. Pursuant to the Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of Phoenix Digital (the “LLC Agreement”) into which we and Moore contributed our rights to certain of our technologies. We believe, based upon consultation with our attorneys, it was not required by applicable law or other existing agreements to obtain approval for the contribution of the license rights to Phoenix Digital from stockholders or any parties other than our various warrant holders.

We and TPL each own 50% of the membership interests of Phoenix Digital, and each of us 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. Pursuant to the LLC Agreement, we and TPL agreed to establish a working capital fund for Phoenix Digital of $4,000,000, of which our contribution was $2,000,000. The working capital fund increases 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 Phoenix Digital in order to maintain working capital of not more than $8,000,000.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company/License Agreement, continued

Neither we nor TPL are required to contribute more than $2,000,000 in any fiscal year. Distributable cash and allocation of profits and losses will be allocated to the members in the priority defined in the LLC Agreement. Phoenix Digital has 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 Phoenix Digital) for supporting efforts to secure licensing agreements by the other member on behalf of Phoenix Digital. During the three months ended August 31, 2007 and 2006, Phoenix Digital paid $873,731 and $968,000, respectively, to TPL pursuant to this commitment.

We are accounting for our investment in Phoenix Digital under the equity method of accounting, and accordingly have recorded our share of Phoenix Digital’s net loss of $1,200,542 during the three months ended August 31, 2007 as a decrease in our investment and our share of Phoenix Digital’s net income of $12,070,198 during the three months ended August 31, 2006 as an increase in our investment. Cash distributions of $11,578,672 received from Phoenix Digital during the three months ended August 31, 2006 have been recorded as a reduction in our investment. No distributions were received during the three months ended August 31, 2007. Our investment in Phoenix Digital is $1,683,427 at August 31, 2007 and has been recorded as “Investment in Affiliated Company”. We have recorded our share of Phoenix Digital’s net loss as “Equity in Loss of Affiliated Company” in the accompanying consolidated statements of operations for the three months ended August 31, 2007. We have recorded our share of Phoenix Digital’s net income as “Equity in Earnings of Affiliated Company” in the accompanying consolidated statements of operations for the three months ended August 31, 2006. At August 31, 2007 we have recorded $396,098 as A/R from affiliated company for reimbursement due to us of legal fees and related costs for the patent litigation (see Note 7).

During the three months ended August 31, 2007 and 2006, Phoenix Digital entered into licensing agreements with third parties, pursuant to which it received aggregate proceeds of $1,500,000 and $25,749,000, respectively. During September 2007, Phoenix Digital entered into licensing agreements pursuant to which it received aggregate proceeds of $1,433,000.

The condensed balance sheets and statements of operations of Phoenix Digital at August 31, 2007 and 2006 and for the three months then ended are as follows:

Condensed Balance Sheets

ASSETS:

		2007		2006
Cash	$	3,759,743	$	8,695,729
Prepaid expenses		135,000		15,000
Total assets	$	3,894,743	$	8,710,729

LIABILITIES AND MEMBERS’ EQUITY:

Accounts payable and accrued expenses	$	516,098	$	299,585
Income taxes payable		11,790		-
Members’ equity		3,366,855		8,411,144
Total liabilities and members’ equity	$	3,894,743	$	8,710,729

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company/License Agreement, continued

Condensed Statements of Operations

Revenues	$	1,500,000		$	25,749,000
Operating expenses		3,966,543			1,717,917
Operating income (loss)		(2,466,543	)		24,031,083
Interest income		65,460			109,312
Net income (loss)	$	(2,401,083	)	$	24,140,395

5. Consolidated Variable Interest Entity

On February 2, 2007, we invested an aggregate of $370,000 in SSDI for 2,100,000 shares of convertible preferred stock. This represents all of SSDI’s preferred stock and a 46% ownership interest in SSDI, a California corporation that manufactures products that protect information transmitted over secure networks. The investment consisted of certain assets contributed by us to SSDI valued at $250,000 and cash of $120,000. The shares are convertible at our option into shares of SSDI’s common stock on a one-to-one basis. The convertible preferred stock entitles us to receive non-cumulative dividends at the per annum rate of $0.04 per share, when and if declared by the Board of Directors of SSDI. The investment in SSDI’s convertible preferred stock also entitles us to a liquidation preference of $0.40 per share, plus an amount equal to all declared but unpaid dividends.

On March 27, 2007, we entered into an 18 month revolving line of credit with SSDI for a maximum amount of $500,000. The line of credit matures on September 27, 2008. If we do not provide notice to SSDI at least 90 days prior to the maturity date, the maturity date automatically extends 12 months. The line of credit is collateralized by all assets presently owned or hereafter acquired by SSDI. The carrying value of the collateral is approximately $328,090 at August 31, 2007. The creditors of SSDI do not have recourse to our other assets. On March 28, 2007, we advanced $150,000 under terms of the agreement, on April 16, 2007 we advanced $100,000 under terms of the agreement and on September 4, 2007 we advanced $100,000 under terms of the agreement.

The line of credit carries a floating interest rate which is defined as the prime rate as announced by Bank of America. At August 31, 2007, the interest rate on the note was 8.25%; On September 18, 2007, the interest rate on the note was 7.75%. SSDI is required to make minimum monthly payments on the line consisting of unpaid and accrued interest on the first day of the month following the initial advance.

As a result of the line of credit, we have a variable interest in SSDI, a variable interest entity, and we have determined that we are the primary beneficiary as we absorb more than half of the variable interest entity’s expected losses. FIN46, requires us to consolidate SSDI as long as we are deemed to be the primary beneficiary. The equity interests of SSDI not owned by us are reported as a minority interest in our August 31, 2007 condensed consolidated balance sheet. As of August 31, 2007, the noncontrolling interest in SSDI, which we are required to consolidate as we are the primary beneficiary, has been reduced to zero due to the initial allocation of losses prior to the period in which we were required to consolidate. If a noncontrolling interest has been reduced to zero, the primary beneficiary must absorb any losses that are in excess of the value of the noncontrolling interest’s equity. For the period in which we are required to consolidate, March 27, 2007 through August 31, 2007 we absorbed $165,164 of SSDI’s losses as we are the primary beneficiary. The noncontrolling interest in any future profits will not be presented until all prior losses have been recovered.

