Mosaic ImmunoEngineering Inc. - Annual Report: 2011 (Form 10-K)

patriot_10k-053111.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended May 31, 2011

[_]	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.)

701 Palomar Airport Road, Suite 170, Carlsbad, California (Address of principal executive offices)	92011 (Zip Code)

(Registrant’s telephone number, including area code): (760) 547-2700

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.00001 par value

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES [_] NO [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES [_] NO [X]

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [_] NO [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_]

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

Large accelerated filer [_] Accelerated filer [_] Non-accelerated filer [_] (do not check if smaller reporting company)

Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [_] NO [X]

Approximate aggregate market value of the registrant’s common stock held by non-affiliates on November 30, 2010 was $40,376,945 based on a closing price of $0.10 as reported on the OTC Electronic Bulletin Board system. For purposes of this calculation, it has been assumed that all shares of the registrant's common stock held by directors, executive officers and shareholders beneficially owning five percent or more of the registrant's common stock are held by affiliates. The treatment of these persons as affiliates for purposes of this calculation is not conclusive as to whether such persons are, in fact, affiliates of the registrant.

On August 12, 2011, 406,972,710 shares of common stock, par value $0.00001 per share were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None

Table of Contents

PART I			4

	ITEM 1.	Business	4
	ITEM 1A.	Risk Factors	10
	ITEM 1B.	Unresolved Staff Comments	13
	ITEM 2.	Properties	13
	ITEM 3.	Legal Proceedings	13
	ITEM 4.	[Removed and Reserved]	14

PART II			14

	ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	14
	ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
	ITEM 8.	Financial Statements and Supplementary Data	25
	ITEM 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	25
	ITEM 9A.	Controls and Procedures	25
	ITEM 9B.	Other Information	26

PART III			26

	ITEM 10.	Directors, Executive Officers and Corporate Governance	26
	ITEM 11.	Executive Compensation	29
	ITEM 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	32
	ITEM 13.	Certain Relationships and Related Transactions, and Director Independence	32
	ITEM 14.	Principal Accountant Fees and Services	33

PART IV			34

	ITEM 15.	EXHIBITS, AND FINANCIAL STATEMENT SCHEDULES	34

SIGNATURES

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, including all documents incorporated by reference herein, includes certain statements constituting “forward-looking” statements within the meaning of Section 27A of the Securities Act, Section 21E of the Exchange Act and the Private Securities Litigation Reform Act of 1995, including statements concerning our beliefs, plans, objectives, goals, expectations, anticipations, estimates, intentions, operations, future results and prospects, and we rely on the “safe harbor” provisions in those laws. We are including this statement for the express purpose of availing ourselves of the protections of such safe harbors with respect to all such forward-looking statements. The forward-looking statements in this report reflect our current views with respect to future events and financial performance. In this report, the words “anticipates,” “believes,” “expects,” “intends,” “future,” “estimates,” “may,” “could,” “should,” “would,” “will,” “shall,” “propose,” “continue,” “predict,” “plan” and similar expressions are generally intended to identify certain of the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made. Any forward-looking statement is not a guarantee of future performance.

These forward-looking statements are subject to certain risks and uncertainties, and actual results may differ materially from those in the forward-looking statements as a result of various factors, including, but not limited to those items shown under “Item 1A. Risk Factors.” You should read this report completely with the understanding that our actual results may differ materially from what we expect. Unless required by law, we undertake no obligation to publicly release the result of any revision of these forward-looking statements to reflect events or circumstances after the date they are made or to reflect the occurrence of unanticipated events.

PART I

ITEM 1 BUSINESS

The Company

Patriot Scientific Corporation (the “Company”, “PTSC”, “we”, “us”, or “our”) pursues two distinct technology enabled business strategies. First, through our joint venture, Phoenix Digital Solutions, LLC (“PDS”) we are an intellectual-property licensing company with several patents (described below) covering the design of microprocessor chips. Chips with our patented technology are used throughout the world in products ranging from computers and cameras to printers, automobiles and industrial devices. We pursue the commercialization of our patented microprocessor technologies through broad and open licensing and by litigating against those who may be infringing on our patents. Secondly, through our wholly-owned subsidiary Patriot Data Solutions Group, Inc. formerly known as Crossflo Systems, Inc. (“PDSG”), we provide data sharing and secure data solutions to address the critical data/information sharing needs of federal, state, and local public safety and law enforcement agencies.

Our business address is 701 Palomar Airport Road, Suite 170, Carlsbad, California 92011; our main telephone number is (760) 547-2700. Our internet website page is located at http://www.ptsc.com. All of our reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available free of charge on our internet website. The information on, or that can be accessed through, our website is not part of this Annual Report.

PTSC is a corporation organized under Delaware law on March 24, 1992, and is the successor by merger to Patriot Financial Corporation, a Colorado corporation, incorporated on June 10, 1987. In June 2005, we entered into a joint venture agreement with Technology Properties Limited, Inc. (“TPL”) to form PDS. During February 2007, we acquired the preferred stock of Holocom, Inc. formerly known as Scripps Secured Data, Inc. (“Holocom”) a company located in San Diego, California that develops and manufactures network-security hardware to government, military, and other high-security facilities. During May 2008, we acquired a minority ownership interest in Talis Data Systems, LLC (“Talis”), a Delaware LLC that produces multi-domain computer networking hardware. During the third quarter of fiscal 2010, Talis was dissolved. In September 2008, we acquired PDSG which engages in data-sharing services and products primarily in the public safety/government sector. During the fiscal year 2009, we acquired preferred shares of Avot Media, Inc. (“Avot”) an innovator of video transcoding and near real-time streaming to web-enabled mobile devices. During March 2010, Avot sold substantially all of its assets.

PDSG is a segment of our business, and Holocom was a segment of our business until April 30, 2009. Refer to footnote 15 of our consolidated financial statements for more information regarding these segments.

Our Technology

General Background. Throughout our history, we have developed a number of innovative technologies for a variety of industries. We’re best known for our microprocessors, including the ShBoom, Ignite, and PSC-1000 families of chips, and for the Moore Microprocessor Patent (“MMP”) portfolio of intellectual property surrounding them. These chips and their underlying innovations were created through a combination of in-house development and acquired technology.

Industry Background. The global semiconductor (or silicon “chip”) market has many segments and categories. The best-known - and most profitable - of these is the microprocessor segment. Microprocessor chips are the “brains” of most electronic and electrical devices throughout the world. Although microprocessors are often closely associated with personal computers (“PCs”), PCs account for only about 2% of the microprocessor chips made and sold every year. The vast majority of microprocessors are used in everyday items like automobiles, digital cameras, cell phones, video game players, data

networks, industrial flow-control valves, sensors, medical devices, weapons, home appliances, robots, security systems, televisions, and much more. These “embedded microprocessors” (so called because they’re embedded into another product) are far more ubiquitous than the chips inside personal computers. This is the market that our technology serves.

Patent Description. Over the years we’ve developed a number of innovative technologies that have been embodied in our own products and, through licensing, into other companies’ products. Many of these patented technologies are available under the MMP portfolio. The MMP portfolio includes several U.S. patents as well as European and Japanese patents. Some highlights of the patent portfolio are:

●

US 5,809,336 (the “’336 patent”). The ’336 patent covers an early and seminal approach to making microprocessor chips go faster. It allows the “core” of the microprocessor to run at a different speed (usually faster) than the rest of the chip. There are many advantages to this, including higher performance, lower power consumption, and simpler manufacturing.

●

US 5,784,584 (the “’584 patent”). The ’584 patent covers an important method for a microprocessor chip to fetch multiple instructions at once. Like speed reading, multiple-instruction fetch allows a chip to get more done in less time - a valuable technique.

●

US 6,598,148 (the “’148 patent). The ’148 patent describes on-chip oscillators (clocks) and covers multi-core and multi-processor implementations - important factors in today’s high-end microprocessor chips.

Our Partners and Affiliates

Phoenix Digital Solutions, LLC. On June 7, 2005, we entered into a Master Agreement (the “Master Agreement”) with Technology Properties Limited, Inc. (“TPL”), and Charles H. Moore, an individual (“Moore”). We, TPL and Moore were parties to certain lawsuits filed by us alleging infringement (the “Infringement Litigation”) of the seven U.S. patents issued dating back to 1989 on our microprocessor technology (the “Microprocessor Patents”) and a lawsuit also filed by us alleging claims for declaratory judgment for determination and correction of inventorship of the Microprocessor Patents (the “Inventorship Litigation”). The transactions described in the Master Agreement and related agreements (the “Transactions”) included the settlement or dismissal of the Inventorship Litigation.

Pursuant to the Master Agreement we agreed with TPL and Moore as follows:

	●	We entered into a patent license agreement (the “Intel License”) with Intel Corporation (“Intel”) pursuant to which we licensed certain rights in the Microprocessor Patents to Intel.
	●	We entered into an Escrow Agreement along with TPL (the “Escrow Agreement”) pursuant to which the proceeds arising from the Intel License were allocated for the benefit of us and TPL. Pursuant to the Escrow Agreement, the proceeds were allocable equally to PTSC and TPL. Accordingly, when the initial capitalization obligations of PTSC and those of TPL with regard to PDS (defined below) were satisfied, and when our payment obligations and those of TPL with regard to the Rights Holders (defined below) were made, we received $6,672,349, and the remaining proceeds were allocated to or for the benefit of TPL.
	●	We caused certain of our respective interests in the Microprocessor Patents to be licensed to PDS, a limited liability company owned 50% by us and 50% by TPL.
	●	PDS engaged TPL to commercialize the Microprocessor Patents pursuant to a Commercialization Agreement among PDS, TPL and us (the “Commercialization Agreement”).

	●	We paid $1,327,651 and TPL paid $1,000,000 to certain holders of rights in the Microprocessor Patents (“Rights Holders”) in exchange for the release of such Rights Holders in connection with the Transactions.
	●	We agreed with TPL and Moore to settle or cause to be dismissed all litigation involving the Microprocessor Patents, pursuant to a stipulated final judgment, including the Inventorship Litigation.

●

We issued warrants to TPL which were exercised by TPL in September 2007, to acquire shares of our common stock, $0.00001 par value (“Common Stock”). 1,400,000 warrants were exercisable upon issue; 700,000 warrants became exercisable when our Common Stock traded at $0.50 per share; an additional 700,000 warrants became exercisable when our Common Stock traded at $0.75 per share; and an additional 700,000 warrants became exercisable when our Common Stock traded at $1.00 per share, all such vesting having been achieved as of the date of this filing.

●

We agreed with TPL and Moore to indemnify each other for, among other things, any inaccuracy or misrepresentation in any representation or warranty contained in the Master Agreement, any breach of the Master Agreement, certain liabilities relating to the respective interests of each of us in the Microprocessor Patents and the Transactions, and certain tax liabilities.

Pursuant to the Commercialization Agreement, PDS granted to TPL the exclusive right to grant licenses and sub-licenses of the Microprocessor Patents and to pursue claims against violators of the Microprocessor Patents, in each case, on behalf of PDS, us, TPL and Moore, and TPL agreed to use reasonable best efforts to commercialize the Microprocessor Patents in accordance with a mutually agreed business plan. Pursuant to the Commercialization Agreement, PDS agreed to a reimbursement policy with regard to TPL’s expenses incurred in connection with the commercialization of the Microprocessor Patents. All proceeds generated by TPL in connection with the commercialization of the Microprocessor Patents are paid directly to PDS. From the inception of the Commercialization Agreement to May 31, 2011, gross license revenues to PDS totaled $284,923,235.

Pursuant to the Master Agreement, we and TPL have entered into the Limited Liability Company Operating Agreement of PDS (“LLC Agreement”). We and TPL each own 50% of the membership interests of PDS, and each have the right to appoint one member of the not to exceed three (3) member management committee. The two (2) current appointees are required to select a mutually acceptable third member of the management committee. Pursuant to the LLC Agreement, we and TPL must each contribute to the working capital of PDS (in addition to the Microprocessor Patent licenses described above), and at the discretion of PDS’ management committee we may be obligated to make future contributions in equal amounts in order to maintain a working capital fund. The LLC Agreement provides that PDS shall indemnify its members, managers, officers and employees, to the fullest extent permitted by applicable law, for any liabilities incurred as a result of their involvement with PDS, if the person seeking indemnification acted in good faith and in a manner reasonably believed to be in the best interest of PDS.

In April 2010, we filed actions against TPL in San Diego County for default on their note receivable with us and in Santa Clara County for breach of the Commercialization Agreement. See Part 1, Item 3. “Legal Proceedings” in this Annual Report for more information.

Holocom, Inc. (formerly known as Scripps Secured Data, Inc). On March 27, 2007, we entered into a revolving line of credit with Holocom, a company that manufactures products that protect information and data transmitted over secured networks. Previously, we maintained an unconsolidated equity investment in Holocom. We determined that the line of credit transaction caused us to become the primary beneficiary under the Financial Accounting Standards Board’s (“FASB”) authoritative guidance for consolidation of variable interest entities and as such we were required to consolidate variable interest entities for which we are deemed to be the primary beneficiary. On August 29, 2008 Holocom paid us $75,000, the remaining balance due on the line of credit and provided us notice effectively terminating the line of credit on August 29, 2008.

During July 2008, Holocom obtained a credit facility for up to $300,000 from a third party, the credit facility term extended to May 1, 2009, and was guaranteed by us. As a result of our guarantee on the third party credit facility, we maintained a variable interest in Holocom. Upon expiration of the credit facility on May 1, 2009 we deconsolidated Holocom as we were no longer deemed to be the primary beneficiary.

Management has determined that the inability of Holocom to meet its business plan, raise capital, and the general economic environment are indicators of impairment on our investment. Accordingly, at May 31, 2010, we wrote-off our investment in the preferred stock of Holocom, amounting to a $435,182 write-off. We continue to hold 100% of the preferred stock in Holocom.

Holocom was an operating segment of our business for the periods in which we were required to consolidate (March 27, 2007 through April 30, 2009).

Talis Data Systems, LLC. On May 16, 2008 we acquired a 15.09% equity share in Talis, a company that produced multi-domain computer and network security products for sale to government, military, and enterprise customers. Talis developed and marketed PCs incorporating its Datagent security device, a patented, hardware based data security solution that avoided the vulnerability of software–based approaches.

Throughout fiscal 2009 and during the first quarter of fiscal 2010, we increased our equity investment in Talis to 39.4% as a result of purchasing additional membership units offered by Talis, as well as acquiring membership units from minority members which included the acquisition of all Talis membership units previously held by Holocom. The acquisition of Talis membership units previously owned by Holocom was made for $100,000 in cash and a reduction on their outstanding line of credit of $219,000.

The inability of Talis to meet its business plan, raise capital, and the general economic environment were indicators of impairment on our investment. Accordingly at August 31, 2009, management determined that our investment in Talis was impaired by approximately $680,000. During the third quarter of fiscal 2010 Talis was dissolved.

Avot Media, Inc. Avot was an innovator of video transcoding and near real-time streaming to web-enabled mobile devices. During the quarter ended August 31, 2008, we invested an aggregate of $1,300,000, including conversion of a note receivable in the amount of $250,000, to obtain 14,444,444 shares of Series B preferred stock issued by Avot, representing 53.3% of the Series B preferred stock and 37.1% of all Avot’s preferred shares issued and outstanding. On March 12, 2009, we entered into a secured revolving loan note with Avot for $500,000. The note bore interest at a rate of 8% and was due December 12, 2009. During fiscal 2009 and 2010 we wrote-off our investment in Avot as management determined that our investment was impaired due to Avot’s inability to meet its business plan, to raise capital, and the general economic environment. During March 2010, Avot sold substantially all of its assets and we collected our $500,000 note.

Licenses, Patents, Trade Secrets and Other Proprietary Rights

We rely on a combination of patents, copyright and trademark laws, trade secrets, software security measures, license agreements and nondisclosure agreements to protect our proprietary technologies. Our policy is to seek the issuance of patents that we consider important to our business to protect inventions and technology that support our microprocessor technology and other lines of business.

We have six unexpired U.S. patents issued dating back to 1989 on our microprocessor technology. We have one unexpired microprocessor technology patent issued in two European countries and one unexpired patent issued in Japan. These patents in the U.S and overseas are currently set to expire between 2012 and 2016. We may file additional applications under international treaties depending on an evaluation of the costs and anticipated benefits that may be obtained by expanding possible patent coverage.

In addition to such factors as innovation, technological expertise and experienced personnel, we believe that a strong patent position is becoming increasingly important to compete effectively in the semiconductor industry. It may become necessary or desirable in the future for us to obtain patent and technology licenses from other companies relating to technology that may be employed in future products or processes. To date, we have not received notices of claimed infringement of patents based on our existing processes or products but, due to the nature of the industry, we may receive such claims in the future.

We have one U.S. patent on our ground-penetrating radar technology, which is currently set to expire in 2011. No foreign application has been made. There are a large number of patents owned by others in the radar field generally and in the field of ground-penetrating radar specifically. Accordingly, although we are not aware of any possible infringement and have not received any notices of claimed infringement, we may receive such claims in the future.

In November, 2004, we filed a patent application for “Remote Power Charging of Electronic Devices”.

During fiscal 2009, we finalized an agreement with NuPower Semiconductor whereby we became co-assignees of a total of seven U.S. patents (five of which had issued and two of which had notices of allowance) related to power management for microprocessor based systems. The agreement was effective until November 30, 2010. The assignment was final in fiscal 2010 with the United States Patent and Trademark Office (“USPTO”) following the final issuance of the remaining two patents. These patents are currently set to expire between 2026 and 2029.

There can be no assurance that any patents will be issued from pending or future applications or that any patents that are issued will provide meaningful protection or other commercial advantages to us. Although we intend to protect our rights vigorously, there can be no assurance that these measures will be successful.

We generally require all of our employees and consultants, including our management, to sign a non-disclosure and invention assignment agreement upon employment with us.

Research and Development

During fiscal years 2011 and 2010, we incurred $753,017 and $1,503,724, respectively, of research and development expenses related to PDSG technologies.

Products and Services

The following technologies comprise the PDSG family of products:

Crossflo DataExchange® Our technology, Crossflo DataExchange® (“CDX”), was developed to exchange data between a customer’s application or database and an XML schema such as NIEM, Universal Core (U-CORE), CAP, GJXDM, or HL7. CDX can use any XML schema or even create a new schema specific to a customer’s needs. Whether the system is a source of data, a target for data, or both, it is “mapped” to the designated XML schema, and the subsequent exchange of data follows this common schema. This loosely coupled approach is easy to implement and maintain and can be accomplished with personnel who are not IT experts. Data exchange can begin in a matter of days or weeks, versus the months or even years that may be required using other solutions. Of particular significance is that this approach makes sharing data invisible to the end users by eliminating operational change and disturbance while utilizing existing infrastructure.

CDX is accessed via a web-based interface used to define publications (sources) and subscriptions (targets), and includes a powerful data-transformation mapper. The mapper offers an intuitive "drag and drop" interface, a rich set of transformation objects, and the ability to connect to web services. It also possesses powerful features for exporting data in the appropriate form to be used immediately by other applications including Geospatial Information System (GIS) programs, intelligence analysis programs, emergency management applications, and case management systems. Further, CDX handles complex schema constructs with ease and supports federated, scheduled, and triggered message exchanges.

CDX was designed and built using the latest standards-based technologies resulting in flexibility and cost savings. For example, because our software is written in JAVA/J2EE, it runs on virtually any platform and operating system. It incorporates Service Oriented Architecture and Web Services so it is easy to access and modify. CDX eliminates the need to make any changes to existing applications, procedures, and databases. Designed and developed in the US by US citizens with deep and targeted domain expertise, strong security measures have been integrated into the technology.

Information exchanges utilizing CDX can easily be implemented in a staged manner in virtually any environment regardless of future technological or infrastructure unknowns, enabling quick and early wins to build confidence and momentum. CDX provides a rapidly deployable, scalable, effective, and affordable means to enable the immediate sharing, integration, and/or aggregation of appropriate data assets across virtually all enterprises, platforms, vendors, and locations. In addition, CDX is compatible with other middleware products and can be implemented using an existing customer-provided Enterprise Service Bus (ESB).

In March 2010 a re-architected version of CDX was completed (CDX 4). Significant additions include the CDX ExchangeBuilder, which is designed to generate National Information Exchange Model (NIEM) conforming Information Exchange Package Documents (IEPDs), significantly reducing the cost and time it takes to specify and deploy standards-based data exchanges. CDX 4 includes the CDX Portal, a secure, end-user interface designed for justice personnel. Built on the Global Federated Identity and Privilege Management (GFIPM) framework, the CDX Portal enables agencies to control and manage access to an exchange’s applications and data services. These data services can include federated queries of information residing in disparate data sources integrated by CDX, or services hosted by third party applications already owned by agencies. The Crossflo DataExchange® is a fully integrated suite of tools, but customers can decide if and when they wish to add individual modules, so an affordable solution can be configured for each client’s specific needs. This will enable agencies of different sizes, with different resources, to choose between a tool such as CDX ExchangeBuilder to design IEPDs, a CDX DataExchange base package for a standard exchange, or a CDX DataExchange enterprise solution to enable large scale exchanges incorporating CDX Portal and multiple data services.

Sales and Marketing

All of PDSG’s sales for the fiscal years ended May 31, 2011 and 2010 were to domestic customers with the exception of one CDX hosting arrangement with a customer in Japan.

PDSG markets its products and services to domestic federal, state, and local governmental agencies through direct contracts and via partnerships with prime contractors.

All of our operating assets are located within the United States. While sales to certain geographic areas generally vary from year to year, we do not expect that changes in the geographic composition of sales will materially affect our operations.

Dependence Upon Single Customers

Ten percent (10%) or more of our consolidated license and service revenues were derived from sales to the following PDSG customers for the fiscal years ended May 31 as follows:

	2011		2010
Customer A	$	136,229	$	281,141
Customer B		-	$	106,064
Customer C	$	81,642		-
Customer D	$	151,323		-

As of May 31, 2011 and 2010, our backlog is $834,485 and $268,103, respectively, which consists of revenues from contracts executed with customers which have yet to be recognized as of the applicable fiscal years then ended.

