Mosaic ImmunoEngineering Inc. - Quarter Report: 2013 February (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended February 28, 2013

OR

For the transition period from ___________ to _______________

Commission File Number 0-22182

PATRIOT SCIENTIFIC CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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 [X]  NO [  ]

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):

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

On April 10, 2013, 405,172,405 shares of common stock, par value $0.00001 per share were outstanding.

INDEX

PART I- FINANCIAL INFORMATION

Item 1. Financial Statements

Patriot Scientific Corporation

Condensed Consolidated Balance Sheets

See accompanying notes to unaudited condensed consolidated financial statements

Condensed Consolidated Statements of Operations

(Unaudited)

Patriot Scientific Corporation

Condensed Consolidated Statements of Cash Flows

(Unaudited)

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

1.  Basis of Presentation and Summary of Significant Accounting Policies

The unaudited condensed consolidated financial statements of Patriot Scientific Corporation (the “Company”, “PTSC”, “Patriot”, “we”, “us” or “our”) presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in our Report on Form 10-K for our fiscal year ended May 31, 2012.

In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the results for the interim period presented.  Operating results for the nine month period ended February 28, 2013 are not necessarily indicative of the results that may be expected for the year ending May 31, 2013.

Subsequent events have been evaluated through the issuance date of these unaudited condensed consolidated financial statements.

Basis of Consolidation

The condensed consolidated balance sheets at February 28, 2013 and May 31, 2012 include our accounts and those of our wholly owned subsidiary Patriot Data Solutions Group, Inc. (“PDSG”) which includes Crossflo Systems, Inc. (“Crossflo”), and our inactive subsidiary Plasma Scientific Corporation.  All significant intercompany accounts and transactions have been eliminated.

The condensed consolidated statements of operations for the three and nine months ended February 28, 2013 and February 29, 2012 includes our accounts, and those of our wholly owned subsidiary PDSG which includes Crossflo, and our inactive subsidiary Plasma Scientific Corporation.  All significant intercompany accounts and transactions have been eliminated.

PDSG is being presented as discontinued operations in the condensed consolidated statements of operations for all periods presented.  See “Discontinued Operations” below for additional information.

Reclassification

Certain amounts presented in the prior period’s condensed consolidated financial statements related to discontinued operations and interest and other income have been reclassified to conform to the current period’s presentation.  Certain amounts presented in the prior period’s condensed consolidated statement of cash flows related to realized recovery on sale of marketable securities and proceeds from the sale of marketable securities have been reclassified to conform to the current period’s presentation.

Our investments in certificates of deposit have been reclassified from Level 1 to Level 2 in the fair value measurements table (see Note 2).

Discontinued Operations and Assets Held for Sale

On February 17, 2012, our board of directors authorized management to sell the assets of PDSG due to the inability of PDSG to meet its business plan and continuing projected negative cash flows.  In accordance with authoritative guidance we have classified the assets, liabilities, operations and cash flows of PDSG as discontinued operations for all periods presented.  During March 2012, we entered into an interim agreement with the purchaser of the assets of PDSG which required the purchaser to pay PDSG $93,450 to subsidize the April 2012 expenses of PDSG during the sale transaction negotiations. On April 30, 2012, we negotiated a sale transaction in which we sold substantially all of the assets of PDSG in exchange for a royalty on PDSG revenues for a period of three years.  At February 28, 2013, the loss on the asset sale of PDSG is approximately $6,300.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Discontinued Operations and Assets Held for Sale (continued)

Summarized operating results of discontinued operations for the three and nine months ended February 28, 2013 and February 29, 2012 are as follows:

PDSG activity for the three and nine months ended February 28, 2013 consists of operating expenses for: legal, insurance, taxes and bank fees offset by PDSG royalty revenues.

The following table summarizes the carrying amount at February 28, 2013 and May 31, 2012 of the major classes of assets and liabilities of PDSG classified as discontinued operations:

Liquidity and Management’s Plans

To the extent cash shortfalls are experienced by Phoenix Digital Solutions, LLC (“PDS”) it will have an adverse effect on our liquidity. During fiscal 2012, we contributed $650,000 in additional capital to PDS, in order to fund a portion of a legal retainer.  During the nine months ended February 28, 2013, we and Technology Properties Limited, Inc. (“TPL”) each contributed $1,097,808 to fund the remaining portions of the legal retainer and the operations of PDS.  During November 2012, December 2012 and February 2013, we received distributions from PDS of $625,000, $350,000 and $175,000, respectively. We have determined that it is in the best interests of the Moore Microprocessor Patent (“MMP”) licensing program that we contribute our 50% share of additional capital to PDS for its operating expenses when license revenues received by PDS are insufficient to pay such expenses.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Liquidity and Management’s Plans (continued)

As the litigation with HTC Corporation, and Acer, Inc., in the United States District Court for the Northern District of California (“U.S. District Court”), and the actions with the U.S. International Trade Commission (“ITC”) Investigation No. 337-TA-853 progress, PDS is incurring significant third-party costs for expert testimony, depositions and other related legal costs.  While the costs going forward for legal representation are principally under a contingency arrangement and the need for litigation support and the associated costs from Alliacense Limited, LLC (“Alliacense”, an affiliate of TPL) is expected to decrease, these third-party costs remain significant.  We will be required to make capital contributions to PDS for these costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.

Our current liquid cash resources as of February 28, 2013, are expected to provide the funds necessary to support our operations through at least the next twelve months.  The cash flows from our interest in PDS represent our only significant source of cash generation. In the event of a continued decrease or interruption in MMP Portfolio licensing we will incur a significant reduction to our cash position. It is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and short-term investment position of $7,220,087 at February 28, 2013.

On March 20, 2013, TPL filed a petition under Chapter 11 of the United States Bankruptcy Code (see Note 8).  We have been appointed to the creditors’ committee and will be closely monitoring the progress in this matter as it relates to our interest in PDS. In the event that we provide funding to PDS that is not reciprocated by TPL, which would result in our having a larger ownership percentage in PDS, we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our consolidated financial statements.  If we determine that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their fair values at the date that we have the controlling financial interest.