Prior to initial consolidation, we recognized a $126,746 impairment loss on our investment for the losses of SSDI for the period February 2007 through March 26, 2007.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Consolidated Variable Interest Entity, continued

Upon initial consolidation of the variable interest entity, on March 27, 2007, $251,146 of current assets, $43,199 of net property and equipment, $47,240 of other assets, $98,331 of current liabilities and no minority interest were included on the consolidated balance sheet.

During the three months ended August 31, 2007, SSDI sold a membership interest in its subsidiary DataSecurus, LLC to an unrelated third party for $100,000 in cash and a $50,000 note receivable due June 2008.

6. Stockholders’ Equity

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. As part of the program we purchased 4,961,640 and 2,075,003 shares of our common stock at an aggregate cost of $2,725,793 and $1,839,085 during the three months ended August 31, 2007 and 2006, respectively.

The following table summarizes equity transactions during the three months ended August 31, 2007:

	Common Stock					Additional Paid-			Accumulated
	Shares			Amounts		in Capital			Deficit			Treasury Stock
Balance June 1, 2007	393,201,134		$	4,066	$	72,150,581		$	(43,151,678	)	$	(8,832,078	)

Exercise of warrants and options at $0.05 to $0.07 per share	150,000			2		7,998			-			-
Cashless exercise of options	982,846			10		(10	)		-			-
Repurchase of warrants	-			-		(921,857	)		-			-
Non-cash compensation	-			-		282,913			-			-
Tax effect of exercise of options	-			-		(25,645	)		-			-
Repurchase of common stock for treasury	(4,961,640	)		-		-			-			(2,725,793	)
Net loss	-			-		-			(1,962,386	)		-
Balance August 31, 2007	389,372,340		$	4,078	$	71,493,980		$	(45,114,064	)	$	(11,557,871	)

Stock Options and Warrant Activity

As of August 31, 2007, we had 100,000 options outstanding pursuant to our 1996 Stock Option Plan exercisable at $0.07 per share expiring in 2009; 775,000 options outstanding pursuant to our 2001 Stock Option Plan exercisable at a range of $0.07 to $0.86 per share expiring through 2012; 3,450,000 options outstanding pursuant to our 2003 Stock Option Plan exercisable at a range of $0.05 to $0.49 per share expiring through 2012; and 3,120,000 options outstanding pursuant to our 2006 Stock Option Plan exercisable at a range of $0.60 to $0.70 per share expiring through 2012. Some of the options outstanding under these plans are not presently exercisable and are subject to meeting vesting criteria.

During the three months ended August 31, 2007, a director exercised stock options to purchase 25,000 shares of common stock for proceeds of $1,750, and a director exercised stock options utilizing a share certification exchange procedure within our stock option plans to exercise 1,500,000 shares and receive 982,846 new shares upon exercise.

During the quarter ended August 31, 2007, we recorded $282,913 of non cash compensation expense related to stock options issued and vesting of stock options.

As of August 31, 2007, we had warrants outstanding to purchase 9,935,915 common shares at exercise prices ranging from $0.05 to $1.00 per share, expiring at various dates through 2012. Some of those outstanding warrants were not exercisable as of August 31, 2007 as they are subject to meeting vesting criteria. During the three months ended August 31, 2007, we issued no warrants to purchase shares of common stock, an investor exercised warrants to purchase 125,000 shares of common stock for proceeds of $6,250 and we repurchased 2,000,000 warrants for $921,857 under terms of our warrant repurchase agreement as detailed below.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Stockholders’ Equity, continued

In connection with a previous debt agreement, the Company entered into an Antidilution Agreement (the “Antidilution Agreement”) with Swartz Private Equity, LLC (“Swartz”) wherein the Company was obligated to issue to Swartz warrants equal to 11% of the common stock issued between January 28, 2002 and March 11, 2002, 20% of the common stock issued between March 12, 2002 and April 1, 2003, and after April 1, 2003, 30% of the common stock issued to any parties other than Swartz. There were no warrants issued during the three month period ended August 31, 2006 in connection with the Antidilution agreement. On October 10, 2006, the Company entered into an Approval Rights Agreement and Termination of Antidilution Agreement and Addendum to Warrants (the “Termination Agreement”) with Swartz to terminate the Antidilution Agreement. In consideration for entering into the Termination Agreement, the Company agrees to obtain Swartz’s written approval at least 30 days prior to entering into (i) any acquisition of any business entity or asset of any kind where the aggregate number of shares of common stock and derivative securities (on a fully diluted basis) issued as consideration for the acquisition equals or exceeds 10% of the number of shares of common stock of the Company outstanding at the time of the acquisition (on a fully diluted basis) or (ii) any acquisition (regardless of size) by the Company of any business entity or asset of any kind that is not unanimously approved by the Company’s board of directors.

On July 19, 2007, we entered into a warrant redemption agreement with Lincoln Ventures, LLC, whereby at our option, we agree to redeem certain warrants representing the right to acquire an aggregate of up to 7,000,000 shares of our common stock, through October 2007. The warrants were redeemable in quantities not to exceed 2,000,000 warrants in the first two calendar months and 3,000,000 in the last calendar month, at a price equal to the product of (a) the volume weighted average of the daily volume weighted average prices of our common stock for all trading days in the applicable calendar month, minus the exercise price of the warrant, multiplied by (b) the number of shares being redeemed from that warrant. Lincoln Ventures, LLC was prohibited from exercising any of the warrants as long as we remained in compliance with the agreement. Additionally, Lincoln Ventures, LLC was prohibited from purchasing any shares of our common stock on the open market during any “pricing month” defined in the agreement as the calendar month immediately preceding the calendar month in which we deliver the redemption notice to Lincoln Ventures, LLC. Subsequent to September 20, 2007, we repurchased all of the additional warrants pursuant to the agreement (see Note 9).