All of our equity in the earnings of affiliates for the years ended May 31, 2011 and 2010 was attributable to our unconsolidated affiliate, PDS, except for $21,707 in losses from our investment in Talis for the year ended May 31, 2010.

Government Regulation and Environmental Compliance

We believe our products are not subject to regulation by any federal, state or local agencies that would materially affect the manufacture, sale or use of our products, other than occupational health and safety laws and labor laws which are generally applicable to most companies. We do not know what sort of regulations of this type may be imposed in the future, but we do not anticipate any unusual difficulties in complying with governmental regulations which may be adopted in the future.

We have not incurred any material costs associated with compliance with environmental laws and do not anticipate such laws will have any material effect on our future business.

Employees

At May 31, 2011, we have twelve employees. All employees are full time. We also engage consultants and part-time persons, as needed.

Our future success depends in significant part upon the continued services of our key technical and senior management personnel. The competition for highly qualified personnel is intense, and there can be no assurance that we will be able to retain our key managerial and technical employees or that we will be able to attract and retain additional highly qualified technical and managerial personnel in the future. None of our employees 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.

Available Information

We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Materials filed with the SEC can be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10 a.m. to 3 p.m. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet web site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. Our filings are available to the public at the website maintained by the SEC, http://www.sec.gov. We also make available, free of charge, through our web site at www.ptsc.com, our reports on Forms 10-K, 10-Q, and 8-K, and amendments to those reports, as soon as reasonably practicable after they are filed with or furnished to the SEC. The information on, or that can be accessed through, our website is not part of this Annual Report.

ITEM 1A. RISK FACTORS

We urge you to carefully consider the following discussion of risks as well as other information contained in this Form 10-K. 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 Initiated Legal Proceedings Against Our Joint Venture Partner Which Could Adversely Affect Our Relationship With Them And Our Receipt Of Licensing Revenues.

Under our joint venture arrangement with TPL, TPL is responsible for the licensing and enforcement of our microprocessor patent portfolio. In April 2010 we filed two actions against TPL (and with respect to one action, Alliacense, LLC) alleging breach of a $1 million promissory note issued to us by TPL and other causes of action. Because we are wholly dependent on TPL to secure licensing revenues with respect to our microprocessor patent portfolio, which revenues have represented substantially all of our income since June 2005, the commencement of these adversarial proceedings against TPL has had, and will likely continue to have, an adverse affect on our continued relationship with TPL and its ability to effectively negotiate licenses or enforce our rights with respect to our microprocessor patent portfolio, which in turn has adversely affected, and is likely to continue to adversely affect our revenues and financial condition. On January 19, 2011 upon receiving payment in full, we settled one of the actions regarding breach of the $1 million promissory note; however, the other action is still pending. On August 3, 2011, we announced that protracted discussions with TPL had not resulted in settlement and that we intend to pursue a resolution through litigation.

We Have Reported Licensing Income In Prior Fiscal Years Which May Not Be Indicative Of Our Future Income.

We have entered into license agreements through our joint venture with TPL and have reported licensing income as a result of this activity for the fiscal years 2006 to 2011. 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, potential adverse outcomes associated with the U. S. Patent and Trademark Office (“USPTO”) re-examinations, our litigation with TPL, the litigation initiated by an inventor of the microprocessor portfolio with TPL, and the possible effect of new judicial interpretations of patent laws, we may not receive revenues from such agreements in the future consistent with amounts received in the past, and we may not receive future revenues from license agreements at all.

Our Joint Venture Is At Risk For Going Concern.

PDS, our joint venture with TPL, has experienced significant declines in revenues while at the same time incurring significant legal costs associated with pending litigation with companies which we allege have infringed on our patent portfolio. Currently, there are no commitments by us or TPL to provide additional working capital to PDS. PDS has cash resources available to continue as a going concern at least through September 30, 2011.

We Are Dependent Upon A Joint Venture In Which Our Role Is Of A Passive Nature For Substantially All Of Our Income.

In June 2005, we entered into a joint venture with TPL, pursuant to which TPL is responsible for the licensing and enforcement of our microprocessor patent portfolio. This joint venture has been the source of substantially all of our income since June 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 TPL on behalf of the joint venture, and the ability of TPL to obtain capital when necessary to fund its operations. In December 2009 and January 2010, we provided operational funding by loaning TPL $950,000 and $1,000,000, respectively. The $1,000,000 note which was due to be repaid by February 28, 2010 went into default; however, on January 19, 2011 we received $1,098, 903 consisting of principal and accrued interest in settlement of this note. On July 15, 2010, we received $1,003,095 from PDS for payment on the $950,000 note issued in December 2009 plus accrued interest. We do not anticipate making additional loans to TPL, and its ability to access liquidity from other sources is not certain.

A Successful Challenge To Our Intellectual Property Rights Could 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 could 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. With respect to our core technologies, we currently have seven 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 likely to vigorously defend their actions and assert that our patents are invalid. Problems with patents or other rights could result in significant costs, limit future license revenue, and impair or hinder our acquisition strategy. 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. From time to time parties have petitioned the USPTO to re-examine certain of our patents. An adverse decision in litigation or in the re-examination process could have a very significant and adverse effect on our business.

We have been named as co-defendants in multiple lawsuits regarding the MMP Portfolio. See footnote 14 to our consolidated financial statements and Part I, Item 3. “Legal Proceedings” in this Report on Form 10-K for more information.

Our Wholly-Owned Subsidiary Cannot Operate Without Our Continued Support.

Since the acquisition of our wholly-owned subsidiary PDSG in September 2008, we have provided 100% of PDSG’s operational funding amounting to approximately $8,200,000 through May 31, 2011. After restructuring measures initiated in October 2009 and continued through 2010, PDSG continues to remain unable to generate sufficient revenues to support its operations and remains entirely dependent on our funding. Should a sale of PDSG occur, it may be on distressed terms with only minimal consideration realized.

Disruptions In The Debt And Equity Markets Will Have An Adverse Affect On Our Ability To Obtain Funding.

The debt and equity markets have been experiencing volatility and disruption for several years. These issues, along with significant write-offs in the financial services sector, the re-pricing of credit risk, and the current weak economic conditions have made, and will likely continue to make, it difficult to obtain funding. The cost of accessing the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards, and reduced or ceased to provide funding to borrowers. Adverse changes in the economy could limit our ability to obtain financing from debt or equity sources or could adversely affect the terms on which we may be able to obtain any such financing for our operating activities See Part II – Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Liquidity.” in this report on Form 10-K for more information.

Unstable Market And Economic Conditions May Have Serious Adverse Consequences On Our Business.

Our general business strategy may be adversely affected by the economic downturn and volatile business environment and continued unpredictable and unstable market conditions. A prolonged or profound economic downturn may result in adverse changes to our sales and pricing, which would harm our operating results. Failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our growth strategy, financial performance and stock price and could require us to delay or abandon development plans. There is also a possibility that our stock price may decline further, due in part to the volatility of the stock market and the general economic downturn.

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.

For our investment accounted for under the equity method (PDS), we record as part of other income or expense our share of the increase or decrease in the equity of this company in which we have invested. Prior to the impairment, we accounted for our investment in Holocom on the cost basis. It is possible that, in the future, our relationships and/or our interests in or with this equity method investee and our cost basis 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.

Exercise Of Options May Have A Substantial Dilutive Effect On Our Common Stock.

If the current per share market price of our Common Stock at the time of exercise of any stock options is in excess of the various exercise prices of such securities, exercise of such securities would have a dilutive effect on our Common Stock. As of May 31, 2011, holders of our outstanding exercisable options would receive 2,792,612 shares of our Common Stock, absent any cashless exercise, at a weighted average exercise price of $0.34 per share. Any additional financing that we secure likely will require that we grant rights senior to those of our Common Stock which may result in substantial dilution of the existing ownership interests of our common stockholders.

We May Issue Preferred Stock, And The Terms Of Such Preferred Stock May Reduce The Value Of Our Common Stock.

We are authorized to issue up to a total of 5,000,000 shares of preferred stock in one or more series. Our Board of Directors may determine whether to issue shares of preferred stock without further action by holders of our Common Stock. If we issue shares of preferred stock, it could affect the rights or reduce the value of our Common Stock. In particular, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with or sell our assets to a third party. These terms may include voting rights, preferences as to dividends and liquidation, conversion and redemption rights, and sinking fund provisions. We continue to seek capital for our business, and this additional capital may be raised through the issuance of additional preferred stock.

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

Our shareholders are not restricted in the price at which they can sell their shares. Shares sold at a price below the current market price at which our Common Stock is trading may cause the market price of our Common Stock to decline.

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 OTCQB operated by OTC Markets, Inc. 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 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

We currently lease 1,371 square feet of office space located at 701 Palomar Airport Road, Suite 170, Carlsbad, California. The lease expires December 31, 2012.

PDSG currently subleases offices located at 11260 El Camino Real, Suites 100 (3,676 square feet) and 102 (2,592 square feet), San Diego, California. These facilities are subleased through December 2011.

The current floor space provides adequate and suitable facilities for all of our corporate functions.

ITEM 3. LEGAL PROCEEDINGS

Litigation

Patent Litigation

On February 8, 2008, we, TPL and Alliacense Ltd. were named as defendants in separate lawsuits filed in the United States District Court for the Northern District of California by HTC Corporation, and Acer, Inc., and affiliated entities of each of them.

The Acer case seeks declaratory relief that its products do not infringe enforceable claims of the '336, ‘749, '148 patents and US 5,530,890 (the “890 patent”). The HTC case similarly seeks declaratory relief that its products do not infringe enforceable claims of those patents. We allege counterclaims for patent infringement of the '336, '749, '148 and '890 patents against Acer and HTC. On June 16, 2009, District Court Judge Jeremy Fogel stayed the HTC and Acer actions until September 18, 2009. The stay has been lifted and the cases are in the discovery and claims construction phase. A claims construction hearing is expected to be scheduled in late 2011.

On December 1, 2008, we, TPL and Alliacense, Ltd. were named as defendants in a lawsuit filed in the United States District Court for the Northern District of California by Barco, N.V. The Barco case seeks declaratory relief that its products do not infringe enforceable claims of the '749 and '890 patents. We allege counterclaims for patent infringement of our '749, '890 and '336 patents. On June 22, 2009, Judge Fogel also stayed the Barco case until September 18, 2009. That stay has been lifted and the case is deemed related to the Acer and HTC cases. The case is now in the discovery and claims construction phase. Barco moved for Summary Judgment with respect to allegations that it has infringed on the '336 patent on grounds independent of claims construction. That Motion was denied on February 25, 2011. A claims construction hearing is expected to be scheduled in late 2011.

Crossflo Systems, Inc. Litigation

Under the terms of our Agreement and Plan of Merger (the "Merger Agreement") with Crossflo, and certain of its principal officers, an escrow account was established to hold back approximately 10% of the merger consideration payable to the shareholders of Crossflo (the "Escrow Merger Consideration"). We contend that certain representations and warranties made by Crossflo and certain of its principal officers in the Merger Agreement were false when made, and were false as of the closing of the merger. We submitted a demand to the escrow agent on August 31, 2009 not to release the Escrow Merger Consideration to the Crossflo shareholders and to instead return it to us. A sufficient number of Crossflo shareholders have opposed our demand that the escrow consideration has not been released to either side.

On August 31, 2009, we initiated an arbitration proceeding before the American Arbitration Association against the three Crossflo principal officers who were signatories to the Merger Agreement alleging they provided false representations and warranties in the Merger Agreement and alleging nondisclosure of information about Crossflo during the due diligence process leading up to the merger. Those three principal officers deny our claims and have filed counterclaims. The arbitration is scheduled to begin November 8, 2011.

TPL Litigation

On April 22, 2010, we filed an action against TPL and Alliacense LLC in Santa Clara Superior Court alleging claims for breach of contract, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and interference with contract, constructive fraud, for preliminary and permanent injunctions and for an accounting. The Action stemmed from TPL's notification of a license written in April 2010 which included a license of the MMP patents and other patent to use portfolios and technologies co-owned and potentially owned by TPL in the future. We objected to the amount of license consideration allocated to the MMP patent license as too low relative to the other license components.

On April 26, 2010, the Court granted our application for a Temporary Restraining Order ("TRO") precluding TPL from executing any license of the MMP patents without providing us five business days' notice of the proposed MMP license and any other proposed license with the licensor, in order to allow us time to seek redress if we are dissatisfied by the proposed licenses. At that time, TPL filed motions to seal the file and to bar press releases commenting on the contents of the court file, and a motion to compel private arbitration of the dispute.

TPL stipulated on August 3, 2010 that the TRO already in place would become a Preliminary Injunction. On August 12, 2010, the Court considered defendants’ request to seal the file indefinitely and to compel private arbitration of the dispute and denied both Motions. On September 30, 2010, the Court agreed to redaction of the court file at TPL’s request for commercially sensitive data such as dollar amounts of licenses, percentage allocation to MMP licenses and other such confidential data. TPL has appealed the denial of its Motion to Compel Arbitration which appeal stays the Superior Court proceeding. The appeal is in the briefing stage and expected to be decided in late 2011 or early 2012. If the Appeal is unsuccessful then the Superior Court action will be activated. If it is successful, some or all of the case would proceed to arbitration.

ITEM 4.

REMOVED AND RESERVED

PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our Common Stock is currently listed for trading in the OTCQB operated by OTC Markets, Inc. under the symbol PTSC. Prices reported represent prices between dealers, do not include markups, markdowns or commissions and do not necessarily represent actual transactions. The market for our shares has been sporadic and at times very limited.

The following table sets forth the high and low closing bid quotations for our Common Stock for the fiscal years ended May 31, 2011 and 2010.

	BID QUOTATIONS
	HIGH	LOW
Fiscal Year Ended May 31, 2011
First Quarter	$0.21	$0.08
Second Quarter	$0.14	$0.09
Third Quarter	$0.14	$0.08
Fourth Quarter	$0.13	$0.08

	HIGH	LOW
Fiscal Year Ended May 31, 2010
First Quarter	$0.18	$0.11
Second Quarter	$0.36	$0.14
Third Quarter	$0.19	$0.12
Fourth Quarter	$0.15	$0.09

On August 12, 2011 the closing price of our stock was $0.06 and we had approximately 690 stockholders of record. Because most of our Common Stock is held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these record holders.

Dividend Policy

On February 22, 2007, our Board of Directors adopted a semi-annual dividend payment policy, subject to determination by our Board of Directors in light of our financial condition, other possible applications of our available resources, and relevant business considerations. We paid no dividends during the fiscal years ended May 31, 2011 and 2010.

Equity Compensation Plan Information

Our stockholders previously approved each of our 2003 and 2006 Stock Option Plans. The following table sets forth certain information concerning aggregate stock options authorized for issuance under our 2003 and 2006 Stock Option Plans as of May 31, 2011. For a narrative description of the material features of the plans, refer to footnote 12 of our consolidated financial statements.

Plan Category		Number of securities to be issued upon exercise of outstanding options				Weighted-average exercise price of outstanding options				Number of securities remaining available for future issuance under equity compensation plans
Equity compensation plans approved by security holders			3,010,000			$	0.33				10,703,404

The number of securities available for future issuance under our stock option plans is as follows at May 31, 2011: 2003 Stock Option Plan 3,473,404 shares, 2006 Stock Option Plan 7,230,000 shares.

Recent Sale of Unregistered Securities

None.

Issuer Purchases of Equity Securities

On April 28, 2006 our 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. We repurchased Common Stock during the fourth quarter of fiscal year 2011 using available cash resources as follows:

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
March 1 - 31, 2011		-	$	-		-
April 1 - 30, 2011		127,598	$	0.10		127,598
May 1 - 31, 2011		138,385	$	0.09		138,385
Total		265,983	$	0.09		265,983

The repurchase plan has no maximum number of shares and is solely at the discretion of the Board of Directors. The repurchase plan has no set expiration date.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS CONCERNING FUTURE EVENTS AND PERFORMANCE OF OUR COMPANY. YOU SHOULD NOT RELY ON THESE FORWARD-LOOKING STATEMENTS, BECAUSE THEY ARE ONLY PREDICTIONS BASED ON OUR CURRENT EXPECTATIONS AND ASSUMPTIONS. MANY FACTORS COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED IN THESE FORWARD-LOOKING STATEMENTS. YOU SHOULD REVIEW CAREFULLY THE RISK FACTORS IDENTIFIED IN THIS REPORT AS SET FORTH BELOW AND UNDER THE CAPTION “RISK FACTORS.” WE DISCLAIM ANY INTENT TO UPDATE ANY FORWARD-LOOKING STATEMENTS TO REFLECT SUBSEQUENT ACTUAL EVENTS OR DEVELOPMENTS.

Overview

In June 2005, we entered into a series of agreements with TPL and others to facilitate the pursuit of unlicensed users of our intellectual property. We intend to continue our joint venture with TPL to pursue license agreements with unlicensed users of our technology. We believe that utilizing the option of working through TPL, as compared to creating and using our own 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. In April 2010, we filed an action against TPL regarding TPL’s management of the MMP portfolio. On August 3, 2011 we issued a press release stating that we cannot come to a settlement with TPL in this matter and are pursuing litigation.

During fiscal 2010 and through the date of this filing we and TPL each contributed $580,000 to fund the working capital of PDS. We expect the contributions to continue in the future due to the working capital demands of PDS. Additionally, we have loaned TPL an aggregate of $1,950,000, evidenced by a secured note in the principal amount of $950,000 and an unsecured note in the principal amount of $1,000,000 intended to cover its operating costs including the furtherance of licensing our MMP Portfolio of microprocessor patents. At February 28, 2010, we reserved $1,013,151 against the unsecured $1,000,000 note receivable which includes accrued interest. In April 2010, we filed suit against TPL for breach of contract regarding the $1,000,000 note non-payment. On July 15, 2010, we received $1,003,095 consisting of principal and accrued interest through July 15, 2010 on the $950,000 secured note. In January 2011, we settled the breach of contract action with respect to the $1,000,000 note and we received $1,098,903 consisting of principal and accrued interest on the unsecured note.

On October 5, 2009, we announced a reorganization of PDSG and our management. On January 25, 2010, we sold the Iameter assets and during August 2010, we sold the Vigilys business line. As a result of our reorganization and PDSG’s continued inability to meet its business plan, we have incurred impairment charges for our intangibles and goodwill in the PDSG segment of our business. We continue to fund the day to day operating costs of PDSG while continuing to reduce expenses. Our merger and acquisition activities have ceased since our October 2009 reorganization.

Cash shortfalls and liquidity issues currently experienced by PDS and TPL, and continued negative cash flows incurred by PDSG, will have an adverse effect on our liquidity. Accordingly, we have and may continue to examine alternatives that could allow for the partnering or divestiture of PDSG. If successful, these measures may provide for a further reduction in expenses and cash use, or additionally in the event of divestiture, cash proceeds, although given the operational history of PDSG to date there can be no guarantee that a divestiture will result in the realization of material consideration. On July 28, 2011, PDSG announced new business initiatives including Software as a Service offerings aimed at providing alternative methods to drive new revenues.

We are currently in litigation with TPL arising from the April 2010 actions filed for breach of the Commercialization Agreement. See Part 1, Item 3. “Legal Proceedings” as well as Part 1, Item 1A. “Risk Factors” in this Annual Report for more information.

Critical Accounting Policies and Estimates

Our 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 consolidated financial statements.

1. Revenue Recognition

PDSG sells software and services to end users primarily through relationships with systems integrators and prime contractors. PDSG recognizes revenue in accordance with authoritative guidance for the software industry. PDSG’s revenue is derived primarily from the following sources: (i) software licensing, (ii) related professional services, and (iii) post contract customer support (“PCS”) agreements. PCS agreements typically include software updates, on a when and if available basis, telephone and Internet access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.

PDSG’s contracts with customers, including systems integrators and prime contractors, are multiple element arrangements which contain professional services that are considered essential to the functionality of the other elements of the arrangement. PDSG accounts for revenue on these arrangements according to authoritative guidance for contract accounting. Under this guidance, PDSG recognizes revenue based on progress towards contract completion measured by actual hours incurred in relation to the estimate of total expected hours. PDSG measures these revenues by applying the contract-specific estimated percentage of completion to the total contract amount for software and professional services. PDSG routinely updates the estimates of future hours for agreements in process and reports any cumulative effects of such adjustments in current operations. PDSG immediately recognizes any loss expected on these contracts when it is projected that loss is probable.

On June 1, 2010 we adopted new authoritative guidance on a prospective basis for revenue arrangements containing multiple deliverables. This guidance requires us to allocate PDSG’s revenues to all deliverables based on their relative selling price using a specific hierarchy. The hierarchy is as follows: vendor-specific objective evidence (“VSOE”), third-party evidence of selling price (“TPE”) or best estimate of selling price (“BESP”).

When a sale involves multiple elements, PDSG allocates the entire fee from the arrangement to each respective element based on VSOE of fair value and recognizes revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately. PDSG has established VSOE for its CDX software licenses and PCS based on historical stand-alone sales to third parties or from the stated renewal rates contained in the customer contracts. PCS is recognized on a straight-line basis over the support period.

PDSG has not yet demonstrated VSOE for the professional services that are rendered in conjunction with its software license sales. In accordance with the hierarchy we attempt to establish the selling price of professional services using TPE. PDSG’s product contains significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained. PDSG is typically not able to obtain TPE for professional services.

When we are unable to establish selling prices using VSOE or TPE, we use BESP. The objective of BESP is to determine the price at which PDSG would transact a sale if professional services were sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for highly customized offerings which is the case with PDSG’s professional services deliverable.

Due to the fact that the majority of PDSG’s contracts require significant customization of software, we are recognizing revenue for the CDX software licenses and professional services over the customization period using contract accounting which reflects continuous release of control of the software to the customer. The adoption of this guidance did not have a material effect on our consolidated financial statements.

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 any estimated losses at the time when we can make a reliable estimate of such loss and it is probable that it has been incurred. By their very nature, contingencies are difficult to estimate. We continually evaluate information related to all contingencies to determine that the basis on which we have recorded our estimated exposure is appropriate.

3. Stock Options and Warrants

We follow authoritative guidance 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. We are required 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 compensation expense recognized during the period is based on the grant date fair value of the portion of share-based payment awards ultimately expected to vest during the period. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeiture rates are based on historical forfeiture experience and estimated future employee forfeitures.

