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U.S. 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, 2003
OR
[ ] 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 84-1070278
(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
10989 Via Frontera, San Diego, California 92127
----------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code): (858) 674-5000
--------------
Securities registered under Section 12(b) of the Exchange Act: NONE Securities
registered under Section 12(g) of the Exchange Act:
Common Stock, $.00001 par value
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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. [ X ]
Indicate by check mark whether the registrant is an accelerated filer.
YES NO
--- ---
As of November 29, 2002, the last business day of Registrant's most recently
completed second fiscal quarter, there were 87,489,354 shares of Registrant's
Common Stock outstanding and the aggregate market value of Common Stock held by
non-affiliates of Registrant was $5,614,000 (based upon the closing price for
shares of Registrant's Common Stock as reported on the OTC Electronic Bulletin
Board system on November 29, 2002). Shares of Common Stock held by each officer,
director and holder of 5% or more of the outstanding Common Stock (including
shares with respect to which a holder has the right to acquire beneficial
ownership within 60 days) have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
At August 28, 2003, 123,518,272 shares of common stock, par value $.00001 per
share (the registrant's only class of voting stock) were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: None
TABLE OF CONTENTS
Page
PART I
ITEM 1. Description of Business 3
ITEM 2. Description of Property 13
ITEM 3. Legal Proceedings 13
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Registrant's Common Equity and Related 13
Stockholder Matters
ITEM 6. Selected Consolidated Financial Data 14
ITEM 7. Management's Discussion and Analysis of Financial 15
Condition and Results of Operations
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 25
ITEM 8. Financial Statements and Supplementary Data 25
ITEM 9. Changes in and Disagreements with Accountants on 26
Accounting and Financial Disclosure
PART III
ITEM 10. Directors, Executive Officers of the Registrant 26
ITEM 11. Executive Compensation 28
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 31
ITEM 13. Certain Relationships and Related Transactions 33
ITEM 14. Controls and Procedures 34
ITEM 15. Principal Accountant Fees and Services 34
PART IV
ITEM 16. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 35
2
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, including all documents incorporated by
reference, includes "forward-looking" statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act and the Private
Securities Litigation Reform Act of 1995, and we desire to take advantage of the
"safe harbor" provisions thereof. Therefore, we are including this statement for
the express purpose of availing ourselves of the protections of such safe harbor
with respect to all of such forward-looking statements. The forward-looking
statements in this Report reflect our current views with respect to future
events and financial performance. These forward-looking statements are subject
to certain risks and uncertainties, including specifically the absence of
significant revenues, a history of losses, no assurance that technology can be
completed or that our completion will not be delayed, significant competition,
the uncertainty of patent and proprietary rights, uncertainty as to royalty
payments and indemnification risks, possible adverse effects of future sales of
shares on the market, trading risks of low-priced stocks and those other risks
and uncertainties discussed herein, that could cause actual results to differ
materially from historical results or those anticipated. In this report, the
words "anticipates," "believes," "expects," "intends," "future" and similar
expressions identify certain of the forward-looking statements. Readers are
cautioned not to place undue reliance on the forward-looking statements
contained herein, which speak only as of the date hereof. We undertake no
obligation to publicly revise these forward-looking statements to reflect events
or circumstances that may arise after the date hereof. All subsequent written
and oral forward-looking statements attributable to us or persons acting on our
behalf are expressly qualified in their entirety by this section.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
THE COMPANY
Patriot Scientific Corporation was organized under Delaware law on
March 24, 1992, as the successor by merger to Patriot Financial Corporation, a
Colorado corporation incorporated on June 10, 1987. Our address is 10989 Via
Frontera, San Diego, California 92127, and our telephone number is (858)
674-5000. Our home page can be located on the World Wide Web at
http://www.ptsc.com.
We develop, market, and sell microprocessors, our technology behind the
microprocessors, and complementary products which enable computers and other
data processing devices to communicate. These products can be used to connect to
the Internet or other telecommunication networks. The microprocessor technology
product line accounted for approximately 25% of our revenue in fiscal 2003. The
balance of our 2003 revenue was generated from a communication product line
that, subsequent to a completed last buy program, is generating minimal revenue.
We also have a patent for special radar technology which, if fully developed,
may allow a potential licensee to penetrate the ground or structures to find
various objects. We also owned gas plasma antenna technology which we sold for
$250,000 in August 1999. We potentially could receive up to an additional
$250,000 from the sale of the gas plasma technology in the form of royalties.
Our strategy is to exploit our microprocessor technologies through product
sales, licensing, and strategic alliances.
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In 1997, we emerged from the development stage primarily as a result of
the acquisition of Metacomp Inc. There can be no assurance that we can achieve
profitable operations, and we may need additional financial resources during the
next twelve months.
BACKGROUND
In February 1989, we completed our initial public offering under a
registration statement on Form S-18 under the Securities Act of 1933. This
offering raised gross proceeds of $50,000 and net proceeds of approximately
$28,640 upon the sale of 2,500,000 units at $.02 per unit. Each unit sold in the
public offering consisted of one common share and one Class A common stock
purchase warrant exercisable to acquire one share of common stock and one Class
B common stock purchase warrant. All Class A and Class B warrants have since
been exercised or have lapsed.
On May 12, 1992, we redomiciled ourselves from Colorado to Delaware by
merging into a wholly owned Delaware subsidiary, Patriot Scientific Corporation,
organized for that purpose. The reincorporation resulted in a reverse stock
split. Three shares of the Colorado corporation, par value $.00001, were
converted into one share of the Delaware corporation, par value $.00001. The
reincorporation also effected a change in our charter and bylaws and a name
change to Patriot Scientific Corporation.
In May 1993, we registered under the Securities Act of 1933 a total of
7,631,606 shares issuable upon the exercise of outstanding Class A and Class B
common stock purchase warrants. We received net proceeds of $3,343,915 upon the
exercise of those warrants and the issuance of 7,538,102 common shares. None of
such warrants remain outstanding.
Effective May 31, 1994, we entered into an asset purchase agreement and
plan of reorganization with nanoTronics Corporation located in Eagle Point,
Oregon and Helmut Falk. We issued a total of 8,500,000 restricted common shares
to nanoTronics to acquire certain microprocessor technology of nanoTronics. The
technology acquired was used to develop a sophisticated yet low cost
microprocessor. 5,000,000 of the shares were issued on a non-contingent basis,
and the remaining 3,500,000 shares were issued subject to the terms of an
earnout escrow arrangement, which concluded on May 31, 1999.
Effective December 26, 1996, we acquired 96.9% of the outstanding
shares of Metacomp, Inc., a California corporation, from 56 shareholders in
exchange for the issuance of 1,272,068 shares of our common stock. Based on the
closing price of our common stock of $1.375 on the date of the acquisition, the
price of the acquisition was $1,749,094. This business combination was accounted
for as a pooling-of-interests.
BUSINESS
ORGANIZATION AND CORPORATE DEVELOPMENT. Our business involves the
following technologies:
o Ignite microprocessor technology,
o high-speed data communications technology, and
o radar technology.
Due to a lack of funds to develop and commercialize JUICEtechnology, a
technology introduced to us in 2001, we assigned our rights in this
technology back to the inventor in April 2003.
The stages of development of our technologies is as follows:
o Ignite microprocessor. This technology is generating minor
amounts of revenue from the sale of development boards,
microprocessors and initial license fees related to the
microprocessor application. We run the technology on a
0.18-micron microprocessor, which is in current production. We
have ported the WindRiver VxWorks operating system and the Sun
Microsystems personalJava virtual machine to the microprocessor.
In addition, the technology is available for sale as intellectual
property which enables the prospective customer to incorporate
the microprocessor functions with other parties' applications to
arrive at a system on a chip solution. Although we anticipate the
Ignite technology to be our main product line, it currently
accounts for only 25% of our revenue in fiscal year 2003.
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o High-speed data communications. Revenue from this technology was
phased out during fiscal year 2002 as a result of the products
reaching the end of their life cycles. During fiscal 2002 we
initiated a last time buy program and except for minor repeat
orders have discontinued to sell this product line. We have
decided to concentrate our efforts on the Ignite microprocessor
technology. Although the communications product line accounted
for approximately 75% of our fiscal year 2003 revenue, we
anticipate that the Ignite microprocessor will be our main
product line in the future.
o Radar and antenna. We sold the gas plasma antenna technology in
August 1999. Our radar technology has not generated any revenue
and we have suspended further development of this technology in
order to concentrate our resources on our Ignite products.
Due to our small size and staffing overlaps among the technologies,
certain personnel may work on any or all of our technologies from time to time.
During at least the last three years, we have focused the majority of
our efforts on the Ignite technology. The Ignite technology is targeted for the
embedded controller and Java language processor marketplaces.
INTERNET GROWTH AND THE EMERGENCE OF THE JAVA PROGRAMMING LANGUAGE. The
Internet is a global web of computer networks. This "network of networks" allows
computers connected to the Internet to "talk" to one another. The Internet
provides organizations and individuals with new means to conduct business.
Commercial uses of the Internet include business-to-business and
business-to-consumer transactions, product marketing, advertising,
entertainment, electronic publishing, electronic services and customer support.
We believe that organizations will also increasingly use the Internet and
private Intranet networks to improve communications, distribute information,
lower operating costs and change operations. Use of the Internet has grown
rapidly impacting computer hardware, software and peripheral industries. The
rapid growth in popularity of the Internet is in part due to continuing
penetration of computers and modems into U.S. households, growth of the
informational, entertainment and commercial applications and resources of the
Internet, the growing awareness of such resources among individuals, and the
increasing availability of user-friendly navigational and utility tools which
enable easier access to the Internet's resources.
The growth of the Internet and corporate Intranets is creating a demand
for hardware, software and peripherals. Software, such as Java, has been
developed to serve the requirements of Internet users.
Java is a programming language that was originally developed for
personal digital assistant devices and television set top boxes. It was formally
announced as an object-oriented language for the Internet in May 1995 by Sun
Microsystems Inc. A large number of major computer, software, browser and
on-line service provider companies have licensed the Java language. Accordingly,
Java is a fundamental platform for Internet related applications. A significant
number of Java applications, or applets, are now available on the Internet.
These applications not only enhance web pages but also perform many functions of
traditional computer software programs. Our Ignite technology lends itself to
potential markets in which the use of Java is prevalent.
With Java, data and programs do not have to be stored on the user's
computer, but can reside anywhere on the Internet to be called upon as needed.
Among its various attributes, two key features of Java are (1) its ability to
run on a variety of computer operating systems thus avoiding the problem of
incompatibility across networks, and (2) security, because Java enables the
construction of virus-resistant, tamper-resistant systems by using
resource-access control and public-key encryption. Because of Java's useful
features, it has also become a popular programming language for embedded
applications.
Since Java is designed to run on multiple types of devices and
operating systems, it allows developers to write a program once for many types
of operating systems, instead of having to write new versions for each type.
Java does this by interpreting a program's commands into something that a
particular type of computer can understand. This interpretive design runs
programs slower than if they were tailored for each type of computer and is
resulting in a need for specialized microprocessors and compilers to increase
Java's speed.
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The growth of Java is causing a number of companies to consider it as a
basis for a new style of computing tailored to the Internet and not encumbered
by the limitations of, or requiring, traditional computer operating systems. The
concept is to design inexpensive access devices to communicate via the Internet.
OUR MICROPROCESSOR TECHNOLOGY.
General Background. In 1991, nanoTronics Corporation was formed and
acquired a base technology for an advanced microprocessor integrated on a single
computer chip. nanoTronics subsequently engaged in substantial technical
development and fabricated a first-generation microprocessor in early 1994.
Since the acquisition of the technology from nanoTronics, effective May
31, 1994, we have been engaged in enhancing the microprocessor design, adding
additional technical features to further modernize the design, and improving and
testing the new design. We initially fabricated a prototype 0.8-micron
microprocessor in May 1996. The next generation was a 0.5-micron microprocessor
that was delivered in September 1997. The 0.5-micron microprocessor was employed
in demonstrations for prospective customers and was shipped in limited numbers
to customers as an embedded microprocessor. In 1998 we introduced a 0.35-micron
microprocessor whose features included a reduction in size and improved
performance. In addition, in September 2000 we completed a VHDL model of this
technology which enables customers to purchase intellectual property
incorporating microprocessor functions with other parties' applications to
arrive at a system on a chip solution. By purchasing this software model,
customers can significantly reduce their time to market by simulating results as
opposed to trial and error commitment to silicon production. We currently have a
0.18-micron enhancement of silicon production for our Ignite microprocessor
technology.
Industry Background. The semiconductor logic market has three major
sectors:
o standard logic products,
o application specific standard products, and
o application specific integrated circuits.
Standard logic products, such as the Intel's X86 and Pentium and
Motorola's 680X0 microprocessor families, are neither application nor customer
specific. They are intended to be utilized by a large group of systems designers
for a broad range of applications. Because they are designed to be used in a
broad array of applications, they may not be cost effective for specific
applications. Application specific integrated circuits are designed to meet the
specific application of one customer. While cost effective for that application,
application specific integrated circuits require large sales volumes of that
application to recover their development costs. Application specific standard
processors are developed for one or more applications but are not generally
proprietary to one customer. Examples of these applications include modems,
cellular telephones, wireless communications, multimedia applications, facsimile
machines and local area networks. We have designed our microprocessor to be
combined with application specific software to serve as an embedded control
product for the application specific standard processor market sector.
Application specific standard processors are typically used in embedded
control systems by manufacturers to provide an integrated solution for
application specific control requirements. Such systems usually contain a
microprocessor or microcontroller, logic circuitry, memory and input/output
circuitry. Electronic system manufacturers combine one or more of these elements
to fit a specific application. The microprocessor provides the intelligence to
control the system. The logic circuitry provides functions specific to the end
application. The input/output circuitry may also be application specific or an
industry standard component. The memory element, if not on the microprocessor,
is usually a standard product used to store program instructions and data. In
the past, these functions have been executed through multiple integrated
circuits assembled on a printed circuit board. The requirements for reduced cost
and improved system performance have created market opportunities for
semiconductor suppliers to integrate some or all of these elements into a single
application specific standard processor or chip set, such as the Ignite family
of microprocessors. The Ignite family provides close integration of the
microprocessor and input/output function with the logic circuitry, thereby
providing an advanced application specific standard processor.
Embedded control systems enable manufacturers to differentiate their
products, replace less efficient electromechanical control devices, add product
functionality and reduce product costs. In addition, embedded control systems
facilitate the emergence of completely new classes of products. Embedded control
systems have been incorporated into thousands of products and subassemblies
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worldwide, including automotive systems, remote controls, appliances, portable
computers and devices, cordless and cellular telephones, motor controls and many
other systems.
Microprocessors are generally available in 4-bit through 64-bit
architectures, which refers to the amount of data they can process. 4-bit
microprocessors are relatively inexpensive, typically less than $1.00 each.
Although they lack certain performance and features, they account for more than
40% of worldwide microcontroller volume. Also in general use today are 8-bit
architectures, generally costing $1.00 to $10.00 each and accounting for an
additional 40% of worldwide microcontroller volume. To date 16-bit, 32-bit and
64-bit architectures, with typical costs of over $10.00 each, have offered very
high performance, but are generally considered to be expensive for high-volume
embedded control applications. The use of 16-bit, 32-bit and 64-bit
architectures offers fewer internal limitations, making programming easier and
providing higher performance. Although generally more expensive per unit and
requiring more support logic and memory, these devices offer many advantages for
more sophisticated embedded control systems.
Electronic system designers, driven by competitive market forces, seek
semiconductor products with more intelligence, functionality and control that
can be used to reduce system costs and improve performance. For these needs, the
Ignite product family was designed to be a sophisticated 32-bit microprocessor
with advanced features. The Ignite product family uses a smaller number of
transistors compared to other RISC processors which results in less power
consumption and more economical prices compared to other embedded control
applications. This creates the opportunity for the development of new,
cost-effective applications.