Investments in Marketable Securities

We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date.  Our investments in marketable securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities.  Available-for-sale marketable securities are stated at fair market value.  Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss).  We follow the authoritative guidance to assess whether our investments with unrealized loss positions are other than temporarily impaired.  Realized gains and losses and declines in fair value judged to be other than temporary are determined based on the specific identification method and are reported in other income (expense), net in the condensed consolidated statements of operations.

Investment in Affiliated Company

We have a 50% interest in PDS (see Note 3).  As of the date of this filing, PDS is a variable interest entity (“VIE”) of which we are not the primary beneficiary and therefore we do not consolidate PDS’ financial statements 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 condensed consolidated statements of operations in the caption “Equity in earnings (loss) of affiliated company” and also is adjusted by contributions to and distributions from PDS.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

PDS, as an unconsolidated equity investee, recognizes revenue from technology license agreements at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), obligations under the license agreement are satisfied, and the realization of revenue is assured which is generally upon the receipt of the license proceeds. PDS may at times enter into license agreements whereby contingent revenues are recognized as one or more contractual milestones are met.

At February 28, 2013 and May 31, 2012, our share of loss in PDS exceeds our investment in PDS by $854,618 and $740,824, respectively. These amounts are recorded as “Cumulative losses in excess of investment in affiliated company” on our condensed consolidated balance sheets at February 28, 2013 and May 31, 2012, due to our and TPL’s intent to fund the working capital requirements of PDS.

At February 28, 2013 and May 31, 2012, our investment in PDS is presented as a liability pursuant to accounting principles generally accepted in the United States of America.  In the event our investment in PDS was to reflect an asset balance, we would review our investment in an affiliated company to determine whether events or changes in circumstances indicate that an asset carrying amount may not be recoverable. The primary factors we would consider in our determination are the financial condition, operating performance and near term prospects of the investee. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.

Earnings Per Share

Basic net loss per share for continuing and discontinued operations 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 for continuing and discontinued operations reflect the potential dilution of securities that could share in the earnings of an entity.

For the three and nine months ended February 28, 2013 and February 29, 2012 potential common shares of 825,000 and 2,450,000, respectively, related to our outstanding options were not included in the calculation of diluted loss per share for continuing and discontinued operations as we recorded a loss. Had we reported net income for the three months ended February 28, 2013 and February 29, 2012, an additional 825,000 and 0, respectively, shares of common stock would have been included in the calculation of diluted income per share for continuing and discontinued operations. Had we reported net income for the nine months ended February 28, 2013 and February 29, 2012, an additional 650,000 and 0, respectively, shares of common stock would have been included in the calculation of diluted income per share for continuing and discontinued operations.

In connection with our acquisition of Crossflo, which is now a part of PDSG, we issued escrow shares that are contingent upon certain representations and warranties made by Crossflo at the time of the merger agreement (see Note 6).  We exclude these escrow shares from the basic loss per share calculations. Had we reported net income for the three and nine months ended February 28, 2013 and February 29, 2012, the escrowed shares would have been included in the diluted income per share calculations.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Income Taxes

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

We follow authoritative guidance to evaluate whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  In making such judgments, significant weight is given to evidence that can be objectively verified.

We are assessing our deferred tax assets under more likely than not scenarios in which they may be realized through future income.

We have determined that it was not more likely than not that all of our deferred tax assets will be realized in the future due to our continuing pre-tax and taxable losses.  As a result of this determination we have placed a full valuation allowance against our deferred tax assets.

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

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.

2. Cash, Cash Equivalents, Restricted Cash and Marketable Securities

We consider all highly liquid investments with original maturities of three months or less to be cash equivalents.

Restricted cash and cash equivalents at February 28, 2013 and May 31, 2012 consist of deposits in a savings account required to be held as collateral for our corporate credit card.

At February 28, 2013 and May 31, 2012, the current portion of our investments in certificates of deposit in the amount of $2,341,871 and $2,907,106, respectively, consists of the par value plus accrued interest of our certificates of deposit.  At May 31, 2012, the non-current portion of our investments in certificates of deposit in the amount of $229,045 consists of the par value plus accrued interest of our certificates of deposit.  Our investments in certificates of deposit are classified as held-to-maturity.  At February 28, 2013 and May 31, 2012, the fair value of these investments approximates their cost basis.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Cash, Cash Equivalents, Restricted Cash and Marketable Securities (continued)

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

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

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

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

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

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Cash, Cash Equivalents, Restricted Cash and Marketable Securities (continued)

Beginning in fiscal 2011, we purchased certificates of deposit with varying maturity dates greater than three months.  The following table summarizes the maturities, gross unrealized gains or losses and fair value of the certificates of deposit as of February 28, 2013:

The following table summarizes the maturities, gross unrealized gains or losses and fair value of the certificates of deposit as of May 31, 2012:

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

3. Investment in Affiliated Company

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

We and TPL each own 50% of the membership interests of PDS, and each member has the right to appoint one member of the three member management committee. The two appointees are required to select a mutually acceptable third member of the management committee. There has not been a third management committee member since May 2010, nor are there any current attempts to seek a replacement member. Pursuant to the LLC Agreement, we and TPL initially agreed to establish a working capital fund for PDS of $4,000,000, of which our contribution was $2,000,000. The working capital fund was increased to a maximum of $8,000,000 as license revenues are achieved. We and TPL are obligated to fund future working capital requirements at the discretion of the management committee of PDS in order to maintain working capital of not more than $8,000,000. If the management committee determines that additional capital is required, neither we nor TPL are required to contribute more than $2,000,000 in any fiscal year. Since there is currently not a third member of the management committee, working capital contributions made to PDS require the approval of both management committee members. During the nine months ended February 28, 2013 we and TPL each contributed $1,097,808 to fund the remaining portions of the legal retainer and the operations of PDS.  Distributable cash and allocation of profits and losses have been allocated to the members in the priority defined in the LLC Agreement.

Pursuant to our June 7, 2005 agreement with PDS and TPL to license the MMP Portfolio (“Commercialization Agreement”), PDS had committed to pay a quarterly amount ranging between $500,000 and $1,000,000 (based upon a percentage of the working capital fund balance of PDS) for supporting efforts to secure licensing agreements by TPL on behalf of PDS. During the nine months ended February 28, 2013 and February 29, 2012, PDS expensed $185,000 and $1,500,000, respectively, pursuant to this commitment. These expenses are recorded in the accompanying PDS statements of operations presented below.  These expenses concluded with the execution of the July 11, 2012 Licensing Program Services Agreement (the “Program Agreement”).