4. 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. 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.

We follow authoritative guidance to evaluate whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. We are assessing our deferred tax assets under more likely than not scenarios in which they may be realized through future income. Accordingly, our deferred tax assets may be subject to a valuation allowance in an upcoming fiscal period. We will continue to analyze the more likely than not standard each quarter, and if it is determined that a valuation allowance is necessary, it may have a material impact.

During the quarter ended February 28, 2011, we determined that all of our deferred tax assets would not be realized in the future due to our continuing pre-tax and taxable losses. As a result of this determination we have placed a full valuation allowance against our deferred tax assets as of February 28, 2011 and increased our tax provision by approximately $8,107,000.

We follow authoritative guidance to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. This authoritative guidance prescribes a recognition threshold and measurement requirement for the financial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Under this guidance we may only recognize tax positions that meet a “more likely than not” threshold.

We follow authoritative guidance to adjust our effective tax rate each quarter to be consistent with the estimated annual effective tax rate. We are also required to record the tax impact of certain discrete items, unusual or infrequently occurring, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur. In addition, jurisdictions with a projected loss for the year or a year-to-date loss where no tax benefit can be recognized are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings or losses versus annual projections.

5. Investments in Affiliated Companies

We have a 50% interest in Phoenix Digital Solutions, LLC (“PDS”). We account for our investment using the equity method of accounting since the investment provides us the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee’s Board of Directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the investee and is recognized in the consolidated statements of operations in the caption “Equity in earnings of affiliated companies.” and also is adjusted by contributions to and distributions from PDS.

We had a 39.4% interest in Talis. Prior to the write-off of our investment in Talis during the quarter ended August 31, 2009, we were accounting for our investment using the equity method of accounting. Under the equity method of accounting, the investment, originally recorded at cost, was adjusted to recognize our share of net earnings or losses of the investee and was presented in the consolidated statements of operations in the caption “Equity in loss of affiliated companies” In December 2009, Talis was dissolved.

We own 100% of the preferred stock of Holocom. During May 31, 2010 we wrote-off our investment in the preferred stock of Holocom amounting to approximately $435,000. Prior to impairment, this investment was accounted for at cost since we did not have the ability to exercise significant influence over the operating and financial policies of Holocom.

We review our investments in these affiliated companies to determine whether events or changes in circumstances indicate that the carrying amounts may not be recoverable. The primary factors we consider in our determination are the financial condition, operating performance and near term prospects of the investees. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.

6. Business Combinations and Intangible Assets Including Goodwill

We account for business combinations using the purchase method of accounting and accordingly, the assets and liabilities of the acquired entities are recorded at their estimated fair values at the acquisition date. Goodwill represents the excess of the purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. Due to the time it takes to obtain pertinent information to finalize the acquired company’s balance sheet, it may be several quarters before we are able to finalize the initial fair value estimates. Accordingly, it is not uncommon for the initial estimates to be subsequently revised. The results of operations of acquired businesses are included in our consolidated financial statements from the acquisition date.

Identifiable intangible assets with finite lives are amortized over their estimated useful lives on a straight line basis. Goodwill and intangible assets are tested for impairment on an annual basis, or sooner if an indicator of impairment occurs.

RESULTS OF OPERATIONS

Comparison of fiscal 2011 and 2010

Consolidated:

	May 31, 2011						May 31, 2010
	Dollars			% of Revenue			Dollars			% of Revenue
Revenue:
License and service revenue	$	468,678			100.0	%	$	567,934			100.0%
Cost of sales:
License and service revenue		76,242			16.3	%		119,568			21.0%
Amortization of purchased intangibles		252,593			53.9	%		551,154			97.0%
Impairment of purchased intangibles		1,469,629			-	%		3,530,263			-%
Total cost of sales		1,798,464			-	%		4,200,985			-%
Gross loss	$	(1,329,786	)		-	%	$	(3,633,051	)		-%

PDSG

Revenue consisting of software licenses and associated services relating to PDSG’s CDX product decreased from approximately $568,000 for the fiscal year ended May 31, 2010 to approximately $469,000 for the fiscal year ended May 31, 2011. The decrease of approximately $99,000 was primarily due to the fact that revenue agreements are one time contracts that vary in size and scope depending upon the requirements of the customer. Cost of sales includes the direct time of PDSG employees on each project. Included in cost of sales is approximately $253,000 and $551,000, respectively, of amortization expense on purchased intangible assets for each of the fiscal years ended May 31, 2011 and 2010.

Consolidated:

		May 31, 2011				May 31, 2010
Research and development		$	753,017			$	1,503,724

PDSG

Research and development costs consist of PDSG’s payroll and related expenses for software engineers as well as outside contractors retained to assist in the development of PDSG’s software product. The primary decreases in research and development costs for the fiscal year ended May 31, 2011 as compared to 2010 were approximately $396,000 in outside contractor costs due to completion of CDX4 and approximately $338,000 in salaries and related costs due to management’s restructuring plan implemented in October of 2009. For the fiscal years ended May 31, 2011 and 2010, approximately $2,000 and $20,000, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.

Consolidated:

		May 31, 2011				May 31, 2010
Selling, general and administrative		$	3,713,240			$	6,530,972

Segment Results:

	May 31, 2011		May 31, 2010
PDSG:
Selling, general and administrative	$	1,162,574	$	2,714,965
PTSC:
Selling, general and administrative	$	2,550,666	$	3,816,007

PDSG

Selling, general and administrative expenses decreased from approximately $2,715,000 for the fiscal year ended May 31, 2010 to approximately $1,163,000 for the fiscal year May 31, 2011, due to management’s restructuring plan to reduce expenses. Decreases consisted primarily of approximately $1,038,000 in salaries and related expenses and approximately $254,000 in marketing expenses. For fiscal years ended May 31, 2011 and 2010, approximately $18,000 and $49,000, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.

PTSC

Selling, general and administrative expenses decreased from approximately $3,816,000 for the fiscal year ended May 31, 2010 to approximately $2,551,000 for the fiscal year ended May 31, 2011. The decrease consisted primarily of approximately $546,000 in payroll and related expenses due to management’s plan of restructuring implemented in October 2009, approximately $250,000 in consulting fees, approximately $155,000 in legal and accounting fees, and approximately $79,000 in public and investor relations expenses. For the fiscal year ended May 31, 2011 and 2010, approximately $56,000 and $153,000, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.

Consolidated

Selling, general and administrative expenses decreased from approximately $6,531,000 for the fiscal year ended May 31, 2010 to approximately $3,713,000 for the fiscal year ended May 31, 2011 primarily due to management’s plan of restructuring implemented in October 2009.

Consolidated:

		May 31, 2011				May 31, 2010
Impairment of goodwill		$	642,981			$	1,096,268

PDSG

Consolidated:

		May 31, 2011				May 31, 2010
Operating loss		$	(6,439,024	)		$	(12,764,015	)

Segment Results:

	May 31, 2011			May 31, 2010
PDSG:
Operating loss	$	(3,888,358	)	$	(8,948,008	)
PTSC:
Operating loss	$	(2,550,666	)	$	(3,816,007	)

PDSG

Operating loss decreased from approximately $8,948,000 for the fiscal year ended May 31, 2010 to approximately $3,888,000 for the fiscal year ended May 31, 2011 primarily due to decreases in impairments of goodwill and intangibles in the current fiscal year as compared to the prior fiscal year and management’s plan of restructuring implemented in October 2009 which reduced salaries and related expenses.

PTSC

Operating loss decreased from approximately $3,816,000 for the fiscal year ended May 31, 2010 to approximately $2,551,000 for the fiscal year ended May 31, 2011 primarily due to management’s plan of restructuring implemented in October 2009 which reduced salaries and related expenses.

Consolidated:

	May 31, 2011			May 31, 2010
Other income (expense):
Interest and other income	$	109,246		$	154,482
Interest expense		(20,810	)		(80,567	)
Gain on sale of Verras Medical, Inc. assets		-			182,397
Gain on sale of Vigilys business line		60,000			-
Recovery of (reserve for) loan losses		1,013,151			(1,013,151	)
Impairment of investment in affiliated company		-			(1,548,807	)
Realized loss on sale of marketable securities		(600,879	)		-
Equity in earnings of affiliated companies		600,460			4,461,483
Total other income, net	$	1,161,168		$	2,155,837

Segment Results:

	May 31, 2011			May 31, 2010
PDSG:
Interest and other income	$	763		$	9,579
Gain on sale of Verras Medical, Inc. assets		-			182,397
Gain on sale of Vigilys business line		60,000			-
Total other income, net	$	60,763		$	191,976
PTSC:
Interest and other income	$	108,483		$	144,903
Interest expense		(20,810	)		(80,567	)
Recovery of (reserve for) loan losses		1,013,151			(1,013,151	)
Impairment of investment in affiliated company		-			(1,548,807	)
Realized loss on sale of marketable securities		(600,879	)		-
Equity in earnings of affiliated companies		600,460			4,461,483
Total other income, net	$	1,100,405		$	1,963,861

Consolidated

Our other income and expenses for the fiscal years ended May 31, 2011 and 2010 included equity in the earnings of PDS consisting of net income after expenses in the amount of approximately $600,000 and approximately $4,462,000, respectively. The decrease is due to PDS’ lack of license revenues and increased legal expenses in connection with the HTC, Acer, and Barco cases. Our investment in PDS is accounted for in accordance with the equity method of accounting for investments. During the fiscal year ended May 31, 2010, we recorded an impairment of our investment in Talis of approximately $680,000, an impairment of our investment in Avot of approximately $433,000 and we wrote-off our investment in Holocom of approximately $435,000. During the fiscal year May 31, 2011, we recorded a gain on the sale of the Vigilys business line of $60,000. During the fiscal year ended May 31, 2011, we realized a loss net of partial par value redemptions on our ARS of approximately $601,000 according to terms of our confidential settlement agreement with Deutsche Bank. During January 2011, we settled our note litigation with TPL and recovered our note receivable balance including principal and interest. Accordingly, we reversed our allowance for loan loss at the settlement date.

Consolidated:

		May 31, 2011				May 31, 2010
Loss before income taxes		$	(5,277,856	)		$	(10,608,178	)

Segment Results:

	May 31, 2011			May 31, 2010
PDSG:
Loss before income taxes	$	(3,827,595	)	$	(8,756,032	)
PTSC:
Loss before income taxes	$	(1,450,261	)	$	(1,852,146	)

PDSG

Loss before income taxes decreased from approximately $8,756,000 for the fiscal year ended May 31, 2010 to approximately $3,828,000 for the fiscal year ended May 31, 2011 primarily due to decreases in impairments of goodwill and intangibles in the current fiscal year as compared to the prior fiscal year and management’s plan of restructuring implemented in October 2009 which reduced salaries and related expenses.

PTSC

Loss before income taxes decreased from approximately $1,852,000 for fiscal year ended May 31, 2010 to approximately $1,450,000 for the fiscal year ended May 31, 2011 primarily due to management’s plan of restructuring implemented in October 2009 which primarily reduced salaries and related expenses.

Provision (benefit) for income taxes

During the fiscal year ended May 31, 2011, we recorded a provision for income taxes related to federal and California taxes of approximately $6,238,000 due to the full valuation allowance placed on our deferred tax assets during the quarter ended February 28, 2011. We determined that all of our deferred tax assets would not be realized in the future due to our continuing pre-tax and taxable losses. As a result of this determination we have placed a full valuation allowance against our deferred tax assets as of February 28, 2011 and increased our tax provision by approximately $8,107,000.

During the fiscal year ended May 31, 2010, we recorded a benefit for income taxes of approximately $3,928,000 related to federal and California taxes.

Net loss

We recorded a net loss for the fiscal years ended May 31, 2011 and 2010 of $11,515,390 and $6,679,821, respectively.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

Our cash and short-term marketable securities balances increased from approximately $10,352,000 as of May 31, 2010 to approximately $10,661,000 as of May 31, 2011. We also have a restricted cash balance amounting to approximately $21,000 as of May 31, 2011 and 2010. Total current assets decreased from approximately $13,417,000 as of May 31, 2010 to approximately $12,196,000 as of May 31, 2011. Total current liabilities amounted to approximately $942,000 and approximately $576,000 as of May 31, 2010 and May 31, 2011, respectively. The change in our current position as of May 31, 2011 as compared with May 31, 2010 results primarily from the collection of our note receivable issuance during the fiscal year ended May 31, 2011 and the valuation allowance placed on the current portion of our deferred tax assets during the current fiscal year ended May 31, 2011 .

Current global economic conditions have resulted in increased volatility in the financial markets. The cost of accessing the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards, and reduced or ceased to provide funding to borrowers. Adverse changes in the economy could limit our ability to obtain financing from debt or equity sources or could adversely affect the terms on which we may be able to obtain any such financing. Currently, we have sufficient resources to fund our operations through at least the next twelve months assuming we do not fund any obligations to PDS.

Cash shortfalls currently experienced by PDS and TPL, and continued negative cash flows incurred by PDSG, will have an adverse effect on our liquidity. Accordingly, we have and may continue to examine alternatives that could allow for the partnering or divestiture of PDSG. If successful, these measures may provide for a further reduction in expenses and cash use, or additionally in the event of divestiture, cash proceeds, although given the operational history of PDSG to date there can be no guarantee that a divestiture will result in the realization of material consideration. With respect to PDS and TPL, we do not intend to fund any cash requirements of these entities.

While our current liquid cash resources as of May 31, 2011, are expected to provide the funds necessary to support our operations through at least the next twelve months, the cash flows from our interest in PDS represents our primary significant source of cash generation. In the event of a continued decrease or interruption in MMP Portfolio licensing we will incur a significant reduction to our cash position as the revenues from our PDSG subsidiary are insufficient to cover the costs of their operations and the costs of Patriot Scientific Corporation as a whole. While our cash position has been enhanced as a result of our September 2010 auction rate securities settlement with Deutsche Bank, it is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and short-term investment position of $10,660,674 at May 31, 2011.

Cash Flows From Operating Activities

Cash used in operating activities for the fiscal years ended May 31, 2011 and 2010 was approximately $4,321,000 and $7,317,000, respectively. The principal non-cash components of the current fiscal year were: deferred taxes of approximately $6,215,000 and impairment of intangibles and goodwill of approximately $2,113,000. These items were offset by: net loss of approximately $11,515,000, and recovery of loan loss of approximately $1,013,000.

Decreases in our net income and equity in earnings of affiliates for the fiscal years ended May 31, 2011 and 2010 are primarily due to the decrease in our share of earnings in our affiliate PDS.

Cash Flows From Investing Activities

Cash provided by investing activities for the fiscal years ended May 31, 2011 and 2010 was approximately $5,698,000 and $11,674,000, respectively. Decreases were primarily due to decreases in distributions received from PDS. Cash used during the fiscal year ended May 31, 2011 included approximately $2,205,000 in purchases of certificates of deposit. Cash provided by investing activities during the current fiscal year consisted of approximately $4,961,000 which includes proceeds we received from Deutsche Bank in connection with our ARS settlement, approximately $808,000 in distributions from PDS and approximately $2,141,000 of repayments on our note receivable advances to TPL.

Cash Flows From Financing Activities

Cash used in financing activities for the fiscal years ended May 31, 2011 and 2010 was approximately $3,264,000 and $223,000, respectively. For the fiscal year ended May 31, 2011, cash of approximately $3,122,000 was used to repay our line of credit with Wedbush and cash of approximately $138,000 was used to repurchase shares of our common stock for treasury. For the fiscal year ended May 31, 2010 cash of approximately $234,000 was used to repurchase shares of our common stock for treasury.

Capital Resources

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the Financial Accounting Standards Board (“FASB”) revised the authoritative guidance for the consolidation of variable interest entities. The objective of this authoritative guidance is to improve financial reporting by enterprises involved with variable interest entities. The revised authoritative guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009. We adopted this guidance on June 1, 2010 and the adoption had no impact on our consolidated financial statements.

In July 2009, the FASB revised the authoritative guidance relating to software revenue recognition to exclude all tangible products containing both software and non-software components that function together to deliver the product’s essential functionality. The revised authoritative guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, and shall be applied on a prospective basis. Earlier application is permitted as of the beginning of an entity’s fiscal year provided it has not previously issued financial statements for any period within that year. We adopted this guidance on June 1, 2010, and the adoption had no impact on our consolidated financial statements.

In September 2009, the FASB revised the authoritative guidance for revenue arrangements with multiple deliverables. This revised authoritative guidance requires companies to allocate revenue in arrangements involving multiple deliverables based on the estimated selling price of each deliverable, even though such deliverables are not sold separately either by the company itself or other vendors. This revised authoritative guidance eliminates the requirement that all undelivered elements must have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to items that already have been delivered. As a result, the new guidance may allow some companies to recognize revenue on transactions that involve multiple deliverables earlier than under previous requirements. This revised authoritative guidance is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after December 15, 2009. Early adoption is permitted at the beginning of a company’s fiscal year. We adopted this guidance on June 1, 2010, and the adoption had no impact on our consolidated financial statements.

In January 2010, the FASB issued guidance to amend the disclosure requirements related to fair value measurements. The guidance requires the disclosure of roll forward activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance will become effective for us with the reporting period beginning June 1, 2011. Other than requiring additional disclosures, the adoption of this new guidance will not have a material impact on our consolidated financial statements.

In May 2011, the FASB issued guidance to amend the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance will be effective for us beginning March 1, 2012. We do not anticipate adoption to have a material impact on our consolidated financial statements.

In June 2011, the FASB issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. The new guidance will be effective for us beginning June 1, 2012 and will result in presentation changes only for our consolidated financial statements.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary data required by this item are included in Part IV, Item 15 of this Report and begin on page F-1 with the index to consolidated financial statements.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Interim Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) of the Exchange Act, as of the end of the period covered by this report. Based on this evaluation, our Interim Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our Interim Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Interim Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of May 31, 2011 based on the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of May 31, 2011.

This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our independent registered public accounting firm pursuant to the rules of the SEC that permit us to provide only management's report in this Annual Report.

Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the fourth fiscal quarter ended May 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Internal Control

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple errors. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

In addition, projections of any evaluation of effectiveness to future periods are subject to risks that controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Director Qualifications – We believe that individuals who serve on our Board should possess the requisite education and experience to make a significant contribution to the Board and bring a range of skills, diverse perspectives and backgrounds to its deliberations; and should have the highest ethical standards, a strong sense of professionalism and dedication to serving the interests of our stockholders. The following are qualifications, experience and skills for Board members which are important to our business:

Leadership Experience – We seek directors who demonstrate extraordinary leadership qualities. Strong leaders bring vision, diverse perspectives, and broad business insight to the company. They demonstrate practical management experience, skills for managing change, and knowledge of industries, geographies and risk management strategies relevant to the company.

Finance Experience – We believe that all directors should possess an understanding of finance and related reporting processes. We also seek directors who qualify as “audit committee financial experts” as defined in rules of the Securities and Exchange Commission for service on the Audit Committee.

Industry Experience – We seek directors who have relevant industry experience including: existing and new technologies, new or expanding businesses and a deep understanding of the company’s business environments.

The following table and biographical summaries set forth information, including principal occupation, business experience, other directorships and director qualifications concerning the members of our Board of Directors and our executive officer as of May 31, 2011. There is no blood or other familial relationship between or among our directors or executive officer. At our annual shareholder meeting in January 2011, we reduced our board seats to three as Helmut Falk Jr., Donald Schrock and Dharmesh Mistry were not re-elected to our board.

NAME	AGE	POSITION and TERM
Carlton M. Johnson, Jr.	51	Director (since August 2001)
Gloria H. Felcyn	64	Director (since October 2002)
Clifford L. Flowers	53	Chief Financial Officer/Secretary (since September 17, 2007) Interim CEO (since October 5, 2009) Director (since January 19, 2011)

CARLTON M. JOHNSON, JR. Carlton Johnson has served as a director of the Company since 2001, and is Chairman of the Executive Committee of the Board of Directors. Mr. Johnson is in-house legal counsel for Roswell Capital Partners, LLC, a position he has held since June 1996. Mr. Johnson has been admitted to the practice of law in Alabama since 1986, Florida since 1982 and Georgia since 1997. He has been a shareholder in the Pensacola, Florida AV- rated law firm of Smith, Sauer, DeMaria Johnson and was President-Elect of the 500 member Escambia-Santa Rosa Bar Association. He also served on the Florida Bar Young Lawyers Division Board of Governors. Mr. Johnson earned a degree in History/Political Science at Auburn University and Juris Doctor at Samford University - Cumberland School of Law. Since 1999, Mr. Johnson has served on the board of directors of Peregrine Pharmaceuticals, Inc., a publicly held emerging bio-tech company. Mr. Johnson serves as chairman of Peregrine’s audit committee and is a member of Peregrine’s compensation and nominating committees. Since May 2009, Mr. Johnson has served on the board of directors of CryoPort, Inc. a publicly held company providing cost-efficient frozen shipping to biopharmaceutical and biotechnology industries. Mr. Johnson serves as chairman of CryoPort’s compensation committee and as a member of its audit committee and nomination and governance committee. Since November 2009, Mr. Johnson has served on the board of directors of ECOtality, Inc. a leader in clean electric transportation and storage technologies. Mr. Johnson serves on the audit committee and compensation committee of ECOtality.

The Board of Directors concluded that Mr. Johnson should serve as a director in light of the extensive public company finance and corporate governance experience that he has obtained through serving on the boards and audit committees of Peregrine Pharmaceuticals, Inc., CryoPort, Inc., and ECOtality, Inc.

GLORIA H. FELCYN. Gloria Felcyn has served as a director of the Company since October, 2002 and is the Chairman of the Audit Committee of the Board of Directors. Since 1982, Ms. Felcyn has been the principal in her own certified public accounting firm, during which time she represented Helmut Falk Sr. and nanoTronics, along with other major individual and corporate clients in Silicon Valley. Following Mr. Falk’s death, Ms. Felcyn represented his estate and family trust as Executrix and Trustee of the Falk Estate and The Falk Trust. Prior to establishing her firm, Ms. Felcyn worked for the national accounting firm of Hurdman and Cranston from 1969 through 1970 and Price Waterhouse & Co. in San Francisco and New York City from 1970 through 1976, during which period, she represented major Fortune 500 companies. Subsequent to that, Ms. Felcyn worked in the field of international tax planning with a major real estate syndication company in Los Angeles until 1982 when she decided to start her own practice in Northern California. A major portion of Ms. Felcyn’s current practice is “Forensic Accounting”, which involves valuation of business entities and investigation of assets. Ms. Felcyn has published tax articles for “The Tax Advisor” and co-authored a book published in 1982, “International Tax Planning”. Ms. Felcyn has a degree in Business Economics from Trinity University and is a member of the American Institute of CPA’s.