Technology Description. Conventional high-performance microprocessors
are register-based with large register sets. These registers are directly
addressable storage locations requiring a complex architecture that consumes
costly silicon. This conventional architecture provides processing power for
computer applications but complicates and slows the execution of individual
instructions and increases silicon size, thereby increasing the microprocessor
cost.
Our technology is fundamentally different from most other
microprocessors in that the data is stored in groups. Our microprocessor employs
certain features of both register and stack designs. The resultant merged
stack-register architecture improves program execution for a wide range of
embedded applications. Our design combines two processors in one highly
integrated package, a microprocessing unit for performing conventional
processing tasks, and an input-output processor for performing input-output
functions. This replaces many dedicated peripheral functions supplied with other
processors. The microprocessor's design simplifies the manipulation of data. Our
architecture employs instructions that are shrunk from 32-bits to 8-bits. This
simplified instruction scheme improves execution speed for computer
instructions. Our architecture incorporates many on-chip system functions, thus
eliminating the requirement of support microprocessors and reducing system cost
to users.
The 0.8-micron microprocessor was designed to operate at a speed of
50Mhz; the 0.5-micron microprocessor at a speed of 100Mhz; the 0.35-micron
microprocessor at 150MHz; and the 0.18-micron to operate at speeds in excess of
300Mhz. They are all compatible with a wide range of memory technology from low
cost dynamic random access memory to high-speed static random access memory. The
microprocessors can be packaged in various surface-mount and die-form packaging.
There can be no assurance that the designed speed will be achieved with the
production model of the 0.18-micron microprocessor or future versions or that
all of the desired functions will perform as anticipated.
Our technology is not designed or targeted to compete with high-end
processors for use in personal computers. It is targeted for embedded control
applications. We believe that the features described above differentiate the
Ignite family from other 8-bit to 64-bit microprocessors targeted for embedded
control applications. Considering the reduced requirement for support
microprocessors, the Ignite family is intended to be available at a high volume
price that should be price competitive with high-end 8-bit microprocessor and
general 16-bit microprocessor systems but with higher performance (speed and
functional capability). The Ignite family has been designed to allow high-speed
and high-yield fabrication using generally available wafer fabrication
technology and facilities.
The Ignite Microprocessor as a Java Processor. We believe the Ignite
microprocessor architecture is capable of being an efficient and cost effective
Java programming language processor, because Java is designed to run on a
stack-oriented architecture and the Ignite architecture executes the virtual
stack machine internal to Java efficiently. Many Java operation codes or
instructions require only a single 8-bit Ignite family instruction to be
executed, providing a performance advantage over other more expensive processors
that require six or more 32-bit instructions to do the same task. This feature
allows the execution of Java programs with increased speed and reduced code size
thereby enabling lower system memory costs. In addition, the incorporation of
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many on-chip system functions is expected to allow the Ignite family to perform
most of the other functions required of an Internet computer device or Java
accelerator, thereby eliminating components. Since Internet computers are
designed to be inexpensive appliances for Internet access, cost, speed and
performance are expected to be key requirements for designers. We believe the
Ignite technology can compete favorably on the basis of such requirements,
although there can be no assurance we can successfully exploit Java related
applications or that competitors will not create superior Java processors.
We have ported the Java operating environment to the Ignite family,
which currently uses the C programming language for software support. We are a
licensee of Sun Microsystems Inc. This enables us to develop and distribute
products based on Sun's personalJava, a platform on which to run Java
applications. We have also licensed from Wind River an operating system,
VxWorks, and entered into a relationship with Forth Inc. whereby Forth will
provide software support and operating system development tools for the Forth
Programming language. We believe this solution is competitive in the Java
virtual machine and embedded applications markets. We believe that, if the
implementation is successfully completed, the Ignite I family will be
competitive with Java microprocessors announced by competitors. However, there
can be no assurance of successful implementation of this package of software or
of a market for an Ignite family Java microprocessor.
Stage of Development. In early 1994, nanoTronics initiated production
of a first generation of wafers at a contract fabrication facility using 6 inch
wafers employing 0.8-micron double-metal CMOS technology. After the May 31, 1994
acquisition, we improved the original design, added new features and performed
simulations and tests of the improved designs. In October 1995, a run of six
wafers of second generation 0.8-micron microprocessors was fabricated by a
contract fabrication facility. Subsequently, we tested these microprocessors,
while completing a C computer language compiler and preparing application
development tools. The compiler and application development tools are necessary
to enable system designers to program the Ignite family for specific
applications. We made corrections to the design suggested by the testing of
prototype units and produced an additional run of second generation
microprocessors from remaining wafers in May 1996. In July 1996, we employed
these microprocessors in demonstration boards for use by developers and
prospective customers and licensees.
In December 1997, we completed development of and started shipping a
0.5-micron microprocessor based on the Ignite technology and found that
0.5-micron double-metal CMOS technology improved operating speed, reduced power
requirements, reduced physical size and reduced fabrication cost. In May 1998,
we began a production run of a 0.35-micron microprocessor that further increased
operating speed and cost performance over the previous generations of the Ignite
family of microprocessors.
At each stage of development, microprocessors require extensive testing
to ascertain performance limitations and the extent and nature of errors (bugs),
if any. When significant limitations or errors are discovered, additional rounds
of design modifications and fabrication are required prior to having functional
and demonstrable microprocessors for prospective customers and licensees.
Although our 0.5 and 0.35-micron microprocessors have been sent to prospective
customers in anticipation of production orders, there can be no assurance that
we, during our continued testing of these products, will not identify errors
requiring additional rounds of design and fabrication prior to commercial
production. Additional delays could have an adverse effect on the marketability
of our technology and financial condition.
In September 2000, we completed the VHDL soft-core version of the
Ignite microprocessor family. The hardware design inside a microprocessor, or
silicon device, can be represented as a software program. This, in essence,
replaces the old style of designing microprocessors using schematics. VHDL is
the predominant software language used to design semiconductors. In addition to
the design aspects, VHDL also contains sophisticated simulation tools that allow
the designer to simulate the functionality of the entire design before
committing to silicon. Also VHDL enables a designer to easily modify and enhance
the design. A design represented in VHDL goes through a synthesis process
whereby it is converted to the most basic element of a design, logical gates.
This gate level representation in turn is used with computer aided engineering
tools to translate the design into the most fundamental component of
semiconductors, transistors. The characteristics of the transistors can be given
as a library to a foundry. Therefore, a design represented in VHDL is technology
and foundry independent and can be targeted for any given transistor geometry
(such as 0.18, 0.25, or 0.35- micron) for any foundry of choice.
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We have developed marketing materials, product manuals and application
development tools for use by licensees and customers. The manuals and tools are
necessary to enable system designers to quickly and easily program the Ignite
family for specific applications.
We believe that the Ignite family is ready for licensing or sale and
that any additional changes encountered in current testing will be minor and can
be made during subsequent production runs of Ignite family microprocessors for
customers, when and if orders are obtained. We also believe the core technology
is ready for licensing for use by others to develop custom microprocessors.
Business Strategy. The increasing demand for embedded control has made
the market for microprocessors one of the largest segments of the semiconductor
logic market. This demand will drive the need for embedded processors. Our
strategy does not entail competing directly with suppliers who have multiple
microprocessor types addressing all parts of the embedded systems market, but on
identifying certain market niches that the Ignite would best address due to its
low cost, low power consumption, small number of transistors and higher
performance.
Because of the above factors, we intend to focus the majority of our
efforts on the embedded microprocessor business, a market without an established
base of microprocessor products and for which we believe the Ignite has
desirable technical and market advantages.
We believe that our architecture is suited for controller applications
requiring high performance and low system cost, such as smart cards, cell
phones, printers, video terminals, robotics, motion controllers, industrial
controllers, digital communication devices, video games, kiosks, cable and
satellite modems and TV set top boxes. We expect that early licensing of the
technology and product applications will focus on embedded control.
We have three international representatives for foreign markets and are
addressing the domestic market with an in-house business development person. We
also have a strategic alliance with an outside microprocessor design house.
We believe the appropriate approach for us initially lies in a balanced
effort of cultivating licensees and developing specific product enhancement
partnerships, producing original equipment manufactured products, and providing
technical support to third parties on a contract basis. The overall balance of
these approaches will be monitored and modified as we attempt to ascertain and
capitalize on the highly dynamic and competitive embedded microprocessor market.
There can be no assurance that we can successfully exploit our microprocessor
technology.
Subject to the availability of financial and personnel resources, while
we are commercializing the Ignite family and the core technology, our strategy
is to also design and develop future versions of the microprocessor with more
demanding sub-micron technology and with more features. However, our resources
are limited, and there can be no assurance that we will be able to continue
microprocessor enhancement.
Initial fabrications of the 0.8-micron and 0.5-micron processors were
performed by contract fabrication facilities. The 0.35-micron microprocessor was
fabricated by a contract fabrication facility that had agreed to provide
production quantities for our customers. We have completed work with a contract
fabrication facility and our design house partner to produce a 0.18-micron
version of the Ignite. There can be no assurance fabrication facilities will be
available to produce the Ignite family in the future. However, since there are a
large number of fabrication facilities with the capability to produce the Ignite
family of microprocessors, we believe microprocessors can be produced on a
contract basis. Industry shortages of fabrication facilities that may exist and
are predicted to exist in the future are generally limited to the more demanding
architectures. If a shortage of fabrication facilities develops, it could have a
material adverse effect on our financial condition.
Competition. The semiconductor industry is intensely competitive and
has been characterized by price erosion, rapid technological change and foreign
competition in many markets. The industry consists of major domestic and
international semiconductor companies, most of which have greater financial,
technical, marketing, distribution, development and other resources than ours.
The market for microprocessors and for embedded control applications is at least
as competitive.
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While our strategy is to target high-volume licensees and
microprocessor customers requiring more sophisticated but low-cost, low-power
consumption devices, we can still expect significant competition. We may also
elect to develop embedded control system products utilizing our own architecture
or by contract for other manufacturers.
We expect that the Ignite family, if successfully commercialized in the
embedded controller market, will compete with a variety of 16/64-bit
microprocessors including those based on intellectual property from ARM and MIPS
and microprocessors from Hitachi, Motorola and IBM. As a Java processor, we
expect our Ignite family will compete with a broad range of microprocessors
including those incorporating co-processor accelerator technology. The producers
of these microprocessors have significantly greater resources than ours.
A new entrant, such as ours, is at a competitive disadvantage compared
to these and other established producers. A number of factors contribute to
this, including:
o the lack of product performance experience,
o lack of experience by customers in using application development
systems,
o no record of technical service and support, and
o limited marketing and sales capabilities.
JUICETECHNOLOGY
During 2001 we introduced a technology to enhance the users experience
of the wireless internet by expanding the capabilities of his device (either a
cell phone, PDA, smart phone or pocket PC). By varying the speed at which the
microprocessor processes information, the device could have presented
information in a richer format than was available from current technologies and,
additionally, doing so with less drain on the device's battery. Due to a lack of
funds to develop and commercialize JUICEtechnology, we assigned our rights in
this technology back to the inventor in April 2003.
HIGH SPEED DATA COMMUNICATIONS PRODUCTS.
The communication products that reached the end of their life cycles
are:
VME Product Line - a line of intelligent high-speed communications
engines in a virtual memory European form factor. Some of our
customers for these products included the military as well as
large satellite based data communications companies.
Atcomm2/4 Product Line - an intelligent two or four channel
product that was used for high-speed data communications.
Except for minor repeat orders, we no longer support this product line.
We have disposed of or fully reserved the communication product line inventory
and are concentrating our efforts and resources on Ignite.
RADAR AND ANTENNA TECHNOLOGY.
General Background. We commenced active development of our ground
penetrating radar technology in April 1992. By May 1993, we were able to
demonstrate the sensing, processing and crude visualization of images from our
technology, and by May 1994 we had completed our prototype device. Since May
1994, we have focused our efforts and limited financial resources on the
microprocessor technology and communication products, effectively suspending
development and marketing efforts related to ground penetrating radar.
Gas Antenna Technology Description.
We sold our gas plasma technology in August 1999.
RESEARCH AND DEVELOPMENT. Our current development efforts are focused
on improvement of and additional features for the Ignite family microprocessor.
The development of this technology has taken longer than anticipated and could
10
be subject to additional delays. Therefore, there can be no assurance of timely
or successful marketing of this technology.
We incurred research and development expenditures of $723,287,
$1,372,421 and $2,218,433 for our fiscal years ended May 31, 2003, 2002 and
2001. The majority of these expenditures have been devoted to our microprocessor
technology. We believe that technical advances are essential to our success and
expect that we will continue to expend substantial funds on research and
development of our technology. However, there can be no assurance that such
research and development efforts will result in the design and development of a
competitive technology in a timely manner.
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.
We have six U.S. patents issued dating back to 1989 on the
microprocessor technology. We have one microprocessor technology patent pending
in five European countries and one patent issued in Japan and 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, we have one U.S. patent issued on the ground
penetrating radar technology and one U.S. patent issued on one of the
communications products.
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 certain 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 believe that we may have claims against other semiconductor
companies and companies that use semiconductors with capabilities in excess of
125 MHz in their products. In 2003 we initiated contacts with companies we
believe are infringing on methodologies covered by our patents. If discussions
with potential infringers do not result in favorable business relationships, we
may resort to legal actions to enforce our patents. However, there can be no
assurance that we will be successful in enforcing any potential patent claims
against larger competitors.
Based on the asset purchase agreement and plan of reorganization
between Patriot, nanoTronics and Mr. Falk, we were the recipients of a number of
warranties and indemnities. We believe nanoTronics has been liquidated and, due
to Mr. Falk's death in July 1995, we may be limited in our ability to obtain
satisfaction should we have any future claims against nanoTronics or its
successor, the Falk Family Estate.
We have entered into the following licenses related to the
microprocessor technology:
o Sierra Systems. In June 1994, we entered into an agreement with
Sierra Systems whereby we could provide the C programming
language on the Ignite. We currently provide development boards
with the C programming language.
o Sun Microsystems Inc. In June 1997, we entered into an agreement
with Sun Microsystems, Inc. which enabled us to develop and
distribute products based on Sun's Java's technology. In June
1998, we exercised an option under that agreement to license from
Sun, personalJava, a smaller platform on which to run Java
applications that did not include an operating system. We
determined that personalJava was better suited to the markets
available to the Ignite. We have ported personalJava to the
Ignite.
o Wind River. In July 1997, we entered into an agreement with Wind
River that provided us with a license for an operating system,
VxWorks, to be used in conjunction with personalJava. We have
ported VxWorks to the Ignite.
11
o Forth Inc. In July 1997, we entered into a license agreement with
Forth Inc. whereby Forth will provide software support and
operating system development tools for the Forth programming
language.
We had one U.S. patent on our gas plasma antenna technology that was
sold in August 1999.
We have one U.S. patent on our ground penetrating radar technology. 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.
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.
MARKETING AND DISTRIBUTION. Our products are marketed through a
combination of direct sales and distributors. Approximate sales by principal
geographic area (as a percentage of sales) for fiscal years ended May 31 were as
follows:
2003 2002 2001
---- ---- ----
Domestic sales 91% 99% 75%
Foreign sales
Asia - % - % 7%
Europe 9% 1% 6%
North America - % - % 12%
----- ---- ----
Total sales 100% 100% 100%
==== ==== ====
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 have a material
adverse effect on operations.
DEPENDENCE UPON SINGLE CUSTOMERS. Ten percent (10%) or more of our
consolidated net sales were derived from shipments to the following customers
for the fiscal years ended May 31as follows:
2003 2002 2001
---- ---- ----
Long Wave, Inc. $43,000 $ - $ -
General Dynamics 23,000 - -
Centratech 15,000 - -
Advanced Relay 15,000 151,000 -
Schindler - 59,000 -
Raytheon - - 88,000
SAIC - - 41,000
Spellcaster - - 40,000
All of the above sales were shipped against multiple purchase orders
from each customer.
We had no backlog as of May 31, 2003 or 2002.
12
EMPLOYEES. We currently have eight personnel. Four persons are employed
in research and development, one in marketing and sales and three are engaged in
general and administrative activities. We also engage additional consultants and
part-time persons as needed from time to time.