7. Commitments and Contingencies

Litigation

Lowell Giffhorn Arbitration

On September 23, 2005, Lowell Giffhorn, a former executive officer and a former director of the Company, submitted a demand for arbitration with the American Arbitration Association related to the termination of Mr. Giffhorn's employment with the Company. Mr. Giffhorn asserts that the termination of his employment with the Company was unlawful, retaliatory, wrongful, violated public policy, violated the covenant of good faith and fair dealing and violated securities laws. Mr. Giffhorn has demanded damages of approximately $4,500,000 (excluding claims for punitive damages and attorneys fees). The Company denies the allegations and believes the claims to be without merit. The Company has retained litigation counsel and intends to vigorously defend the claims. The amount, if any, of ultimate liability with respect to the foregoing cannot be determined. Despite the inherent uncertainties of litigation, the Company at this time does not believe that Mr. Giffhorn's claim will have a material adverse impact on its financial condition, results of operations, or cash flows.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Commitments and Contingencies, continued

Patent Litigation

Pursuant to the joint venture that the Company entered into in June 2005 with TPL (in settlement of inventorship/ownership litigation between the parties, and in return for a 50-50 sharing of net licensing and enforcement revenues), the Company granted TPL the complete and exclusive right to enforce and license its microprocessor patent portfolio. The Company then dismissed its patent infringement claims against Fujitsu Computer Systems, Inc. (“Fujitsu”), Matsushita Electric Corporation of America (“MEI”), NEC Solutions (America) Inc. (“NEC”), Sony Electronics Inc. (“Sony”), and Toshiba America Inc., and certain related entities of these defendants which had been pending in the Federal District Court for the Northern District of California. Thereafter, TPL, on behalf of the TPL/Patriot joint venture, filed patent infringement actions against certain of the foregoing defendants (except Sony) and their related entities in the Federal District Court for the Eastern District of Texas, which litigation is currently pending. Patriot was subsequently joined as a party to the litigation. Litigation is not currently pending with regard to Fujitsu or NEC and certain of NEC’s subsidiaries as listed below.

On August 25, 2006, ARM Ltd. and ARM, Inc. intervened as defendants, seeking a declaration of non-infringement of our ‘584 patent with respect to ARM processor cores contained within some alleged infringing chips of other defendants.

In February 2006, a license agreement was entered into with Fujitsu regarding the Company's patent portfolio, and in connection with that transaction, litigation involving Fujitsu and TPL and the Company in both California and Texas was dismissed.

In February 2007, a license agreement was entered into with: NEC Corporation, NEC Corporation of America, Inc., NEC Display Solutions of America, Inc. and NEC Unified Solutions, Inc. In connection with that transaction, the above named defendants, excluding NEC Electronics America, Inc., were dismissed from the lawsuit.

A Claims Construction Hearing was held May 3, 2007 in The United States District Court for the Eastern District of Texas. On June 15, 2007, the court handed down claims construction of the patents-in-suit, the ‘336, ‘148 and ‘584 patents. Based on the claims construction ruling, TPL/Patriot are vigorously proceeding with discovery with respect to the ‘336 and ‘148 patents. However, based on the claims construction ruling as to the ‘584 patent claims of “instruction groups”, TPL/Patriot announced on August 8, 2007, a Stipulation with ARM intended to expedite an appeal of that claims construction. The Stipulation is a declaration of non-infringement by the accused ARM products with respect to the ‘584 patent. This is intended to bolster TPL/Patriot’s efforts in the long run to enforce rights under the ‘584 patent. A notice of appeal to the Federal Circuit has been filed with respect to the ARM Stipulation and the District Court's claims construction with respect to the '584 patent.

During the discovery phase, TPL and Patriot reached stipulations regarding representative chips and products to streamline the presentation of the evidence at trial. As such, only a portion of the accused chips and products of those defendants will be the subject of evidence at trial. NEC Electronics America, Inc. is accused in the litigation of contributory infringement by virtue of manufacturing chips utilized by the other defendants in accused products.

The parties proceeded to mediation September 25-26, 2007. During the mediation TPL did not reach an agreement with any of the three sets of defendants with respect to the issues of the lawsuit, or with respect to potential licensing agreements broader in scope than the claims of the litigation. Jury selection is scheduled to begin January 7, 2008.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Commitments and Contingencies, continued

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 50% of each participant’s voluntary contributions, subject to a maximum contribution of 6% of the participant’s compensation. Participants vest 33% per year over a three year period in our contributions. Our matching contributions during the three months ended August 31, 2007 and 2006 were $928 and $2,562, respectively.

Employment Contracts

In connection with Mr. Turley’s appointment as President and Chief Executive Officer, and commencing on June 5, 2007, we entered into an employment agreement with Mr. Turley for a one-year term. Pursuant to the agreement, if Mr. Turley is terminated without cause, he is entitled to his then current salary level for the remaining term of his agreement conditional upon the execution of a general release.

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 within the first two years of employment, he is entitled to receive an amount equal to his annual base salary for the greater of (i) 6 months or (ii) the period remaining in the extended one-year term. 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 12 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 and California for SSDI. In connection with our facility leases, we have indemnified our lessors for certain claims arising from the use of the facilities. 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.

Operating Leases

We have a non-cancelable operating lease agreement for our Carlsbad, California office facility. Future minimum lease payments required under the operating lease are $96,201 and $73,710 in fiscal years ended 2008 and 2009, respectively.

SSDI subleases their Carlsbad, California office facility which expires in December 2007. Future minimum lease payments required under the operating lease are $52,983 in the fiscal year ended 2008.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Commitments and Contingencies, continued

SSDI also leases office space in Annapolis, Maryland on a month to month basis at $750 per month expiring February 2008. The lease may be terminated by either party with 30 days notice.

Earn-Out Agreement

SSDI entered into an earn-out agreement with a former debt holder of Holocom Networks, Inc. (“Holocom Networks”) upon our contribution of the foreclosure sale collateral of Holocom Networks to SSDI in fiscal 2007. The agreement required the former debt holder to release all of his rights to any Holocom Networks collateral in exchange for receiving 3% of the net sales (defined as cash revenues actually received less credits or discounts and other claims of customers) of SSDI’s protected distribution system products for a period of 48 months from the foreclosure sale date of February 2, 2007. The earn-out is to be paid each calendar quarter. A liability for payment under this agreement of $13,236 is included in accrued expenses in the accompanying condensed consolidated balance sheet at August 31, 2007.