PDS reimburses TPL for payment of all legal and third-party expert fees and other related third-party costs and other expenses, although the majority of third-party costs are paid directly by PDS. During the nine months ended February 28, 2013 and February 29, 2012, PDS expensed $2,593,099 and $5,412,451, respectively, pursuant to the agreement.  While as a result of the fee arrangement with current litigation counsel we expect the attorney fees of PDS to decrease substantially from fiscal year end 2012 levels, we also expect some offsetting increase for other litigation related costs as the actions before the U.S. District Court and the ITC move forward.  These expenses are recorded in the accompanying PDS statements of operations presented below.

On July 11, 2012, we entered into the Program Agreement executed by PDS, TPL, PTSC, and Alliacense and an Agreement (the “TPL Agreement”) with TPL. Pursuant to the Program Agreement, PDS engaged Alliacense to negotiate MMP portfolio licenses and to pursue claims against violators of the MMP portfolio on behalf of PDS, TPL, and the Company. The Program Agreement continues through the useful life of the MMP portfolio patents. Pursuant to the TPL Agreement, we and TPL agreed to certain allocations of obligations in connection with the engagement of Alliacense.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

On July 17, 2012, we entered into an Agreement with PDS and TPL whereby we agreed to certain additional allocations of obligations relating to the Program Agreement.

Pursuant to the Program Agreement, PDS has committed to Alliacense a quarterly amount of $500,000 which represents the licensing services fees due Alliacense, subject to a contingency arrangement which provides for a percentage on future revenues, for its efforts to secure licensing agreements on behalf of PDS. These payments can be capped at $2,000,000 pursuant to six-month notice from PDS, at which time the PDS management committee will review and decide the warranting of future payments. These payments replace the quarterly amounts previously paid to TPL pursuant to the Commercialization Agreement. During the three and nine months ended February 28, 2013 PDS expensed $500,000 and $1,315,000, respectively pursuant to this contingency commitment. These expenses are recorded in the accompanying PDS statement of operations for the three and nine months ended February 28, 2013 presented below.

Pursuant to the Program Agreement, PDS has committed to pay Alliacense litigation support fees relating to Alliacense’s special work and effort regarding internal costs related to MMP maintenance and litigation support including support in the U.S. District Court and the complaints filed on behalf of TPL, PDS and us with the ITC.  During the three and nine months ended February 28, 2013, PDS expensed $297,596 and $1,751,117, respectively, pursuant to this commitment.  Future litigation support payments to Alliacense relating to the ITC litigation are subject to a contingency arrangement which provides for a percentage of future recoveries in these actions. These expenses are recorded in the accompanying PDS statement of operations for the three and nine months ended February 28, 2013 presented below.

During January 2013, TPL and Moore settled their litigation. Terms of the settlement include the payment by PDS to Moore of a consulting fee of $250,000 for four years or until the completion of all outstanding MMP litigation whichever comes first. Per terms of the agreement PDS paid Moore $150,000 on the settlement date and will pay Moore $16,667 per month from July through December 2013 and $20,833 per month beginning January 2014 through December 2016.  Terms of the settlement also require Moore to receive an advisory seat on the PDS Operating Committee effective February 1, 2013.

We are accounting for our investment in PDS under the equity method of accounting, and accordingly have recorded our share of PDS’ net loss during the three months ended February 28, 2013 of $601,929 as a decrease in our investment. We have recorded our share of PDS’ net income during the nine months ended February 28, 2013 of $75,666 as an increase in our investment. We have recorded PDS’ net loss during the three and nine months ended February 29, 2012 of $105,000 and $632,551, respectively, as a decrease in our investment.  During the nine months ended February 28, 2013, we received cash distributions of $1,150,000. We received no cash distributions for the nine months ended February 29, 2012. These distributions have been recorded as a decrease in our investment.

During the fiscal year ended May 31, 2012, we accounted for an advance of $227,268 for legal services, which are reimbursable by PDS as equity in loss of PDS, under the equity method of accounting given that this amount remained unreimbursed at May 31, 2012. During the fiscal year ended May 31, 2012, we advanced PDS $10,000 for legal services and received $100,000 in payment on previous advances. During the three months ended November 30, 2012 we received a total of $229,157 which represented the balance due us on legal services advanced to PDS in prior fiscal periods. During December 2012, we received approximately $7,012 from PDS for legal services incurred during the three months ended November 30, 2012. At February 28, 2013, our receivable from PDS of $10,285 represents advances for February 2013 legal services.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

At February 28, 2013 and May 31, 2012, our share of loss in PDS exceeded our investment in PDS by $854,618 and $740,824, respectively.  These amounts are recorded as “Cumulative losses in excess of investment in affiliated company” on our condensed consolidated balance sheets at February 28, 2013 and May 31, 2012.

We have recorded our share of PDS’ net income and loss for the nine months ended February 28, 2013 and February 29, 2012 as “Equity in earnings (loss) of affiliated company” in the accompanying condensed consolidated statements of operations.

During the three and nine months ended February 28, 2013, PDS entered into licensing agreements with third parties, pursuant to which PDS recognized revenues of $0 and $4,820,000, respectively.

During the three and nine months ended February 28, 2013, PDS recognized revenues of $1,500,000 for license agreements previously entered into by TPL.

During the three and nine months ended February 29, 2012, TPL entered into licensing agreements with third parties, pursuant to which PDS recognized revenues of $2,452,000 and $3,009,300, respectively.

At February 28, 2013, PDS had a prepaid balance to Alliacense of $500,000 for advance payment of the March 1, 2013 quarterly payment.  At February 28, 2013, PDS had accounts payable balances of approximately $1,340,169, $215,219, and $10,000 to TPL, Alliacense, and PTSC, respectively. At May 31, 2012, PDS had accounts payable and accrued expense balances of approximately $1,340,169 and $137,000 to TPL and PTSC, respectively.

Variable Interest Entity Disclosures

At April 10, 2013, PDS’ cash and cash equivalents balance was $1,093.

For the period June 1, 2012 through February 28, 2013, we and TPL each contributed $1,097,808 to fund the operations of PDS.