Our future success depends in significant part upon the continued
service 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 is represented by a
labor union, and we consider our relations with our employees to be good. None
of our employees is covered by key man life insurance policies.
GOVERNMENT REGULATION. To our knowledge, our products are not subject
to governmental regulation by any federal, state or local agencies that would
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 cannot, of course, predict what sort of regulations of this type
may be imposed in the future but do not anticipate any unusual difficulties in
complying with governmental regulations which may be adopted in the future.
We have not incurred costs associated with environmental laws and do
not anticipate such laws will have any significant effect on our future
business.
ITEM 2. DESCRIPTION OF PROPERTY
We have one 10,300 square foot office located at 10989 Via Frontera,
San Diego, California. The facility is leased through July 2006. In July 2002,
we sublet approximately 5,000 square feet of our facility to an independent
third party. The term of the sublease coincides with the remaining term of our
lease. The reduced floor space provides adequate and suitable facilities for all
of our corporate functions.
ITEM 3. LEGAL PROCEEDINGS
In January 1999, we were sued in the Superior Court of San Diego
County, California by the Fish Family Trust, a co-inventor of the original
ShBoom technology. The suit also named as defendants nanoTronics and Gloria
Felcyn on behalf of the Falk Family Trust. The suit sought a judgment for
damages, a rescission of the Technology Transfer Agreement and a restoration of
the technology to the co-inventor. In March 1999, we joined with nanoTronics and
Gloria Felcyn and filed our response and cross-complaint against the Fish Family
Trust. In November 2000, the judge issued a summary ruling in favor of the
defendants on all counts. The Fish Family Trust filed an appeal in January 2001.
In June 2003, the Appellate Court confirmed the trial court's ruling, thereby,
bringing the dispute to a favorable conclusion.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Common Stock is traded in the over-the-counter market and is quoted
on the NASD OTC Bulletin Board system maintained by the National Association of
Securities Dealers, Inc. 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.
13
The following table sets forth the high and low closing bid quotations
for the Common Stock for the fiscal years ended May 31, 2003 and 2002.
BID QUOTATIONS
HIGH LOW
Fiscal Year Ended May 31, 2003
First Quarter $0.08 $0.06
Second Quarter $0.14 $0.04
Third Quarter $0.09 $0.04
Fourth Quarter $0.09 $0.04
Fiscal Year Ended May 31, 2002
First Quarter $0.53 $0.25
Second Quarter $0.25 $0.10
Third Quarter $0.15 $0.07
Fourth Quarter $0.14 $0.07
We have approximately 550 shareholders of record as of May 31, 2003.
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
stockholders represented by these record holders. We have never paid a cash
dividend on our common stock and do not expect to pay one in the foreseeable
future.
RECENT SALE OF UNREGISTERED SECURITIES
During the fourth fiscal quarter ended May 31, 2003, we offered and
sold the following common stock for cash without registration under the
Securities Act of 1933, as amended, and exemption for such sale from
registration under the Act is claimed in reliance upon the exemption provided by
Section 4(2) thereof on the basis that such offer and sale was a transaction not
involving any public offering. Appropriate precautions against transfer have
been taken, including the placing of a restrictive legend on the certificate
evidencing such securities. The sale was effected without the aid of
underwriters, and no sales commissions were paid.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
You should read the selected consolidated financial data set forth
below in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our consolidated financial statements
and the notes to those statements included elsewhere in this report. The
selected consolidated financial data set forth below for the fiscal years ended
May 31, 2003, 2002, 2001, 2000, and 1999 have been derived from our consolidated
financial statements which have been audited by Nation Smith Hermes Diamond,
independent auditors, for the years ended May 31, 2003 and 2002 and BDO Seidman,
LLP, independent auditors, for the preceding three years.
YEARS ENDED MAY 31,
----------------------------------------------------------------------------------
2003 2002 2001 2000 1999
--------------- --------------- -------------- -------------- --------------
STATEMENTS OF OPERATIONS DATA:
Revenue:
Sales $ 123,903 $ 358,809 $ 337,384 $ 716,960 $ 1,134,545
--------------- --------------- -------------- -------------- --------------
Costs and expenses:
Cost of sales 18,660 393,980 544,320 725,008 711,195
Research and development 723,287 1,372,421 2,218,433 3,170,166 2,149,361
Selling, general and administrative 1,821,902 2,708,579 2,588,579 3,501,128 2,015,058
--------------- --------------- -------------- -------------- --------------
Total costs and expenses 2,563,849 4,474,980 5,351,332 7,396,302 4,875,614
--------------- --------------- -------------- -------------- --------------
Operating loss (2,439,946) (4,116,171) (5,013,948) (6,679,342) (3,741,069)
Other income (expense), net (1,448,353) (1,370,880) 45,045 (809,366) (535,387)
--------------- --------------- -------------- -------------- --------------
Net loss $ (3,888,299) $ (5,487,051) $ (4,968,903) $ (7,488,708) $ (4,276,456)
=============== =============== ============== ============== ==============
Basic and diluted loss per common share $ (0.04) $ (0.08) $ (0.09) $ (0.17) $ (0.11)
Weighted average number of shares-
basic and diluted 93,791,470 66,810,028 53,433,788 44,156,418 38,042,734
MAY 31,
----------------------------------------------------------------------------------
2003 2002 2001 2000 1999
--------------- --------------- -------------- -------------- --------------
BALANCE SHEET DATA:
Cash and cash equivalents $ 32,663 $ 88,108 $ 464,350 $ 2,100,242 $ 35,813
Working capital (deficiency) (1,457,003) (918,768) 328,605 1,769,340 (1,545,055)
Total assets 465,234 934,526 1,543,693 2,733,148 1,145,027
Long-term obligations, net of current
maturities 290,436 331,929 - - -
Total stockholders' equity (deficit) (1,411,764) (444,825) 922,388 2,209,882 (981,234)
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Our Results of Operations have been and may continue to be subject to
significant variations. The results for a particular period may vary due to a
number of factors. These include:
o the overall state of the semiconductor industry,
o the development status of and demand for our products,
o economic conditions in our markets,
o the timing of orders,
o the timing of expenditures in anticipation of future sales,
o the mix of products sold by us,
o the introduction of new products,
o product enhancements by us or our competitors, and
o pricing and other competitive conditions.
15
CRITICAL ACCOUNTING POLICIES
We believe that the following represent our critical accounting
policies:
Property, Equipment and Depreciation
Property and equipment are stated at cost. Depreciation is computed
over the estimated useful life of three to five years using the straight-line
method. Long-lived assets and certain identifiable intangibles to be held and
used by the Company are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. We continuously evaluate the recoverability of our long-lived
assets based on estimated future cash flows from and the estimated fair value of
such long-lived assets, and provide for impairment if such undiscounted cash
flows are insufficient to recover the carrying amount of the long-lived asset.
Patents and Trademarks
Patents and trademarks are carried at cost less accumulated
amortization and are amortized over their estimated useful lives of four years.
The carrying value of patents and trademarks is periodically reviewed and
impairments, if any, are recognized when the expected future benefit to be
derived from an individual intangible asset is less than its carrying value.
Revenue Recognition
We recognize revenue on the shipment to our customers of communication
products, microprocessor integrated chips and evaluation boards. We also derive
revenue from fees for the transfer of proven and reusable intellectual property
components or the performance of engineering services. We enter into licensing
agreements that will provide licensees the right to incorporate our intellectual
property components in their products with terms and conditions that will vary
by licensee. Generally, these payments will include a nonrefundable technology
license fee, which will be payable upon the transfer of intellectual property,
or a nonrefundable engineering service fee, which generally will be payable upon
achievement of defined milestones. In addition, we anticipate these agreements
will include royalty payments, which will be payable upon sale of a licensee's
product, and maintenance and limited support fees. We will classify all revenue
that involves the future sale of a licensee's products as royalty revenue.
Royalty revenue will be generally recognized in the quarter in which a report is
received from a licensee detailing the shipments of products incorporating our
intellectual property components (i.e., in the quarter following the sale of
licensed product by the licensee). We will classify all revenue that does not
involve the future sale of a licensee's products, primarily license fees and
engineering service fees and maintenance and support fees, as contract revenue.
License fees will be recognized upon the execution of the license agreement and
transfer of intellectual property, provided no further significant performance
obligations exist and collectibility is deemed probable. Fees related to
engineering services contracts, which will be performed on a best efforts basis
and for which we will receive periodic milestone payments, will be recognized as
revenue over the estimated development period, using a cost-based percentage of
completion method. Annual maintenance and support fees, which will be renewable
by the licensee, will be classified as contract revenue and will be amortized
over the period of support, generally 12 months.
Research and Development Costs
Research and development costs are expensed as incurred.
Stock Options
The Company applies Accounting Principles Board ("APB") Opinion 25,
"Accounting for Stock Issued to Employees," and related Interpretations in
accounting for all stock option plans. Under APB Opinion 25, compensation cost
has been recognized for stock options granted to employees when the option price
is less than the market price of the underlying common stock on the date of
grant.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," requires the Company to provide pro forma information
regarding net income as if compensation cost for the Company's stock option
plans had been determined in accordance with the fair value based method
prescribed in SFAS No. 123. To provide the required pro forma information, the
Company estimates the fair value of each stock option at the grant date by using
the Black-Scholes option-pricing model.
16
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 of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. During the year ended May 31, 2002, based upon information
then available, we revised our estimates regarding the recovery of our
inventories. As a result, we increased existing reserves for obsolescence by
$111,381.
RESULTS OF OPERATIONS FOR THE YEARS ENDED MAY 31, 2003, 2002 AND 2001
OUR NET SALES IN FISCAL 2003, 2002 AND 2001 WERE AS FOLLOWS:
Fiscal Year Amount % Change from the Previous Fiscal Year
----------- ------ --------------------------------------
2003 $ 123,903 Decrease of 65.5%
2002 $ 358,809 Increase of 6.3%
2001 $ 337,384
Net sales. Net sales for the year ended May 31, 2003 decreased over the
previous year as a result of minimal sales for the communications products all
of which reached the end of their life cycles and only minimal sales of the
microprocessor products. Net sales for the year ended May 31, 2002 increased
slightly over the previous year as a result of a last buy program for the
communications products. We have stopped production of our communications
products and are now concentrating on the microprocessor product line. We
anticipate only minor, if any, future communication product revenue. We have not
been successful in selling this line and have liquidated substantially all of
the inventory related thereto. Future sales will be derived from sales of
microprocessors and licensing of microprocessor technology.
OUR COST OF SALES IN FISCAL 2003, 2002 AND 2001 WERE AS FOLLOWS:
Fiscal Year Amount % Change from the % of Net Sales
----------- ------- Previous Fiscal Year --------------
--------------------
2003 $ 18,660 Decrease of 95.3% 15.1%
2002 $ 393,980 Decrease of 27.6% 109.8%
2001 $ 544,320 161.3%
Cost of sales. Cost of sales as a percentage of net sales decreased
significantly in the fiscal year ended May 31, 2003 compared to the previous
fiscal year. This reduction was a result of the end of production of our
communication products and the elimination of manufacturing and overhead costs
necessary to support that product line. Cost of sales as a percentage of net
sales decreased in the fiscal year ended May 31, 2002 compared to the previous
fiscal year. This decrease was due to a reduction in fixed manufacturing
overhead as a result of cost cutting programs instituted in conjunction with the
completion of the communication product line during the current fiscal year.
OUR RESEARCH AND DEVELOPMENT EXPENSES IN FISCAL 2003, 2002 AND 2001
WERE AS FOLLOWS:
Fiscal Year Amount % Change from the Previous Fiscal Year
----------- ------ --------------------------------------
2003 $ 723,287 Decrease of 47.3%
2002 $1,372,421 Decrease of 38.1%
2001 $2,218,433
Research and development expenses decreased during the fiscal year
ended May 31, 2003 compared to the previous fiscal year. This decrease was due
primarily to a reduction of approximately $428,000 in personnel costs and a
$143,000 reduction in the costs of outside consultants. Research and development
expenses decreased during the fiscal year ended May 31, 2002 compared to the
previous fiscal year. This decrease was due primarily to a reduction of
17
approximately $406,000 in personnel costs, a $221, 000 reduction in the costs of
outside consultants and a reduction in software maintenance costs of $77,000.
The reductions in costs were as a result of a cost cutting program initiated
during the first half of the 2002 fiscal year.
OUR SELLING, GENERAL AND ADMINISTRATIVE EXPENSES IN FISCAL 2003, 2002
AND 2001 WERE AS FOLLOWS:
Fiscal Year Amount % Change from the Previous Fiscal Year
----------- ------ --------------------------------------
2003 $1,821,902 Decrease of 32.7%
2002 $2,708,579 Increase of 4.6%
2001 $2,588,579
Selling, general and administrative expenses decreased during the
fiscal year ended May 31, 2003, compared to the previous fiscal year. This
decrease was due primarily to a reduction of approximately $519,000 in personnel
costs, $178,000 in consulting expenses and $134,000 in professional expenses.
The reductions in costs were as a result of a cost cutting program initiated
during the first half of the 2002 fiscal year. Selling, general and
administrative expenses increased during the fiscal year ended May 31, 2002.
This increase was due primarily to approximately $294,000 of legal, accounting
and shareholder costs associated with several registrations of securities and
two shareholder meetings, non-cash compensation of $105,000 related to services
provided to support our merger and acquisition activities, offset by reductions
in consulting expenses of $286,000.
OUR OTHER INCOME (EXPENSES) IN FISCAL 2003, 2002 AND 2001 WERE AS
FOLLOWS:
Fiscal Year Amount % Change from the Previous Fiscal Year
----------- ------ --------------------------------------
2003 $(1,448,353) Not meaningful
2002 $(1,370,880) Not meaningful
2001 $ 45,045
Other income (expense) increased for the fiscal year ended May 31, 2003
compared to the previous fiscal year. This change resulted primarily from the
recognition of non-cash interest expense of approximately $1,305,000 related to
the amortization of the debt discount associated with the issuance of warrants
under the convertible debentures and interest expense of $144,000 related to our
debt. Other income (expense) changed significantly for the fiscal year ended May
31, 2002 compared to the previous fiscal year. This change resulted primarily
from the recognition of non-cash interest expense of approximately $1,324,000
related to the amortization of the debt discount associated with the issuance of
warrants under the secured note payable, convertible debentures, and equity line
of credit and interest expense related to the excess of the market price over
the carrying value of the common shares sold to Swartz for which the proceeds
were applied to the note payable balance.
LIQUIDITY AND CAPITAL RESOURCES
In connection with their report on our consolidated financial
statements as of and for the year ended May 31, 2003, Nation Smith Hermes
Diamond, our independent certified public accountants, expressed substantial
doubt about our ability to continue as a going concern because of recurring net
losses and negative cash flow from operations.
At May 31, 2003, we had deficit working capital of $1,457,003 and cash
and cash equivalents of $32,663. We have historically funded our operations
primarily through the issuance of securities and debt financings. Cash and cash
equivalents decreased $55,445 during the year ended May 31, 2003 due to net cash
used in operations of $1,885,762 offset by funds generated primarily from the
issuance of convertible debentures of $1,507,000 and short term notes payable of
$180,000. The net cash used in operations was $1,855,762 for the year ended May
31, 2003 compared to $3,632,534 for the corresponding period of the previous
fiscal year. The decrease in cash required in operations was due primarily to a
$1,400,801 reduction in net loss as adjusted to reconcile to cash used in
operating activities coupled with a $299,529 change in prepaid expenses and
other assets between the two periods. Cash used in investing activities was
$2,194 for the year ended May 31, 2003 compared to $146,156 for the
corresponding period of the previous fiscal year. This decrease was the result
of a paydown of $60,000 on a note receivable coupled with a $83,962 reduction in
additions to property, equipment and patents. Cash provided by financing
activities was $1,832,511 for the year ended May 31, 2003 compared to $3,402,448
18
for the corresponding period of the previous fiscal year. This decrease was
primarily the result of a reduced issuance of common stock of $759,255 during
the current fiscal year compared to the previous fiscal year coupled with a
reduction in the issuance of notes payable and convertible debentures of
$611,000 and the sale of accounts receivable of $123,881.