8. Segment Information

SSDI began operations in February 2007 and we consolidated SSDI in our financial statements in March 2007. SSDI is an operating segment under FASB Statement No. 131, Disclosures About Segments of an Enterprise, as revenue is 10% or more of the total revenue of all operating segments.

SSDI is engaged in the business of developing and manufacturing network-security hardware for sale to government, military, and other high-security facilities. There is no inter-segment revenue, and the accounting policies for segment reporting are the same as for us as a whole.

The “all other” category includes the results for Patriot Scientific Corporation.

Operating segment net revenue, operating loss and income (loss) before taxes for three months ended August 31, 2007 and 2006 were as follows:

	2007			2006
Net revenue:
SSDI	$	511,864		$	-
All other		9,505			26,375
Total net revenue	$	521,369		$	26,375

Operating loss:
SSDI	$	(145,629	)	$	-
All other		(1,472,727	)		(2,706,149	)
Total operating loss	$	(1,618,356	)	$	(2,706,149	)

Income (loss) before taxes:
SSDI	$	4,749		$	-
All other		(2,199,704	)		9,490,273
Total income (loss) before taxes	$	(2,194,955	)	$	9,490,273

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Segment Information, continued

All sales were to unaffiliated customers within the United States. During the three months ended August 31, 2007, one customer accounted for 73% of SSDI’s product sales and this same customer accounted for 19% of SSDI’s accounts receivable at August 31, 2007, and this same customer accounted for 81% of SSDI’s accounts receivable at May 31, 2007.

Operating segment total assets and depreciation and amortization as of and for the three months ended August 31, 2007 and 2006 were as follows:

		2007		2006
Depreciation and amortization:
SSDI	$	4,154	$	-

All other

7,168

10,635

Total depreciation and amortization

11,322

10,635

		2007		2006
Total assets:
SSDI	$	594,320	$	-
All other		23,536,644		20,669,433
Total assets	$	24,130,964	$	20,669,433

9. Subsequent Events

During the period September 1, 2007 through October 10, 2007, Phoenix Digital entered into license agreements with third parties, pursuant to which it received aggregate proceeds totaling $1,433,000.

On September 4, 2007, we repurchased 2,000,000 warrants for $799,647 pursuant to the terms of our warrant repurchase agreement with Lincoln Ventures, LLC.

On September 4, 2007, we advanced $100,000 to SSDI pursuant to the line of credit agreement. On September 18, 2007, the interest rate on the line of credit decreased to 7.75% in accordance with the change in the prime interest rate.

During the period September 1, 2007 through October 10, 2007, we purchased 737,181 shares of our common stock for treasury at an aggregate cost of $317,128.

On September 13, 2007, a director exercised stock options to purchase 100,000 shares of common stock for proceeds of $10,200.

On September 17, 2007, a warrant holder exercised 3,500,000 warrants on a cashless basis, receiving 2,536,942 shares of our common stock upon exercise.

On September 17, 2007, we granted stock options, from our 2006 Stock Option Plan to our newly-appointed chief financial officer in accordance with his employment contract as follows: 600,000 non-qualified stock options, subject to vesting provisions within the option, and 150,000 non-qualified stock options which fully vest on January 17, 2008.

On October 2, 2007, we repurchased the remaining 3,000,000 warrants for $1,039,398 pursuant to the terms of our warrant repurchase agreement with Lincoln Ventures, LLC.

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, "RISK FACTORS" SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31, 2007.

Overview

In June 2005, we entered into a series of agreements with Technology Properties Limited, Inc. (“TPL”) and others to facilitate the pursuit of infringers of our intellectual property. We intend to continue our joint venture with TPL to pursue license agreements with infringers of our technology. We believe that utilizing the option of working through TPL, as compared to creating and using a Company licensing team for those activities, avoids a competitive devaluation of our principal assets and is a prudent way to achieve the desired results as we seek to obtain fair value from users of our intellectual property.

During the fiscal year ended May 31, 2006, we finalized an agreement for the licensing of our technology with Intel Corporation. During the fiscal years ended May 31, 2006 and 2007, the joint venture entered into licensing agreements with Hewlett-Packard, Fujitsu, Casio, Nikkon, Sony, Seiko Epson, Pentax, Olympus, Kenwood, Agilent Technologies, Schneider Electric, Lexmark, NEC, Funai Electric, SanDisk, Sharp and Nokia through our joint venture entity, Phoenix Digital Solutions, LLC (“PDS”). During the three months ended August 31, 2007, PDS entered into licensing agreements with Lego Systems and Bull. We believe that these agreements represent validation of our position that our intellectual property was and is being infringed by major manufacturers and users of microprocessor technology. We believe the early stage agreements demonstrate the potential value of our intellectual property in that they are "arms length" transactions with major electronics manufacturers.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods. We believe the following critical accounting policies affect our most significant estimates and judgments used in the preparation of our condensed consolidated financial statements.

1. Revenue Recognition

Accounting for revenue recognition is complex and affected by interpretations of guidance provided by several sources, including the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (“SEC”). This guidance is subject to change. We follow the guidance established by the SEC in Staff Accounting Bulletin No. 104, as well as generally accepted criteria for revenue recognition, which require that, before revenue is recorded, there is persuasive evidence of an arrangement, the fee is fixed or determinable, collection is reasonably assured, and delivery to our customer has occurred. Applying these criteria to certain of our revenue arrangements requires us to carefully analyze the terms and conditions of our license agreements. Revenue from our technology license agreements is generally recognized at the time we enter into a contract and provide our customer with the licensed technology. We believe that this is the point at which we have performed all of our obligations under the agreement; however, this remains a highly interpretive area of accounting and future license agreements may result in a different method of revenue recognition. Fees for maintenance or support of our licenses are recorded on a straight-line basis over the underlying period of performance.