The Board of Directors concluded that Ms. Felcyn should serve as a director and the chairperson of the Audit Committee in light of the extensive financial and accounting experience that she has obtained over her career.

CLIFFORD L. FLOWERS. Cliff Flowers became our Chief Financial Officer and Secretary on September 17, 2007. On October 5, 2009 Mr. Flowers was named Interim CEO and was elected a director of the Company on January 19, 2011. From May 2007 to September 17, 2007, Mr. Flowers was the interim CFO for BakBone Software Inc., working as a consultant on behalf of Resources Global Professionals, Inc. From June 2004 through December 2006, Mr. Flowers was the senior vice president of finance and operations and CFO for Financial Profiles, Inc. a developer and marketer of software for the financial planning industry. Prior to joining Financial Profiles, Mr. Flowers served as CFO of Xifin, Inc., a provider of hosted software services to the commercial laboratory marketplace. Prior to Xifin, Mr. Flowers served for nine years in positions of increasing responsibility at Previo, Inc., a developer and marketer of various PC and server-based products, including back up and business continuity offerings. As CFO of Previo, Mr. Flowers’ global responsibilities included all financial operations and legal affairs. He earlier served as an audit manager with Price Waterhouse, LLP. Mr. Flowers is a graduate of San Diego State University with a B.S. summa cum laude in Business Administration with an emphasis in accounting.

The Board of Directors concluded that Mr. Flowers should serve as a director due to his leadership and financial experience combined with the perspective and experience he brings as our current Chief Financial Officer and interim Chief Executive Officer.

Board Leadership Structure

Our bylaws provide that the Chairman of the Board shall preside over all meetings of the Board of Directors. Our bylaws also state that the Chairman of the Board shall serve as the Chief Executive Officer unless determined otherwise by our Board. Since October 5, 2009 our Chief Financial Officer has served as our interim CEO and our Board has not appointed a Chairman of the Board. On January 19, 2011, our Chief Financial Officer who also serves as our interim CEO was elected to the Board of Directors. During meetings of our Board of Directors, Mr. Johnson, an independent director, serves as Chairman of the Board.

Our independent directors meet in executive sessions without management present to evaluate whether management is performing its responsibilities in a manner consistent with the direction of the Board. Additionally, all Board committee members are independent directors. The committee chairs have authority to hold executive sessions without management present. The Board has determined that its current structure is in the best interests of the Company and its stockholders. We believe the independent nature of the Audit Committee and the Compensation Committee as well as the practice of the independent directors regularly meeting in executive session without Mr. Flowers present ensures that the Board maintains a level of independent oversight of management that is appropriate for the Company.

Board Risk Oversight

Our Board oversees and maintains our governance and compliance processes and procedures to promote the conduct of our business in accordance with applicable laws and regulations and with the highest standards of responsibility, ethics and integrity. As part of its oversight responsibility, our Board is responsible for the oversight of risks facing the Company and seeks to provide guidance with respect to the management and mitigation of those risks. Our board also delegates specific areas of risk to the Audit Committee which is responsible for the oversight of risk policies and processes relating to our financial statements and financial reporting processes. The Audit Committee reviews and discusses with management and the independent auditors significant risks and exposures to the company and steps management has taken or plans to take to minimize or manage such risks. The Audit Committee meets in executive session with our Chief Financial Officer and our independent auditor at each regular meeting of the Audit Committee.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act requires our directors, executive officers and persons who beneficially own 10% or more of a class of securities registered under Section 12 of the Exchange Act to file reports of beneficial ownership and changes in beneficial ownership with SEC. Directors, executive officers and greater than 10% stockholders are required by the rules and regulations of the SEC to furnish us with copies of all reports filed by them in compliance with Section 16(a).

Based solely on our review of the copies of such forms received by us, or written representations from reporting persons, we believe that our insiders complied with all applicable Section 16(a) filing requirements during fiscal year 2011.

Code of Ethics

We have adopted a Code of Ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. Our Code of Ethics is available on our website at www.ptsc.com under the link “Investors” and “Management Team”.

Audit Committee

We have an audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act, currently comprised of: Gloria H. Felcyn (Committee Chair) and Carlton M. Johnson, Jr. Each member of our Audit Committee (the “Audit Committee”) is independent as defined under the applicable rules of the SEC and NASDAQ Stock Market LLC (“NASDAQ”) listing standards. The Board of Directors has determined that Gloria H. Felcyn, who serves on the Audit Committee, is an “audit committee financial expert” as defined in applicable SEC rules.

Director Legal Proceedings

During the past ten years, no director, executive officer or nominee for our Board of Directors has been involved in any legal proceedings that are material to an evaluation of their ability or integrity to become our director or executive officer.

ITEM 11. EXECUTIVE COMPENSATION

The following table summarizes the compensation of the named executive officers for the fiscal years ended May 31, 2011 and 2010. For fiscal 2011, the named executive officers are our Chief Executive Officer and our Chief Financial Officer. For fiscal 2010, the named executive officers are our Chief Executive Officer, Chief Financial Officer and Vice President of Business Development.

Summary Compensation Table

For Fiscal Years Ended May 31, 2011 and 2010

Name and Principal Position	Year	Salary ($)		Bonus ($)			Option Awards ($)(1)		All Other Compensation ($) (2)		Total Compensation ($)
Frederick C. Goerner, CEO(a)	2010	$	95,731	$	-		$	-	$	168,236	$	263,967

Clifford L. Flowers, Interim	2011		292,872		-			12,000		8,455		313,327
CEO and CFO
Clifford L. Flowers, Interim	2010		272,103		208,375	(3)		-		8,095		488,573
CEO and CFO

Paul R. Bibeau,	2010		85,354		-			-		18,655		104,009
V.P. Business Development

Represents the aggregate grant date fair value of grants awarded in fiscal 2011 and 2010 computed in accordance with authoritative guidance issued by the Financial Accounting Standards Board. For the fiscal year ended May 31, 2010, Mr. Goerner forfeited 2,000,000 options due to vesting criteria not being met upon our October 5, 2009 restructuring.

2.	See the All Other Compensation Table below for details of the total amounts represented.

3.	Mr. Flowers was paid a $62,500 discretionary bonus in July 2009 per his employment contract. At May 31, 2010 $145,875 was accrued for his interim CEO bonus which was paid to him in fiscal 2011.

(a)	Mr. Goerner served as CEO until October 5, 2009. Mr. Flowers is currently serving as Interim CEO.

All Other Compensation Table

For Fiscal Years Ended May 31, 2011 and 2010

Name and Principal Position	Year	Vacation Payout On Termination ($)		401(k) Company Match ($)		Severance ($) (1)		Other ($) (2)		Total ($)
Frederick C. Goerner, CEO	2010	$	7,267	$	3,023	$	145,833	$	12,113	$	168,236

Clifford L. Flowers, Interim	2011		-		8,455		-		-		8,455
CEO and CFO
Clifford L. Flowers, Interim	2010		-		8,095		-		-		8,095
CEO and CFO

Paul R. Bibeau,	2010		3,050		2,624		12,981		-		18,655
V.P. Business Development

1.	Severance for both Mr. Goerner and Mr. Bibeau was paid entirely in fiscal 2010.

2.	Consists of $3,500 in outplacement services and $8,613 in health and dental insurance premium reimbursement payments to Mr. Goerner in connection with his Separation Agreement.

The following table shows the number of shares covered by exercisable and un-exercisable options held by our named executive officers as of May 31, 2011.

Outstanding Equity Awards

As of May 31, 2011

Name	Number of Securities Underlying Options (#)Exercisable			Number of Securities Underlying Unexercised Options (#) Unexercisable		Option Exercise Price($)		Option Expiration Date
Clifford L. Flowers		750,000	(1)		-		0.45	9/17/2012
		150,000			-		0.10	6/3/2015

1.	On October 5, 2009, in connection with Mr. Flowers’ appointment as Interim CEO, the Compensation Committee authorized his unvested options to immediately vest.

Employment Contracts

In connection with Mr. Flowers’ appointment as Chief Financial Officer on September 17, 2007, we entered into an Employment Agreement (the “Flowers Agreement”) with Mr. Flowers for an initial 120-day term if not terminated pursuant to the Flowers Agreement, with an extension period of one year and on a day-to-day basis thereafter. Pursuant to the Flowers Agreement, Mr. Flowers’ initial base salary was $225,000 per year and he is eligible to receive an annual merit bonus of up to 50% of his base salary, as determined in the sole discretion of the Board of Directors. Effective October 1, 2008 and October 5, 2009, Mr. Flowers’ base salary was increased to $231,750 and $291,750, respectively. Also pursuant to the Flowers Agreement and on the date of the Flowers Agreement, Mr. Flowers received a grant of non-qualified stock options to purchase 150,000 shares of our Common Stock and a grant of non-qualified stock options to purchase 600,000 shares of our Common Stock. Mr. Flowers’ right to exercise the foregoing stock options became fully vested on October 9, 2009, in connection with his appointment as Interim CEO. The Flowers Agreement also provides for Mr. Flowers to receive customary employee benefits, including health, life and disability insurance.

Pursuant to the Flowers Agreement, if Mr. Flowers is terminated without cause or resigns with good reason any time after two years of continuous employment, he is entitled to receive an amount equal to 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.

We had an employment agreement with Mr. Goerner. Under terms his Separation Agreement, Mr. Goerner was paid outplacement assistance of $3,500 and a severance payment of $145,833. The severance payment was paid in bi-weekly installments over a seven month period that ended May 2010. We also reimbursed Mr. Goerner for a portion of his health and dental insurance premiums totaling $8,613 during the seven month period ended May 2010 according to provisions in his Separation Agreement.

Director Compensation

As described more fully below, this table summarizes the annual cash compensation for our non-employee directors during the fiscal year ended May 31, 2011.

Director Compensation

For Fiscal Year Ended May 31, 2011

Name	Fees Earned or Paid in Cash ($)			Option Awards ($)		All Other Compensation		Total Compensation ($)
Carlton M. Johnson, Jr.	$	122,400	(1)	$	20,000		--	$	142,400
Gloria H. Felcyn		96,000	(2)		20,000		--		116,000
Helmut Falk, Jr.		24,000	(3)		-		--		24,000
Donald E. Schrock		38,400	(4)		-		--		38,400
Dharmesh Mistry		56,000	(5)		-		--		56,000

1.	Consists of $28,800 board fee, $36,000 Phoenix Digital Solutions, LLC management committee fee, $28,800 Compensation Committee Chair fee and $28,800 Executive Committee Chair fee.

2.	Consists of $28,800 board fee and $67,200 Audit Committee Chair fee.

3.	Mr. Falk was paid board fees through January 2011. Mr. Falk was not nominated to be reelected at our annual meeting of stockholders in January 2011.

4.	Consists of $19,200 board fee and $19,200 Corporate Development, M & A Committee Chair fee through January 2011. Mr. Schrock was not nominated to be reelected at our annual meeting of stockholders in January 2011.

5.	Consists of $24,000 board fee and $32,000 Technology Committee Chair fee through January 2011. Mr. Mistry was not nominated to be reelected at our annual meeting of stockholders in January 2011.

At May 31, 2011, the aggregate number of options outstanding was: Mr. Johnson – 450,000 shares and Ms. Felcyn – 450,000 shares.

Directors who are not our employees are compensated for their service as a director as shown in the table below:

Schedule of Director Fees

May 31, 2011

Compensation Item	Amount
Board	$	36,000/28,800(1)
Corporate Development, M & A Committee Chair		28,800
Audit Committee Chair		67,200
Compensation Committee Chair		28,800
Executive Committee Chair		28,800
Technology Committee Chair		48,000
Phoenix Digital Solutions, LLC Management Committee Board Member		36,000

1.	Mr. Johnson, Ms. Felcyn and Mr. Schrock receive the lesser amount in conjunction with their fee reductions implemented in May 2009.

All retainers are paid in monthly installments.

Other

We reimburse all directors for travel and other necessary business expenses incurred in the performance of their services for us.

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth, as of August 12, 2011, the stock ownership of each of our officers and directors, of all our officers and directors as a group, and of each person known to us to be a beneficial owner of 5% or more of our Common Stock. The number of shares of Common Stock outstanding as of August 12, 2011, was 406,972,710. Except as otherwise noted, each person listed below is the sole beneficial owner of the shares and has sole investment and voting power over such shares. Each individual’s address is 701 Palomar Airport Road, Suite 170, Carlsbad, California 92011-1045.

Name	Amount & Nature of Beneficial Ownership			Percent of Class
Gloria H. Felcyn, CPA		1,259,700	(1)		*
Carlton M. Johnson, Jr.		975,000	(2)		*
Clifford L. Flowers		900,000	(3)		*
All directors & officers as a group (3 persons)		3,134,700	(4)		0.77%

*Less than 1%

(1)	Includes 450,000 shares issuable upon the exercise of outstanding stock options exercisable within 60 days of August 12, 2011.

(2)	Includes 450,000 shares issuable upon the exercise of outstanding stock options exercisable within 60 days of August 12, 2011.

(3)	Represents shares issuable upon the exercise of outstanding stock options exercisable within 60 days of August 12, 2011.

(4)	Includes 1,800,000 shares issuable upon the exercise of outstanding stock options exercisable within 60 days of August 12, 2011.

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Transactions With Directors, Executive Officers and Principal Stockholders

There were no transactions, or series of transactions during the fiscal year ended May 31, 2011, nor are there any currently proposed transactions, or series of transactions, to which we are a party, in which the amount exceeds $120,000, and in which to our knowledge any director, executive officer, nominee, five percent or greater stockholder, or any member of the immediate family of any of the foregoing persons, has or will have any direct or indirect material interest other than as described below.

Director Independence

Our Board of Directors has determined that a majority of the members of, and nominees to, our Board of Directors qualify as “independent,” as defined by the listing standards of NASDAQ. Consistent with these considerations, after review of all relevant transactions and relationships between each director and nominee, or any of his or her family members, and us, our senior executive management and our independent auditors, the Board of Directors has determined further that all of our directors and nominees are independent under the listing standards of NASDAQ. In making this determination, the Board of Directors considered that there were no new transactions or relationships between its current independent directors and the Company, its senior management and its independent auditors since last making this determination. Each member of our Audit Committee, and each member of the Compensation Committee of our Board of Directors, is independent as defined by the listing standards of NASDAQ.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Pursuant to the Policy on Engagement of Independent Auditor, the Audit Committee is directly responsible for the appointment, compensation and oversight of the independent auditor. The Audit Committee pre-approves all audit services and non-audit services to be provided by the independent auditor and has approved 100% of the audit, audit-related and tax fees listed below. The Audit Committee may delegate to one or more of its members the authority to grant the required approvals, provided that any exercise of such authority is presented at the next Audit Committee meeting for ratification.

Each audit, non-audit and tax service that is approved by the Audit Committee will be reflected in a written engagement letter or writing specifying the services to be performed and the cost of such services, which will be signed by either a member of the Audit Committee or by one of our officers authorized by the Audit Committee to sign on our behalf.

The Audit Committee will not approve any prohibited non-audit service or any non-audit service that individually or in the aggregate may impair, in the Audit Committee’s opinion, the independence of the independent auditor.

In addition, since January 1, 2003, our independent auditor may not provide any services to our officers or Audit Committee members, including financial counseling or tax services.

Audit Fees

During the fiscal years ended May 31, 2011 and 2010, the aggregate fees billed by our principal accountants for professional services rendered for the audit of our annual financial statements, audits of effectiveness of internal control over financial reporting for fiscal 2010 only, and reviews of quarterly financial statements included in our reports on Form 10-Q, and audit services provided in connection with other statutory or regulatory filings were $166,650 and $229,900, respectively.

Audit-Related Fees

None.

Tax Fees

During the fiscal years ended May 31, 2011 and 2010, the aggregate fees billed by our principal accountant for tax compliance, tax advice and tax planning rendered on our behalf were $13,708 and $18,934, respectively, which related to the preparation of federal and state income tax returns.

All Other Fees

Our principal accountant billed no other fees for the fiscal years ended May 31, 2011 and 2010, except as disclosed above.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) The following documents are filed as a part of this report:

Financial Statements. The following consolidated financial statements and Report of Independent Registered Public Accounting Firm are included starting on page F-1 of this Report:

Patriot Scientific Corporation

Report of KMJ Corbin & Company LLP, Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of May 31, 2011 and 2010

Consolidated Statements of Operations for the Years Ended May 31, 2011 and 2010

Consolidated Statements of Stockholders’ Equity and Comprehensive Loss for the Years Ended May 31, 2011 and 2010

Consolidated Statements of Cash Flows for the Years Ended May 31, 2011 and 2010

Notes to Consolidated Financial Statements

Phoenix Digital Solutions, LLC

Report of KMJ Corbin & Company LLP, Independent Registered Public Accounting Firm

Balance Sheets as of May 31, 2011 and 2010

Statements of Income for the Years Ended May 31, 2011 and 2010

Statement of Members’ Equity for the Years Ended May 31, 2011 and 2010

Statements of Cash Flows for the Years Ended May 31, 2011 and 2010

Notes to Financial Statements

Financial Statement Schedules. All financial statement schedules have been omitted since the information is either not applicable or required or is included in the financial statements or notes thereof.

Exhibits. Those exhibits marked with a (*) refer to exhibits filed herewith. The other exhibits are incorporated herein by reference, as indicated in the following list. Those exhibits marked with a (†) refer to management contracts or compensatory plans or arrangements.

Exhibit No.	Document
2.1	Agreement 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)

2.2.1	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)
2.5	Agreement and Plan of Merger dated August 4, 2008, among the Company, PTSC Acquisition 1 Corp, Crossflo Systems, Inc. and the Crossflo principal officers, incorporated by reference to Exhibit 99.1 to Form 8-K filed August 11, 2008 (Commission file No. 000-22182)
3.1	Original Articles of incorporation of the Company’s predecessor, Patriot Financial Corporation, incorporated by reference to Exhibit 3.1 to registration statement on Form S-18, (Commission file No. 33-23143-FW)
3.2	Articles of Amendment of Patriot Financial Corporation, as filed with the Colorado Secretary of State on July 21, 1988, incorporated by reference to Exhibit 3.2 to registration statement on Form S-18, (Commission file No. 33-23143-FW)
3.3	Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on March 24, 1992, incorporated by reference to Exhibit 3.3 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)
3.3.1	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on April 18, 1995, incorporated by reference to Exhibit 3.3.1 to Form 10-KSB for the fiscal year ended May 31, 1995 (Commission file No. 000-22182)
3.3.2	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on June 24, 1997, incorporated by reference to Exhibit 3.3.2 to Form 10-KSB for the fiscal year ended May 31, 1997, filed July 18, 1997 (Commission file No. 000-22182)
3.3.3	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on April 28, 2000, incorporated by reference to Exhibit 3.3.3 to Registration Statement on Form S-3 filed May 5, 2000 (Commission file No. 333-36418)
3.3.4	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on May 6, 2002, incorporated by reference to Exhibit 3.3.4 to Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)
3.3.5	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on October 16, 2003, incorporated by reference to Exhibit 3.3.5 to Registration Statement on Form SB-2 filed May 21, 2004 (Commission file No. 333-115752)
3.3.6	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on April 29, 2005, incorporated by reference to Exhibit 3.3.6 to Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)
3.3.7	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on November 14, 2005, incorporated by reference to Exhibit 3.3.7 to Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)

3.3.8	Certificate of Amendment to the Certificate of Incorporation of the Company, as filed with the Delaware Secretary of State on March 18, 2009, incorporated by reference to Exhibit 3.3.8 to Form 10-K for the fiscal year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)
3.4	Articles and Certificate of Merger of Patriot Financial Corporation into the Company dated May 1, 1992, with Agreement and Plan of Merger attached thereto as Exhibit A, incorporated by reference to Exhibit 3.4 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)
3.5	Certificate of Merger issued by the Delaware Secretary of State on May 8, 1992, incorporated by reference to Exhibit 3.5 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)
3.6	Certificate of Merger issued by the Colorado Secretary of State on May 12, 1992, incorporated by reference to Exhibit 3.6 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)
3.7	Bylaws of the Company, incorporated by reference to Exhibit 3.7 to Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)
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†	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)
4.3†	2006 Stock Option Plan of the Company as amended and restated, incorporated by reference to Appendix C to the Company Proxy Statement filed September 22, 2008 (Commission file No. 000-22182)
10.1	Master Agreement, dated as of June 7, 2005, by and among the Company, Technology Properties Limited Inc., a California corporation and Charles H. Moore, an individual, incorporated by reference to Exhibit 10.40 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)
10.2	Commercialization Agreement dated as of June 7, 2005 by and among the JV LLC, Technology Properties Limited Inc., a California corporation, and the Company, incorporated by reference to Exhibit 10.41 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)
10.3	Limited Liability Company Operating Agreement of JV LLC, a Delaware limited liability company, dated as of June 7, 2005, incorporated by reference to Exhibit 10.42 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)
10.4†	Employment Agreement dated September 17, 2007 by and between the Company and Clifford L. Flowers, incorporated by reference to Exhibit 10.1 to Form 8-K filed September 19, 2007 (Commission file No. 000-22182)
10.5†	Employment Agreement dated February 29, 2008 by and between the Company and Frederick C. Goerner, incorporated by reference to Exhibit 99.1 to Form 8-K filed May 20, 2008 (Commission file No. 000-22182)
10.6*	Form of Indemnification Agreement by and between the Company and the Board of Directors
14.1	Code of Ethics for Senior Financial Officers incorporated by reference to Exhibit 14.1 to Form 10-K for the fiscal year ended May 31, 2003, filed August 29, 2003 (Commission file No. 000-22182)
21*	List of subsidiaries of the Company
23.1*	Consent of Independent Registered Public Accounting Firm

31.1*	Certification of Clifford L. Flowers, Interim CEO, pursuant to Rule 13a-15(e) or Rule 15d-15(e)
31.2*	Certification of Clifford L. Flowers, CFO, pursuant to Rule 13a-15(e) or Rule 15d-15(e)
32.1*	Certification of Clifford L. Flowers, Interim CEO and CFO, pursuant to 18 U.S.C. Section 1350
99.1	Form of Incentive Stock Option Agreement to the Company’s 2001 Stock Option Plan incorporated by reference to Exhibit 99.6 to Registration Statement on Form S-8 filed March 26, 2001 (Commission file No. 333-57602)
99.2	Form of Non-Qualified Stock Option Agreement to the Company’s 2001 Stock Option Plan incorporated by reference to Exhibit 99.7 to Registration Statement on Form S-8 filed March 26, 2001 (Commission file No. 333-57602)
99.3	Form of Incentive Stock Option Agreement to the Company’s 2003 Stock Option Plan incorporated by reference to Exhibit 99.8 to Registration Statement on Form S-8 filed September 4, 2003 (Commission file No. 333-108489)
99.4	Form of Non-Qualified Stock Option Agreement to the Company’s 2003 Stock Option Plan incorporated by reference to Exhibit 99.9 to Registration Statement on Form S-8 filed September 4, 2003 (Commission file No. 333-108489)
99.5	Form of Incentive Stock Option Agreement to the Company’s 2006 Stock Option Plan incorporated by reference to Exhibit 99.10 on Form 10-K for the fiscal year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)
99.6	Form of Non-Qualified Stock Option Agreement to the Company’s 2006 Stock Option Plan incorporated by reference to Exhibit 99.11 on Form 10-K for the fiscal year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)

Patriot Scientific Corporation

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

		Page

Report of Independent Registered Public Accounting Firm		F-2

Financial Statements:

Consolidated Balance Sheets		F-3

Consolidated Statements of Operations		F-4

Consolidated Statements of Stockholders’ Equity and Comprehensive Loss		F-5

Consolidated Statements of Cash Flows		F-6

Notes to Consolidated Financial Statements		F-8

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors

Patriot Scientific Corporation

We have audited the accompanying consolidated balance sheets of Patriot Scientific Corporation and subsidiaries (the "Company") as of May 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss and cash flows for each of the two years in the period ended May 31, 2011. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit on its internal control over financial reporting for the year ended May 31, 2011. Our audit for the year ended May 31, 2011 included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion for the year ended May 31, 2011. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Patriot Scientific Corporation and subsidiaries as of May 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the two years in the period ended May 31, 2011, in conformity with accounting principles generally accepted in the United States of America.