We estimate our current cash requirements to sustain our operations
through August 2004 to be $2.1 million. Since we are no longer supporting the
communications product line, we are assuming that there will be no
communications product revenue. We have a note payable to Swartz Private Equity,
LLC ("Swartz") of $635,276 at May 31, 2003 which is due March 1, 2004. We also
have convertible debentures with a group of investors as of May 31, 2003
aggregating $1,165,000 and advances of $50,000 on a convertible debenture that
closed subsequent to May 31, 2003. At the option of the debenture holders, they
may purchase additional debentures up to $1 million at any time during the next
two years as long as the price of our common stock is in excess of $0.20 per
share. During the year ended May 31, 2003, we obtained $120,350 from the sale of
equity to several private investors and $180,000 from short term notes entered
into with a related party. Subsequent to May 31, 2003, we obtained an additional
$422,500 from the issuance of convertible debentures net of advances discussed
above, $50,100 from the exercise of a warrant, $10,000 from a loan issued to a
related party, and $31,000 from the sale of common stock.
If the optional amounts under the convertible debentures are not raised
in sufficient amounts, then we may not have funds sufficient to meet our cash
requirements. In such circumstances, we may need to secure additional short-term
debt, private placement debt and/or equity financings with individual or
institutional investors. In addition, we may need to make additional cost
reductions if our cash requirements cannot be met from external sources. We
expect that the $2.1 million requirement will be provided by:
o additional debt and/or equity financings; and
o proceeds from the exercise of outstanding stock options and warrants.
In addition, we have formulated additional cost reduction plans which
can be implemented if the required funds are not obtainable. We also have a
$400,000 accounts receivable factoring agreement with our bank. As of May 31,
2003 there was a balance due under the factoring agreement of $3,811.
We anticipate our future revenue to be derived primarily from the sale
of licenses and royalties. To receive this revenue, we may require additional
equipment, fabrication, components and supplies during the next twelve months to
support potential customer requirements and further develop our technologies.
Product introductions such as those currently underway for the Ignite I may
require significant product launch, marketing personnel and other expenditures
that cannot be currently estimated. Further, if expanded development is
commenced or new generations of microprocessor technology are accelerated beyond
current plans, additional expenditures we cannot currently estimate, may be
required. It is possible therefore, that higher levels of expenditures may be
required than we currently contemplate resulting from changes in development
plans or as required to support new developments or commercialization activities
or otherwise.
If we are unable to obtain the necessary funds, we could be forced to
substantially curtail or cease operations which would have a material adverse
effect on our business. Further, there can be no assurance that we will be able
to timely receive shareholder approval to increase the number of authorized
shares or that required funds, if available, will be available on attractive
terms or that they will not have a significantly dilutive effect on our existing
shareholders. As such, there is substantial doubt about our ability to continue
as a going concern. The consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from our possible inability to continue as a going concern.
$25 MILLION EQUITY LINE OF CREDIT
Overview. On September 17, 2001, we entered into an investment
agreement with Swartz. The investment agreement entitles us to issue and sell
our common stock to Swartz for up to an aggregate of $25 million from time to
time during a three-year period following the effective date of the registration
statement. This is also referred to as a put right. We filed a registration
statement on Form S-1 on October 11, 2001 that was declared effective on
November 5, 2001 for 15,000,000 shares of our common stock which we issued to
19
Swartz during the fiscal year ended May 31, 2002. There remains approximately
$24 million available under this line conditioned on us filing one or more
additional registration statements. As of May 31, 2003, we have not filed a
statement requesting the registration of additional shares to put to Swartz
under the $25 million equity line of credit.
Put Rights. In order to invoke a put right, we must have an effective
registration statement on file with the SEC registering the resale of the common
shares which may be issued as a consequence of the invocation of that put right.
Additionally, we must give at least ten but not more than twenty business days
advance notice to Swartz of the date on which we intend to exercise a particular
put right, and we must indicate the number of shares of common stock we intend
to sell to Swartz. At our option, we may also designate a maximum dollar amount
of common stock (not to exceed $3 million) which we will sell to Swartz during
the put and/or a minimum purchase price per common share at which Swartz may
purchase shares during the put. The number of common shares sold to Swartz may
not exceed 20% of the aggregate daily reported trading volume during each of two
consecutive ten business day periods beginning on the business day immediately
following the day we invoked the put right.
The price Swartz will pay for each share of common stock sold in a put
is equal to the lesser of (i) the market price for each of the two consecutive
ten business day periods beginning on the business day immediately following the
day we invoked the put right minus $0.10, or (ii) X percent of the market price
for each of the two ten day periods, where, X is equal to 90% if the market
price is below $2.00 and 93% if market price is equal to or greater than $2.00.
Market price is defined as the lowest closing bid price for the common stock
during each of the two consecutive ten business day periods. However, the
purchase price may not be less than the designated minimum per share price, if
any, that we indicated in our notice.
Limitations and Conditions Precedent to Our Put Rights. We may
not initiate a put if, as of the proposed date of such put:
o we have issued shares of our common stock that have been paid for
by Swartz and the amount of proceeds we have received is equal to
the maximum offering amount;
o the registration statement covering the resale of the shares
becomes ineffective or unavailable for use;
o our common stock is not actively trading on the OTC Bulletin
Board, the Nasdaq Small Cap Market, the Nasdaq National Market,
the American Stock Exchange, or the New York Stock Exchange, or
is suspended or delisted with respect to the trading on such
market or exchange.
If any of the following events occur during the pricing period for a
put, the volume accrual shall cease. For the put, the pricing period shall be
adjusted to end 10 business days after the date that we notify Swartz of the
event, and any minimum price per share we specified shall not apply to the put:
o we have announced or implemented a stock split or combination of
our common stock between the advanced put notice date and the end
of the pricing period;
o we have paid a common stock dividend or made any other
distribution of our common stock between the advanced put notice
date and the end of the pricing period;
o we have made a distribution to the holders of our common stock or
of all or any portion of our assets or evidences of indebtedness
between the put notice date and the end of the pricing period;
o we have consummated a major transaction (including a transaction,
which constitutes a change of control) between the advance put
notice date and the end of the pricing period, the registration
statement covering the resale of the shares becomes ineffective
or unavailable for use, or our stock becomes delisted for trading
on our then primary exchange; or
o we discover the existence of facts that cause us to believe that
the registration statement contains an untrue statement or omits
to state a material fact.
20
Short Sales. Swartz and its affiliates are prohibited from engaging in
short sales of our common stock unless they have received a put notice and the
amount of shares involved in a short sale does not exceed the number of shares
specified in the put notice.
Shareholder Approval. We may currently issue more than 20% of our
outstanding shares under the investment agreement. If we become listed on the
Nasdaq Small Cap Market or Nasdaq National Market, then we must get shareholder
approval to issue more than 20% of our outstanding shares. Since we are
currently a bulletin board company, we do not need shareholder approval.
Termination of Investment Agreement. We may also terminate our right to
initiate further puts or terminate the investment agreement by providing Swartz
with notice of such intention to terminate; however, any such termination will
not affect any other rights or obligations we have concerning the investment
agreement or any related agreement.
Restrictive Covenants. During the term of the investment agreement and
for a period of two months thereafter, we are prohibited from certain
transactions. These include the issuance of any debt or equity securities in a
private transaction which are convertible or exercisable into shares of common
stock at a price based on the trading price of the common stock at any time
after the initial issuance of such securities or with a fixed conversion or
exercise price subject to adjustment without obtaining Swartz's prior written
approval.
Right of First Refusal. Swartz has a right of first refusal to purchase
any variable priced securities offered by us in any private transaction which
closes on or prior to two months after the termination of the investment
agreement and a right of participation for any equity securities offered by us
in any private transaction which closes on or prior to two months after the
termination of the investment agreement.
Swartz's Right of Indemnification. We are obligated to indemnify Swartz
(including their stockholders, officers, directors, employees and agents) from
all liability and losses resulting from any misrepresentations or breaches we
made in connection with the investment agreement, our registration rights
agreement, other related agreements, or the registration statement.
Waiver and Agreement. On March 12, 2002, we entered into an amended
waiver and agreement with Swartz which replaced and superseded all previous
waivers and agreements. This amended waiver and agreement extended the time of
the put beyond twenty days and redefined the price of the put to be the lesser
of the factor of (a) the volume weighted average price per share, as defined by
Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume
weighted average price per share minus $0.05 multiplied by 20% of the acceptable
daily volume as defined in the waiver. At the discretion of Swartz, the 20%
daily volume limitation could be increased up to 30% of the daily volume. In
addition, the amended waiver and agreement increased the intended put share
amount for the first put to 14,100,000 shares, which is the total number of
shares we had registered so far under the $25 million equity line of credit. On
May 30, 2002 we closed the first put under the $25 million equity line of credit
by applying the proceeds of $926,924 to the secured note payable discussed
below.
Warrants. In connection with closing the $25 million equity line of
credit, we issued to Swartz a commitment warrant to purchase 900,000 shares of
our common stock as discussed further in Note 6 to the consolidated financial
statements. This warrant was valued on the issuance date using the Black-Scholes
pricing model and the value was recorded as a debt discount.
SECURED NOTE PAYABLE
On March 12, 2002, we replaced and superceded a previously issued
Secured Promissory Note with Swartz with an Amended Secured Promissory Note and
Agreement with an effective date of October 9, 2001, an Addendum to Amended
Secured Promissory Note dated March 12, 2002 and an Antidilution Agreement and
Addendum to Warrants dated March 19, 2003. The amended note, which originally
was to mature on January 9, 2003, has been extended to March 1, 2004 and amounts
outstanding under the note bear interest at the rate of 5% per annum. Per the
antidilution agreement, principal and interest payments are deferred until March
1, 2004.
As part of the consideration for entering into the above amended note,
we agreed to issue warrants to Swartz related to each advance against the note.
In connection with each advance, we issued to Swartz a warrant to purchase a
21
number of shares of common stock equal to the amount of the advance multiplied
by 8.25 at an initial exercise price equal to the lesser of (a) the factor of
the average of the volume weighted average price per share, as defined by
Bloomberg L.P., for each trading day in the period beginning on the date of the
previous advance and ending on the trading day immediately preceding the date of
the current advance multiplied by .70 or (b) the volume weighted average price
per share minus $0.05. In addition, we were obligated under the addendum to the
note to issue to Swartz warrants equal to 20% of the common stock issued between
March 12, 2002 and April 1, 2003 and we are obligated under the antidilution
agreement to issue to Swartz warrants equal to 30% of the common stock issued
subsequent to April 1, 2003 to any parties other than Swartz. In addition, we
agreed to extend the expiration date to December 31, 2006 on certain warrants
that were to expire previous to December 31, 2006. In exchange for these
concessions, Swartz agreed to extend the due date to March 1, 2004 on a note for
$635,276 net of accrued interest and unreserved 20,007,350 shares that have been
reserved for the exercise of warrants for a period the sooner of 1) March 19,
2004, or 2) 90 days after the date on which our common stock exceeds $0.375 for
10 consecutive trading days.
As of May 31, 2003 we issued warrants to purchase up to 18,243,712
shares of our common stock in accordance with the amended note agreements and
antidilution agreement. The warrants issued were valued using the Black-Scholes
pricing model based on the expected fair value at issuance and the estimated
fair value was also recorded as debt discount.
The note is secured by our assets.
All debt discounts were amortized as additional interest expense over
the initial term of the note payable. As of May 31, 2003, $1,107,238 had been
reflected as debt discount of which $917,722 and $189,516 was amortized to
interest expense during the years ended May 31, 2002 and 2003, respectively.
Advances against the note $1,790,000
Less amount applied against $30 million equity line of credit (227,800)
Less amount applied against $25 million equity line of credit (926,924)
Less debt discount
Total 1,107,238
Amount amortized to expense (1,107,238) -
------------ ----------
Note payable at May 31, 2003 $ 635,276
==========
On November 9, 2001, an offset of $227,800 from the sale of 2,500,000 shares of
common stock was applied against the final put under a $30 million equity line
of credit.
On May 30, 2002, an offset of $926,924 from the sale of 14,100,000 shares of
common stock was applied against the first and only put under the $25 million
equity line of credit discussed above.
8% CONVERTIBLE DEBENTURES
Overview. From April 23, 2002 through August 26, 2003, we sold an
aggregate of $2,437,500 of 8% convertible debentures to a group of eleven
investors. The convertible debentures entitle the debenture holder to convert
the principal and unpaid accrued interest into our common stock for two years
from the date of closing. In addition, the debenture holders received warrants
exercisable into a number of our common shares.
Number of Shares Debentures May Be Converted Into. The debentures can
be converted into a number of our common shares at conversion prices that
initially equaled $0.041 to $0.10289 per share.
Resets of Conversion Price and Conversion Shares. A reset date occurs
on each three month anniversary of the closing date of each debenture and on the
date the registration statement becomes effective, October 29, 2002 for the
first $1,000,000 of principal, March 7, 2003 for the second $605,000 of
principal and June 26, 2003 for the third $510,000 of principal. If the volume
weighted average price for our common stock for the ten days previous to the
reset date is less than the conversion price in effect at the time of the reset
date, then the number of common shares issuable to the selling shareholder on
conversion will be increased. If the conversion price is reset, the debenture
can be converted into a number of our common shares based on the following
calculation: the amount of the debenture plus any unpaid accrued interest
22
divided by the reset conversion price which shall equal the volume weighted
average price for our common stock for the ten days previous to the reset date.
On October 29, 2002, the date the registration statement for the first
$1,000,000 of principal became effective, the conversion prices were reset to
$0.04457 from initial conversion prices ranging from $0.08616 to $0.10289. On
March 7, 2003, the date the registration statement for the second $605,000 of
principal became effective, the conversion prices were reset to $0.04722 from
initial conversion prices ranging from $0.05126 to $0.0727. On June 26, 2003,
the date the registration statement for the third $510,000 of principal became
effective, the conversion prices for debentures with initial conversion prices
of $0.065 were reset to $0.06346.
Warrants. Concurrent with the issuance of the convertible debentures,
we issued to the debenture holders warrants to purchase up to 33,471,953 shares
of our common stock. These warrants are exercisable for five years from the date
of issuance at either initial negotiated exercise prices or prices equal to 115%
of the volume weighted average price for our common stock for the ten days
previous to the debenture date. The warrant exercise price is subject to being
reset on each six month anniversary of its issuance.
Options to Purchase Additional Debentures. Subject to the price of our
common stock being equal to or greater than $0.20 per share and a two year
limitation, the debenture holders may purchase additional debentures equal to
the value of their initial debentures. The price at which the optional
additional debentures could be converted would initially equal 115% of the
volume weighted average price for our common stock for the ten days previous to
the date on which the optional additional debentures were closed. The optional
additional debentures would carry the same warrant amounts and reset privileges
as the initial debentures.
Shareholder Approval. We may currently issue more than 20% of our
outstanding shares under the convertible debentures. If we become listed on the
NASDAQ Small Cap Market or NASDAQ National Market, then we must get shareholder
approval to issue more than 20% of our outstanding shares. Since we are
currently a bulletin board company, we do not need shareholder approval.
Restrictive Covenants. For a period of 18 months from the date of the
debentures, we are prohibited from certain transactions. These include the
issuance of any debt or equity securities in a private transaction which are
convertible or exercisable into shares of common stock at a price based on the
trading price of the common stock at any time after the initial issuance of such
securities; the issuance of any debt or equity securities with a fixed
conversion or exercise price subject to adjustment; and any private equity line
type agreements without obtaining the debenture holders' prior written approval.
Right of First Refusal. The debenture holders have a right of first
refusal to purchase or participate in any equity securities offered by us in any
private transaction which closes on or prior to the date that is two years after
the issue date of each debenture.