Our consolidated variable interest entity recognizes revenue upon shipment of its product and recognizes revenue on its short-term installation contracts as time and materials costs are incurred.

2. 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 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.

3. Stock Options and Warrants

In November 2005, FASB issued FASB Staff Position No. FAS 123R-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (“FAS123R-3”). We have elected to adopt the alternative transition method provided in FAS 123R-3. The alternative transition method includes a simplified method to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R).

Employee stock-based compensation expense recognized under SFAS No. 123(R) for the three months ended August 31, 2007 and 2006 was $282,913 and $1,575,000, respectively, as determined by the Black-Scholes valuation model.

4. Patents and Trademarks

We carry our patents and trademarks at cost less accumulated amortization and we amortize the patents over their estimated useful lives of four years. We periodically review the carrying value of the patents and trademarks for impairment and recognize impairment when the expected future benefit to be derived from an individual intangible asset is less than its carrying value.

5. Income Taxes

We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that a substantial majority of the deferred tax assets recorded on our balance sheet will ultimately be recovered. However, should there be a change in our ability to recover the deferred tax assets; the tax provision would increase in the period in which we determined that the recovery was not probable.

6. 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 statement of operations in the caption “Equity in earnings of affiliated company”.

We review our investment to determine whether events or changes in circumstances indicate that our 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 investee. If a decline in value is deemed to be other than temporary, we would recognize an impairment loss.

7. Variable Interest Entity

We own 100% of the preferred stock of Scripps Secured Data, Inc. (“SSDI”). On March 27, 2007 we entered into an 18 month revolving line of credit with SSDI for a maximum amount of $500,000. The line of credit caused us to have a variable interest in SSDI, a variable interest entity, and we have determined that we are the primary beneficiary as we absorb more than half of the variable interest entity’s expected losses. FIN46(R), Consolidation of Variable Interest Entities, requires us to consolidate SSDI as long as we are deemed to be the primary beneficiary.

We reevaluate our primary beneficiary position at each of our balance sheet dates using the guidance in FIN46(R). If we are no longer deemed to be the primary beneficiary of the variable interest entity, we will discontinue consolidation.

Results of Operations

Our revenues increased from approximately $26,000 for the three months ended August 31, 2006 to approximately $521,000 for the three months ended August 31, 2007. Our revenue amounts do not include income of approximately $12,070,000 from our investment in Phoenix Digital Solutions, LLC for the three months ended August 31, 2006, or loss of approximately $1,201,000 from our investment in Phoenix Digital Solutions, LLC for the three months ended August 31, 2007. During the three months ended August 31, 2007 we recorded sales amounting to approximately $512,000 by our consolidated variable interest entity, SSDI, with cost of sales amounting to approximately $152,000. During the three months ended August 31, 2006 and 2007, we recognized maintenance fee revenues totaling approximately $6,250 and $6,250 in connection with an agreement with AMD Corporation during the 2005 fiscal year. The agreement called for maintenance fees totaling $100,000 connected with a license agreement for our Ignite technology; the license fee revenue is being recognized as revenue evenly over the four year period of the license. In addition during the three months ended August 31, 2007, we recorded sales of approximately $3,300 from the sale of microprocessor chips that we no longer market. Inventory associated with the sales of these microprocessor chips is carried at zero value. During the three months ended August 31, 2006, we recorded sales of approximately $20,100 relating to the microprocessor chips.

Selling, general and administrative expenses decreased from approximately $2,733,000 for the three months ended August 31, 2006 to approximately $1,988,000 for the three months ended August 31, 2007. Legal expenses decreased by approximately $127,000 for the three months ended August 31, 2007 compared with the three months ended August 31, 2006 and accounting expenses increased by approximately $70,000 for the three months ended August 31, 2007 compared with the three months ended August 31, 2006 primarily due to fees for the audits of our affiliate, consolidated variable interest entity and the completion of the testing of our internal controls. Salary costs and related expenses included non-cash expenses associated with the fair value of options granted during the period in accordance with SFAS No. 123R. During the three months ended August 31, 2007, options were granted to our newly-appointed chief executive officer pursuant to terms of his employment contract, those option grants plus the related vesting on the grants resulted in non-cash compensation expense of approximately $170,000. On August 16, 2007 options were granted to certain employees and a newly-appointed director resulting in non-cash compensation of approximately $113,000. During the three months ended August 31, 2006, 1,500,000 options were granted to our then chief executive officer resulting in a non-cash compensation expense amounting to approximately $1,527,000. Board of director fees amounting to approximately $98,000 were paid during the three months ended August 31, 2007 as compared to $60,000 paid for the three months ended August 31, 2006. Other salary expenses increased by approximately $371,000 for the three months ended August 31, 2007 as compared with the three months ended August 31, 2006 including approximately $307,000 in salaries and related expenses for SSDI during the three months ended August 31, 2007. Salary expenses for the parent company including wages, payroll taxes, employee benefits and expenses connected with 401(k) employer matching increased by approximately $64,000 during the three months ended August 31, 2007 as compared with the three months ended August 31, 2006. Travel and related expenses for the three months ended August 31, 2007 increased by approximately $43,000 as expenses for SSDI of approximately $51,000 were combined with the decrease in travel expenses for the parent company of approximately $8,300. Consulting expenses increased by approximately $27,000 for the three months ended August 31, 2007 as compared to the three months ended August 31, 2006 due to one time fees for evaluations of our various technologies and expenses associated with our production of materials for the upcoming litigation. Offsetting the increases in selling, general and administrative expenses for the three months ended August 31, 2007 as compared to the three months ended August 31, 2006, were decreases amounting to approximately $55,000 for public relations expenses and $13,000 for investor relations expenses.

Settlement and license expenses amounting to $30,000 were recorded for the three months ended August 31, 2007 relating to royalties payable resulting from an agreement with Fish (see Note 3 to our condensed consolidated financial statements for more information). No such expenses were recorded for the three months ended August 31, 2006.