/s/ KMJ Corbin & Company LLP

Costa Mesa, California

August 29, 2011

F-2

Patriot Scientific Corporation

Consolidated Balance Sheets

May 31,	2011			2010
ASSETS
Current assets:
Cash and cash equivalents	$	8,453,665		$	10,340,110
Restricted cash and cash equivalents		20,809			20,705
Current portion of marketable securities		2,207,009			12,105
Accounts receivable		187,465			149,504
Accounts receivable – affiliated company		129,345			7,010
Notes receivable, net		-			1,116,382
Work-in-process		30,581			136,637
Prepaid income taxes		904,200			930,272
Current portion of deferred tax assets		-			472,707
Prepaid expenses and other current assets		262,629			231,718
Total current assets		12,195,703			13,417,150

Marketable securities, net of current portion		-			5,133,835
Property and equipment, net		17,613			37,099
Goodwill		-			642,981
Other intangible assets, net		-			1,722,222
Deferred tax assets, net of current portion		-			5,911,732
Other assets		83,804			43,033
Investment in affiliated company		300,283			507,629
Total assets	$	12,597,403		$	27,415,681

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	328,245		$	493,519
Accrued expenses and other		196,830			292,004
Deferred revenue		50,502			156,084
Total current liabilities		575,577			941,607

Other non-current liabilities		3,240			-
Long term debt, including accrued interest		-			3,122,144
Total liabilities		578,817			4,063,751

Commitments and contingencies

Stockholders’ equity
Preferred stock, $0.00001 par value; 5,000,000 shares authorized: none outstanding		-			-
Common stock, $0.00001 par value: 600,000,000 shares authorized: 438,167,618 shares issued and 407,526,799 shares outstanding at May 31, 2011 and 438,167,618 shares issued and 408,821,071 shares outstanding at May 31, 2010		4,381			4,381
Additional paid-in capital		77,314,301			77,241,227
Accumulated deficit		(51,077,059	)		(39,561,669	)
Common stock held in treasury, at cost – 30,640,819 shares at May 31, 2011 and 29,346,547 shares at May 31, 2010		(14,223,037	)		(14,085,015	)
Accumulated other comprehensive loss		-			(246,994	)
Total stockholders’ equity		12,018,586			23,351,930
Total liabilities and stockholders’ equity	$	12,597,403		$	27,415,681

See accompanying notes to consolidated financial statements

F-3

Patriot Scientific Corporation

Consolidated Statements of Operations

Years Ended May 31,	2011			2010
Revenues:
License and service revenue	$	468,678		$	567,934

Cost of sales:
License and service revenue		76,242			119,568
Amortization of purchased intangibles		252,593			551,154
Impairment of purchased intangibles		1,469,629			3,530,263
Total cost of sales		1,798,464			4,200,985
Gross loss		(1,329,786	)		(3,633,051	)

Operating expenses:
Research and development		753,017			1,503,724
Selling, general and administrative		3,713,240			6,530,972
Impairment of goodwill		642,981			1,096,268
Total operating expenses		5,109,238			9,130,964
Operating loss		(6,439,024	)		(12,764,015	)

Other income (expense):
Interest and other income		109,246			154,482
Interest expense		(20,810	)		(80,567	)
Gain on sale of Verras Medical, Inc. assets		-			182,397
Gain on sale of Vigilys business line		60,000			-
Recovery of (reserve for) loan loss		1,013,151			(1,013,151	)
Impairment of investment in affiliated companies		-			(1,548,807	)
Realized loss on sale of marketable securities		(600,879	)		-
Equity in earnings of affiliated companies, net		600,460			4,461,483
Total other income, net		1,161,168			2,155,837

Loss before income taxes		(5,277,856	)		(10,608,178	)

Provision (benefit) for income taxes		6,237,534			(3,928,357	)

Net loss	$	(11,515,390	)	$	(6,679,821	)

Basic loss per common share	$	(0.03	)	$	(0.02	)

Diluted loss per common share	$	(0.03	)	$	(0.02	)

Weighted average number of common shares outstanding - basic		405,252,953			407,051,407

Weighted average number of common shares outstanding - diluted		405,252,953			407,051,407

See accompanying notes to consolidated financial statements.

F-4

Patriot Scientific Corporation

Consolidated Statements of Stockholders’ Equity and Comprehensive Loss

	Common Stock														Accumulated
	Shares			Amounts		Additional Paid-in Capital			Accumulated Deficit			Treasury Stock			Other Comprehensive Loss			Stockholders’ Equity			Comprehensive Loss
Balance, June 1, 2009		410,354,054		$	4,380	$	77,008,332		$	(32,881,848	)	$	(13,850,659	)	$	(629,314	)	$	29,650,891
Exercise of options at $0.07 per share		100,000			1		7,449												7,450
Share-based compensation							221,642												221,642
Tax effect of exercise of stock options							3,804												3,804
Purchase of common stock for treasury		(1,632,983	)		-		-			-			(234,356	)		-			(234,356	)
Net loss										(6,679,821	)								(6,679,821	)		(6,679,821	)
Unrealized gain on investments, net of tax		-			-		-			-			-			382,320			382,320			382,320
Total comprehensive loss																					$	(6,297,501	)
Balance, May 31, 2010		408,821,071		$	4,381	$	77,241,227		$	(39,561,669	)	$	(14,085,015	)	$	(246,994	)	$	23,351,930
Share-based compensation					-		76,879			-			-			-			76,879
Tax effect of exercise of stock options					-		(3,805	)		-			-			-			(3,805	)
Purchase of common stock for treasury		(1,294,272	)		-		-			-			(138,022	)		-			(138,022	)
Net loss					-		-			(11,515,390	)		-			-			(11,515,390	)		(11,515,390	)
Reversal of unrealized loss due to recognition in current fiscal year																246,994			246,994			246,994
Total comprehensive loss																					$	(11,268,396	)
Balance May 31, 2011		407,526,799		$	4,381	$	77,314,301		$	(51,077,059	)	$	(14,223,037	)	$	-		$	12,018,586

See accompanying notes to consolidated financial statements.

F-5

Patriot Scientific Corporation

Consolidated Statements of Cash Flows

Years Ended May 31,	2011			2010
Operating activities:
Net loss	$	(11,515,390	)	$	(6,679,821	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization and depreciation		277,163			602,226
Share-based compensation relating to issuance of stock options		76,879			221,642
Impairment of intangibles		1,469,629			3,530,263
Impairment of goodwill		642,981			1,096,268
Accrued interest income added to investments and notes receivable		(13,826	)		(55,020	)
Equity in earnings of affiliated companies		(600,460	)		(4,461,483	)
Realized loss on sale of marketable securities		600,879			-
Impairment of investment in affiliated companies		-			1,548,807
Gain on sale of Verras Medical, Inc. assets		-			(182,397	)
Gain on sale of Vigilys business line		(60,000	)		-
Loss on sale of assets		1,719			3,122
Reserve for (recovery of) loan loss		(1,013,151	)		1,013,151
Deferred income taxes		6,215,268			(3,508,416	)
Changes in operating assets and liabilities:
Accounts receivable		(37,961	)		18,146
Receivable from affiliated company		(122,335	)		(1,543	)
Work-in-process		106,056			(109,358	)
Prepaid expenses and other current assets		(11,682	)		83,213
Prepaid income taxes		26,072			(423,746	)
Deferred revenue		(105,582	)		129,773
Accounts payable and accrued expenses		(257,208	)		(142,083	)
Net cash used in operating activities		(4,320,949	)		(7,317,256	)
Investing activities:
Proceeds from sale of marketable securities		4,961,226			6,146,187
Purchases of marketable securities		(2,205,000	)		-
Proceeds from sale of restricted investments		-			31,643
Purchases of property and equipment		(6,803	)		(72,669	)
Issuance of note receivable		-			(2,005,000	)
Repayment of note receivable		2,141,246			628,112
Investments in affiliated companies		-			(612,500	)
Distributions from affiliated company		807,806			7,557,827
Net cash provided by investing activities		5,698,475			11,673,600
Financing activities:
Proceeds from exercise of common stock options		-			7,450
Repurchase of common stock for treasury		(138,022	)		(234,356	)
Tax effect of expiration/cancellation/exercise of stock options		(3,805	)		3,804
Payment on note payable		(3,122,144	)		-
Net cash used in financing activities		(3,263,971	)		(223,102	)
Net increase (decrease) in cash and cash equivalents		(1,886,445	)		4,133,242
Cash and cash equivalents, beginning of year		10,340,110			6,206,868
Cash and cash equivalents, end of year	$	8,453,665		$	10,340,110

F-6

Patriot Scientific Corporation

Consolidated Statements of Cash Flows, continued

Years Ended May 31,	2011			2010

Supplemental Disclosure of Cash Flow Information:
Cash payments for interest	$	137,785		$	-
Cash payments for income taxes	$	-		$	-

Supplemental Disclosure of Non-Cash Investing and Financing Activities:
Unrealized recovery on investments in marketable securities charged to other comprehensive income adjusted for deferred tax benefit	$	-		$	382,320
Reversal of unrealized loss charged to other comprehensive income at May 31, 2010 adjusted for deferred tax benefit due to recognition of loss in current fiscal year	$	(246,994	)	$	-

See accompanying notes to consolidated financial statements.

F-7

Patriot Scientific Corporation

Notes to Consolidated Financial Statements

1. Organization and Business

Patriot Scientific Corporation (the “Company”, “PTSC”, “we”, “us”, or “our”), was organized under Delaware law on March 24, 1992 and is the successor by merger to Patriot Financial Corporation, a Colorado corporation, incorporated on June 10, 1987. In 1997, we acquired Metacomp, Inc. which we dissolved in September 2008 and in June 2005 we entered into a joint venture agreement with Technology Properties Limited, Inc. (“TPL”) to form Phoenix Digital Solutions, LLC (“PDS”). During May 2008, we acquired an interest in Talis Data Systems, LLC (“Talis”), a Delaware LLC that produces multi-domain hardware. During the third quarter of fiscal 2010, Talis was dissolved. In September 2008, we acquired Patriot Data Solutions Group, Inc. (formerly known as Crossflo Systems, Inc.) (“PDSG”), a California company. During the fiscal year 2009, we acquired preferred shares of Avot Media, Inc. (“Avot”) an innovator of video transcoding and near real-time streaming to web-enabled mobile devices. In March 2010, Avot sold substantially all of its assets. In January 2010, we sold the assets of Verras Medical, Inc. and in August 2010 we sold the Vigilys business line both formerly associated with PDSG.

Our primary operating activity has been as an intellectual property company that licenses our jointly held patent portfolio technology, through our interest in PDS, to others and litigates against those who infringe upon the patent portfolio technology. Through the acquisition of PDSG, an additional primary operating activity is providing data sharing services and secure data solutions.

Liquidity and Management’s Plans

2. Summary of Significant Accounting Policies

Basis of Consolidation

The consolidated balance sheet at May 31, 2011 includes our accounts and those of our wholly owned subsidiary PDSG which includes Crossflo Systems, Inc., and our inactive subsidiary Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated. In August 2010, we sold the business line Vigilys.

The consolidated balance sheet at May 31, 2010 includes our accounts and those of our wholly owned subsidiary PDSG which includes our acquisitions of Crossflo Systems, Inc., the business line Vigilys and our inactive subsidiary Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated. In January 2010, we sold the assets of Verras Medical, Inc.

The consolidated statement of operations for the fiscal year ended May 31, 2011 includes our accounts, and those of our wholly owned subsidiary PDSG which includes Crossflo Systems, Inc., the business line Vigilys (until August 2010) and our inactive subsidiary Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated.

F-8

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Basis of Consolidation (continued)

The consolidated statement of operations for the fiscal year ended May 31, 2010 includes our accounts, and those of our wholly owned subsidiary PDSG which includes Crossflo Systems, Inc., the operations of Verras Medical, Inc. (until January 2010), and the business line Vigilys and our inactive subsidiary Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated.

Financial Instruments and Concentrations of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash, cash equivalents, investments in marketable securities, and trade accounts receivable.

At times, our balance of cash maintained with our bank may exceed the Federal Deposit Insurance Corporation’s (“FDIC”) insured limit of $250,000. At May 31, 2011 and 2010, neither PTSC’s nor PDSG’s cash and cash equivalents balances subject to FDIC insurance exceeded the FDIC limit. At May 31, 2011 and 2010, PTSC’s cash and cash equivalents balance consisting of money market accounts not subject to FDIC insurance was $8,080,005 and $10,095,240, respectively. We limit our exposure of loss by maintaining our cash with financially stable financial institutions. When we have excess cash, our cash equivalents are placed in certificates of deposit and high quality money market accounts with major financial institutions. We believe this investment policy limits our exposure to concentrations of credit risk.

At May 31, 2011, investments in marketable securities consist of certificates of deposit with maturities greater than three months. Each certificate of deposit is invested with a financial institution for $245,000 or less so as not to exceed the FDIC insurance limit.

At May 31, 2010, investments in marketable securities consisted of AAA rated student loan auction rate instruments issued by various state agencies pursuant to the Federal Family Educational Loan Program (“FFELP”). These investments were collateralized in excess of the underlying obligations, were insured by the various state educational agencies, and were guaranteed by the Department of Education as an insurer of last resort.

Concentrations of credit risk with respect to accounts receivable can be significant. We routinely assess the financial strength of our customers and, as a consequence, believe that our accounts receivable credit risk exposure is limited. Generally, we do not require collateral or other security to support customer receivables. The table below illustrates PDSG’s gross accounts receivable concentrations by customer as of May 31, 2011 and 2010:

	2011		2010
Customer A		13.2%		71.5
Customer B		-		22.1
Customer C		71.3%		-
Customer D		15.5%		-

Fair Value of Financial Instruments

Our financial instruments consist principally of cash and cash equivalents, investments in marketable securities, accounts receivable, accounts payable, accrued expenses and long term debt. The carrying value of these financial instruments, other than the investments in marketable securities consisting of auction rate securities, approximates fair value because of the immediate or short-term maturity of the instruments. The interest rate on our long term debt was based on market indices, The fair value of our cash equivalents and investments in marketable securities is determined based on quoted prices in active markets for identical assets or Level 1 inputs. The fair value of our auction rate securities was based on Level 3 inputs. Level 3 inputs are unobservable inputs used to estimate the fair value of assets or liabilities and are utilized to the extent observable inputs are not available. We recognize transfers between Levels 1 through 3 of the fair value hierarchy at the beginning of the reporting period. We believe that the carrying values of all other financial instruments approximate their current fair values due to their nature and respective durations.

F-9

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Cash Equivalents, Restricted Cash, and Short-Term Marketable Securities

For purposes of balance sheet classification and the statements of cash flows, we consider all highly liquid investments acquired with a maturity of three months or less to be cash equivalents.

Restricted cash and cash equivalents at May 31, 2011 and 2010 consist of a savings account held as collateral for our corporate credit card account.

At May 31, 2011 our short-term marketable securities in the amount of $2,207,009 consist of certificates of deposit with various financial institutions, with maturity dates of twelve months or less.

Accounts Receivable

At May 31, 2011 and 2010, our accounts receivable consists of the accounts of PDSG. PDSG’s accounts receivable consist of trade receivables recorded at the original invoice amount, less an estimated allowance for uncollectible accounts of which there was none at May 31, 2011 and 2010. Trade receivables are periodically evaluated for collectibility based on past credit histories with customers and their current financial condition. Changes in the estimated collectibility of trade receivables are recorded in the results of operations for the period in which the estimate is revised. Trade receivables that are deemed uncollectible are written off against the allowance for uncollectible accounts.

Work-In-Process

At May 31, 2011 and 2010, work-in-process represents the excess of recognized revenue over invoices to customers on PDSG’s current contracts in-progress.

Investments in Marketable Securities

We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date. Our investments in marketable securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities. Available-for-sale marketable securities are stated at fair value. Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss). We follow the authoritative guidance to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in other income, net in the consolidated statements of operations. During the year ended May 31, 2011, we disposed of our remaining investments in auction rate securities which had an aggregate fair value of $5.2 million (see Note 4).

Property, Equipment and Depreciation

Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to five years. Major betterments and renewals are capitalized, while routine repairs and maintenance are charged to expense when incurred.

Business Combinations and Intangible Assets Including Goodwill

Business combinations are accounted for using the purchase method of accounting and accordingly, the assets and liabilities of the acquired entities are recorded at their estimated fair values at the acquisition date. Goodwill represents the excess of the purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. Obtaining information needed to finalize the fair value of the acquired assets and liabilities takes time and frequently occurs over several quarters. Accordingly, it is common for initial fair value estimates to be subsequently revised. The results of operations of acquired businesses are included in our consolidated financial statements from the acquisition date.

Identifiable intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives. They are reviewed for impairment if indicators of potential impairment exist. Goodwill is tested for impairment on an annual basis.

Impairment of Goodwill, Intangible Assets and Other Long-Lived Assets

Management assesses the recoverability of our long-lived assets by determining whether the carrying value can be recovered through projected undiscounted future cash flows for identifiable intangible assets with infinite lives and based on a valuation utilizing the income approach for goodwill. The amount of long-lived asset impairment, if any, is measured based on fair value and is charged to operations in the period in which long-lived asset impairment is determined by management.

F-10

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Impairment of Goodwill, Intangible Assets and Other Long-Lived Assets (continued)

Based on a combination of factors occurring during fiscal 2011 and fiscal 2010, including the current economic environment, market conditions, and decline in value of our common stock, management has determined that indicators for impairment of goodwill and intangible assets existed.

The inability of PDSG to meet its business plan and the general economic environment were indicators of potential impairment on our goodwill and intangible assets, accordingly, management determined that goodwill was impaired by approximately $643,000 and $1,096,000, respectively, for the fiscal years ended May 31, 2011 and 2010 and PDSG’s intangibles were impaired by approximately $1,470,000 and $3,530,000, respectively, for the fiscal years ended May 31, 2011 and 2010. We have recorded these as impairments of goodwill and purchased intangibles on our consolidated statements of operations for the fiscal years ended May 31, 2011 and 2010 in general and administrative expenses and cost of sales, respectively.

Investments in Affiliated Companies

We have a 50% interest in PDS (see Note 9). Effective June 1, 2010, we adopted new authoritative guidance for consolidation of variable interest entities (“VIE”). The adoption of this guidance did not have a material effect on our consolidated financial statements. As of the date of this filing, PDS is a VIE of which we are not the primary beneficiary and therefore do not consolidate PDS’ accounts with our own as we cannot direct the licensing activity of TPL on behalf of PDS. 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 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 which is presented in the consolidated statements of operations in the caption “Equity in earnings of affiliated companies, net” and also is adjusted by contributions to and distributions from PDS.

We had a 39.4% interest in Talis (see Note 9). Prior to the write-off of our investment in Talis during the quarter ended August 31, 2009, we were accounting for our investment using the equity method of accounting. Under the equity method of accounting, the investment, originally recorded at cost, was adjusted to recognize our share of net earnings or losses of the investee and was presented in the consolidated statements of operations in the caption “Equity in earnings of affiliated companies, net.” In December 2009, Talis was dissolved.

We owned 37.1% of the preferred stock of Avot (see Note 9). Prior to the write-off of our investment in Avot during the quarter ended November 30, 2009, we were accounting for our investment at cost since we did not have the ability to exercise significant influence over the operating and financial policies of Avot. During March 2010, Avot sold substantially all of its assets and we collected our note receivable and accrued interest.

We own 100% of the preferred stock of Holocom (see Note 9). Prior to impairment, this investment was accounted for at cost since we did not have the ability to exercise significant influence over the operating and financial policies of Holocom.