Our variable interest in PDS consists of 50% of PDS’ Members Deficit of $(854,618) as well as the accounts payable balance due us of $10,285 for a total of $(864,903) at February 28, 2013.

On March 20, 2013, TPL filed a petition under Chapter 11 of the United States Bankruptcy Code (see Note 8).  We have been appointed to the creditors’ committee and will be closely monitoring the progress in this matter as it relates to our interest in PDS. In the event that we provide funding to PDS that is not reciprocated by TPL, which would result in our having a larger ownership percentage in PDS, we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our consolidated financial statements.  If we determine that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their fair values at the date that we have the controlling financial interest.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

PDS’ balance sheets at February 28, 2013 and May 31, 2012 and statements of operations for the three and nine months ended February 28, 2013 and February 29, 2012 are as follows:

Balance Sheets

ASSETS:

LIABILITIES AND MEMBERS’ EQUITY (DEFICIT):

Statements of Operations

PDS Related Party Balances And Transactions

Balances with related parties as of February 28, 2013 (unaudited) and May 31, 2012 are summarized as follows:

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

Transactions with related parties for the three and nine months ended February 28, 2013 and February 29, 2012 are as follows:

Significant Contractual Legal Relationship

PTSC through its unconsolidated affiliate, PDS has incurred legal fees from an unrelated law firm and legal subcontractors to provide substantial legal services for the commercialization of the MMP portfolio of microprocessor patents.

Accounts payable balances due this law firm and legal subcontractors as of February 28, 2013 and May 31, 2012 were $1,286,666 and $0, respectively.

Transactions with this law firm and legal subcontractors for the three and nine months ended February 28, 2013 and February 29, 2012 were as follows:

Contractual Commitments

In January 2013, PDS entered into a contractual commitment with a related party entity to provide consulting services at a cost of $250,000 per year for a duration of four years or the completion of all outstanding MMP litigation, whichever comes first.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

For the three and nine months ended February 28, 2013, PDS expensed $150,000 and $150,000, respectively, related to this agreement.

In connection with the Program Agreement, PDS is required to make payments to Alliacense of $500,000 no later than three days prior to the start of each calendar quarter. Such payments are non-accountable and non-recoupable, but are offset against the licensing series fees owed to Alliacense pursuant to the Program Agreement. Upon six months notice to Alliacense, and in conjunction with a proportionate reduction in the scope of the Project Description, as defined, PDS may determine to implement a maximum of advances not-yet-offset of $2,000,000.

4.   Income Taxes

We have determined that it was not more likely than not that all of our deferred tax assets will be realized in the future due to our continuing pre-tax and taxable losses.  As a result of this determination we have placed a full valuation allowance against our deferred tax assets.  There have been no changes to our determination during the current fiscal year.

5.   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.  As part of the program we purchased 563,553 and 1,578,616 shares of our common stock at an aggregate cost of $57,140 and $101,777 during the nine months ended February 28, 2013 and February 29, 2012, respectively.

Equity Transactions

The following table summarizes equity transactions during the nine months ended February 28, 2013:

Stock Option Activity

As of February 28, 2013, we had 825,000 fully vested options outstanding pursuant to our 2006 Stock Option Plan exercisable at a range of $0.10 to $0.12 per share expiring through 2015.  

During the nine months ended February 29, 2012, we recorded $14,968 of share-based compensation expense related to vesting of stock options granted to PDSG employees.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Stockholders’ Equity (continued)

Share-based Compensation

Summary of Assumptions and Activity

The fair value of share-based awards to employees and directors is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the pricing term of the grant effective as of the date of the grant.  No stock options were granted during the three and nine months ended February 28, 2013 and February 29, 2012.

A summary of option activity as of February 28, 2013 and changes during the nine months then ended, is presented below:

There were no options granted or exercised during the nine months ended February 28, 2013 or February 29, 2012.

The aggregate intrinsic value represents the differences in market price at the close of the quarter ($0.11 per share on February 28, 2013) and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.11) on February 28, 2013.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Stockholders’ Equity (continued)

The following table summarizes employee share-based compensation for PDSG for the three and nine months ended February 28, 2013 and February 29, 2012, which was recorded in loss from discontinued operations, net as follows:

6.  Commitments and Contingencies

Litigation

Patent Litigation

On February 8, 2008, we, TPL and Alliacense Ltd. were named as defendants in separate lawsuits filed in the United States District Court for the Northern District of California by HTC Corporation, and Acer, Inc., and affiliated entities of each of them.  (Those cases were related, and are referred to herein as the “N.D. Cal. Case”).

The Acer case seeks declaratory relief that its products do not infringe enforceable claims of the '336, ‘749, '148, and '890 patents.  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 in the N.D. Cal. Case.

The Court issued a first claim construction ruling in the N.D. Cal. Case on June 12, 2012, which preserved our ability to proceed on our infringement claims against Acer and HTC.  Thereafter, Chief Judge James Ware retired and the N.D. Cal. Case was reassigned to Magistrate Judge Paul S. Grewal, who held a supplemental claim construction hearing on November 30, 2012.  Judge Grewal then issued a supplemental claim construction ruling on December 5, 2012, which preserved our ability to proceed with our infringement claims. Judge Grewal has set the N.D. Cal. Case for jury trial starting on September 23, 2013.  However, the N.D. Cal. Case is currently stayed under 11 U.S.C. § 362(a) due to a filing under Chapter 11 by TPL. TPL has asked the bankruptcy court to lift the stay of the N.D. Cal. Case; and believes that the stay will likely be lifted by no later than April 24, 2013.

On July 24, 2012 complaints were filed on behalf of us, TPL, and PDS with the ITC (ITC Investigation No. 337-TA-853, or the “853 Investigation”) alleging infringement of the ‘336 patent, and in U.S. District Court for the Northern District of California alleging infringement of the ‘749, ‘890 and ‘336 patents against respondents Acer Inc., Amazon.com Inc., Barnes & Noble Inc., Garmin Ltd., HTC Corporation, Huawei Technologies Co. Ltd., Kyocera Corporation, LG Electronics, Nintendo Co. Ltd., Novatel Wireless Inc., Samsung Electronics Co. Ltd., Sierra Wireless Inc., and ZTE Corporation.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Commitments and Contingencies (continued)

Certain respondents moved for a stay of the 853 Investigation pending resolution of patent ownership and standing issues that are the subject of a pending lawsuit against TPL.  The ITC judge denied that motion in an order dated April 4, 2013.