Our other income and expenses for the three months ended August 31, 2007 and 2006 included equity in the earnings and loss of PDS. The investment is accounted for in accordance with the equity method of accounting for investments. Our investment in PDS for the three months ended August 31, 2007 generated a loss after expenses in the amount of approximately $1,201,000 resulting from licensing agreements for our intellectual property with Lego Systems and Bull for one time payments. Our investment in PDS provided net income after expenses in the amount of approximately $12,070,000 for the three months ended August 31, 2006. Total other income and expense for the three months ended August 31, 2007 amounted to net other expense of approximately $577,000 compared with total other income and expense for the three months ended August 31, 2006 of net other income amounting to approximately $12,196,000. Interest income and other income increased from approximately $127,000 for the three months ended August 31, 2006 to approximately $475,000 for the three months ended August 31, 2007 as interest bearing account balances increased from cash received as distributions from our investment in PDS and we recognized other income of approximately $227,000 in connection with our reimbursement request billings to PDS for our prior period legal expenses incurred in connection with the patent litigation. During the three months ended August 31, 2007, SSDI recognized $150,000 of other income in connection with the sale of a portion of its interest in Holocom MultiDomain Computers, LLC, now known as DataSecurus, LLC.

During the quarter ended August 31, 2006, we recorded a provision for income taxes of $3,500,000 related to federal and California taxes. During the quarter ended August 31, 2007, we recorded a benefit from income taxes of approximately $233,000 related to federal and California taxes. Also, during the quarters ended August 31, 2006, and August 31, 2007, we utilized approximately $34,300,000 and $5,600,000, respectively, of our available federal net operating loss carry-forwards. At August 31, 2007 we have utilized all of our remaining available federal net operating loss carry-forwards. At May 31, 2007, we have utilized all of our state net operating loss carry-forwards of approximately $17,822,000.

We recorded net income for the three months ended August 31, 2006 of $5,990,273 compared with a net loss of $1,962,386 for the three months ended August 31, 2007.

Liquidity and Capital Resources

Liquidity

Our cash, marketable securities and short-term investment balances decreased from approximately $25,955,000 as of May 31, 2007 to approximately $20,278,000 as of August 31, 2007. We also have restricted cash balances amounting to approximately $102,000 as of May 31, 2007 and approximately $103,000 as of August 31, 2007. Total current assets decreased from approximately $31,399,000 as of May 31, 2007 to approximately $22,319,000 as of August 31, 2007. Total current liabilities amounted to approximately $2,021,000 and approximately $8,551,000 as of May 31, 2007 and August 31, 2007, respectively. The change in our current position as of August 31, 2007 as compared with May 31, 2007 results from our utilization of cash to repurchase warrants and to purchase treasury stock while not receiving cash distributions from PDS during the three months ended August 31, 2007. Additionally, during the three months ended August 31, 2007, we utilized our remaining federal net operating losses for income tax purposes, resulting in a current tax liability of approximately $7,678,000 and causing our prepaid income taxes and deferred tax assets at May 31, 2007 to be reclassified to the current tax liability.

Cash Flows From Operating Activities

Cash used in operating activities for the three months ended August 31, 2007 was approximately $2,129,000 as compared with cash used in operating activities for the three months ended August 31, 2006 of approximately $1,629,000. The principal components of the current period amount were: our share of loss in our investee of approximately $1,201,000, change in refundable income taxes of approximately $2,071,000 change in income taxes payable of approximately $7,678,000. These increases were partially offset by: net loss of approximately $1,962,000, change in deferred taxes of approximately $9,956,000, and changes in accounts payable and accrued expenses of approximately $1,148,000.

Cash Flows From Investing Activities

Cash used in investing activities was approximately $255,000 for the three months ended August 31, 2007 as compared to cash provided by investing activities of approximately $9,098,000 for the three months ended August 31, 2006. The decrease was primarily due to lack of distributions received from our investment in affiliate. Cash used during the three months ended August 31, 2007 consisted of approximately $347,000 in net purchases of short-term investments and purchases of fixed assets of approximately $8,000. The cash used during the three months ended August 31, 2007 was partially offset by proceeds of $100,000 received by SSDI for the sale of a membership interest in DataSecurus, LLC.

Cash Flows From Financing Activities

Cash used in financing activities for the three months ended August 31, 2007 was approximately $3,640,000 as compared to approximately $1,774,000 for the three months ended August 31, 2006 primarily due to payments of approximately $2,726,000 to repurchase shares of our common stock for treasury and warrant repurchases of approximately $922,000 for the three months ended August 31, 2007. The cash used during the three months ended August 31, 2007 was partially offset by cash received of approximately $8,000 from the exercise of common stock options and warrants.

Capital Resources

Our current position as of August 31, 2007 is expected to provide the funds necessary to support our operations through at least the next twelve months.

Contractual Obligations and Committments

A summary of our outstanding contractual obligations at August 31, 2007 is as follows:

Contractual Cash Obligations	Total Amounts Committed		1-3 Years

Operating leases - facilities	$	180,810	$	180,810

Recent Accounting Pronouncements

Risk Factors

We urge you to carefully consider the following discussion of risks as well as other information regarding our common stock. We believe the following to be our most significant risk factors as of the date this report is being filed. The risks and uncertainties described below are not the only ones we face.

We Have Reported Substantial Income In 2006 and 2007 Which May Not Be Indicative Of Our Future Income

During fiscal 2007 and 2006, we entered into license agreements, directly and through our joint venture with Technology Properties Limited. Because of the uncertain nature of the negotiations that lead to license revenues, pending litigation with companies which we allege have infringed on our patent portfolio, the possibility of legislative action regarding patent rights, and the possible effect of new judicial interpretation of patent laws, we cannot predict the amount of future revenues from such agreements, or whether there will be future revenues from license agreements at all.

We Are Dependent Upon A Joint Venture In Which We Are A Passive Partner For Substantially All Of Our Income

In June of 2005, we entered into a joint venture with Technology Properties Limited, pursuant to which Technology Properties Limited is responsible for the licensing and enforcement of our microprocessor patent portfolio. This joint venture has been the source of virtually all of our income since June of 2005. Therefore, in light of the absence of significant revenue from other sources, we should be regarded as entirely dependent on the success or failure of the licensing and prosecution efforts of Technology Properties Limited on behalf of the joint venture. Sales of our microprocessor products and data security products have resulted in limited revenues. Our other product lines are no longer being actively marketed, and also only generate limited and sporadic sales.