During the fiscal year ended May 31, 2010, management determined that: our investment in Talis was impaired by approximately $680,000, our investment in Avot was impaired by approximately $433,000 and that the inability of Holocom to meet its business plan, raise capital, and the general economic environment were indicators of impairment on our investment, and accordingly we wrote-off our investment in the preferred stock of Holocom amounting to approximately $435,000. We have recorded these as “Impairment of investment in affiliated companies, net” on our consolidated statement of operations in other income (expense) for the fiscal year ended May 31, 2010.

Treasury Stock

We account for treasury stock under the cost method and include treasury stock as a component of stockholders’ equity.

F-11

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Comprehensive Income (Loss)

Comprehensive income (loss) as presented in the consolidated statements of stockholders’ equity includes unrealized gains and losses which are excluded from the consolidated statements of operations. For the fiscal year ended May 31, 2010, this amount included unrealized gains and losses on investments classified as available-for-sale. The amount is presented net of fiscal year 2010 tax-related expense of $253,126. For the fiscal year ended May 31, 2011 due to the settlement of our ARS, we reversed the unrealized loss of $416,165 adjusted for deferred tax benefit of $169,171 as of August 31, 2010.

Revenue Recognition

Revenue from technology license agreements is recognized at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), and the customer is provided with the licensed technology, if applicable. Fees for maintenance or support are recorded on a straight-line basis over the underlying period of performance.

On June 1, 2010, we adopted new authoritative guidance on a prospective basis for revenue arrangements containing multiple deliverables. This guidance requires us to allocate PDSG’s revenues to all deliverables based on their relative selling price using a specific hierarchy. The hierarchy is as follows: vendor-specific objective evidence (“VSOE”), third-party evidence of selling price (“TPE”) or best estimate of selling price (“BESP”).

F-12

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Selling, General and Administrative

Selling expenses include items such as sales salaries and commissions, marketing and advertising costs and consultant services. Advertising costs are expensed as incurred and were not significant for the fiscal years ended May 31, 2011 and 2010. General and administrative expenses include costs for items such as salaries, legal and accounting, and insurance.

Research and Development

Research and development costs are expensed as incurred and primarily include payroll and related benefit costs and contractor fees.

Income Taxes

We recognize deferred income taxes for the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. We establish valuation allowances when necessary to reduce deferred tax assets to the amount we expect to realize.

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 the deferred tax assets recorded on our balance sheet will not be recovered. Accordingly, we have a full valuation allowance on our net deferred tax assets.

Net Loss Per Share

Basic net loss per share includes no dilution and is computed by dividing loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an entity. At May 31, 2011 potential common shares of 3,010,000 related to our outstanding options were not included in the calculation of diluted income per share as we had no income. At May 31, 2010 potential common shares of 5,962,917 related to our outstanding warrants and options were not included in the calculation of diluted income per share as we had no income. Had we reported net income for the years ended May 31, 2011 and 2010, an additional 755,000 and 410,000, respectively, shares of common stock would have been included in the calculation of diluted income per share.

In connection with our acquisition of Crossflo, which is now a part of PDSG, we issued 2,844,630 escrow shares that are contingent upon certain representations and warranties made by Crossflo at the time of the merger agreement (see Note 14). We exclude these escrow shares from the basic loss per share calculations and include the escrowed shares in the diluted earnings per share calculations.

The following presents the basic loss per share for the years ended May 31, 2011 and 2010:

	Year Ended May 31, 2011
	Numerator (Loss)			Denominator (Shares)		Per Share Amount
Basic EPS:
Net loss	$	(11,515,390	)		405,252,953	$	(0.03	)
Diluted EPS:		-			-
Loss available to common shareholders	$	(11,515,390	)		405,252,953	$	(0.03	)

F-13

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Net Loss Per Share (continued)

	Year Ended May 31, 2010
	Numerator (Loss)			Denominator (Shares)		Per Share Amount
Basic EPS:
Net loss	$	(6,679,821	)		407,051,407	$	(0.02	)
Diluted EPS:		-			-
Loss available to common shareholders	$	(6,679,821	)		407,051,407	$	(0.02	)

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities in the consolidated financial statements and accompanying footnotes. Actual results could differ from those estimates. On an ongoing basis we evaluate our estimates, including, but not limited to: the realizability of accounts and notes receivable, valuation of work-in-process, fair values of investments in marketable securities, the use, recoverability, and /or realizability of certain assets, including investments in affiliated companies, intangible assets, goodwill, deferred tax assets, and stock-based compensation.

Share-Based Compensation

Share-based compensation expense recognized during the year is based on the grant date fair value of the portion of share-based payment awards ultimately expected to vest during the year. As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeiture rates are based on historical forfeiture experience and estimated future employee forfeitures.

Recent Accounting Pronouncements

F-14

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Recent Accounting Pronouncements (continued)

3. Goodwill and Other Intangible Assets

Goodwill originating from acquisitions is not amortized and is tested for impairment on an annual basis and between annual tests based on certain circumstances.

Purchased intangible assets were being amortized over a period of 9 months to 10 years. After impairment, the technology of PDSG was being amortized over 81 months.

Management’s plan of restructuring on October 5, 2009 and the continuing inability of PDSG to meet its business plan were indicators of potential impairment on our intangible assets. Accordingly, during the fiscal years ended May 31, 2011 and 2010, it was determined that intangibles were impaired by approximately $1,470,000 and $3,530,000, respectively. We have recorded this as an impairment of purchased intangibles on our consolidated statements of operations for the fiscal years ended May 31, 2011 and 2010.

The following tables present detail of our other intangible assets and related accumulated amortization balances, which were recorded as a result of business combinations and asset purchases:

	Estimated Life in Years		Allocated Value		Accumulated Amortization			Impairment			Net Carrying Value May 31, 2011

Technologies and processes		6.75	$	1,722,222	$	(252,593	)	$	(1,469,629	)	$	-

F-15

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Goodwill and Other Intangible Assets (continued)

	Estimated													Net Carrying Value
	Life in		Allocated			Accumulated								May 31,
	Years		Value			Amortization				Impairment				2010

Customer contracts –open orders		0.75		$	63,600		$	(63,600	)		$	-			$	-
Customer relationships		5.00			65,000			(11,064	)			(53,936	)			-
Maintenance agreements		4.00			75,400			(23,565	)			(51,835	)			-
Trademarks/names		10.00			124,500			(11,972	)			(112,528	)			-
Technologies and processes		5.00–8.00			6,136,900			(1,102,714	)			(3,311,964	)			1,722,222
				$	6,465,400		$	(1,212,915	)		$	(3,530,263	)		$	1,722,222

We have included the amortization expense and related impairment charges on intangible assets that relate to products sold in cost of sales.

The amortization expense related to intangible assets was as follows:

	Fiscal Year Ended		Fiscal Year Ended
	May 31, 2011		May 31, 2010
Amortization of intangible assets included in:
Cost of sales	$	252,593	$	551,154

Management’s plan of restructuring on October 5, 2009 and the continuing inability of PDSG to meet its business plan were indicators of potential impairment on our goodwill. Accordingly, during the fiscal years ended May 31, 2011 and 2010, management determined that goodwill was impaired by an aggregate of approximately $643,000 and $1,096,000, respectively. We have recorded this as an impairment of goodwill on our consolidated statement of operations for the fiscal years ended May 31, 2011 and 2010.

The changes in the carrying amount of goodwill for the fiscal years ended May 31, 2011 and 2010 are as follows:

Balance, June 1, 2009	$	1,739,249
Impairment of Verras goodwill		(196,512	)
Impairment of Vigilys goodwill		(110,004	)
Impairment of Crossflo goodwill		(789,752	)
Balance, May 31, 2010	$	642,981
Impairment of Crossflo goodwill		(642,981	)
Balance, May 31, 2011	$	-

F-16

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

4. Fair Value Measurements

At May 31, 2011, our current portion of marketable securities in the amount of $2,207,009 consists of the par value plus accrued interest of time deposits. At May 31, 2010, our current portion of marketable securities in the amount of $12,105 consists of accrued interest receivable on our auction rate securities which was receivable semi-annually according to the terms specified in each auction rate security instrument. These values are reported at cost, which approximate fair market value.

We follow authoritative guidance to account for our financial assets and liabilities at fair value. Under this authoritative guidance we are required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. We determine fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment or valuations by third party professionals. The three levels of inputs that we may use to measure fair value are:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2: Quoted prices in markets that are not active or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; and

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).

The following tables detail the fair value measurements within the fair value hierarchy of our cash, cash equivalents and investments in marketable securities:

			Fair Value Measurements at May 31, 2011 Using
			Quoted Prices		Significant
			in Active		Other		Significant
	Fair Value at		Markets for		Observable		Unobservable
	May 31,		Identical Assets		Inputs		Inputs
	2011		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents:
Cash:
Cash	$	128,655	$	128,655	$	-	$	-
Restricted cash		20,809		20,809		-		-
Cash equivalents:
Money market funds		8,080,005		8,080,005		-		-
Certificates of deposit		245,005		245,005		-		-
Marketable securities:
Certificates of deposit		2,207,009		2,207,009		-		-
Total	$	10,681,483	$	10,681,483	$	-	$	-

F-17

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Fair Value Measurements (continued)

			Fair Value Measurements at May 31, 2010 Using
			Quoted Prices		Significant
			in Active		Other		Significant
	Fair Value at		Markets for		Observable		Unobservable
	May 31,		Identical Assets		Inputs		Inputs
	2010		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents:
Cash:
Cash	$	244,870	$	244,870	$	-	$	-
Restricted cash		20,705		20,705		-		-
Cash equivalents:
Money market funds		10,095,240		10,095,240		-		-
Marketable securities:
Auction rate securities		5,133,835		-		-		5,133,835
Total	$	15,494,650	$	10,360,815	$	-	$	5,133,835

The following table summarizes the activity for the period by investment type for the fiscal years ended May 31, 2011 and 2010:

	Fair Value Measurements Using Quoted Prices in Active Markets for Identical Assets (Level 1)		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	Time Deposits		Auction Rate Securities
Beginning balance June 1, 2010	$	-	$	5,133,835
Purchases and interest		2,452,014		-
Total realized/unrealized recovery (losses):
Realized loss included in earnings		-		(600,879	)
Reversal of unrealized losses included in other comprehensive income (loss)		-		416,165
Settlements		-		(350,000	)
Settlements		-		(4,599,121	)
Ending balance May 31, 2011	$	2,452,014	$	-

F-18

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Fair Value Measurements (continued)

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Description	Auction Rate Securities
Beginning balance, June 1, 2009	$	10,598,389
Transfers in to Level 3		—
Total realized/unrealized recovery (losses):		—
Included in earnings		—
Recoveries of unrealized losses included in other comprehensive loss		635,446
Unrealized losses included in other comprehensive income (loss)		-
Settlements		(6,100,000	)
Ending balance, May 31, 2010	$	5,133,835


Total amount of unrealized losses for the fiscal year ended May 31, 2010 included in accumulated other comprehensive loss (before taxes) attributable to the change in fair market value relating to assets still held at the reporting date.	$	(416,165)

During the fiscal year ended May 31, 2011 we purchased certificates of deposit with varying maturity dates. The following table summarizes the maturities, gross unrealized gains or losses and fair value of the certificates of deposit as of May 31, 2011:

	May 31, 2011
	Cost			Gross Unrealized Gains/(Losses)			Fair Value
Maturity
Due in one year or less		$	2,452,014		$	-		$	2,452,014

The following table summarizes unrealized losses on our investments in marketable securities based on an independent third-party valuation at May 31, 2010:

	As of May 31, 2010
		Amortized Cost		Gross Unrealized Losses			Estimated Fair Value
Short-term
Accrued interest - auction rate securities		$	12,105	$	—		$	12,105
Long-term
Auction rate securities			5,550,000		(416,165	)		5,133,835

Total		$	5,562,105	$	(416,165	)	$	5,145,940

F-19

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Fair Value Measurements (continued)

At May 31, 2010, we held four investments that were in an unrealized loss position. The following table presents the amortized cost and fair value of our investments in marketable securities classified as available-for-sale at May 31, 2010 by contractual maturity:

	May 31, 2010
	Amortized Cost			Fair Value
Maturity
Greater than two years		$	5,550,000		$	5,133,835

At May 31, 2010, we held auction rate securities with a par value totaling approximately $5.6 million which failed to sell at auction. In the event we needed to access funds invested in these auction rate securities we would not have been able to liquidate these securities until (i) a future auction of these securities was successful, (ii) they were refinanced and redeemed by the issuers, or (iii) a buyer was found outside of the auction process. The investments consisted of student loan auction rate instruments issued by various state agencies pursuant to the Federal Family Educational Loan Program (“FFELP”). These instruments were insured by the various state educational agencies and were guaranteed by the Department of Education as an insurer of last resort. We had the intent and the ability to hold these investments until the anticipated recovery period.

As a result of temporary declines in the fair value of our auction rate securities, which we attributed to liquidity issues rather than credit issues, we recorded an unrealized loss of $246,994 in other comprehensive loss at May 31, 2010 which represented the gross valuation adjustment of $416,165, net of the related tax benefit of $169,171.

Due to the uncertainty surrounding the timing of a market recovery, we classified our auction rate securities as long- term investments in our consolidated balance sheet as of May 31, 2010.

During September 2010, we reached a confidential settlement agreement with Deutsche Bank. Under terms of the agreement, we transferred approximately $5.2 million in illiquid auction rate securities instruments to Deutsche Bank for a substantial portion of the face value of the securities, and if the instruments are redeemed by a certain date then we will receive the full face amount of the instruments. On October 4, 2010, we received settlement proceeds from Deutsche Bank of $4,551,260 plus $6,330 of interest income. During the fiscal year ended May 31, 2011 we received proceeds of $47,860 pursuant to this agreement and during June 2011 we received proceeds of $39,005 based on partial redemptions of these securities at par value.

During June 2008, we obtained a credit facility for as long as needed, which provided for financing up to 50% of the par value balance of our outstanding auction rate securities on that date. The facility was collateralized by the full value of the outstanding auction rate securities, required no origination fee, and bore interest at the federal funds rate plus 3% (see Note 11). On September 20, 2010, we paid $2,642,954, which consisted of the balance on the credit facility at August 31, 2010 plus interest through September 20, 2010. The credit facility was terminated in connection with the settlement agreement with Deutsche Bank.

5. Accounts Receivable

Trade accounts receivable at May 31, 2011 and 2010 is $187,465 and $149,504, respectively, which relates entirely to PDSG. No allowance for doubtful accounts has been recorded for the fiscal years ended May 31, 2011 or 2010.

At May 31, 2011 and 2010, accounts receivable from our investee PDS was $129,345 and $7,010, respectively. These balances represent reimbursements we submit to PDS for our legal and related costs incurred in various legal matters of which we are listed as co-defendant with TPL.

F-20

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

6. Notes Receivable

On December 24, 2009, we entered into a secured note receivable with TPL for $950,000, intended to cover its operating costs including the furtherance of Moore Microprocessor Patent (“MMP”) portfolio licensing, which was due and payable on or before July 12, 2010. Terms of the note required interest payable at the rate of 10%. The note was secured by TPL’s specific portion of its future license receivable distribution. At May 31, 2010 the balance of the note receivable was $991,382, including accrued interest receivable of $41,382. The note named both TPL and PDS individually; both jointly and severally liable to pay us. Accordingly, on July 15, 2010, PDS paid us $1,003,095 which included the principal balance of the note plus interest of $53,095 through July 15, 2010.

On January 12, 2010, we entered into an unsecured note receivable with TPL for $1,000,000, intended to cover its operating costs including the furtherance of MMP portfolio licensing, which was due and payable on or before February 28, 2010. Terms of the note required interest payable at the rate of 10%. TPL defaulted on the note on February 28, 2010. During the third quarter of fiscal 2010, the $1,013,151 balance of the note receivable including accrued interest through February 28, 2010, was fully reserved for. On January 19, 2011, we and TPL reached a settlement regarding the San Diego Superior Court action (see Note 9) and we received $1,098,903 in January 2011 consisting of the principal balance of the note plus accrued interest through January 2011.

Index for Clinical Excellence, Ltd.

On January 25, 2010, the assets of Verras were sold for $250,000. At closing we received $62,500 and a non-interest bearing promissory note for $187,500 from Index for Clinical Excellence, Ltd. Terms of the note required payment on each of the three, six and nine month anniversaries of the closing date. Due to the nominal amount of the note and its short term duration interest income was not separately accounted for. During April 2010, July 2010 and October 2010 we received the three, six and nine month anniversary payments consisting of $62,500 each on the note. At May 31, 2010 the balance of the note was $125,000 and the balance was paid in full as of May 31, 2011.

7. Work-In-Process

At May 31, 2011, work-in-process consisting of recognized revenue on PDSG’s current contracts was $455,381 and invoices to customers were $424,800. At May 31, 2010, work-in-process consisting of recognized revenue on PDSG’s current contracts was $264,637 and invoices to customers were $128,000. These amounts are shown on our May 31, 2011 and 2010 balance sheets at net of $30,581 and $136,637, respectively, due to their immateriality.

8. Property and Equipment

Property and equipment consisted of the following at May 31, 2011 and 2010:

	2011			2010
Computer equipment and software	$	82,865		$	92,416
Furniture and fixtures		31,580			51,725
		114,445			144,141
Less: accumulated depreciation and amortization		(96,832	)		(107,042	)
Net property and equipment	$	17,613		$	37,099

Depreciation and amortization expense related to property and equipment was $24,570 and $35,695 for the years ended May 31, 2011 and 2010, respectively.

F-21

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

9. Investments in Affiliated Companies

Phoenix Digital Solutions, LLC

On June 7, 2005, we entered into a Master Agreement (the “Master Agreement”) with TPL, and Charles H. Moore (“Moore”), the co-inventor of the technology which is the subject of the MMP Portfolio of microprocessor patents, pursuant to which the parties resolved all legal disputes between them. Pursuant to the Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of PDS (the “LLC Agreement”) into which we and Moore contributed our rights to certain of our technologies.

We and TPL each own 50% of the membership interests of PDS, 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 PDS 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 PDS in order to maintain working capital of not more than $8,000,000. Neither we nor TPL are required to contribute more than $2,000,000 in any fiscal year. During the fiscal year ended May 31, 2010 we and TPL each contributed $580,000 to PDS for working capital requirements. No such contributions were made during the fiscal year ended May 31, 2011. Distributable cash and allocation of profits and losses are allocated to the members in the priority defined in the LLC Agreement.

Pursuant to the Master Agreement, PDS 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 PDS) for supporting efforts to secure licensing agreements by TPL on behalf of PDS. During the fiscal years ended May 31, 2011 and 2010, PDS paid $2,500,000 and $1,500,000, respectively, to TPL pursuant to this commitment. This expense is recorded in the accompanying statements of operations presented below.

PDS reimburses TPL for payment of all legal and third-party expert fees and other related third-party costs and expenses, and certain internally generated costs as approved on August 17, 2009 and more fully described below. During the fiscal years ended May 31, 2011 and 2010, PDS expensed $6,833,708 and $3,684,154, respectively, to TPL pursuant to the agreement. This expense is recorded in the accompanying statements of operations presented below.

On August 17, 2009, the management committee of PDS resolved to pay TPL $500,000 per quarter beginning on June 1, 2009 and continuing through May 31, 2010 relating to TPL’s special work and effort regarding the MMP litigation and U.S. Patent Office re-examinations. In the event that PDS had insufficient funds to make such payments, we were required to advance half of the quarterly amount to PDS. Our advances to PDS were to be without interest and were to be repaid to us no later than May 31, 2010. During the fiscal year ended May 31, 2010, TPL received $1,500,000 from PDS pursuant to this agreement which is included in the fiscal 2010 legal and third-party expenses of PDS above. We did not advance any funds to PDS under this resolution. On May 31, 2010, the resolution terminated. On January 19, 2011, in accordance with our settlement agreement with TPL, PDS agreed to pay TPL an additional $750,000 pursuant to this agreement representing reimbursement of special litigation support costs incurred by TPL.

During April 2010, we filed two separate actions against TPL in the Superior Courts of San Diego and Santa Clara counties. We and TPL had been in negotiations to restructure our relationship. On January 19, 2011, we settled the San Diego Superior Court action.

F-22

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Investments in Affiliated Companies (continued)

On July 15, 2010, we received payment from PDS of $1,003,095 consisting of principal and interest through July 15, 2010 on our $950,000 secured note with TPL for which PDS was jointly and severally liable. This amount was recorded as a note receivable from TPL on PDS’ balance sheet on July 15, 2010. Due to TPL’s inability to pay the note, it was fully reserved for at July 15, 2010 and the allowance was recorded as “Reserve for loan loss and uncollectable receivable” on PDS’ statement of operations for the six months ended November 30, 2010. On January 19, 2011, pursuant to our settlement agreement with TPL, $1,048,903 consisting of principal and interest through January 2011 was applied against the March 1, 2010 and June 1, 2010 $500,000 quarterly expense amounts payable to TPL in accordance with the LLC Agreement for supporting efforts to secure licensing agreements and a portion of the fiscal 2010 special litigation support payments owed to TPL by PDS. PDS has paid TPL in cash for the September 1, 2010 and subsequent quarters’ expense amounts pursuant to the LLC Agreement for supporting efforts to secure licensing agreements.

During June 2010, PDS advanced Alliacense, LLC TPL’s intellectual property licensing enterprise, $410,000 to fund payroll and rent obligations. Due to non-payment by Alliacense, this amount was fully reserved for at August 31, 2010 and the allowance was recorded as “Reserve for loan loss and uncollectable receivable” on PDS’ statement of operations for the six months ended November 30, 2010. On January 19, 2011, pursuant to our settlement agreement with TPL, the $410,000 was applied against the fiscal 2010 special litigation support payments owed to TPL by PDS.

On January 19, 2011, pursuant to our settlement agreement with TPL, PDS agreed to pay TPL $67,000 per month from September 1, 2010 to April 30, 2011 relating to TPL’s special work and effort regarding internal costs related to litigation support and patent re-examinations.