Registration Rights. We are responsible for registering the resale of
the shares of our common stock which will be issued on the conversion of the
debentures. On October 29, 2002, a registration statement covering the first
$1,000,000 of debentures was declared effective by the Securities and Exchange
Commission. On March 7, 2003, a registration statement covering the second
$605,000 of debentures was declared effective by the Securities and Exchange
Commission. On June 26, 2003, a registration statement covering the third
$510,000 of debentures was declared effective by the Securities and Exchange
Commission.
23
The convertible debentures are secured by our assets.
Convertbile debenture dated April 23, 2002 $ 225,000
Convertbile debentures dated June 10, 2002 775,000
Convertbile debenture dated August 23, 2002 175,000
Convertbile debentures dated October 29, 2002 180,000
Convertbile debenture dated December 16, 2002 100,000
Convertbile debenture dated January 24, 2003 150,000
Convertbile debenture dated March 24, 2003 162,500
Convertbile debenture dated April 15, 2003 10,000
Convertbile debenture dated May 20, 2003 187,500
Advances against debenture issued subsequent to May 31, 2003 50,000
Less amounts converted to common stock (800,000)
Less debt discount
Total discounts recorded $ 1,965,000
Amount amortized to expense (624,922)
Amount cancelled on conversion (527,067) (813,011)
------------- ----------------
Convertible debentures at May 31, 2003 401,989
Less current portion 121,879
----------------
Long term portion $ 280,110
================
NEW ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No.
123." SFAS No. 148 amends the disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. SFAS No. 148 is effective
for fiscal years ending after December 15, 2002 and is effective for interim
periods beginning after December 15, 2002. The Company's adoption of SFAS No.
148 did not have a material effect on the Company's financial position or
results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." This interpretation elaborates on the
disclosures required in financial statements concerning obligations under
certain guarantees. It also clarifies the requirements related to the
recognition of liabilities by a guarantor at the inception of certain
guarantees. The disclosure requirements of this interpretation were effective on
December 31, 2002. We adopted the recognition provisions of the interpretation
in the quarter ended February 28, 2003. The adoption of this interpretation did
not impact our financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51." This
interpretation provides guidance on: 1) the identification of entities for which
control is achieved through means other than through voting rights, known as
"variable interest entities" (VIEs); and 2) which business enterprise is the
primary beneficiary and when it should consolidate the VIE. This new model for
consolidation applies to entities: 1) where the equity investors (if any) do not
have a controlling financial interest; or 2) whose equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, this
interpretation requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. This interpretation is effective for all new VIEs created or
acquired after January 31, 2003. For VIEs created or acquired prior to February
1, 2003, the provisions of the interpretation must be applied no later than the
beginning of the first interim or annual reporting period beginning after June
15, 2003. Certain disclosures are effective immediately. The adoption of this
interpretation did not impact our financial position or results of operations.
In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
24
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 149 requires that contracts with comparable characteristics be accounted for
similarly. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003, and for hedging relationships designated after June 30,
2003. The adoption of this Statement is not expected to have a material effect
on the consolidated financial statements
In May 2003 the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003, except for mandatorily redeemable financial instruments of
nonpublic entities. The adoption of this Statement is not expected to have a
material effect on the consolidated financial statements.
TAX LOSS CARRYFORWARDS
Deferred income taxes are provided for temporary differences in
recognizing certain income and expense items for financial and tax reporting
purposes. Deferred tax assets consist primarily of income tax benefits from net
operating loss carry-forwards. A valuation allowance has been recorded to fully
offset the deferred tax asset as it is more likely than not that the assets will
not be utilized. The valuation allowance increased approximately $845,000 in the
year ended May 31, 2003, from $13,446,000 at May 31, 2002 to $14,291,000 at May
31, 2003.
ITEM 7A. QUANITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to interest rate risk on investments of our excess cash.
The primary objective of our investment activities is to preserve capital. To
achieve this objective and minimize the exposure due to adverse shifts in
interest rates, we invest from time to time in high quality short-term maturity
commercial paper and money market funds operated by reputable financial
institutions in the United States. Due to the nature of our investments, we
believe that we do not have a material interest rate exposure.
As of May 31, 2003, our notes payable to corporations and individuals
totaling $2 million bore interest at fixed rates of 5% to 8%. Our capital lease
obligation totaling $16,731 is discounted at a fixed rate of interest of 22.7%.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The following table presents selected unaudited quarterly information
for fiscal 2003 and 2002
FIRST SECOND THIRD FOURTH
Quarter Quarter Quarter Quarter
----------------- ------------------ ---------------- -----------------
Fiscal 2003:
Total revenues $ 39,889 $ 5,160 $ 41,390 $ 37,464
Operating loss (661,408) (743,271) (514,883) (520,384)
Net loss (943,441) (1,077,288) (842,661) (1,024,909)
Net loss per basic and diluted share $ (0.01) $ (0.01) $ (0.01) $ (0.01)
Fiscal 2002:
Total revenues $ 314,500 $ 7,389 $ 4,620 $ 32,300
Operating loss (1,039,217) (1,292,564) (964,703) (819,687)
Net loss (1,046,970) (1,558,602) (1,260,676) (1,620,803)
Net loss per basic and diluted share $ (0.02) $ (0.02) $ (0.02) $ (0.02)
Also see Part IV, Item 14(a).
25
The financial statements required by this item 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
Effective May 20, 2002, the client-auditor relationship between Patriot
Scientific Corporation (the "Company") and BDO Seidman, LLP ("BDO") ceased. The
Company dismissed BDO on May 20, 2002 as part of its cost reduction program
which was initiated earlier in that fiscal year.
The change in certifying accountants was approved by the Company's
board of directors.
BDO's reports on the consolidated financial statements of the Company
for each of the past two years did not contain an adverse opinion or a
disclaimer of opinion, nor were qualified as to any uncertainty in audit scope
or accounting principle; however the audit opinion of BDO on the Company's most
recent consolidated financial statements as of and for the period ending May 31,
2001 was modified to include an explanatory paragraph which contained a
statement that the Company's recurring losses from operations and negative cash
flows raised substantial doubt about the Company's ability to continue as a
going concern.
During the two years ended May 31, 2001 and the subsequent interim
periods preceding the date of the dismissal of BDO on May 20, 2002, there were
no disagreements with BDO on any matters of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreement(s), if not resolved to the satisfaction of BDO, would have caused
the former accountant to make a reference to the subject matter of the
disagreement(s) in connection with its reports covering such periods.
During the two years ended May 31, 2001 and the subsequent interim
periods preceding the date of the dismissal of BDO on May 20, 2002, there were
no "reportable events" (hereinafter defined) requiring disclosure pursuant to
Item 304 (a) (1) (v) of Regulation S-K. As used herein, the term "reportable
events" means any of the items listed in paragraphs (a) (1) (v) (A) - (D) of
Item 304 of Regulation S-K.
Effective May 20, 2002, the Company engaged Nation Smith Hermes
Diamond, a professional corporation, which is a member of the BDO Seidman
Alliance ("Nation") , as its independent accountants. During the two years ended
May 31, 2001 and the subsequent interim periods preceding the effective date of
the engagement of May 20, 2002, neither the Company nor anyone on its behalf
consulted Nation regarding either the application of accounting principles to a
specified transaction, either completed or proposed, or the type of audit
opinion that might be rendered on the Company's consolidated financial
statements, nor has Nation provided to the Company a written report or oral
advice regarding such principles or audit opinion.
The Company requested that BDO furnish it with a letter addressed to
the Securities and Exchange Commission stating whether or not it agrees with the
above statements. A copy of the letter from BDO dated June 4, 2002 was filed as
Exhibit 16.1 to the Form 8-K/A filed June 5, 2002.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table and biographical summaries set forth information,
including principal occupation and business experience, about our directors and
the executive officers at June 1, 2003:
NAME AGE POSITION AND OFFICES DIRECTOR SINCE
- ---- --- -------------------- --------------
Donald R. Bernier 61 Chairman and Director January 1995
David H. Pohl 65 Director April 2001
Jeffrey Wallin 55 President and CEO n/a
Lowell W. Giffhorn 56 Executive Vice President, CFO, Secretary and August 1999
Director
Carlton M. Johnson, Jr. 43 Director August 2001
Helmut Falk, Jr. 46 Director December 1997
Gloria Felcyn 56 Director October 2002
Joey Maitra 53 Vice President Engineering n/a
Patrick Nunally 39 Vice President and CTO n/a
26
BIOGRAPHICAL INFORMATION
DONALD R. BERNIER. Mr. Bernier was appointed Chairman of the Board on
August 5, 2001. Since 1971, Mr. Bernier has been the owner and President of
Compunetics Incorporated, a Troy, Michigan-based electronics firm of which he is
the founder. Compunetics engages in contract research and development,
specializing in microelectronics primarily for the automotive industry.
DAVID H. POHL. Mr. Pohl has served on our board of directors since
April 2001, and served as an officer of the Company from January 2001 to March
2002. Except for his service with PTSC, Mr. Pohl has been in the private
practice of law counseling business clients since 1997, and from 1995 to 1996
was Special Counsel to the Ohio Attorney General. Previously, he was a senior
attorney with a large U.S. law firm, and held positions as a senior officer and
general counsel in large financial services corporations. Mr. Pohl earned a J.D.
degree in 1962 from the Ohio State University College of Law, and also holds a
BS in Administrative Sciences from Ohio State.
JEFFREY E. WALLIN. Mr. Wallin has served as our Chief Executive Officer
and President since March 2002. Since 1999, Mr. Wallin was president of SDMC
Inc., a consulting company serving the multimedia system integration and
communications markets. From 1996 to 1999, Mr. Wallin was President and CEO of
TV/COM International, a division of Hyundai that developed and manufactured
end-to-end digital communications systems. Previously Mr. Wallin held senior
level management positions with Snell & Wilcox, General Instrument, now a major
division of Motorola, and Teledyne Corporation. Mr. Wallin obtained a B.S.
degree from Bemidji State University in 1970.
LOWELL W. GIFFHORN. Mr. Giffhorn was the principal in his own financial
management consulting firm from August 1996 until joining Patriot as Chief
Financial Officer (CFO) in May 1997. Mr. Giffhorn has served on our board of
directors since August 1999. From June 1992 to August 1996 and from September
1987 to June 1990 he was the CFO of Sym-Tek Systems, Inc. and Vice President of
Finance for its successor, Sym-Tek Inc., a major supplier of capital equipment
to the semiconductor industry. Mr. Giffhorn obtained a M.B.A. degree from
National University in 1975 and he obtained a B.S. in Accountancy from the
University of Illinois in 1969. Mr. Giffhorn is also a director and chairman of
the audit committee of DND Technologies, Inc., a publicly held company.
CARLTON M. JOHNSON, JR. Mr. Johnson was appointed a Director on August
5, 2001. Mr. Johnson is in-house legal counsel for Swartz Investments, LLC, a
position he has held since June 1996. Mr. Johnson has practiced law in Alabama
since 1986, Florida since 1988, and Georgia since 1997. He has been a
shareholder in the Pensacola, Florida AV rated law firm of Smith, Sauer, DeMaria
& Johnson and as 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.
Mr. Johnson is also a director and member of the audit committee of Peregrine
Pharmaceuticals, Inc., a publicly held company.
HELMUT FALK, JR. Since 1992, Dr. Falk has been the Director of
Anesthesia for the Johnson Memorial Hospital in Franklin, Indiana. Dr. Falk
received his D.O. from the College of Osteopathic Medicine of the Pacific in
1987 and his B.S. in Biology from the University of California, Irvine in 1983.
Dr. Falk is the son of the late Helmut Falk, who was the sole shareholder of
nanoTronics and the Chairman and CEO of Patriot until his death in July 1995.
Dr. Falk is also an heir to the Helmut Falk Estate, which is the beneficial
owner of the Company's shares held by the Helmut Falk Family Trust.
GLORIA FELCYN. Ms. Felcyn was appointed a Director and chairman of our
audit committee on October 10, 2002. Since 1982 Ms. Felcyn has been the
principal in her own public accounting firm. Ms. Felcyn received a B.S. degree
in Business Economics for Trinity University in 1968.
PATRICK O. NUNALLY. Dr. Nunally joined us as Vice President of Business
Development and Chief Technical Officer in June 2001, previous to which he had
been providing consulting services to us since May 2000. Dr. Nunally has more
27
than 20 years of entrepreneurial experience in semiconductor and embedded
processor design. From December 1998 to May 2000, he was President and CEO of
Intertech, a company he founded specializing in intellectual property
development for embedded processor and communications systems. From June 1998 to
December 1998, he was President and CEO of Gruppe Telekom, Inc., a licensee of
Interactive Video and Data Service Spectrum. From April 1996 to June 1998, he
served as Chief Technical Officer and co-founder of Aristo, now PlayNet Inc., a
Java-based games company. Dr. Nunally also held other senior management
positions with Wave Interactive Network, Sensormatic Video Products Division,
Intellisys Automation Inc., E-Metrics Inc., General Dynamics Corporation and
Interstate Electronics. Dr. Nunally received his PhD in Electrical Engineering
from the Pacific Western University in 1996, a MBA from the University of
LaVerne in 1993 and a BS in Electrical and Electronics Engineering from
California State Polytechnic University in 1987.
JOEY MAITRA. Mr. Maitra was Vice President of Engineering for Metacomp
since 1990 and was appointed Vice President of Engineering of Patriot in
December 1996 through February 2001. Mr. Maitra was reappointed to the same
position in November 2001. Previously Mr. Maitra held various engineering
positions with several computer related technology companies. Mr. Maitra
obtained a B.S. in Electrical Engineering from the Indian Institute of
Technology in 1972 and a M.S. in Electrical Sciences at State University of New
York in 1973.
There is no family relationship between any of our executive officers
and directors.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
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 the Securities and Exchange
Commission. Directors, executive officers and greater than 10% shareholders are
required by the rules and regulations of the Commission to furnish us with
copies of all reports filed by them in compliance with Section 16(a).
Based solely on our review of copies of the reports we received from
persons required to make such filings and our own records, we believe that from
the period June 1, 2002 through May 31, 2003, all persons subject to the Section
16(a) reporting requirements timely filed the required reports.
ITEM 11. EXECUTIVE COMPENSATION
There is shown below information concerning the compensation of our
chief executive officer and the most highly compensated executive officers whose
salary and bonus exceeded $100,000 (each a "Named Officer") for the fiscal years
ended May 31, 2003, 2002, and 2001.
SUMMARY COMPENSATION TABLE
Annual Cash Compensation Long-Term Compensation
------------------------ ----------------------
Name and Fiscal Repriced All Other
Principal Position Year Salary Bonus (# of Shares) Options Compensation
------------------ ---- ------ ----- ------------- ------- ------------
Jeff Wallin 2003 $127,650 (1) Nil 250,000 None None
President and CEO 2002 $68,800 (1) Nil 1,000,000 None None
Lowell W. Giffhorn 2003 $150,779 (1) Nil 115,000 None None
Exec. V.P., CFO and Secy. 2002 $139,908 (1) Nil 255,000 None None
2001 $126,650 (1) Nil 125,000 None None
Joey Maitra 2003 $131,040 (1) Nil 100,000 None None
VP Engineering 2002 $125,058 (1) Nil 335,000 None None
2001 $120,000 Nil None None None
Patrick O. Nunally 2003 $189,521 (1) Nil 400,000 None $52,500 (2)
VP and CTO 2002 $173,046 (1) Nil 250,000 None $105,000 (2)
28
(1) Included in Mssr. Wallin, Giffhorn, Maitra and Nunally is cash
compensation of $400 per month for car allowance.
(2) Payments through November 30, 2002 to Dr. Nunally for assignments
to the Company of intellectual property rights. The rights were
returned to Dr. Nunally in April 2003.
The Company maintains employee benefits that are generally
available to all of its employees, including medical, dental and life insurance
benefits and a 401(k) retirement savings plan. The Company did not make any
matching contributions under the 401(k) plan for any of the above named officers
during the fiscal years ended May 31, 2003, 2002 and 2001.
OPTION GRANTS
Shown below is information on grants of stock options pursuant to the
Company's 1992, 1996 and 2001 Stock Option Plans to the Named Officers reflected
in the Summary Compensation Table shown above.