Several respondents (Garmin and Sierra Wireless) also moved for termination of the 853 Investigation based on an alleged violation of the duty of candor. The ITC judge rejected that motion in an order dated December 18, 2012.

The ITC judge conducted a claim construction hearing on March 5, 2013, and is expected to issue a Markman ruling by no later than May 3, 2013. In addition, the 853 Investigation is currently set for a two week trial beginning on June 3, 2013.  All of the District Court Actions against the new parties (i.e., all respondents other than Acer and HTC) are currently stayed pending resolution of the 853 Investigation.

401(k) Plan

Patriot has a retirement plan that complies with Section 401(k) of the Internal Revenue Code. All employees are eligible to participate in the plan. Patriot matches 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 three months ended February 28, 2013 and February 29, 2012 were $2,739 and $4,592, respectively.  Patriot’s matching contributions during the nine months ended February 28, 2013 and February 29, 2012 were $7,584 and $13,357, respectively.

Guarantees and Indemnities

We have made certain guarantees and indemnities, under which we may be required to make payments to a guaranteed or indemnified party. We indemnify our directors, officers, employees and agents to the maximum extent permitted under the laws of the State of Delaware. In connection with our facility lease, we have indemnified our lessor for certain claims arising from the use of the facility. The duration of the guarantees and indemnities varies, and in many cases is indefinite. These guarantees and indemnities do not provide for any limitation of the maximum potential future payments we could be obligated to make. Historically, we have not been obligated to make any payments for these obligations and no liabilities have been recorded for these guarantees and indemnities in the accompanying condensed consolidated balance sheets.

Escrow Shares

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

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

7. Segment Information

Prior to the quarter ended February 29, 2012, we operated in two segments. PDSG was reflected as a separate reporting unit. On April 30, 2012, we sold substantially all of the assets of PDSG and we have classified PDSG as discontinued operations (see Note 1). As a result, we now operate in one segment.

8.  Subsequent Events

On March 20, 2013, TPL, our joint venture partner in PDS, filed a petition under Chapter 11 of the United States Bankruptcy Code. A creditors’ committee has been formed and we are a member of the committee. We intend to pursue all options to protect the financial condition and operations of PTSC and PDS and have retained legal counsel to represent our interests. Due to the recent timing of the TPL bankruptcy, we are unable to estimate the outcome, if any, on its financial condition or results of operations.

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

THE FOLLOWING DISCUSSION AND THE REST OF THIS QUARTERLY REPORT ON FORM 10-Q INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS". SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31, 2012.

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. In October 2011, we settled litigation with TPL that was initiated by us over matters related to the management of the MMP Portfolio.  In July 2012, we entered into additional agreements with TPL, PDS and the TPL affiliate Alliacense in furtherance of the management and commercialization of the MMP Portfolio.  The July 2012 Agreements (“July 2012 Agreements”) paved the way for an aggressive litigation strategy subsequently initiated on July 24, 2012 whereby Alliacense filed parallel actions with the ITC and in the U.S. District Court against multiple companies alleged to be infringers of the MMP portfolio.  We believe that the significant investment in legal effort and costs incurred to date at PDS, in addition to this expanded litigation strategy, is necessary for the protection of our interests in the MMP portfolio and its future success. We intend to continue our joint venture with TPL to pursue license agreements with unlicensed users of our technology. We believe that continuing to work through TPL and its affiliate Alliacense, as compared to pursuing other alternatives, including 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.

During fiscal 2012 and through the date of this filing, we and TPL each contributed $1,747,808 to fund the working capital of PDS.  To the extent MMP portfolio license proceeds are insufficient; we expect working capital contributions to PDS to continue in the future.  Cash shortfalls currently experienced by PDS will have an adverse effect on our liquidity. To date, we have determined that it is in the best interests of the MMP licensing program that we contribute our 50% share of additional capital to PDS to provide for PDS litigation support payments to Alliacense, in the event license revenues received by PDS are insufficient to meet these needs.

On April 10, 2013 PDS’ cash balance was $1,093.  Management’s plans for the continued operation of PDS rely on the ability of Alliacense to obtain license agreements to cover the operational costs of PDS.   The November 30, 2012 fiscal quarter notwithstanding, PDS has experienced a decline in licensing revenues and has experienced an increase in legal costs due to the patent litigation actions currently in progress although as a result of the fee arrangement with current litigation counsel we expect the legal costs of PDS to decrease substantially from fiscal year end 2012 levels.

As the litigation with HTC Corporation, and Acer, Inc., in the U.S. District Court, and the actions with the ITC Investigation No. 337-TA-853 progress, PDS is incurring significant third-party costs for expert testimony, depositions and other related legal costs.  While the costs going forward for legal representation are principally under a contingency arrangement and the need for litigation support and the associated costs from Alliacense is expected to decrease, these third-party costs remain significant.  We will be required to make capital contributions to PDS for these costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.

On March 20, 2013, TPL filed a petition under Chapter 11 of the United States Bankruptcy Code (see Note 8).  We have been appointed to the creditors’ committee and will be closely monitoring the progress in this matter as it relates to our interest in PDS. In the event that we provide funding to PDS that is not reciprocated by TPL, which would result in our having a larger ownership percentage in PDS, we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our consolidated financial statements.  If we determine that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their fair values at the date that we have the controlling financial interest.

The results of PDSG, which was previously reported as a separate business segment, is being presented as income (loss) from discontinued operations, net in the condensed consolidated statements of operations for all periods presented.

Discontinued Operations and Assets Held for Sale

On February 17, 2012, our board of directors authorized management to sell the assets of PDSG due to the inability of PDSG to meet its business plan and continuing projected negative cash flows.  In accordance with authoritative guidance we have classified the assets, liabilities, operations and cash flows of PDSG as discontinued operations for all periods presented.  During March 2012, we entered into an interim agreement with the purchaser of the assets of PDSG which required the purchaser to pay PDSG $93,450 to subsidize the April 2012 expenses of PDSG during the sale transaction negotiations. On April 30, 2012, we negotiated a sale transaction in which we sold substantially all of the assets of PDSG in exchange for a royalty on PDSG revenues for a period of three years.  At February 28, 2013, the loss on the asset sale of PDSG is approximately $6,300.