Based on our analysis of current authoritative accounting guidance with respect to our investment in PDS, we continue to account for our investment in PDS under the equity method of accounting, and accordingly have recorded our share of PDS’ net income of $600,460 and $4,483,190 during the years ended May 31, 2011 and 2010, respectively, as an increase in our investment. Cash distributions of $807,806 and $7,557,827 received from PDS during the years ended May 31, 2011 and 2010, respectively, have been recorded as a reduction in our investment. Cash contributions of $580,000 made during the fiscal year ended May 31, 2010 have been recorded as in increase in our investment. Our investment in PDS of $300,283 and $507,629 at May 31, 2011 and 2010, respectively, has been recorded as “Investment in affiliated company”. We have recorded our share of PDS’ net income as “Equity in earnings of affiliated companies, net” in the accompanying consolidated statements of operations for the years ended May 31, 2011 and 2010.

During the years ended May 31, 2011 and 2010, TPL entered into licensing agreements with third parties, pursuant to which PDS recorded license revenues of approximately $11,090,000 and $14,279,000, respectively.

At May 31, 2011, PDS had accounts payable balances of approximately $1,754,000 and $129,400 to TPL and PTSC, respectively. At May 31, 2010, PDS had accounts payable and accrued expense balances of approximately $1,724,000 and $7,000 to TPL and PTSC, respectively.

Variable Interest Entity Disclosures

At August 26, 2011, PDS’ cash and cash equivalents balance was $689,169. Management has concluded that PDS’ equity investment at risk is insufficient to finance its activities as the volume of license revenue has not supported litigation costs independent of additional working capital funding.

We have not provided financial support to PDS other than required capital contributions and we are not contractually obligated to provide financial support to PDS other than to fund the working capital account at the discretion of PDS’ management committee. In the event we, and not TPL, provide working capital funding to PDS we would consolidate PDS’ financials with our own as our ownership in PDS would be greater than 50%.

Our variable interest in PDS consists of 50% of PDS’ Members Equity or $300,283 at May 31, 2011. We are unable to quantify our maximum exposure to loss associated with this VIE as we may incur future capital funding requirements.

F-23

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Investments in Affiliated Companies (continued)

The condensed balance sheets of PDS at May 31, 2011 and 2010 and statements of income of PDS for the years ended May 31, 2011 and 2010 are as follows:

Balance Sheets

Assets:

	2011		2010
Cash and cash equivalents	$	1,895,653	$	779,932
Prepaid expenses		600,000		25,000
Licenses receivable		-		2,000,000
Total assets	$	2,495,653	$	2,804,932

Liabilities and Members’ Equity:

Related party payables and accrued expenses	$	1,883,296	$	1,777,884
LLC tax payable		11,790		11,790
Members’ equity		600,567		1,015,258
Total liabilities and members’ equity	$	2,495,653	$	2,804,932

Statements of Income

	2011		2010
License revenues	$	11,090,000	$	14,278,855
Operating expenses		9,922,580		5,301,273
Operating income		1,167,420		8,977,582
Interest and other income		46,091		588
Income before LLC taxes		1,213,511		8,978,170
Provision for LLC taxes		12,590		11,790
Net income	$	1,200,921	$	8,966,380

Talis Data Systems, LLC

We had a 39.4% interest in Talis. The inability of Talis to meet its business plan, to raise capital, and the general economic environment were indicators of impairment on our investment, accordingly at August 31, 2009, management determined that our investment in Talis was impaired by approximately $680,000. We have recorded this as an impairment of investment in affiliated company on our consolidated statement of operations for the fiscal year ended May 31, 2010.

We were accounting for our investment in Talis under the equity method of accounting. We had recorded our share of Talis’ net loss of $21,706 during the two months ended July 31, 2009 as “Equity in earnings of affiliated companies, net” in the accompanying consolidated statement of operations for the fiscal year ended May 31, 2010. The carrying value of our investment in Talis after impairment was zero at August 31, 2009. During the third quarter of fiscal 2010, Talis was dissolved.

Due to the immaterial nature of Talis’ operations, no condensed financial statement information is presented herein.

F-24

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Investments in Affiliated Companies (continued)

Avot Media, Inc.

During the quarter ended August 31, 2008, we invested an aggregate of $1,300,000, including conversion of a note receivable in the amount of $250,000, to obtain 14,444,444 shares of Series B preferred stock issued by Avot, representing 53.3% of the Series B preferred stock and 37.1% of all Avot’s preferred shares issued and outstanding.

We reviewed the Series B Preferred Stock Purchase Agreement and related agreements in addition to evaluating our voting rights for our investment in the preferred stock of Avot, and as such we concluded that we did not have the ability to exercise significant control over Avot. As a result, we were accounting for our investment in Avot at cost.

The inability of Avot to meet its business plan, to raise capital, and the general economic environment were indicators of impairment of our investment, accordingly at May 31, 2009, management determined that our investment in Avot was impaired by approximately $867,000. We had recorded this as an impairment of investment in affiliated company on our consolidated statement of operations for the fiscal year ended May 31, 2009.

During the quarter ended November 30, 2009, we wrote-off $433,333 which represented the remaining carrying value of our preferred stock investment in Avot. We have presented the $433,333 as an impairment of investment in affiliated companies on our consolidated statement of operations for the fiscal year ended May 31, 2010.

During March 2010, Avot sold substantially all of its assets and we collected our note receivable. There was not adequate consideration to redeem any portion of our preferred stock investment which had been fully written off during the fiscal quarters ending in May 2009 and November 2009.

Scripps Secured Data, Inc. (d/b/a Holocom, Inc.)

On February 2, 2007, we invested an aggregate of $370,000 in convertible preferred stock, representing all of the issued preferred stock and a 46% ownership interest, of and in Holocom, a California corporation that manufactures products that protect information transmitted over secure networks. The investment consisted of certain assets we contributed to Holocom valued at $250,000 and cash of $120,000. The investment is represented by 2,100,00 shares of convertible preferred stock, and the shares are convertible at our option into shares of Holocom’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 Holocom. The investment in Holocom’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.

We reviewed the Preferred Stock Purchase Agreement and related agreements to determine whether our convertible preferred stock investment in Holocom was in substance an investment in common stock pursuant to authoritative guidance. We also evaluated our voting rights pursuant to other agreements with Holocom and, when considered together with authoritative guidance, we believe that we do not have the ability to exercise significant influence over Holocom. As a result, we were accounting for our investment in Holocom at cost.

Management determined that the inability of Holocom to meet its business plan, raise capital, and the general economic environment were indicators of impairment on our investment. At May 31, 2010, we wrote-off our investment in the preferred stock of Holocom amounting to $435,182. We have presented the $435,182 as an impairment of investment in affiliated companies on our consolidated statement of operations for the fiscal year ended May 31, 2010.

We review our investments in affiliated companies to determine whether events or changes in circumstances indicate that the carrying amounts may not be recoverable. The primary factors we consider in our determination are the financial condition, operating performance and near term prospects of the investees. If a decline in value is deemed to be other than temporary, we would recognize an impairment loss.

F-25

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

10. Accrued Expenses and Other

At May 31, 2011 and 2010, accrued expenses and other consisted of the following:

	2011		2010
Accrued lease obligation	$	17,362	$	19,837
Compensation and benefits		175,864		269,611
Commissions payable		3,604		2,556
	$	196,830	$	292,004

11. Notes Payable

Long Term

On October 14, 2008, we borrowed $3,000,000 on our credit facility with Wedbush. The facility was collateralized by the full value of the outstanding auction rate securities, required no origination fee and bore interest at the federal funds rate plus 3%. The amount we could borrow on the facility was limited by the Financial Industry Regulatory Authority (“FINRA”). At May 31, 2010, the balance on the facility of $3,122,144 included accrued interest of $122,144 at an approximate average annual rate of 2.6%. During June 2010, we paid $500,000 on the credit facility. On September 20, 2010, we paid $2,642,954, the balance on the credit facility at August 31, 2010 plus interest through September 20, 2010. The credit facility was terminated in connection with the settlement with Deutsche Bank.

12. Stockholders’ Equity

Share Repurchases

During July 2006, we commenced our Board of Director approved stock buyback program in which we repurchase our outstanding common stock from time to time on the open market. The repurchase plan has no maximum number of shares and is solely at the discretion of the Board of Directors. The repurchase plan has no set expiration date.

The following table summarizes share repurchases during the years ended May 31, 2011 and 2010:

	2011		2010
Number of shares repurchased		1,294,272		1,632,983
Aggregate cost	$	138,022	$	234,356

Warrants

At May 31, 2010, we had warrants outstanding to purchase 325,000 common shares at exercise prices ranging from $0.15 to $1.00 per share, expiring at various dates through 2011. On January 25, 2010, we issued 25,000 warrants expiring on December 21, 2010 with an exercise price of $0.15 to a former consultant in connection with a legal settlement. We recorded $857 of share-based compensation in connection with the issuance. On November 9, 2009, we gave notice to our current investor relations firm of our intent to cancel our contract within 30 days. Accordingly, the 250,000 warrants granted under contract that were not vested were cancelled. In connection with the cancellation of the unvested warrants we reversed approximately $10,400 of share-based compensation previously recorded, including $6,932 recorded during the year ended May 31, 2009.

F-26

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Stockholders’ Equity (continued)

The following table presents outstanding warrants at May 31, 2011 and 2010:

	2011		2010
Issued in conjunction with:
Services	$	-		300,000
Legal settlements		-		25,000
Total warrants outstanding		-		325,000

Share-based Compensation Summary of Assumptions and Activity

The fair value of share-based awards to employees and directors is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the pricing term of the grant effective as of the date of the grant. The expected volatility for the fiscal years ended May 31, 2011 and 2010 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.

	Year Ended May 31, 2011		Year Ended May 31, 2010
Expected term	5 yrs		5 yrs
Expected volatility		106%		116 – 117%
Risk-free interest rate		2.17%		2.14 - 2.55%

A summary of option activity as of May 31, 2011 and changes during the fiscal year then ended, is presented below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Options outstanding at June 1, 2010		5,637,917		$	0.42
Options granted		650,000		$	0.10
Options exercised		-		$	-
Options forfeited		(3,277,917	)	$	0.44
Options outstanding at May 31, 2011		3,010,000		$	0.33		2.19	$	-
Options vested and expected to vest at May 31, 2011		2,901,306		$	0.33		2.18	$	-
Options exercisable at May 31, 2011		2,792,612		$	0.34		2.17	$	-

The weighted average grant date fair value of options granted during the fiscal years ended May 31, 2011 and 2010 was $0.08 and $0.15 per option, respectively. The total intrinsic value of options exercised during the fiscal year ended May 31, 2010 was $9,550 based on the difference in market price on the date of exercise and the option exercise price.

F-27

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Stockholders’ Equity (continued)

The aggregate intrinsic value in the table above represents the differences in market price at the close of the fiscal year ($0.08 per share on May 31, 2011) and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.08) on May 31, 2011.

As of May 31, 2011, there was $16,759 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 24 months.

The following table summarizes employee and director stock-based compensation expense for PTSC and employee stock-based compensation expense for PDSG for the fiscal years ended May 31, 2011 and 2010, which was recorded as follows:

	Year Ended		Year Ended
	May 31, 2011		May 31, 2010
Research and development - PDSG	$	2,038	$	19,523
Selling, general and administrative expense - PDSG		18,462		49,498
Selling, general and administrative expense - PTSC		56,379		158,696
Total	$	76,879	$	227,717

During the fiscal year ended May 31, 2010, we expensed $857 relating to warrants issued during the fiscal year and we recognized an adjustment of ($6,932) relating to the forfeiture of warrants during the fiscal year. We incurred no such expense during the fiscal year ended May 31, 2011.

2001 Stock Option Plan

The 2001 Stock Option Plan, which expired in February 2011, provided for the granting of options to purchase up to 3,000,000 shares of our common stock to either full or part time employees, directors and our consultants at a price not less than the fair market value on the date of grant for incentive stock options or not less than 85% of the fair market value on the date of grant for non-qualified stock options. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2001 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). We made no grants under this plan during fiscal 2011 and 2010. As of May 31, 2011, options to purchase 240,000 shares of common stock are outstanding under the 2001 Stock Option Plan.

2003 Stock Option Plan

The 2003 Stock Option Plan, which expires in July 2013, provides for the granting of options to acquire up to 6,000,000 shares of our common stock to either full or part time employees, directors and our consultants at a price not less than the fair market value on the date of grant for incentive stock options or not less than 85% of the fair market value on the date of grant for non-qualified stock options. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2003 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). There were no grants made under the 2003 Stock Option Plan during the fiscal years ended May 31, 2011 and 2010. As of May 31, 2011, there are no options outstanding under the 2003 Stock Option Plan.

F-28

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Stockholders’ Equity (continued)

2006 Stock Option Plan

The 2006 Stock Option Plan, as amended, which expires in March 2016, provides for the granting of options to acquire up to 10,000,000 shares, with a limit of 8,000,000 Incentive Stock Option (“ISO”) shares of our common stock to either full or part time employees, directors and our consultants at a price not less than the fair market value on the date of grant. In the case of a significant stockholder, the option price of the share is not less than 110 percent of the fair market value of the shares on the date of grant. Any option granted under the 2006 Stock Option Plan must be exercised within ten years of the date they are granted (five years in the case of a significant stockholder). During the fiscal years ended May 31, 2011 and 2010, we granted options to purchase 650,000 and 670,000 shares of our common stock, respectively, under this plan none of which were ISOs. As of May 31, 2011, options to purchase 2,770,000 shares of common stock are outstanding under the 2006 Stock Option Plan.

A summary of the status of our stock option plans and warrants as of May 31, 2011 and 2010 and changes during the years ended on those dates is presented below:

	Options					Warrants
	Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price

Outstanding, June 1, 2009		10,210,000		$	0.39		550,000		$	0.41
Granted		670,000			0.18		25,000			0.15
Cancelled/Expired		(5,142,083	)		0.33		(250,000	)		0.23
Exercised		(100,000	)		0.07		-			-
Outstanding, May 31, 2010		5,637,917			0.42		325,000			0.53
Granted		650,000			0.10		-			-
Cancelled/Expired		(3,277,917	)		0.44		(325,000	)		0.53
Exercised		-			-		-			-

Outstanding, May 31, 2011		3,010,000		$	0.33		-		$	-

Exercisable, May 31, 2010		5,000,108		$	0.45		325,000		$	0.53

Exercisable, May 31, 2011		2,792,612		$	0.34		-		$	-

Weighted average fair value of options and warrants granted during the year ended May 31, 2010				$	0.15				$	0.03

Weighted average fair value of options granted during the year ended May 31, 2011				$	0.08

F-29

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

13. Income Taxes

The provision (benefit) for income taxes is as follows for the years ended May 31:

	2011			2010
Current:
Federal	$	(110,102	)	$	(627,000	)
State		(36,803	)		(46,066	)
Total current		(146,905	)		(673,066	)

Deferred:
Federal		5,161,525			(2,447,633	)
State		1,222,914			(807,658	)
Total deferred		6,384,439			(3,255,291	)
Total provision (benefit)	$	6,237,534		$	(3,928,357	)

During the fiscal year ended May 31, 2011, we determined that all of our deferred tax assets would not be realized in the future due to our continuing pre-tax and taxable losses. As a result of this determination we have placed a full valuation allowance against our deferred tax assets and increased our tax provision by approximately $8,971,000.

The reconciliation of the effective income tax rate to the Federal statutory rate is as follows for the years ended May 31:

	2011			2010

Statutory federal income tax rate		35.0 %			35.0 %
State income tax rate, net of Federal effect		(13.8%	)		5.3 %
Change in tax rate		(1.0%	)		(1.0%	)
Stock option expense		(0.7%	)		- %
Tax credits		- %			0.2 %
Tax exempt interest		- %			0.2 %
Deconsolidation of variable interest entity		- %			(0.2%	)
Goodwill		(4.1%%	)		(2.5%	)
Other		(4.5%	)		- %
Change in valuation allowance		(129.1%	)		- %
Effective income tax rate		(118.2%	)		37.0 %

F-30

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Income Taxes (continued)

Deferred tax assets and liabilities reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of our deferred tax assets are as follows as of May 31:

	2011			2010
Current deferred tax assets (liabilities):
State taxes	$	49,287		$	(34,509	)
Accrued expenses		72,031			73,182
Reserve for loan loss		-			434,034
Less: valuation allowance		(121,318	)		-
Total net current deferred tax asset		-			472,707

Long-term deferred tax assets (liabilities):
Investment in affiliated company		(507,180	)		212,202
Basis difference in property and equipment		5,905			(5,486	)
Basis difference in intangibles		176,415			(240,892	)
Stock based compensation expense		462,607			480,869
Impairment of note receivable		331,896			331,896
State taxes		-			(796,678	)
Deferred rent		5,721			8,498
Other comprehensive loss		-			178,285
Capital loss carryover		887,155			29,131
Net operating loss carryforwards		7,919,035			6,178,342
Credit carryover		111,090			78,090
Valuation allowance		(9,392,644	)		(542,525	)
Total net long-term deferred tax asset		-			5,911,732
Net deferred tax asset	$	-		$	6,384,439

We have carried back a federal net operating loss of approximately $1,394,000 to the tax year ending May 31, 2009. We have federal and state net operating loss carryforwards available to offset future taxable income of approximately $17,827,000 and $21,018,000, respectively, at May 31, 2011. These carryforwards begin to expire in the years ending May 31, 2023 and 2013, respectively. The state of California has suspended NOL deductions for taxable years beginning in 2008 or 2009 for taxpayers with business income of $500,000 or more.

On June 1, 2007, we adopted authoritative guidance which defines criteria that an individual tax position must meet for any part of the benefit of that position to be recognized in a company’s financial statements and also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The adoption of this guidance did not result in any cumulative effect adjustment to retained earnings. Interest and penalties, if any, related to unrecognized tax benefits are recorded in income tax expense. As of May 31, 2011, we are subject to U.S. Federal income tax examinations for the tax years May 31, 1994 through May 31, 2010, and we are subject to state and local income tax examinations for the tax years May 31, 2002 through May 31, 2010 due to the carryover of net operating losses related to PDSG from previous years.

F-31

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Income Taxes (continued)

The table below summarizes our liability relating to unrecognized tax benefits under the authoritative guidance for the fiscal years ended May 31, 2011 and 2010:

Balance at June 1, 2009	$	-
Increase in unrecognized tax benefit liability		-
Decrease in unrecognized tax benefit liability		-
Accrual of interest related to unrecognized tax benefits		7,000
Balance at May 31, 2010	$	7,000
Increase in unrecognized tax benefit liability		-
Decrease in unrecognized tax benefit liability		-
Accrual of interest related to unrecognized tax benefits		-
Balance at May 31, 2011	$	7,000

Our liability relating to unrecognized tax benefits has been presented net of our prepaid income taxes on our consolidated balance sheet at May 31, 2011 and 2010.

Our continuing practice is to recognize accrued interest and penalties related to unrecognized tax benefits as a component of tax expense. This policy did not change as a result of our adoption of the authoritative guidance on June 1, 2007. We do not expect our unrecognized tax benefits to change significantly over the next twelve months.

14. Commitments and Contingencies

Litigation

Patent Litigation

F-32

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Commitments and Contingencies (continued)

Crossflo Systems, Inc. Litigation

Under the terms of our Agreement and Plan of Merger (the "Merger Agreement") with Crossflo, and certain of its principal officers, an escrow account was established to hold back approximately 10% of the merger consideration payable to the shareholders of Crossflo (the "Escrow Merger Consideration"). See Escrow Shares below. We contend that certain representations and warranties made by Crossflo and certain of its principal officers in the Merger Agreement were false when made, and were false as of the closing of the merger. We submitted a demand to the escrow agent on August 31, 2009 not to release the Escrow Merger Consideration to the Crossflo shareholders and to instead return it to us. A sufficient number of Crossflo shareholders have opposed our demand that the escrow consideration has not been released to either side.

TPL Litigation

401(k) Plan

Patriot and PDSG have retirement plans that comply with Section 401(k) of the Internal Revenue Code. All employees are eligible to participate in the plans. Prior to January 1, 2011 Patriot matched 50% of each participant’s voluntary contributions, subject to a maximum contribution of 6% of the participant’s compensation. On January 1, 2011 Patriot implemented a Safe Harbor 401(k) retirement plan which requires Patriot to match 100% of elective deferrals subject to a maximum of 4% of the participant’s eligible earnings. Patriot’s participants vest 33% per year over a three year period in their matching contributions. Patriot’s matching contributions during the fiscal years ended May 31, 2011 and 2010 were $17,790 and $18,242, respectively. PDSG does not match participant voluntary contributions.

F-33

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Commitments and Contingencies (continued)

Employment Contracts

In connection with Mr. Flowers’ appointment as the Chief Financial Officer, and commencing on September 17, 2007, we entered into an employment agreement with Mr. Flowers for an initial 120-day term if not terminated pursuant to the agreement, with an extension period of one year and on a continuing basis thereafter. Pursuant to the agreement, if Mr. Flowers is terminated without cause or resigns with good reason any time after two years of continuous employment, he is entitled to receive an amount equal to twelve months of his annual base salary. Mr. Flowers is also entitled to certain payments upon a change of control of the Company if the surviving corporation does not retain him. All such payments are conditional upon the execution of a general release.

In connection with Mr. Goerner’s appointment as Interim President and Chief Executive Officer, and commencing on February 29, 2008, we entered into an employment agreement with Mr. Goerner 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. Goerner was terminated without cause within the first year of employment, after the initial 120-day term, he was entitled to receive an amount equal to his base salary for the period remaining in the agreement. Payments were conditional upon the execution of a general release. In connection with management’s restructuring plan on October 7, 2009, we entered into a Separation Agreement with Mr. Goerner which required us to pay his base salary for the next seven months in exchange for a general release of claims against us. During the fiscal year 2010 we recorded a one-time severance charge of $145,833 pursuant to the Separation Agreement. At May 31, 2010 we have satisfied all payments under the Separation Agreement.

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 PDSG. 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.

Pursuant to the acquisition of Crossflo, we have agreed to indemnify the former owners of Crossflo for certain claims or losses resulting from any untrue, allegedly untrue or misleading statement made in a registration statement, prospectus or similar document.