Our Limited Sales And Marketing Capabilities Have Affected Our Revenue

We currently have limited marketing capabilities and may need to hire additional sales and marketing personnel. We may not be able to recruit, train, or retain qualified personnel to sell and market our products. We also may not be able to develop a successful sales and marketing strategy. We also have very limited marketing experience. Any marketing efforts we undertake may not be successful and may not result in any significant sales of our products.

We May Experience Difficulties In The Completion Of Our Development Stage Products

Our technologies and products are in various stages of development. We do not currently have in-house development personnel, nor have we retained independent researchers. Therefore, our development stage products may not be completed on a timely basis or at all. Additionally, even if we do recommence our development activities, our development stage products may not be completed due to the inherent risks of new product and technology development, limitations on financing, competition, obsolescence, the absence or loss of key personnel and other factors. Although we have licensed some of our technology at its current stage of development, we may not continue to be able to do so and any revenues generated from licensing may not be sufficient to support operations at their current level. Also, unanticipated technical obstacles can arise at any time and result in lengthy and costly delays or in a determination that further development is not feasible.

Changes In Our Relationships With Companies In Which We Hold Less Than A Majority Interest Could Change The Way We Account For Such Interests In The Future.

We hold a minority interest in a company (Scripps Secured Data, Inc.) to which we provide financing. Under the applicable provisions of accounting principles generally accepted in the United States of America, including FIN 46(R), we currently consolidate the financial statements and results of operations of this company into our consolidated financial statements and results of operations, and record the equity interest that we do not own as a minority interest. For our other investment (Phoenix Digital Solutions, LLC), accounted for under the equity method, we record as part of other income or expense our share of the increase or decrease in the equity of the company in which we have invested. It is possible that, in the future, our relationships and/or our interests in or with this consolidated entity and equity method investee could change. Such potential future changes could result in deconsolidation or consolidation of such entities, as the case may be, which could result in changes in our reported results.

We Have Settled A Legal Dispute Which Could Affect Our Future Results Of Operations And Working Capital Position

We were sued by a co-inventor of the technology underlying our microprocessor patent portfolio with regard to proceeds we received as a consequence of recently signed license agreements. On February 14, 2007, we finalized a settlement of this litigation. This settlement required us to pay the co-inventor $6,400,000 and requires us to pay up to $2,000,000 from the proceeds we receive from future licensing transactions. As of the date of this filing, we have paid $1,194,000 of the $2,000,000 obligation for future licensing transaction proceeds required under the settlement agreement. These payments have resulted, and will result, in a reduction of our net income in the current fiscal year and future quarters until our obligations under the settlement have been fulfilled.

A Successful Challenge To The Proprietary Nature Of Our Intellectual Property Would Have A Significant And Adverse Effect On Us

A successful challenge to our ownership of our technology or the proprietary nature of our intellectual property would materially damage our business prospects. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We currently have eight U.S. patents, one European patent, and one Japanese patent issued. Any issued patent may be challenged and invalidated. Patents may not be issued for any of our pending applications. Any claims allowed from existing or pending patents may not be of sufficient scope or strength to provide significant protection for our products. Patents may not be issued in all countries where our products can be sold so as to provide meaningful protection or any commercial advantage to us. Our competitors may also be able to design around our patents.

Vigorous protection and pursuit of intellectual property rights or positions characterize the fiercely competitive semiconductor industry, which has resulted in significant and often protracted and expensive litigation. Therefore, our competitors and others may assert that our technologies or products infringe on their patents or proprietary rights. Persons we believe are infringing our patents are vigorously defending their actions and have asserted that our patents are invalid. Problems with patents or other rights could increase the cost of our products or delay, preclude new product development and commercialization by us, and limit future license revenue. If infringement claims against us are deemed valid or if our infringement claims are successfully opposed, we may not be able to obtain appropriate licenses on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our future patent and/or technology license positions or to defend against infringement claims. We are currently involved in patent litigation in the United States District Court for the Eastern District of Texas (see the Section entitled “Legal Proceedings”). Additionally, opposing parties in the litigation and one other person have petitioned the U. S. Patent and Trademark Office to re-examine certain of our patents. An adverse decision in the litigation or in the re-examination process would have a very significant and adverse effect on our business.

If A Large Number Of Our Shares Are Sold All At Once Or In Blocks, The Market Price Of Our Shares Would Most Likely Decline

Our warrant holders are not restricted in the price at which they can sell common stock acquired through the exercise of warrants. Shares sold at a price below the current market price at which the common stock is trading may cause the market price to decline. The shares of common stock that are issuable on the exercise of our warrants represent a significant portion of our fully-diluted capitalization.

The Market For Our Stock Is Subject To Rules Relating To Low-Priced Stock (“Penny Stock”) Which May Limit Our Ability To Raise Capital

Our common stock is currently listed for trading in the National Association of Securities Dealers (“NASD”) Over-The-Counter Bulletin (“OTC”) Board Market and is subject to the “penny stock rules” adopted pursuant to Section 15(g) of the Exchange Act. In general, the penny stock rules apply to non-NASDAQ or non-national stock exchange companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years). Such rules require, among other things, that brokers who trade “penny stock” on behalf of persons other than “established customers” complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document, quote information, broker’s commission information and rights and remedies available to investors in penny stocks. Many brokers have decided not to trade “penny stock” because of the requirements of the penny stock rules, and as a result, the number of broker-dealers willing to act as market makers in such securities is limited. The “penny stock rules,” therefore, may have an adverse impact on the market for our common stock and may affect our ability to raise additional capital if we decide to do so.

Our Share Price Could Decline As A Result Of Short Sales

When an investor sells stock that he does not own, it is known as a short sale. The seller, anticipating that the price of the stock will go down, intends to buy stock to cover his sale at a later date. If the price of the stock goes down, the seller will profit to the extent of the difference between the price at which he originally sold it less his later purchase price. Short sales enable the seller to profit in a down market. Short sales could place significant downward pressure on the price of our common stock. Penny stocks which do not trade on an exchange, such as our common stock, are particularly susceptible to short sales.