Summarized operating results of discontinued operations for the three and nine months ended February 28, 2013 and February 29, 2012 are as follows:

PDSG activity for the three and nine months ended February 28, 2013 consists of operating expenses for:  legal, insurance, taxes and bank fees offset by PDSG royalty revenues.

The following table summarizes the carrying amount at February 28, 2013 and May 31, 2012 of the major classes of assets and liabilities of PDSG classified as discontinued operations:

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.           Investments in Marketable Securities

We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date. Our investments in marketable securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities.  Available-for-sale marketable securities are stated at fair market value.  Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss).  We follow the authoritative guidance to assess whether our investments with unrealized loss positions are other than temporarily impaired.  Realized gains and losses and declines in fair value judged to be other than temporary are determined based on the specific identification method and are reported in other income (expense), net in the condensed consolidated statements of operations.

2.           Investment in Affiliated Company

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

PDS, as an unconsolidated equity investee,  recognizes revenue from technology license agreements at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), obligations under the license agreement are satisfied, and the realization of revenue is assured which is generally upon the receipt of the license proceeds.  PDS may at times enter into license agreements whereby contingent revenues are recognized as one or more contractual milestones are met.

In the event our investment in PDS was to reflect an asset balance, we would review our investment in an affiliated company to determine whether events or changes in circumstances indicate that an asset carrying amount may not be recoverable. The primary factors we would consider in our determination are the financial condition, operating performance and near term prospects of the investee. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.

3.           Share-Based Compensation

Share-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 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.

4.           Income Taxes

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

We follow authoritative guidance to evaluate whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  In making such judgments, significant weight is given to evidence that can be objectively verified. We are assessing our deferred tax assets under more likely than not scenarios in which they may be realized through future income.

We have determined that it was not more likely than not that all of our deferred tax assets will be realized in the future due to our continuing pre-tax and taxable losses. As a result of this determination we have placed a full valuation allowance against our deferred tax assets.

5.           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.

Results of Operations

Comparison of the Three Months Ended February 28, 2013 and Three Months Ended February 29, 2012.

Selling, general and administrative expenses decreased from approximately $623,000 for the three months ended February 29, 2012 to approximately $345,000 for the three months ended February 28, 2013.  The decrease consisted primarily of approximately $122,000 in legal and related fees primarily associated with the Crossflo officers legal matter in fiscal 2012, $72,000 in salaries and related payroll costs and approximately $53,000 in investor relations fees due to the fact that the 2011 annual meeting was held in February 2012 and the 2012 annual meeting will be held in April 2013.

Our other income (expenses) for the three months ended February 28, 2013 and February 29, 2012 included equity in the loss of PDS of approximately $(602,000) and $(105,000), respectively. Our investment in PDS is accounted for in accordance with the equity method of accounting for investments. The change in the earnings of PDS is due to the increasing legal costs and decreasing licensing revenue for the current period.

Loss from continuing operations before income taxes increased from approximately $(684,000) for the three months ended February 29, 2012 to approximately $(916,000) for the three months ended February 28, 2013 primarily due to the change in equity in loss of PDS.

Benefit for income taxes

During the three months ended February 28, 2013 and February 29, 2012, we recorded a benefit for income taxes related to federal and California taxes of approximately $(2,800) and $(4,300), respectively.

Net loss

Our net loss for the three months ended February 28, 2013 and February 29, 2012, was $(911,721) and $(1,246,125), respectively.

Comparison of the Nine Months Ended February 28, 2013 and Nine Months Ended February 29, 2012.

Selling, general and administrative expenses decreased from approximately $1,547,000 for the nine months ended February 29, 2012 to approximately $975,000 for the nine months ended February 28, 2013.  The decrease consisted primarily of approximately $336,000 in legal and related fees of which approximately $145,000 was associated with  the Crossflo officers legal matter in fiscal 2012, and approximately $92,000 recorded as a credit stemming from PDS’ reimbursement to PTSC in the current nine month period for legal costs incurred for the benefit of PDS that were originally expensed by us principally during the nine month period ending February 29, 2012, $74,000 in consulting fees due to the sale of the PDSG assets in fiscal 2012, $59,000 in salaries and related payroll costs and approximately $52,000 in investor relations fees due to the fact that the 2011 annual meeting was held in February 2012 and the 2012 annual meeting will be held in April 2013.

Our other income (expenses) for the nine months ended February 28, 2013 and February 29, 2012 included equity in the earnings (loss) of PDS of approximately $76,000 and $(633,000), respectively.  Our investment in PDS is accounted for in accordance with the equity method of accounting for investments. The change in the earnings of PDS is primarily due to the increase in licensing revenue during the current fiscal year. Included in realized recovery on marketable securities for the nine months ended February 28, 2013 and February 29, 2012 is approximately $56,000 and $79,000, respectively, of recovery on the $600,879 realized loss on sale of marketable securities relating to our auction rate securities recognized during the fiscal year ended May 31, 2011.  Through February 2013, we have received proceeds totaling $403,325 relating to the recovery of our fiscal 2011 realized loss. Also included in interest and other income for the nine months ended February 28, 2013 is the one time receipt of proceeds associated with the settlement of certain litigation unrelated to our patent portfolio.

Loss from continuing operations before income taxes decreased from  approximately ($2,086,000) for the nine months ended February 29, 2012 to approximately $(613,000) for the nine months ended February 28, 2013 due to the change in equity in earnings of PDS and decrease in operating expenses.

Benefit for income taxes

During the nine months ended February 28, 2013 and February 29, 2012, we recorded a benefit for income taxes related to federal and California taxes of approximately $(100) and $(1,100), respectively.

Net loss

Our net loss for the nine months ended February 28, 2013 and February 29, 2012, was $(611,437) and $(3,314,575), respectively.

Results of Discontinued Operations

Comparison of the Three Months Ended February 28, 2013 and Three Months Ended February 29, 2012.

Revenue consisted of software licenses and associated services relating to PDSG’s CDX product.  Cost of sales included the direct time of PDSG employees on each project.