Bonuses

In connection with the acquisition of Crossflo, retention bonuses were to be paid to individuals who were Crossflo employees pre-merger who remain with PDSG until March 1, 2010. In connection with the acquisition of Vigilys, a retention bonus was to be paid to a key employee who remains with PDSG until March 27, 2010. The projected liability for such bonuses was $75,000. These liabilities were being accrued ratably over the retention periods. During March 2010 retention bonuses in the amount of $75,000 were paid to qualified key employees.

By the terms of his employment contract, our CFO, who also currently serves as our interim CEO, is eligible to earn an annual bonus equivalent to 50% of his base salary. In connection with management’s restructuring plan on October 5, 2009, our Compensation Committee determined that this bonus would be payable at the end of the interim period. The projected liability for such bonus was $145,875 and was recorded on our consolidated balance sheet in “Accrued expenses and other” at May 31, 2010. The bonus was paid during fiscal 2011. No such bonus has been accrued for fiscal 2011.

F-34

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Commitments and Contingencies (continued)

During the fiscal year ended May 31, 2011, a retention bonus program was implemented to be paid to individuals who remain with PDSG until February 29, 2012. The projected liability for such bonuses is $90,000. This liability is being accrued ratably over the retention period.

Escrow Shares

On August 31, 2009 we gave notice to the former shareholders of Crossflo and Union Bank of California (the “Escrow Agent”) under Section 2.5 of the Agreement and Plan of Merger between us and Crossflo (the “Agreement”), outlining damages incurred by us in conjunction with the acquisition of Crossflo, and seeking the return of 2,844,630 shares of our common stock held by the Escrow Agent. Subsequently, former shareholders of Crossflo representing a majority of the escrowed shares responded in protest to our claim, delaying the release of the escrowed shares until a formal resolution is reached. In the event we fail to prevail in our claim against the escrowed shares, we may be obligated to deposit into escrow approximately $256,000 of cash consideration due to the decline in our average stock price over the one year escrow period, calculated in accordance with the Section 2.5 of the Agreement. We have evaluated the potential for loss regarding our claim and believe that it is probable that we will prevail although there is no assurance that we will. Accordingly, we have not recorded a liability for this matter.

Operating Leases

We lease our facilities through operating leases that expire at various dates through 2013. Rental expense, net of sublease income, is presented in the following table:

	Year Ended		Year Ended
	May 31, 2011		May 31, 2010
Rental expense	$	213,154	$	275,392

A summary of future minimum payments under our operating lease commitments, net of sublease income as of May 31, 2011 is as follows:

Fiscal Year
2012	$	112,166
2013		21,253
Total minimum lease payments		133,419

15. Segment Information

We acquired PDSG in a series of transactions in the second, third and fourth quarters of fiscal 2009 and consolidate our wholly-owned subsidiary PDSG in our consolidated financial statements. PDSG provides data sharing services and products to the public sector. There is no inter-segment revenue and the accounting policies for segment reporting are the same as for us as a whole.

This reportable segment is a strategic business unit that is managed separately because it requires different technology and marketing strategies.

Operating segment net revenue, operating loss and loss before taxes for each of the years ended May 31 were as follows:

F-35

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Segment Information (continued)

	2011			2010
Net revenue:
PDSG	$	468,678		$	567,934
PTSC		-			-
Total net revenue	$	468,678		$	567,934
Operating loss:
PDSG	$	(3,888,358	)	$	(8,948,008	)
PTSC		(2,550,666	)		(3,816,007	)
Total operating loss	$	(6,439,024	)	$	(12,764,015	)
Loss before income taxes:
PDSG	$	(3,827,595	)	$	(8,756,032	)
PTSC		(1,450,261	)		(1,852,146	)
Total loss before income taxes	$	(5,277,856	)	$	(10,608,178	)
Provision (benefit) for income taxes:
PDSG	$	4,267,167		$	(2,996,841	)
PTSC		1,970,367			(931,516	)
Total provision (benefit) for income taxes	$	6,237,534		$	(3,928,357	)

All PDSG sales were to unaffiliated customers within the United States, with the exception of a hosting arrangement with a customer in Japan.

Sales and accounts receivable concentration information for PDSG as of and for the year ended May 31, 2011 and 2010 was as follows:

	2011						2010
	Sales		% of sales		% of A/R		Sales		% of sales		% of A/R
Customer A	$	136,229		29%		-	$	281,141		50%		22%
Customer B	$	23,928		5%		13%	$	106,064		19%		72%
Customer C	$	81,642		17%		15%		-		-		-
Customer D	$	151,323		32%		71%		-		-		-

Operating segment depreciation and amortization for each of the years ended May 31 and total assets at May 31 were as follows:

	2011		2010
Depreciation and amortization:
PDSG	$	267,797	$	588,806
PTSC		9,366		13,420
Total depreciation and amortization	$	277,163	$	602,226

F-36

Patriot Scientific Corporation

Notes to Consolidated Financial Statements (Continued)

Segment Information (continued)

	2011		2010
Total assets:
PDSG	$	399,560	$	7,227,033
PTSC		12,197,843		20,188,648
Total assets	$	12,597,403	$	27,415,681

16. Subsequent Events

During the period June 1, 2011 through August 12, 2011, we purchased 554,089 shares of our common stock at an aggregate cost of $43,023 pursuant to our stock buyback program.

In July 2011 we received $38,985 from Deutsche Bank relating to partial redemptions of auction rate securities occurring on June 1, 2011. Such amount is a recovery on the $600,879 realized loss on sale of marketable securities recognized during the fiscal year ended May 31, 2011. Deutsche Bank had repurchased our illiquid auction rate securities pursuant to our settlement agreement with them in September 2010.

On August 4, 2011 we received a refund of federal taxes in the amount of $400,042 relating to the NOL carryback for the fiscal year ended May 31, 2009.

F-37

Phoenix Digital Solutions, LLC

INDEX TO FINANCIAL STATEMENTS

		Page

Report of Independent Registered Public Accounting Firm		F-39

Financial Statements:

Balance Sheets		F-40

Statements of Income		F-41

Statements of Members’ Equity		F-42

Statements of Cash Flows		F-43

Notes to Financial Statements		F-44

F-38

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Members

Phoenix Digital Solutions, LLC

We have audited the accompanying balance sheets of Phoenix Digital Solutions, LLC (the "Company") as of May 31, 2011 and 2010, and the related statements of income, members' equity and cash flows for each of the two years in the period ended May 31, 2011. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above, present fairly, in all material respects, the financial position of Phoenix Digital Solutions, LLC as of May 31, 2011 and 2010, and the results of its operations and its cash flows for each of the two years in the period ended May 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As more fully described in Note 1 to the financial statements, the Company has experienced a decline in license revenues and because of the uncertain nature of the negotiations that lead to license revenues, there is no assurance that the Company will receive any future revenues from license agreements, or if it does, that such license revenues in the future will be consistent with amounts received in the past. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern.

/s/ KMJ Corbin & Company LLP

Costa Mesa, California

August 29, 2011

F-39

Phoenix Digital Solutions, LLC

Balance Sheets

May 31,	2011		2010
ASSETS

Current assets:
Cash and cash equivalents	$	1,895,653	$	779,932
Prepaid expenses		600,000		25,000
Licenses receivable		-		2,000,000
Total assets	$	2,495,653	$	2,804,932

LIABILITIES AND MEMBERS’ EQUITY

Current liabilities:
Related party payables and accrued expenses	$	1,883,296	$	1,777,884
LLC tax payable		11,790		11,790

Total liabilities		1,895,086		1,789,674

Commitments and Contingencies

Members’ equity		600,567		1,015,258

Total liabilities and members’ equity	$	2,495,653	$	2,804,932

See accompanying notes to financial statements.

F-40

Phoenix Digital Solutions, LLC

Statements of Income

Years Ended May 31,	2011		2010

License revenues	$	11,090,000	$	14,278,855

Operating expenses:
General and administrative		9,922,580		5,301,273

Operating income		1,167,420		8,977,582

Other income:
Interest and other income		46,091		588

Income before LLC taxes		1,213,511		8,978,170

Provision for LLC taxes		12,590		11,790

Net income	$	1,200,921	$	8,966,380

See accompanying notes to financial statements.

F-41

Phoenix Digital Solutions, LLC

Statements of Members’ Equity

Balance June 1, 2009	$	6,004,533
Contributions		1,160,000
Net income		8,966,380
Distributions		(15,115,655	)
Balance May 31, 2010		1,015,258
Net income		1,200,921
Distributions		(1,615,612	)
Balance May 31, 2011	$	600,567

See accompanying notes to financial statements.

F-42

Phoenix Digital Solutions, LLC

Statements of Cash Flows

Years Ended May 31,	2011			2010

Operating activities:
Net income	$	1,200,921		$	8,966,380
Adjustments to reconcile net income to net cash provided by operating activities:
Changes in operating assets and liabilities:
Prepaid expenses		(575,000	)		(25,000	)
Licenses receivable		2,000,000			4,148,750
Related party payables and accrued expenses		105,412			290,085
LLC tax payable		-			11,790
Net cash provided by operating activities		2,731,333			13,392,005

Financing activities:
Contributions from members		-			1,160,000
Distributions to members		(1,615,612	)		(15,115,655	)
Net cash used in financing activities		(1,615,612	)		(13,955,655	)

Net increase (decrease) in cash and cash equivalents		1,115,721			(563,650	)
Cash and cash equivalents, beginning of year		779,932			1,343,582
Cash and cash equivalents, end of year	$	1,895,653		$	779,932

Supplemental Disclosure of Cash Flow Information
Cash payments for income taxes	$	12,590		$	800

See accompanying notes to financial statements.

F-43

Phoenix Digital Solutions, LLC

Notes to Financial Statements

1. Organization and Business

Phoenix Digital Solutions, LLC (the “Company”) is a Delaware limited liability company organized on June 7, 2005. Through a commercialization agreement dated June 7, 2005, the Company holds the rights to certain patents of its members. The Company receives license fees from license agreements entered into between licensees and a member of the Company and distributes license fee proceeds to its members.

Going Concern and Management’s Plans

The Company’s financial statements have been prepared using the accrual method of accounting in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities in the normal course of business.

During the years ended May 31, 2011 and 2010, the Company has experienced a decline in license revenues. At August 26, 2011, the Company’s cash and cash equivalents balance was $689,169. The ability of PDS to continue as a going concern is dependent on its ability to generate or obtain sufficient cash to meet its obligations on a timely basis. The Company will need to generate proceeds from new license agreements or obtain equity or debt financing to fund its planned operating expenses and working capital requirements for the foreseeable future. Currently, the Company has no commitments to obtain additional capital from sources outside of that which may be contributed by the members, and there can be no assurance that financing will be available in amounts or on terms acceptable to the Company, if at all.

Because of the uncertain nature of the negotiations that lead to license revenues, pending litigation with companies which the members believe have infringed on their patent portfolio, the possibility of legislative action regarding patent rights, the possible effect of new judicial interpretations of patent laws, and current litigation between the members of PDS, there is no assurance that the Company will receive any future revenues from license agreements, or if it does, that such license revenues in the future will be consistent with amounts received in the past.

In the event the Company is unable to successfully generate proceeds from license agreements at historical levels or obtain additional capital, it is unlikely that the Company will have sufficient cash flows and liquidity to finance its business operations as currently contemplated. Accordingly, in the event new financing is not obtained, the Company will likely reduce general and administrative expenses, including legal fees, litigation activity and other licensing costs, until it is able to obtain sufficient financing to do so.

Management believes that its current sources of funds and current liquid assets will allow the Company to continue as a going concern through at least September 30, 2011. As such, these financial statements do not include any adjustments that might result from the outcome of this uncertainty.

2. Summary of Significant Accounting Policies

Limited Liability Company Operating Agreement

As a limited liability company, each member’s liability is limited to the capital invested. Allocation of profits, losses and distributions is in accordance with the terms as defined in the operating agreement.

The Company is treated as a partnership for federal income tax purposes. Consequently, federal income taxes are not payable by the Company. The Company’s net income or loss is allocated among the members in accordance with the operating agreement of the Company and members are taxed individually on their share of the Company’s earnings. The State of California assesses a limited liability company fee based on the Company’s income in addition to a flat limited liability company tax. Accordingly the financial statements reflect a provision for these California taxes.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts and disclosures. Accordingly, actual results could differ from those estimates.

F-44

Phoenix Digital Solutions, LLC

Notes to Financial Statements (Continued)

Summary of Significant Accounting Policies (continued)

Revenue Recognition

The Company recognizes revenue when all obligations are satisfied under the license agreement and realization of the revenue is assured, which is generally upon receipt of the license proceeds (see Note 3).

Cash Equivalents

The Company considers all highly liquid investments with a maturity of three months or less at the date of acquisition to be cash equivalents.

Financial Instruments and Concentrations

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents.

Credit Risk

At May 31, 2011, the Company’s cash and cash equivalents balance consisting of its checking account balance over the FDIC insurance limit and its money market account not subject to FDIC insurance was $1,645,653.

At May 31, 2010, the Company’s cash and cash equivalents balance consisting of money market accounts not subject to FDIC insurance was $779,932. The Company limits its exposure of loss by maintaining its cash with a financially stable financial institution.

Legal Fees

For the years ended May 31, 2011 and 2010, one legal service provider accounted for $5,024,404 and $1,038,568, respectively, of legal costs associated with the litigation of the MMP patent portfolio. These amounts are included in general and administrative expense in the accompanying statements of income.

Intellectual Property Rights

The Company relies on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. The Company currently has seven U.S. patents, one European patent, and one Japanese patent issued. A successful challenge to its ownership of the technology or the proprietary nature of the intellectual property would materially damage the Company’s business prospects. Any issued patent may be challenged and invalidated.

3. Prepaid Expenses

At May 31, 2011 prepaid expenses consist of the June 1, 2011 $500,000 quarterly amount for supporting efforts to secure licensing agreements by TPL on behalf of PDS of which TPL requested early payment in May 2011 and a $100,000 retainer for the attorney representing TPL in the HTC/Acer/Barco litigation.

At May 31, 2010 prepaid expenses consist of a retainer in the amount of $25,000 for the attorney presenting the Company in the dispute between TPL and PTSC regarding the Commercialization Agreement.

4. Licenses Receivable

The Company generally recognizes revenue upon receipt of the license proceeds from the licensee at which time all obligations of the Company have been performed under the license agreements.

At May 31, 2010, the balance in licenses receivable consists of a license agreement for which partial payment was made in fiscal 2010 and the remaining payment of $2,000,000 was received by the Company during July 2010.

F-45

Phoenix Digital Solutions, LLC

Notes to Financial Statements (Continued)

5. Formation and Commercialization Agreement

The Company has two members: Technology Properties Limited Inc. (“TPL”), and Patriot Scientific Corporation (“PTSC”). Each member owns 50% of the membership interests of the Company. Each member has the right to appoint one member of the three member management committee. The two appointees are required to select a mutually acceptable third member of the management committee.

Pursuant to the LLC Agreement, the members agreed to establish a working capital fund for the Company of $4,000,000, of which each member contributed $2,000,000. The working capital fund increases to a maximum of $8,000,000 as license revenues are achieved. The members are obligated to fund future working capital requirements at the discretion of the management committee of the Company in order to maintain working capital of not more than $8,000,000. Neither member is required to contribute more than $2,000,000 in any fiscal year. During the fiscal year ended May 31, 2010 PTSC and TPL each contributed $580,000 to the Company for working capital requirements. No such contributions were made during the fiscal year ended May 31, 2011. Distributable cash and allocation of profits and losses are allocated to the members in the priority defined in the LLC Agreement.

On June 7, 2005, the Company entered into a Commercialization Agreement with TPL and PTSC. This Commercialization Agreement allows TPL to commercialize the patent portfolio by entering into settlement and/or license agreements, suing in the name of TPL, PTSC, the Company and Charles Moore, and manage the use of the patent portfolio by third parties.

Under terms of the Commercialization Agreement, the Company is required to pay a quarterly amount ranging between $500,000 and $1,000,000 (based upon a percentage of the working capital fund balance) to TPL for TPL’s supporting efforts to secure licensing agreements for the Company. During the years ended May 31, 2011 and 2010, the Company expensed $2,500,000 and $1,500,000, respectively, pursuant to the agreement. The Company is also required to reimburse TPL for payment of all legal and third-party expert fess and other related third party costs and expenses. During the years ended May 31, 2011 and 2010, the Company expensed $6,833,708 and $3,684,154, respectively, pursuant to the agreement.

On August 17, 2009, the Company’s management committee resolved to pay TPL $500,000 per quarter beginning on June 1, 2009 and continuing through May 31, 2010 relating to TPL’s special work and effort regarding the MMP litigation and U.S. Patent Office re-examinations. In the event that the Company had insufficient funds to make such payments, PTSC was required to advance half of the quarterly amount to the Company. PTSC’s advances to the Company were to be without interest and were to be repaid to PTSC no later than May 31, 2010. During the fiscal year ended May 31, 2010, TPL received $1,500,000 from the Company pursuant to this agreement which is included in the fiscal 2010 legal and third-party expenses above. PTSC did not advance any funds to the Company or TPL under this resolution. On May 31, 2010, the resolution terminated. On January 19, 2011, in accordance with PTSC’s settlement agreement with TPL, PDS agreed to pay TPL an additional $750,000 pursuant to this agreement representing reimbursement of special litigation support costs incurred by TPL.

All of the amounts are recorded in general and administrative expense in the accompanying statements of income.

During April 2010, PTSC filed two separate actions against TPL in the Superior Courts of San Diego and Santa Clara counties. PTSC and TPL had been in negotiations to restructure their relationship. On January 19, 2011, PTSC settled the San Diego Superior Court action.

On July 15, 2010, the Company paid PTSC $1,003,095 consisting of principal and interest through July 15, 2010 on PTSC’s $950,000 secured note with TPL for which the Company was jointly and severally liable. This amount had been recorded as a note receivable from TPL on the Company’s balance sheet on July 15, 2010. Due to TPL’s inability to pay the note, it was fully reserved for at July 15, 2010 and the allowance was recorded as “Reserve for loan loss and uncollectable receivable” on the Company’s statement of operations for the six months ended November 30, 2010. On January 19, 2011, pursuant to PTSC’s settlement agreement with TPL, $1,048,903 consisting of principal and interest through January 2011 was applied against the March 1, 2010 and June 1, 2010 $500,000 quarterly expense amounts payable to TPL in accordance with the LLC Agreement for supporting efforts to secure licensing agreements and a portion of the fiscal 2010 special litigation support payments owed to TPL by the Company. The Company has paid TPL in cash for the September 1, 2010 and subsequent quarters’ expense amounts pursuant to the LLC Agreement for supporting efforts to secure licensing agreements.

F-46

Phoenix Digital Solutions, LLC

Notes to Financial Statements (Continued)

Formation and Commercialization Agreement (continued)

During June 2010, the Company advanced Alliacense, LLC TPL’s intellectual property licensing enterprise $410,000 to fund payroll and rent obligations. Due to non-payment by Alliacense, this amount was fully reserved for at August 31, 2010 and the allowance was recorded as “Reserve for loan loss and uncollectable receivable” on the Company’s statement of operations for the six months ended November 30, 2010. On January 19, 2011, pursuant to PTSC’s settlement agreement with TPL, the $410,000 was applied against the fiscal 2010 special litigation support payments owed to TPL by the Company.

On January 19, 2011, pursuant to PTSC’s settlement agreement with TPL, the Company agreed to pay TPL $67,000 per month from September 1, 2010 to April 30, 2011 relating to TPL’s special work and effort regarding internal costs related to litigation support and patent re-examinations.

6. Commitments and Contingencies

Litigation

On April 22, 2010, PTSC filed an action against TPL and Alliacense LLC in Santa Clara Superior Court alleging claims for breach of contract, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and interference with contract, constructive fraud, for preliminary and permanent injunctions and for an accounting. The Action stemmed from TPL's notification of a license written in April 2010 which included a license of the MMP patents and other patent to use portfolios and technologies co-owned and potentially owned by TPL in the future. PTSC objected to the amount of license consideration allocated to the MMP patent license as too low relative to the other license components.

On April 26, 2010, the Court granted PTSC's application for a Temporary Restraining Order ("TRO") precluding TPL from executing any license of the MMP patents without providing PTSC five business days' notice of the proposed MMP license and any other proposed license with the licensor, in order to allow PTSC time to seek redress if PTSC is dissatisfied by the proposed licenses. At that time, TPL filed motions to seal the file and to bar press releases commenting on the contents of the court file, and a motion to compel private arbitration of the dispute.

Guarantees and Indemnities

Under the LLC Operating Agreement, the Company indemnifies its members, managers, officers and employees from any damages and liabilities by reason of their management or involvement in the affairs of the Company as long as the indemnitee acted in good faith and in the best interests of the Company.

Under the Commercialization Agreement, the Company and PTSC hold harmless TPL and its representatives with respect to all claims of any nature by or on behalf of the Company and PTSC related to the preparation, execution and delivery of the Commercialization Agreement.

F-47

Phoenix Digital Solutions, LLC

Notes to Financial Statements (Continued)

Commitments and Contingencies (continued)

The duration of the guarantees and indemnities varies, and in many cases is indefinite. These guarantees and indemnities do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. Historically, the Company has not been obligated to make any payments for these obligations and no liabilities have been recorded for these guarantees and indemnities in the accompanying balance sheets.

7. Related Party Transactions

Significant related party transactions between the Company and TPL are described in Note 5 “Formation and Commercialization Agreement.”

During the fiscal year ended May 31, 2010 TPL and PTSC each contributed $580,000 to the Company for working capital obligations.

During the fiscal years ended May 31, 2011 and 2010, the Company expensed $204,498 and $14,677, respectively, for reimbursement of legal and related fees incurred by PTSC due to patent litigation.

At May 31, 2011, the Company had accounts payable balances of approximately $1,754,000 and $129,400 to TPL and PTSC, respectively, for direct expenses incurred by TPL and PTSC.

At May 31, 2010, the Company had accounts payable balances of approximately $1,724,000 and $7,000 to TPL and PTSC, respectively, for direct expenses incurred by TPL and PTSC.

F-48

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

DATED: August 29, 2011

PATRIOT SCIENTIFIC CORPORATION

/S/ CLIFFORD L. FLOWERS

Clifford L. Flowers

Interim Chief Executive Officer and Chief Financial Officer

(Duly Authorized and Principal Financial Officer)