OPTION GRANTS TABLE FOR FISCAL YEAR ENDED MAY 31, 2003
Potential Realizable Value
Percent of Total of Assumed Annual Rates
Options Granted of Stock Price Appreciation
Number of to Employees in Exercise Expiration for Option Term (1)
Name Options Granted Fiscal Year Price Date 5% ($) 10% ($)
---- --------------- ----------- ----- ---- ------ -------
Jeffrey E. Wallin 250,000 20.6% $ 0.043 4/15/2008 $ 2,935 $ 6,563
Lowell W. Giffhorn 115,000 9.5% $ 0.070 8/12/2007 $ 2,224 $ 4,915
Joey Maitra 100,000 8.2% $ 0.059 1/2/2008 $ 1,630 $ 3,602
Patrick Nunally 400,000 32.9% $ 0.043 4/15/2008 $ 4,697 $ 10,379
(1) These amounts represent certain assumed rates of appreciation only. Actual
gains, if any, on stock option exercises are dependent upon the future
performance of the company's common stock, overall market conditions and the
executive's continued involvement with the company. The amounts represented in
this table will not necessarily be achieved.
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
There were no exercises of stock options for the fiscal year ended May
31, 2003 by any of the officers reflected in the Summary Compensation Table
shown above. Shown below is information on fiscal year-end values under the
Company's 1992, 1996 and 2001 Stock Option Plans to the officers reflected in
the Summary Compensation Table shown above.
29
The fair market value of the unexercised in-the-money options at May
31, 2003 was determined by subtracting the option exercise price from the last
sale price as reported on the over the counter bulletin board on May 31, 2003,
$0.065.
The Company has not awarded stock appreciation rights to any of its
employees. The Company has no long-term incentive plans.
COMPENSATION COMMITTEE
The Compensation Committee reviews and recommends to the Board the
salaries, bonuses and prerequisites of the Company's executive officers. The
Compensation Committee also reviews and recommends to the Board any new
compensation or retirement plans and administers the Company's 1992, 1996 and
2001 Stock Option Plans.
The Compensation Committee currently consists of three outside
directors. Each member of the Compensation Committee is independent as defined
under the National Association of Securities Dealers' listing standards.
COMPENSATION OF DIRECTORS
No direct or indirect remuneration has been paid or is payable by us to
the directors in their capacity as directors other than the granting of stock
options. We expect that, during the next twelve months, we will not pay any
direct or indirect remuneration to any directors of ours in their capacity as
directors other than in the form of stock option grants or the reimbursement of
expenses of attending directors' or committee meetings.
EMPLOYMENT CONTRACTS
The Company entered into a consulting agreement dated as of March 7,
2002, with SDMC, Inc. whereby SDMC would provide the services of Mr. Wallin to
be the President and Chief Executive Officer. The agreement is for a term
through March 18, 2004 providing for payments of $133,200 per annum. The
agreement provides for a bonus up to 50% of the annual base consideration for
the applicable year. The agreement also provides for potential bonuses to be
paid based on the increase in the price of the Company's common stock. Should
the price of the common stock reach $0.25 for twenty consecutive days, SDMC
would receive a cash payment of $10,000, $0.40- $20,000, $0.50- $20,000, $0.60-
$30,000, $0.80- $30,000, $1.00- $50,000, $1.50- $100,000, and $2.00- $150,000.
The Company may terminate SDMC's agreement with or without cause, but
termination without cause (other than disability or death) would result in
severance payments equal to the lesser of (i) four months of the then current
compensation or (ii) the balance remaining of the current compensation for the
term of his agreement. If a change in control, as defined in the agreement,
occurs during the term of his agreement, and if Mr. Wallin refuses to accept or
voluntarily resigns from a position other than a qualified position, as that
term is defined in the agreement, then SDMC will receive a lump sum severance
payment equal to twelve months of the then current compensation. Under the
agreement, the Company granted SDMC options to purchase 1,000,000 common shares,
500,000 vesting on March 7, 2002, 250,000 vesting on March 7, 2003 and 250,000
vesting on March 7, 2004. The Company also placed in escrow four months of
payments which shall be released to SDMC on the termination of Mr. Wallin's
services for any reason other than cause or his resignation.
30
The Company entered into an employment agreement dated as of November
17, 2001, with Mr. Giffhorn providing for his employment as Executive Vice
President and Chief Financial Officer. The agreement is for a term through
September 4, 2004 providing for a base salary of $144,000 per annum. The base
salary may be increased at the discretion of the Board of Directors. The
agreement provides for a bonus up to 50% of the annual base salary for the
applicable year. The agreement also provides Mr. Giffhorn a monthly car
allowance of $400. The Company may terminate Mr.Giffhorn's employment with or
without cause, but termination without cause (other than disability or death)
would result in severance payments equal to the lesser of (i) four months of the
then current base salary or (ii) the balance remaining of the current base
salary for the term of his agreement. If a change in control, as defined in the
agreement, occurs during the term of his agreement, and if Mr. Giffhorn refuses
to accept or voluntarily resigns from a position other than a qualified
position, as that term is defined in the agreement, then he will receive a lump
sum severance payment equal to twelve months of his then current salary.
The Company entered into an employment agreement dated as of December
23, 2002, with Mr. Maitra providing for his employment as Vice President of
Engineering. The agreement is for a term through January 2, 2004 providing for a
base salary initially of $126,000 per annum. The base salary may be increased at
the discretion of the Board of Directors. The agreement provides for a bonus up
to 50% of the annual base salary for the applicable year. The agreement also
provides Mr. Maitra a monthly car allowance of $400. The Company may terminate
Mr.Maitra's employment with or without cause, but termination without cause
(other than disability or death) would result in severance payments equal to the
lesser of (i) four months of the then current base salary or (ii) the balance
remaining of the current base salary for the term of his agreement. If a change
in control, as defined in the agreement, occurs during the term of his
agreement, and if Mr. Maitra refuses to accept or voluntarily resigns from a
position other than a qualified position, as that term is defined in the
agreement, then he will receive a lump sum severance payment equal to twelve
months of his then current salary. Under the agreement, the Company granted Mr.
Maitra options to purchase 100,000 common shares, 50,000 vesting on January 2,
2004 and 50,000 vesting on January 2, 2005.
The Company entered into a letter of intent dated May 31, 2001 with Dr.
Nunally providing for his employment as the Chief Technical Officer of the
Company. The terms of the letter provide for a base salary of $180,000 per
annum. The letter provides for a bonus up to 50% of the annual base
consideration for the applicable year. In addition, the letter provided for
monthly payments of $4,500 for the purchase from Dr. Nunally of certain
intellectual property assets and assignment of worldwide patent rights. On March
30, 2001, the Company entered into an agreement with Dr. Nunally providing for
additional monthly payments of $3,000 for additional intellectual property
assets. On April 16, 2003, the agreements were amended to reflect a return of
the intellectual property assets to Dr. Nunally, forgiveness by Dr. Nunally of
payments due him for the intellectual property assets subsequent to January 1,
2003 and termination of the $7,500 per month payments accruing on the
intellectual property assets. In exchange the Company granted a stock option to
Dr. Nunally for the purchase of up to 400,000 shares of common stock at an
exercise price of $0.0425. The option vested upon grant.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of August 28, 2003, the stock
ownership of each officer and director of the Company, of all officers and
directors of the Company as a group, and of each person known by the Company to
be a beneficial owner of 5% or more of its Common Stock. 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. No person listed below
has any option, warrant or other right to acquire additional securities of the
Company, except as otherwise noted.
31
Name and Address Amount & Nature
Title of Beneficial of Beneficial Percent
of Class Owner Ownership of Class
-------- ----- --------- --------
Common stock Gloria Felcyn, CPA 18,214,527 (1) 15.4%
par value 10989 Via Frontera
$0.00001 San Diego, CA 92127
SAME Donald R. Bernier 487,500 (2) *
10989 Via Frontera
San Diego, CA 92127
SAME Helmut Falk, Jr. 149,500 (3) *
10989 Via Frontera
San Diego, CA 92127
SAME Lowell W. Giffhorn 536,614 (4) *
10989 Via Frontera
San Diego, CA 92127
SAME SDMC, Inc. 1,020,000 (5) *
10989 Via Frontera
San Diego, CA 92127
SAME David H. Pohl 325,000 (6) *
10989 Via Frontera
San Diego, CA 92127
SAME Patrick O. Nunally 799,500 (7) *
10989 Via Frontera
San Diego, CA 92127
SAME Joey Maitra 512,342 (8) *
10989 Via Frontera
San Diego, CA 92127
SAME Carlton M. Johnson, Jr. 75,000 (9) *
10989 Via Frontera
San Diego, CA 92127
All directors & officers 22,119,983 (10) 18.2%
as a group (8 persons)
* Less than 1%
1) As trustee of the Helmut Falk Family Trust and executor of the Helmut
Falk estate, Ms. Felcyn effectively controls the shares which were
subject to an escrow arrangement (as described in "Certain Transactions"
below) originally issued to nanoTronics in connection with the ShBoom
technology acquisition and shares that remain from 5,000,000
non-escrowed shares that were originally issued to nanoTronics in
connection with the ShBoom technology acquisition and were subsequently
transferred to the Helmut Falk Family Trust. Includes 11,548,304 shares
that are issuable on the conversion of 8% Convertible Debentures and the
exercise of warrants into shares of common stock and 50,000 shares
issuable upon the exercise of outstanding stock options.
32
2) Includes 262,500 shares issuable upon the exercise of outstanding
stock options.
3) Includes 115,000 shares issuable upon the exercise of outstanding
stock options.
4) Includes 311,666 shares issuable upon the exercise of outstanding
stock options.
5) Includes 1,020,000 shares issuable upon the exercise of outstanding
stock options.
6) Includes 325,000 shares issuable upon the exercise of outstanding
stock options.
7) Includes 787,500 shares issuable upon the exercise of outstanding
stock options.
8) Includes 335,000 shares issuable upon the exercise of outstanding
stock options.
9) Includes 75,000 shares issuable upon the exercise of outstanding
stock options.
10) Includes 7,290,013 shares issued and outstanding and 14,829,970
shares issuable upon exercise of stock options, conversion of
convertible debentures and exercise of warrants.
EQUITY COMPENSATION PLAN INFORMATION
Plan category Number of securities Weighted average Number of securities
to be issued upon exercise price of remaining available
exercise of outstanding options, for future issuance
outstanding options, warrants and rights under equity
warrants and rights compensation plans
(excluding securities
reflected in column (a)
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 5,054,000 $0.28 250,188
Equity compensation plans not
approved by security holders 58,992,468 $0.06 None
---------------------------------------------------------------------------------
Total 64,046,468 $0.08 250,188
=================================================================================
Common shares issuable on the exercise of stock warrants have not been
approved by the security holders and, accordingly, have been segregated in the
above table.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There were no transactions, or series of transactions, during fiscal
2003, 2002 or 2001, nor are there any currently proposed transactions, or series
of transactions, to which the Company is a party, in which the amount exceeds
$60,000, and in which to its knowledge any director, executive officer, nominee,
five percent or greater shareholder, 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.
In June 2000, we entered into a three-year, $80,000 secured promissory
note receivable with James T. Lunney, a previous Chairman, President and CEO.
The note bore interest at the rate of 6% with interest payments due
semi-annually and the principal due at the maturity of the note. Mr. Lunney
pledged 100,000 shares of Patriot's common stock that he held on the date of
issuance as security for this note. In April 2003, we negotiated an early
payment discount and Mr. Lunney paid $60,000 to retire this note.
33
During the fiscal years ended May 31, 2002 and 2001, we paid $70,292
and $139,253 to Webster Incorporated for design and maintenance of our web site
and for marketing support and materials. The principal in Webster Incorporated,
Christine Blum, is the daughter of our previous Chairman, President and CEO,
Richard Blum.
From June 10, 2002 through August 23, 2002, we issued to Gloria Felcyn,
Trustee of the Helmut Falk Family Trust, two 8% Convertible Debentures with
accumulative principal balances of $275,000 due June 10, 2004 through August 23,
2004. The initial exercise prices ranged from $0.0727 to $0.08616 and are
subject to a downward revisions if the price of our stock is lower on any three
month anniversary of the debentures or on the date that a statement registering
the resale of the common stock issuable upon conversion of the debentures
becomes effective. Also, in conjunction with the debentures, we issued five year
warrants to purchase up to 4,102,431 shares of our common stock at an initial
exercise prices ranging from $0.0727 to $0.08616 subject to reset provisions on
each six month anniversary of the issuance of the warrants. If the price of our
common stock is in excess of $0.20 per share, Ms. Felcyn has a two year option
to purchase up to an additional $275,000 of 8% Convertible Debentures on the
same terms.
During October 2002 through December 2002, we entered into three 8%
short-term notes with Gloria Felcyn, the trustee for the Falk Family Trust,
aggregating $180,000 with initial maturity dates ranging from January 1 to
January 31, 2003. In July 2003 we issued a new 8% short-term note in the amount
of $200,354 with a maturity date of October 7, 2003 in exchange for cancellation
of the three 8% short term notes issued in October through December 2002, the
accrued interest on the cancelled notes and an additional $10,000 in cash.
ITEM 14. CONTROLS AND PROCEDURES
Our President and Chief Executive Officer and our Executive Vice
President and Chief Financial Officer conducted an evaluation of our disclosure
controls and procedures (as defined in Securities Exchange Act Rules 13a-14 and
15d-14) as of July 1, 2003. Based on their evaluation, they concluded that our
disclosure controls and procedures are effective to ensure that information
required to be disclosed by us in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms. There have been no significant changes
in our internal controls or in other factors that could significantly affect
these controls subsequent to the date of this evaluation.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Nation Smith Hermes Diamond was our principal accountant during the
year ended May 31, 2003 and for the year end audit for the year ended May 31,
2002. BDO Seidman, LLP was our principal accountant for previous fiscal years
and for the review of quarterly reports and registration statements through May
20, 2002. Presented below are the fees billed during the fiscal years ended May
31, 2003 and 2002.
Nation Smith Hermes Diamond BDO Seidman
------------------------------- -----------------------------
2003 2002 2003 2002
---- ---- ---- ----
Audit fees $ 72,902 $ 14,875 $ - $ 121,890
Audit-related fees 40,099 - 20,000 50,550
Tax fees 635 - - 6,300
All other fees 57 - - 9,149
--------------- ------------- ------------- -------------
Total $ 113,693 $ 14,875 $ 20,000 $ 187,889
=============== ============= ============= =============
Audit Fees. Represents fees for professional services provided for the
audit of Patriot Scientific's annual financial statements and review of
Patriot Scientific's quarterly financial statements, and audit services
provided in connection with other statutory or regulatory filings.
Audit-related Fees. Represents fees for assurance services related to
the audit of Patriot Scientific's financial statements. The fees are
primarily for review of registration and proxy statements.
34
Tax Fees. Represents fees for professional services provided primarily
for compliance, advice and tax return preparation.
All Other Fees. Represents fees for products and services not otherwise
included in the categories above. The 2002 fees are primarily related
to travel expenses and retention review fees.
To help ensure the independence of our independent auditor, the Audit
Committee of the Board of Directors of Patriot Scientific has approved and
adopted a Policy on Engagement of Independent Auditor, which is available on
Patriot Scientific's Web site at http:/www.ptsc.com.
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 preapproves all audit
services and non-audit services to be provided by our independent auditor. 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.
Each audit, non-audit or 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 an officer of Patriot Scientific
authorized by the Audit Committee to sign on behalf of Patriot Scientific.
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 our independent auditor.
In addition, beginning on January 1, 2003, our independent auditor may
not provide any services to Patriot Scientific officers or Audit Committee
members, including financial counseling and tax services.