Research and development costs consisted 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.  For the three months ended February 29, 2012, approximately $500 of share-based compensation was recorded in connection with vesting of employee stock options.

Selling, general and administrative expenses decreased from approximately $268,000 for the three months ended February 29, 2012 to approximately $800 for the three months ended February 28, 2013 due to the sale of substantially all of the assets of PDSG in April 2012.  For the three months ended February 29, 2012 approximately $4,500 of share-based compensation was recorded in connection with vesting of employee stock options.

Interest and other income for the three months ended February 28, 2013 of approximately $2,000 consists of royalties earned for the period.  On April 30, 2012, we negotiated a sale transaction in which we sold substantially all of the assets of PDSG in exchange for a royalty on PDSG revenues for a period of three years.

Operating loss decreased from approximately $(552,000) for the three months ended February 29, 2012 to operating income of approximately $1,200 for the three months ended February 28, 2013 due to the sale of substantially all of the assets of PDSG in April 2012.

Income (Loss) from Discontinued Operations, Net

We recorded net income from discontinued operations for the three months ended February 28, 2013 of $1,248 and a net loss from discontinued operations for the three months ended February 29, 2012 of $(566,722).

Comparison of the Nine Months Ended February 28, 2013 and Nine Months Ended February 29, 2012.

Revenue consisted of software licenses and associated services relating to PDSG’s CDX product. Cost of sales included the direct time of PDSG employees on each project.

Research and development costs consisted 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. For the nine months ended February 29, 2012, approximately $1,500 of share-based compensation was recorded in connection with vesting of employee stock options.

Selling, general and administrative expenses decreased from approximately $747,000 for the nine months ended February 29, 2012 to approximately $3,000 for the nine months ended February 28, 2013 due to the sale of substantially all of the assets of PDSG in April 2012.  For the nine months ended February 29, 2012 approximately $13,500 of share-based compensation was recorded in connection with vesting of employee stock options.

Interest and other income for the nine months ended February 28, 2013 of approximately $4,700 consists of royalties earned for the period.  On April 30, 2012, we negotiated a sale transaction in which we sold substantially all of the assets of PDSG in exchange for a royalty on PDSG revenues for a period of three years.

Operating loss decreased from approximately $(1,215,000) for the nine months ended February 29, 2012 to operating income of approximately $1,500 for the nine months ended February 28, 2013 due to the sale of substantially all of the assets of PDSG in April 2012.

Income (Loss) from Discontinued Operations, Net

We recorded net income from discontinued operations for the nine months ended February 28, 2013 of $1,472 and a net loss from discontinued operations for the nine months ended February 29, 2012 of $(1,229,268).

Liquidity and Capital Resources

Liquidity

Our cash and short-term investment balances decreased from approximately $7,606,000 as of May 31, 2012 to approximately $7,220,000 as of February 28, 2013. We also have restricted cash balances amounting to approximately $21,000 as of May 31, 2012 and February 28, 2013. Total current assets decreased from approximately $7,860,000 as of May 31, 2012 to approximately $7,325,000 as of February 28, 2013. Total current liabilities amounted to approximately $307,000 and approximately $90,000 as of May 31, 2012 and February 28, 2013, respectively.  The change in our working capital position as of February 28, 2013 as compared with May 31, 2012 results primarily from our capital contributions to and distributions from PDS.

The cost of accessing the credit markets could be challenging as many lenders and institutional investors have enacted tighter lending standards and reduced or ceased to provide funding to borrowers.  Credit sources if identified, could come at significant cost.  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.

To the extent cash shortfalls are experienced by PDS it will have an adverse effect on our liquidity. During fiscal 2012, we contributed $650,000 in additional capital to PDS in order to fund a portion of a legal retainer.  During the nine months ended February 28, 2013, we and TPL each contributed $1,097,808 to fund the remaining portions of the legal retainer and the operations of PDS.  During November 2012, December 2012 and February 2013, we received distributions from PDS of $625,000, $350,000 and $175,000, respectively. We have determined that it is in the best interests of the MMP licensing program that we contribute our 50% share of additional capital to PDS for its operating expenses when license revenues received by PDS are insufficient to pay such expenses.

As the litigation with HTC Corporation, and Acer, Inc., in the U.S. District Court, and the actions with the ITC Investigation No. 337-TA-853 progress, PDS is incurring significant third-party costs for expert testimony, depositions and other related legal costs.  While the costs going forward for legal representation are principally under a contingency arrangement and the need for litigation support and the associated cost from Alliacense is expected to decrease, these third-party costs remain significant.  We will be required to make capital contributions to PDS for these costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.

Our current liquid cash resources as of February 28, 2013, are expected to provide the funds necessary to support our operations through at least the next twelve months.  The cash flows from our interest in PDS represent our only significant source of cash generation. In the event of a continued decrease or interruption in MMP Portfolio licensing we will incur a significant reduction to our cash position. It is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and short-term investment position of $7,220,087 at February 28, 2013.

On March 20, 2013, TPL filed a petition under Chapter 11 of the United States Bankruptcy Code (see Note 8).  We have been appointed to the creditors’ committee and will be closely monitoring the progress in this matter as it relates to our interest in PDS. In the event that we provide funding to PDS that is not reciprocated by TPL, which would result in our having a larger ownership percentage in PDS, we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our consolidated financial statements. If we determine that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their fair values at the date that we have the controlling financial interest.

Cash Flows From Operating Activities

Cash used in operating activities of continuing operations was approximately $686,000 and $1,786,000 for the nine months ended February 28, 2013 and February 29, 2012, respectively. The principal components of the current period amount were the net loss from continuing operations of approximately $613,000 and changes in accounts payable and accrued expenses of approximately $214,000. These decreases were primarily offset by changes in the receivable from affiliated company of approximately $127,000 and changes in prepaid expenses and other current assets of approximately $150,000. The principal components of the prior period are the prior period net loss from continuing operations and changes in accounts payable and accrued expenses, offset by the loss in earnings of affiliated company and changes in the receivable from affiliated company.

Cash provided by operating activities of discontinued operations for the nine months ended February 28, 2013 and February 29, 2012 was approximately $16,000 and $19,000, respectively.  The change is attributed to the sale of the PDSG assets in April of 2012.