Our Future Success Depends In Significant Part Upon The Continued Services Of Our Key Senior Management

Our future success depends in significant part upon the continued services of our key senior management personnel. The competition for highly qualified personnel is intense, and we may not be able to retain our key managerial employees or attract and retain additional highly qualified technical and managerial personnel in the future. None of our employees are represented by a labor union, and we consider our relations with our employees to be good. None of our employees are covered by key man life insurance policies.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

N/A

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(e) under the Exchange Act, as of August 31, 2007, the end of the period to which this quarterly report relates, we have carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our report filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of August 31, 2007, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recently completed fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Lowell Giffhorn Arbitration

Patent Litigation

Item 1A. Risk Factors

No material changes from the risk factors contained in our 10-K for the year ended May 31, 2007. Please see Part I, Item 2, above, for our risk factors.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On April 28, 2006, the Company’s Board of Directors authorized a stock repurchase program. We commenced the program in July 2006 and plan to repurchase outstanding shares of our common stock on the open market from time to time. As part of the program, we purchased 4,961,640 shares of our common stock at an aggregate cost of $2,725,793 during the three months ended August 31, 2007.

Following is a summary of all repurchases by the Company of its common stock during the three month period ended August 31, 2007:

Period	Total Number of Shares Purchased		Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

June 1 - 30, 2007	2,229,700	$	0.54	2,229,700
July 1 - 31, 2007	2,570,940	$	0.56	2,570,940
August 1 - 31, 2007	161,000	$	0.54	161,000
Total	4,961,640	$	0.55	4,961,640

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits

Those exhibits marked with an asterisk (*) refer to exhibits filed herewith. The other exhibits are incorporated herein by reference, as indicated in the following list.

Exhibit No.		Document

2.1		Agreement to Exchange Technology for Stock in the Company, incorporated by reference to Exhibit 2.1 to Form 8-K dated August 10, 1989 (Commission file No. 33-23143-FW)

2.2		Assets Purchase Agreement and Plan of Reorganization dated June 22, 1994, among the Company, nanoTronics Corporation and Helmut Falk, incorporated by reference to Exhibit 10.4 to Form 8-K dated July 6, 1994 (Commission file No. 000-22182)

2.2.1		Amendment to Development Agreement dated April 23, 1996 between the Company and Sierra Systems, incorporated by reference to Exhibit 2.2.1 to Pre-Effective Amendment No. 1 to Registration Statement on Form SB-2 filed April 29, 1996 (Commission file No. 333-01765)

2.3		Form of Exchange Offer dated December 4, 1996 between the Company and certain shareholders of Metacomp, Inc., incorporated by reference to Exhibit 2.3 to Form 8-K filed January 9, 1997 (Commission file No. 000-22182)

2.4		Letter of Transmittal to Accompany Shares of Common Stock of Metacomp, Inc. Tendered Pursuant to the Exchange Offer Dated December 4, 1996, incorporated by reference to Exhibit 2.4 to Form 8-K filed January 9, 1997 (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 Registration Statement on Form S-3 filed June 27, 2002 (Commission file No. 333-91352)

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)

3.4		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)

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		1996 Stock Option Plan of the Company dated March 25, 1996 and approved by the Shareholders on May 17, 1996, incorporated by reference to Exhibit 10.13 to Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2 filed May 23, 1996 (Commission file No. 333-01765)

4.3		2001 Stock Option Plan of the Company dated February 21, 2001 incorporated by reference to Exhibit 4.19 to Registration Statement on Form S-8 filed March 26, 2001 (Commission file No. 333-57602)

4.4		2003 Stock Option Plan of the Company dated July 2, 2003 incorporated by reference to Exhibit 4.27 to Registration Statement on Form S-8 filed September 4, 2003 (Commission file No. 333-108489)

4.5		2006 Stock Option Plan of the Company dated March 31, 2006 incorporated by reference to Exhibit 4.19 to Registration Statement on Form S-8 filed June 20, 2006 (Commission file No. 333-135156)

4.6		Approval Rights Agreement and Termination of Antidilution Agreement and Addendum to Warrants dated October 10, 2006, incorporated by reference to Exhibit 4.29 to Form 10-KSB for the fiscal year ended May 31, 2006, filed on October 13, 2006 (Commission file No. 000-22182)

10.1		Employment Agreement dated June 5, 2007 by and between the Company and James Turley, incorporated by reference to Exhibit 10.1 to Form 8-K filed June 8, 2007 (Commission file No. 000-22182)

10.2		Employment Agreement dated September 17, 2007 by and between the Company and Clifford Flowers, incorporated by reference to Exhibit 10.1 to Form 8-K filed September 19, 2007 (Commission file No. 000-22182)

31.1*		Certification of James L. Turley, CEO, pursuant to Rule 13a-14(a)/15d-14(a)

31.2*		Certification of Clifford L. Flowers, CFO, pursuant to Rule 13a-14(a)/15d-14(a)

32.1*		Certification of James L. Turley, CEO, pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code

32.2*		Certification of Clifford L. Flowers, CFO, pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code

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: October 10, 2007

PATRIOT SCIENTIFIC CORPORATION

/S/ JAMES L. TURLEY

James L. Turley

Chief Executive Officer

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date

/S/ JAMES L. TURLEY James L. Turley	President, Chief Executive Officer, and Director	October 10, 2007

/S/ CLIFFORD L. FLOWERS Clifford L. Flowers	Chief Financial Officer and Principal Accounting Officer	October 10, 2007

/S/ DAVID H. POHL David H. Pohl	Chairman	October 10, 2007

/S/ CARLTON M. JOHNSON Carlton M. Johnson	Director	October 10, 2007

/S/ GLORIA H. FELCYN Gloria H. Felcyn	Director	October 10, 2007

/S/ HELMUT FALK, JR. Helmut Falk, Jr.	Director	October 10, 2007

/S/ HARRY L. TREDENNICK Harry L. Tredennick	Director	October 10, 2007