PART IV
ITEM 16. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
1. Financial Statements. The following consolidated financial
statements and supplementary information of the Company and
Report of Independent Auditors are included in Part II of this
Report:
Report of Nation Smith Hermes Diamond, Certified Public
Accountants
Report of BDO Seidman, LLP, Certified Public Accountants
Consolidated Balance Sheets- As of May 31, 2003 and 2002
Consolidated Statements of Operations- Years Ended May 31, 2003,
2002 and 2001
Consolidated Statement of Stockholders' Equity (Deficit)- Years
Ended May 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows- Years Ended May 31, 2003,
2002 and 2001
Notes to Consolidated Financial Statements
2. Exhibits. The following Exhibits are filed as part of, or incorporated by
reference into, this Report:
35
Exhibit No. Document
- ----------- --------
2.0 PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION (1)
OR SUCCESSION.
2.1 Agreement to Exchange Technology for Stock in Patriot (1)
Scientific Corporation, incorporated by reference to Exhibit
2.1 to Form 8-K dated August 10, 1989
2.2 Assets Purchase Agreement and Plan of Reorganization dated (1)
June 22, 1994, among the Company, nanoTronics Corporation and
Helmut Falk, incorporated by reference to Exhibit 10.4 to
Form 8-K dated July 6, 1994
2.2.1 Amendment to Development Agreement dated April 23, 1996 (1)
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 dated April 29, 1996
2.3 Form of Exchange Offer dated December 4, 1996 between the (1)
Company and certain shareholders of Metacomp, Inc.
incorporated by reference to Exhibit 2.3 to Form 8-K dated
January 9, 1997
36
Exhibit No. Document
- ----------- --------
2.4 Letter of Transmittal to Accompany Shares of Common Stock of (1)
Metacomp, Inc. Tendered Pursuant to the Exchange Offer Dated
December 4, 1996 incorporated by reference to Exhibit 2.4 to
Form 8-K dated January 9, 1997
3.0 ARTICLES AND BYLAWS.
3.1 Original Articles of Incorporation of the Company's (1)
predecessor, Patriot Financial Corporation, incorporated by
reference to Exhibit 3.1 to registration statement on Form
S-18, file no. 33-23143-FW
3.2 Articles of Amendment of Patriot Financial Corporation, as (1)
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, File No. 33-23143-FW
3.3 Certificate of Incorporation of the Company, as filed with (1)
the Delaware Secretary of State on March 24, 1992,
incorporated by reference to Exhibit 3.3 to Form 8-K dated
May 12, 1992
3.3.1 Certificate of Amendment to the Certificate of Incorporation (1)
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
3.3.2 Certificate of Amendment to the Certificate of Incorporation (1)
of the Company, as filed with the Delaware Secretary of State
on June 19,1997, incorporated by reference to Exhibit 3.3.2
to Form 10-KSB for the fiscal year ended May 31, 1997
3.3.3 Certificate of Amendment to the Certificate of Incorporation (1)
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 dated May 5, 2000
3.3.4 Certificate of Amendment to the Certificate of Incorporation (1)
of the Company, as filed with the Delaware Secretary of State
on May 6, 2002, incorporated by reference to Exhibit 3.3.4 to
Registration Statement on Form S-3 dated June 27, 2002
3.4 Articles and Certificate of Merger of Patriot Financial (1)
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
3.5 Certificate of Merger issued by the Delaware Secretary of (1)
State on May 8, 1992, incorporated by reference to Exhibit
3.5 to Form 8-K dated May 12, 1992
3.6 Certificate of Merger issued by the Colorado Secretary of (1)
State on May 12, 1992, incorporated by reference to Exhibit
3.6 to Form 8-K dated May 12, 1992
37
Exhibit No. Document
- ----------- --------
3.7 Bylaws of the Company, incorporated by reference to Exhibit (1)
3.7 to Form 8-K dated May 12, 1992
4.0 INSTRUMENTS ESTABLISHING RIGHTS OF SECURITY HOLDERS.
4.1 Specimen common stock certificate, incorporated by reference (1)
to Exhibit 4.1 Form 8-K dated May 12, 1992
4.2 Form of Stock Purchase Warrant (Labway Corporation) dated (1)
February 29, 1996, exercisable to purchase 253,166 common
shares at $1.58 per share until August 31, 1996, granted to
investors in connection with an offering of securities made
in reliance upon Regulation S, incorporated by reference to
Exhibit 4.2 to Form 10-QSB for fiscal quarter ended February
29, 1996
4.3 Form of 6% Convertible Subordinated Promissory Note due (1)
September 30, 1998 aggregating $1,500,000 to six investors
incorporated by reference to Exhibit 4.3 to Form 10-QSB for
fiscal quarter ended August 31, 1996
4.4 Form of 5% Convertible Term Debenture (CC Investments, LDC) (1)
due June 2, 1999 aggregating $2,000,000 to two investors
incorporated by reference to Exhibit 4.4 to Form 8-K dated
June 16, 1997
4.5 Form of Stock Purchase Warrant (CC Investments, LDC) dated (1)
June 2, 1997 exercisable to purchase an aggregate of 400,000
common shares at $1.69125 per share until June 2, 2002,
granted to two investors in connection with the offering of
securities in Exhibit 4.4 incorporated by reference to
Exhibit 4.5 to Form 8-K dated June 16, 1997
4.6 Registration Rights Agreement dated June 2, 1997 by and among (1)
the Company and CC Investments, LDC and the Matthew Fund,
N.V. related to the registration of the common stock related
to Exhibits 4.4 and 4.5 incorporated by reference to Exhibit
4.6 to Form 8-K dated June 16, 1997
4.7 Form of Warrant to Purchase Common Stock (Swartz Family (1)
Partnership, L.P.) dated June 2, 1997 exercisable to purchase
an aggregate of 211,733 common shares at $1.69125 per share
until June 2, 2002, granted to a group of investors in
connection with the offering of securities in Exhibit 4.4
incorporated by reference to Exhibit 4.7 to Form 8-K dated
June 16, 1997
4.8 Registration Rights Agreement dated June 2, 1997 by and among (1)
the Company and Swartz Investments, LLC related to the
registration of the common stock related to Exhibit 4.7
incorporated by reference to Exhibit 4.8 to Form 8-K dated
June 16, 1997
4.9 Form of 5% Convertible Term Debenture (CC Investments, LDC) (1)
due June 2, 1999 aggregating $1,000,000 to two investors
incorporated by reference to Exhibit 4.9 to Form 10-KSB for
the fiscal year ended May 31, 1998
38
Exhibit No. Document
- ----------- --------
4.10 Form of Stock Purchase Warrant (CC Investments, LDC) dated (1)
November 24, 1997 exercisable to purchase an aggregate of
200,000 common shares at $1.50 per share until June 2, 2002,
granted to two investors in connection with the offering of
securities described in Exhibit 4.9 incorporated by reference
to Exhibit 4.10 to Form 10-KSB for the year ended May 31,
1998
4.11 Form of Warrant to Purchase Common Stock (Swartz Family (1)
Partnership, L.P.) dated November 24, 1997 exercisable to
purchase an aggregate of 105,867 common shares at $1.50 per
share until June 2, 2002, granted to a group of investors in
connection with the offering of securities described in
Exhibit 4.9 incorporated by reference to Exhibit 4.11 to Form
10-KSB for the year ended May 31, 1998
4.12 Form of Warrant to Purchase Common Stock (Investor (1)
Communications Group, Inc.) dated June 16, 1997 exercisable
to purchase an aggregate of 130,000 common shares at prices
ranging from $2.50 to $7.50 per share until June 15, 1999
incorporated by reference to Exhibit 4.12 to Form 10-KSB for
the year ended May 31, 1998
4.13 Warrant to Purchase Common Stock issued to Spellcaster (1)
Telecommunications, Inc. dated April 28, 1998 exercisable to
purchase an aggregate of 100,000 common shares at $1.25 per
share until April 28, 2000 incorporated by reference to
Exhibit 4.13 to Form 10-KSB for the year ended May 31, 1998
4.14 Investment agreement dated February 24, 1999 by and between (1)
the Company and Swartz Private Equity, LLC for a maximum
aggregate amount of $5,000,000 incorporated by reference to
Exhibit 4.14 to Form 10-QSB/A for the fiscal quarter ended
November 30, 1998
4.15 Registration Rights Agreement dated February 24, 1999 by and (1)
between the Company and Swartz Private Equity, LLC related to
the registration of the common stock related to Exhibit 4.14
incorporated by reference to Exhibit 4.15 to Form 10-QSB/A
for the fiscal quarter ended November 30, 1998
4.16 Form of Warrant to Purchase Common Stock (Swartz Private (1)
Equity, LLC) dated February 24, 1999 exercisable to purchase
common shares in connection with the offering of securities
in Exhibit 4.14 incorporated by reference to Exhibit 4.16 to
Form 10-QSB/A for the fiscal quarter ended November 30, 1998
4.17 Amended and Restated Investment Agreement dated July 12, 1999 (1)
by and between the Company and Swartz Private Equity, LLC for
a maximum aggregate amount of $5,000,000 incorporated by
reference to Exhibit 4.17 to Pre-Effective Amendment No. 2 to
Registration Statement on Form SB-2 dated July 14, 1999
39
Exhibit No. Document
- ----------- --------
4.18 Investment Agreement dated April 28, 2000 by and between the (1)
Company and Swartz Private Equity, LLC for a maximum
aggregate amount of $30,000,000 incorporated by reference to
Exhibit 4.18 to Registration Statement on Form S-3 dated May
5, 2000
4.18.1 Waiver and Agreement dated September 24, 2001 amending the (1)
Investment Agreement dated April 28, 2000 by and between the
Company and Swartz Private Equity, LLC for a maximum
aggregate amount of $30,000,000 incorporated by reference to
Exhibit 4.18.1 to Registration Statement on Form S-1 dated
October 11, 2001
4.19 2001 Stock Option Plan of the Company dated February 21, 2001 (1)
incorporated by reference to Exhibit 4.19 to Registration
Statement on Form S-8 dated March 26, 2001
4.20 Investment agreement dated September 17, 2001 by and between (1)
the Company and Swartz Private Equity, LLC for a maximum
aggregate amount of $25,000,000 incorporated by reference to
Exhibit 4.20 to Registration Statement on Form S-1 dated
October 11, 2001
4.21 Registration Rights Agreement dated September 17, 2001 by and (1)
between the Company and Swartz Private Equity, LLC related to
the registration of the common stock related to Exhibit 4.20
incorporated by reference to Exhibit 4.21to Registration
Statement on Form S-1 dated October 11, 2001
4.22 Warrant to Purchase Common Stock dated September 17, 2001 (1)
exercisable to purchase common shares in connection with the
Offering of securities in Exhibit 4.20 incorporated by
reference to Exhibit 4.22 to Registration Statement on Form
S-1 dated October 11, 2001
4.23 Financial Consulting Services Agreement between the Company (1)
and M. Blaine Riley, Randall Letcavage and Rosemary Nguyen
incorporated by reference to Exhibit 4.23 to Registration
Statement on Form S-8 dated January 22, 2002
4.24 Form of 8% Convertible Debenture (Lincoln Ventures, LLC) due (1)
June 10, 2004 aggregating $1,000,000 to six investors
incorporated by reference to Exhibit 4.24 to Registration
Statement on Form S-3 dated June 27, 2002
4.25 Form of Stock Purchase Warrant (Lincoln Ventures, LLC) dated (1)
June 10, 2002 exercisable to purchase an aggregate of
12,859,175 common shares at initial exercise prices ranging
form $0.08616 to $0.10289 per share until June 10, 2007,
granted to six investors in connection with the offering of
securities described in Exhibit 4.24 incorporated by
reference to Exhibit 4.25 to Registration Statement on Form
S-3 dated June 27, 2002
40
Exhibit No. Document
- ----------- --------
4.26 Form of Registration Rights Agreement (Lincoln Ventures, LLC) (1)
dated June 10, 2002 by and among the Company and six
investors related to the registration of the common stock
related to Exhibit 4.24 incorporated by reference to Exhibit
4.26 to Registration Statement on Form S-3 dated June 27,
2002
10.0 MATERIAL CONTRACTS.
10.1 1992 Incentive Stock Option Plan of the Company, incorporated (1)
by reference to Exhibit 10.1 to Form 8-K dated May 12, 1992
10.1.1 Amendment to 1992 Incentive Stock Option Plan dated January (1)
11, 1995, incorporated by reference to Exhibit 10.1.1 to Form
S-8 dated July 17, 1996
10.2 1992 Non-Statutory Stock Option Plan of the Company, (1)
incorporated by reference to Exhibit 10.2 to Form 8-K dated
May 12, 1992
10.2.1 Amendment to 1992 Non-Statutory Stock Option Plan dated (1)
January 11, 1995 incorporated by reference to Exhibit 10.2.1
to Form 10-KSB for fiscal year ended May 31, 1996
10.3 Lease Agreement between the Company's subsidiary Metacomp, (1)
Inc. and Clar-O-Wood Partnership, a California limited
partnership dated April 11, 1991 as amended November 11, 1992
and November 2, 1995 incorporated by reference to Exhibit
10.3 to Form 10-KSB for fiscal year ended May 31, 1997
10.4 Stock Purchase Agreement dated November 29 and 30, 1995, (1)
between the Company and SEA, Ltd., incorporated by reference
to Exhibit 10.4 to Form 8-K dated December 11, 1995
10.4.1 Letter Amendment to Stock Purchase Agreement dated February (1)
21, 1996, between the Company and SEA, Ltd., incorporated by
reference to Exhibit 10.4.1 to Form 10-QSB for fiscal quarter
ended 2/29/96
10.5 1995 Employee Stock Compensation Plan of the Company, (1)
incorporated by reference to Exhibit 10.5 to Form 10-QSB for
fiscal quarter ended 11/30/95
10.6 Letter Stock and Warrant Agreement dated January 10, 1996 (1)
between the Company and Robert E. Crawford, Jr., incorporated
by reference to Exhibit 10.6 to Form 10-QSB for fiscal
quarter ended February 29, 1996
10.7 Non-Exclusive Manufacturing and Line of Credit Agreement (1)
dated February 28, 1996, between the Company and Labway
Corporation, incorporated by reference to Exhibit 10.7 to
Form 10-QSB for fiscal quarter ended February 29, 1996
10.8 Distribution and Representation Agreement dated February 28, (1)
1996, between the Company and Innoware, Inc., incorporated by
reference to Exhibit 10.8 to Form 10-QSB for fiscal quarter
ended February 29, 1996
41
Exhibit No Document
- ---------- --------
10.9 Employment Agreement dated November 20, 1995 between the
Company and Elwood G. Norris, incorporated by reference to
Exhibit 10.9 to Registration Statement on Form SB-2 dated
March 18, 1996
10.9.1 First Amendment to Employment Agreement dated May 17, 1996
between the Company and Elwood G. Norris, incorporated by
reference to Exhibit 10.9.1 to Pre-Effective Amendment No. 2
to Registration Statement on Form SB-2 dated May 23, 1996
10.10 Employment Agreement dated November 20, 1995 between the
Company and Robert Putnam, incorporated by reference to
Exhibit 10.10 to Registration Statement on Form SB-2 dated
March 18, 1996
10.11 Sales Contractual Agreement dated March 19, 1996 between the
Company and Evolve Software, Inc., incorporated by reference
to Exhibit 10.11 to Pre-Effective Amendment No. 1 to
Registration Statement on Form SB-2 dated April 29, 1996
10.11.1 Two Year Stock Purchase Warrant dated March 19, 1996 Granted
to Evolve Software, Inc. Providing for the Purchase of up to
50,000 Common Shares at $2.85, incorporated by reference to
Exhibit 10.11.1 to Pre-Effective Amendment No. 1 to
Registration Statement on Form SB-2 dated April 29, 1996
10.12 Employment Agreement dated as of May 8, 1996 between the
Company and Michael A. Carenzo, including Schedule A - Stock
Option Agreement, incorporated by reference to Exhibit 10.12
to Pre-Effective Amendment No. 2 to Registration Statement on
Form SB-2 dated May 23, 1996
10.12.1 First Amendment to Employment Agreement dated as of May 8,
1996 between the Company and Michael A. Carenzo dated
September 23, 1996, incorporated by reference to Exhibit
10.12.1 to Form 10-KSB for the fiscal year ended May 31, 1997
10.13 1996 Stock Option Plan of the Company dated March 25, 1996
and approved by the Shareholders on May 17, 1996,
incorporated by reference to Exhibit 10.13 to Pre-Effective
Amendment No. 2 to Registration Statement on Form SB-2 dated
May 23, 1996
10.14 Sales Contractual Agreement dated June 20, 1996 between the
Company and Compunetics Incorporated incorporated by
reference to Exhibit 10.14 to Form 10-KSB for fiscal year
ended May 31, 1996
42
Exhibit No. Document
- ----------- --------
10.15 Sales Contractual Agreement dated July 31, 1996 between the (1)
Company and Premier Technical Sales, Inc. incorporated by
reference to Exhibit 10.15 to Form 10-KSB for fiscal year
ended May 31, 1996
10.16 Employment Agreement dated January 1, 1997 between the (1)
Company and Norman J. Dawson incorporated by reference to
Exhibit 10.16 to Form 10-KSB for fiscal year ended May 31,
1997
10.17 Employment Agreement dated January 1, 1997 between the (1)
Company and Jayanta K. Maitra incorporated by reference to
Exhibit 10.17 to Form 10-KSB for fiscal year ended May 31,
1997
10.18 Technology License and Distribution Agreement dated June 23, (1)
1997 between the Company and Sun Microsystems, Inc.