Cash Flows From Investing Activities

Cash provided by investing activities of continuing operations for the nine months ended February 28, 2013 was approximately $907,000.  Cash used in investing activities of continuing operations for the nine months ended February 29, 2012 was approximately $119,000. Cash activities for the current period were primarily attributable to purchases and sales of marketable securities and capital contributions to and distributions from PDS.  Cash activities for the prior period were attributable to purchases and sales of marketable securities.

Cash Flows From Financing Activities

Cash used in financing activities for the nine months ended February 28, 2013 and February 29, 2012 was approximately $57,000 and $102,000, respectively. Cash activities for the current and prior periods were attributable to purchases of common stock for treasury.

Capital Resources

Our current liquid cash resources as of February 28, 2013, are expected to provide the funds necessary to support our operations through at least the next twelve months. The cash flows from our interest in PDS represent our only significant source of cash generation. In the event of a continued decrease or interruption in MMP Portfolio licensing we will incur a significant reduction to our cash position. It is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and short-term investment position of $7,220,087 at February 28, 2013.

Recent Accounting Pronouncements

During the nine months ended February 28, 2013, there were no recent issuances of accounting pronouncements as compared to those described in our Annual Report on Form 10-K for the fiscal year ended May 31, 2012, that are of significance, or have potential material significance to us.

Risk Factors

We urge you to carefully consider the following discussion of risks as well as other information regarding our common stock. We believe the following to be our most significant risk factors as of the date this report is being filed. The risks and uncertainties described below are not the only ones we face. Please refer to our risk factors contained in our Form 10-K for the year ended May 31, 2012 for additional risk factors.

We May Be Required To Fund Our Joint Venture’s Legal Costs.

On March 20, 2013 TPL filed a petition under Chapter 11 of the United States Bankruptcy Code.  While TPL’s petition does not affect the licensing agreement between PDS and Alliacense, PDS has incurred increased third-party legal costs as the litigation with HTC Corporation, and Acer, Inc., in the U.S. District Court, and the actions with the ITC Investigation No. 337-TA-853 progress.  If PDS does not receive sufficient licensing revenues to pay these expenses, we may be required to pay these expenses. In the event the cost of the U.S. District Court and ITC Investigation actions exceeds our ability to fund these efforts, our options for additional sources of financing may be limited.

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 income from the joint venture 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, 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.

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, which as a result of agreements entered into in June 2005 and July 2012, TPL and its affiliate Alliacense are 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 and Alliacense on behalf of the joint venture, and the ability of TPL and Alliacense to obtain capital when necessary to fund their operations.

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 five of which are unexpired, 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 6 to our condensed consolidated financial statements and Part II, Item 1. “Legal Proceedings” in this quarterly report on Form 10-Q for more information.

In the event that one or more of these lawsuits regarding the MMP Portfolio are not resolved in our favor, such outcome (or lack of an outcome) could weaken the MMP Portfolio which would have a negative effect on PDS's ability to procure future license revenues and, therefore, adversely affect PDS's and our cash flows.

We Are Dependent On A Single Law Firm To Defend And Enforce Our Intellectual Property Rights.

A single law firm has been engaged to defend and enforce our intellectual property rights.  Any significant interruption in their services, or the loss of their services for any reason, would have a material adverse effect on our ability to defend and prosecute such lawsuits and, therefore, have a material adverse effect on our business, financial condition and result of operations.  The law firm’s services could be disrupted for a variety of reasons, and any disruption would have a material adverse effect on our business. Our inability to engage the services of a new law firm in a timely manner could have a substantial negative effect on our business.

Disruptions In The Debt And Equity Markets Will Have An Adverse Effect 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 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 I – Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Liquidity.” in this report on Form 10-Q 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 strategy, financial performance and stock price and could require us to delay or abandon 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. It is possible that, in the future, our relationships and/or our interests in or with this equity method investee could change. Such potential future changes could result in consolidation of such entity which could result in changes in our reported results.

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

Most of 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 personnel. The competition for highly qualified personnel is intense, and we may not be able to retain our key employees or attract and retain additional highly qualified personnel in the future. None of our employees are represented by a labor union, and we consider our relations with our employees to be good. None of our employees are covered by key man life insurance policies.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, as of February 28, 2013, the end of the period to which this quarterly report relates, we have carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures.  This evaluation was carried out under the supervision and with the participation of our management, including our Interim Chief Executive Officer and our Chief Financial Officer.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the Interim Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on the evaluation of our disclosure controls and procedures as of February 28, 2013, our management, with the participation of our Interim Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

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

PART II- OTHER INFORMATION

Item 1. Legal Proceedings

Patent Litigation

Our patent litigation with TPL and Alliacense Ltd. in the United States District Court for the Northern District of California against Acer, Inc., HTC Corporation and affiliated entities, as described in Item 3 – “Legal Proceedings” in our Annual Report on Form 10-K for the year ended May 31, 2012 ("Annual Report"), is still ongoing, but there have been no material developments in such litigation since our Annual Report.

Our patent litigation with TPL and PDS in the ITC against Acer Inc., Amazon.com Inc., Barnes & Noble Inc., Garmin Ltd., HTC Corporation, Huawei Technologies Co. Ltd., Kyocera Corporation, LG Electronics, Nintendo Co. Ltd., Novatel Wireless Inc., Samsung Electronics Co. Ltd., Sierra Wireless Inc., and ZTE Corporation, as described in Item 3 – “Legal Proceedings” in our Annual Report, is still ongoing.  Several respondents (Garmin and Sierra Wireless) moved for termination of the litigation based on an alleged violation of the duty of candor.  The ITC judge rejected that motion in an order dated December 18, 2012.

Item 1A. Risk Factors

Please see Part I, Item 2, above, for our risk factors.

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

On April 28, 2006, 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.  As part of the program, we purchased 83,438 shares of our common stock at an aggregate cost of $10,079 during the three months ended February 28, 2013.

Following is a summary of all repurchases by us of our common stock during the three month period ended February 28, 2013:

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

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits

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

Those exhibits marked with a cross (†) refer to contracts with respect to which we have requested confidential treatment pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. The confidential portions of such exhibits have been omitted and are marked accordingly and the confidential portions have been filed separately with the Securities and Exchange Commission.

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.