incorporated by reference to Exhibit 10.18 to Form 10-KSB for
the fiscal year ended May 31, 1997
10.19 Employment Agreement dated March 23, 1998 between the Company (1)
and James T. Lunney incorporated by reference to Exhibit
10.19 to Form 10-KSB for the fiscal year ended May 31, 1998
10.20 Employment Agreement dated July 28, 1997 between the Company (1)
and Phillip Morettini incorporated by reference to Exhibit
10.20 to Form 10-KSB for the fiscal year ended May 31, 1998
10.21 Employment Agreement dated July 23, 1998 between the Company (1)
and Lowell W. Giffhorn incorporated by reference to Exhibit
10.21 to Form 10-KSB for the fiscal year ended May 31, 1998
10.22 Secured Promissory Note dated June 12, 2000 between the (1)
Company and James T. Lunney incorporated by reference to
Exhibit 10.22 to Form 10-KSB for the fiscal year ended May
31, 2000
10.23 Purchase Agreement dated June 29, 2000 between the Company (1)
and 4S 37/38, LLC incorporated by reference to Exhibit 10.23
to Form 10-KSB for the fiscal year ended May 31, 2000
10.24 Employment Agreement dated October 2, 2000 between the (1)
Company and Miklos B. Korodi incorporated by reference to
Exhibit 10.24 to Form 10-QSB for the fiscal quarter ended
November 30, 2000
10.25 Employment Agreement dated December 1, 2000 between the (1)
Company and Richard G. Blum incorporated by reference to
Exhibit 10.25 to Form 10-QSB for the fiscal quarter ended
November 30, 2000
10.26 Employment Agreement dated January 29, 2001 between the (1)
Company and Serge J. Miller incorporated by reference to
Exhibit 10.26 to Form 10-KSB for the fiscal year ended May
31, 2001
43
Exhibit No. Document
- ----------- --------
10.27 Lease Agreement dated February 23, 2001 between the Company (1)
and Arden Realty Finance IV, LLC incorporated by reference to
Exhibit 10.27 to Form 10-KSB for the fiscal year ended May
31, 2001
10.28 Employment Agreement dated January 1, 2001 between the (1)
Company and David H. Pohl incorporated by reference to
Exhibit 10.28 to Form 10-KSB for the fiscal year ended May
31, 2001
10.29 Employment Agreement dated April 26, 2001 between the Company (1)
and David H. Pohl incorporated by reference to Exhibit 10.29
to Form 10-KSB for the fiscal year ended May 31, 2001
10.30 Employment Agreement dated November 17, 2001 between the (1)
Company and Lowell W. Giffhorn incorporated by reference to
Exhibit 10.30 to Registration Statement on Form S-3 dated
June 27, 2002
10.31 Employment Agreement dated December 20, 2001 between the (1)
Company and Jayanta Maitra incorporated by reference to
Exhibit 10.31 to Registration Statement on Form S-3 dated
June 27, 2002
10.32 Consulting Agreement dated March 7, 2002 between the Company (1)
and SDMC, Inc. incorporated by reference to Exhibit 10.32 to
Registration Statement on Form S-3 dated June 27, 2002
14.0 CODE OF ETHICS.
14.1 Code of Ethics for Senior Financial Officers (1)
23.0 CONSENTS OF EXPERTS AND COUNSEL.
23.1 Consent of Nation Smith Hermes Diamond, LLP independent (1)
certified public accountants
23.2 Consent of BDO Seidman, LLP independent certified public (1)
accountants
44
Exhibit No. Document
- ----------- --------
31.0 CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY
ACT OF 2002.
31.1 Certification of Jeffrey E. Wallin, CEO (1)
31.2 Certification of Lowell W. Giffhorn, CFO (1)
32.0 CERTIFICATIONS PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY
ACT OF 2002.
321.1 Certification of Jeffrey E. Wallin, CEO (1)
32.2 Certification of Lowell W. Giffhorn, CFO (1)
99.0 ADDITIONAL EXHIBITS.
99.1 Form of ISO Plan Option (Gaspar) dated May 29, 1992, (1)
incorporated by reference to Exhibit 28.2 to registration
statement on Form SB-2, file no. 33-57858
99.2 Form of NSO Plan Option (Berlin) dated May 29, 1992, (1)
incorporated by reference to Exhibit 28.3 to registration
statement on Form SB-2, file no. 33-57858
99.3 Form of Incentive Stock Option Agreement to the Company's (1)
1996 Stock Option Plan (individual agreements differ as to
number of shares, dates, prices and vesting), incorporated by
reference to Pre-Effective Amendment No. 2 to Registration
Statement on Form SB-2 dated May 23, 1996
99.4 Form of NonQualified Stock Option Agreement to the Company's (1)
1996 Stock Option Plan (individual agreement differ as to
number of shares, date, prices and vesting), incorporated by
reference to Pre-Effective Amendment No. 2 to Registration
Statement on Form SB-2 dated May 23, 1996
99.5 Press Release of the Company dated November 4, 1996 (1)
incorporated by reference to Exbibit 99.5 to Form 8-K dated
January 9, 1997
99.6 Form of Incentive Stock Option Agreement to the Company's (1)
2001 Stock Option Plan incorporated by reference to Exhibit
99.6 to Registration Statement on Form S-8 filed March 26,
2001
99.7 Form of Non-Qualified Stock Option Agreement to the Company's (1)
2001 Stock Option Plan incorporated by reference to Exhibit
99.7 to Registration Statement on Form S-8 filed March 26,
2001
(1) Previously filed in indicated registration statement or report.
(2) Exhibit filed herewith this Annual Report on Form 10-K for the
fiscal year ended May 31, 2003
(b) Financial Statement Schedules
The following financial statement schedule filed herein as a part
of this report at F-33
45
Schedule II- Valuation and Qualifying Accounts
All other schedules have been omitted because the information required
to be set forth therein is not applicable or is shown in the
Consolidated Financial Statements or the Notes thereto.
(c) Reports on Form 8-K - None.
46
Patriot Scientific Corporation
Index to Consolidated Financial Statements
Report of Nation Smith Hermes Diamond, Independent Certified Public
Accountants............................................................... F-2
Report of BDO Seidman, LLP, Independent Certified Public Accountants........ F-3
Consolidated Balance Sheets as of May 31, 2003 and 2002..................... F-4
Consolidated Statements of Operations for the Years Ended May 31,
2003, 2002 and 2001....................................................... F-5
Consolidated Statement of Stockholders' Equity (Deficit) for the
Years Ended May 31, 2003, 2002 and 2001................................... F-6
Consolidated Statements of Cash Flows for the Years Ended
May 31, 2003, 2002 and 2001............................................... F-7
Summary of Accounting Policies.............................................. F-8-
F-13
Notes to Consolidated Financial Statements.................................. F-14-
F-32
Schedule II- Valuation and Qualifying Accounts.............................. F-33
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
Patriot Scientific Corporation
San Diego, California
We have audited the accompanying consolidated balance sheets of Patriot
Scientific Corporation as of May 31, 2003 and 2002, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the years in the two year period ended May 31, 2003. We have also audited the
schedule listed in the accompanying index. These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. 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 consolidated financial position of Patriot Scientific
Corporation at May 31, 2003 and 2002, and the consolidated results of its
operations and its cash flows for each of the years in the two year period ended
May 31, 2003, in conformity with accounting principles generally accepted in the
United States of America.
Also, in our opinion, the schedule presents fairly, in all material respects,
the information set forth therein.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations,
has negative cash flows and has negative working capital that raise substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
/s/ Nation Smith Hermes Diamond
San Diego, California
August 14, 2003, except for note 1, dated as of August 26, 2003.
F-2
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
Patriot Scientific Corporation
San Diego, California
We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows for the year ended May 31, 2001. We have
also audited the schedule listed in the accompanying index for the year ended
May 31, 2001. These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements and schedule are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and schedule. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement and schedule presentation. We
believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above, present fairly, in
all material respects, the consolidated results of Patriot Scientific
Corporation's operations and cash flows for the year ended May 31, 2001, in
conformity with accounting principles generally accepted in the United States of
America.
Also, in our opinion, the schedule presents fairly, in all material respects,
the information set forth therein for the year ended May 31, 2001.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has negative cash flows that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ BDO Seidman, LLP
Los Angeles, California
August 9, 2001, except for Note 1, dated as
of August 15, 2001
F-3
PATRIOT SCIENTIFIC CORPORATION
Consolidated Balance Sheets
May 31, 2003 2002
- -----------------------------------------------------------------------------------------------------------------
ASSETS (Notes 4 and 5)
CURRENT ASSETS:
Cash and cash equivalents $ 32,663 $ 88,108
Accounts receivable, net of allowance
of $10,000 and $6,000 for uncollectible accounts 3,866 4,797
Prepaid expenses 93,030 35,749
- -----------------------------------------------------------------------------------------------------------------
Total current assets 129,559 128,654
PROPERTY AND EQUIPMENT, net (Note 2) 153,530 285,488
OTHER ASSETS, net of accumulated amortization of none and $20,333 53,220 330,863
PATENTS AND TRADEMARKS, net of accumulated amortization
of $522,948 and $400,158 128,925 189,521
- -----------------------------------------------------------------------------------------------------------------
$ 465,234 $ 934,526
- -----------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Secured note payable, net of debt discount of none and $189,516 (Note$4) 635,276 $ 445,760
Current portion of 8% Convertible Debentures, net of debt discount of
$103,121 and none (Note 5) 121,879 -
Secured notes payable to shareholder 180,000 -
Accounts payable 397,180 385,255
Accrued liabilities 245,822 211,291
Current portion of capital lease obligation 6,405 5,116
- -----------------------------------------------------------------------------------------------------------------
Total current liabilities 1,586,562 1,047,422
8% CONVERTIBLE DEBENTURES, net of debt discount of $709,890 and $192,802 (Note 5) 280,110 315,198
LONG TERM PORTION OF CAPITAL LEASE OBLIGATION 10,326 16,731
COMMITMENTS AND CONTINGENCIES (Notes 1, 7 and 11)
STOCKHOLDERS' DEFICIT (Notes 4, 5, 6 and 7):
Preferred stock, $.00001 par value; 5,000,000 shares
authorized: none outstanding - -
Common stock, $.00001par value; 200,000,000 shares authorized:
106,547,807 and 81,465,757 issued and outstanding at May 31, 2003
and 2002, respectively 1,066 815
Additional paid-in capital 44,281,210 41,440,101
Accumulated deficit (45,694,040) (41,805,741)
Note receivable (Note 3) - (80,000)
- -----------------------------------------------------------------------------------------------------------------
Total stockholders' deficit (1,411,764) (444,825)
- -----------------------------------------------------------------------------------------------------------------
$ 465,234 $ 934,526
- -----------------------------------------------------------------------------------------------------------------
See accompanying reports of independent certified public accountants,
summary of accounting policies and notes to consolidated financial
statements.
F-4
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended May 31, 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
Net sales (Note 12):
Product $ 108,403 $ 358,809 $ 336,684
Licenses and royalties 15,500 - 700
- ---------------------------------------------------------------------------------------------------------------------------
Net sales 123,903 358,809 337,384
- ---------------------------------------------------------------------------------------------------------------------------
Cost of sales:
Product costs 18,660 244,547 444,320
Inventory obsolescence - 149,433 100,000
- ---------------------------------------------------------------------------------------------------------------------------
Cost of sales 18,660 393,980 544,320
- ---------------------------------------------------------------------------------------------------------------------------
Gross profit (loss) 105,243 (35,171) (206,936)
Operating expenses:
Research and development 723,287 1,372,421 2,218,433
Selling, general and administrative 1,821,902 2,708,579 2,588,579
- ---------------------------------------------------------------------------------------------------------------------------
Operating expenses 2,545,189 4,081,000 4,807,012
- ---------------------------------------------------------------------------------------------------------------------------
Operating loss (2,439,946) (4,116,171) (5,013,948)
- ---------------------------------------------------------------------------------------------------------------------------
Other income (expenses):
Interest income 191 2,662 48,329
Interest expense (Notes 4, 5 and 6) (1,448,544) (1,373,542) (3,284)
- ---------------------------------------------------------------------------------------------------------------------------
Other income (expenses) (1,448,353) (1,370,880) 45,045
- ---------------------------------------------------------------------------------------------------------------------------
Net loss $ (3,888,299) $ (5,487,051) $ (4,968,903)
- ---------------------------------------------------------------------------------------------------------------------------
Basic and diluted loss
per common share (Note 8) $ (0.04) $ (0.08) $ (0.09)
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average number of
common shares outstanding
during the period (Note 8) 93,791,470 66,810,028 53,433,788
- ---------------------------------------------------------------------------------------------------------------------------
See accompanying reports of independent certified public accountants,
summary of accounting policies and notes to consolidated financial
statements.
F-5
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
- ----------------------------------------------------------------------------------------------------------------------------
Years Ended May 31, 2003, 2002 and 2001
Common Stock Additional Accumulated Stockholders'
-----------------------
Shares Amount Paid-in Capital Deficit Equity (Deficit)
- ----------------------------------------------------------------------------------------------------------------------------
Balance, June 1, 2000 51,126,675 $ 511 $ 33,559,158 $ (31,349,787) $ 2,209,882
- ----------------------------------------------------------------------------------------------------------------------------
Issuance of common stock at $.43 to $1.05
per share (Note 7) 5,411,320 54 3,342,143 - 3,342,197
Exercise of common stock warrants and
options at $.25 to $.32 per share (Note 7) 997,416 10 289,063 - 289,073
Issuance of options for services - - 130,139 - 130,139
Issuance of note receivable (Note 3) - - (80,000) - (80,000)
Net loss - - - (4,968,903) (4,968,903)
- ----------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 2001 57,535,411 $ 575 $ 37,240,503 (1) $ (36,318,690) $ 922,388
- ----------------------------------------------------------------------------------------------------------------------------
Issuance of common stock at $.07 to $.30
per share (Notes 6 and 7) 4,888,680 49 879,556 - 879,605
Exercise of common stock warrants and
options at $.25 to $.32 per share (Note 7) 241,666 3 73,830 - 73,833
Issuance of options for services - - 106,926 - 106,926
Issuance of common stock for services
at $.09 per share 2,200,000 22 197,978 - 198,000
Conversion of notes payable
at $.07 to $.09 per share (Note 4) 16,600,000 166 1,552,885 - 1,553,051
Value of warrants issued - - 1,308,423 - 1,308,423
Net loss - - - (5,487,051) (5,487,051)
- ----------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 2002 81,465,757 $ 815 $ 41,360,101 (1) $ (41,805,741) $ (444,825)
- ----------------------------------------------------------------------------------------------------------------------------
Issuance of common stock at $.03 to $.05
per share (Notes 6 and 7) 3,765,266 38 120,312 - 120,350
Collection of note receivable (Note 3) - - 80,000 - 80,000
Issuance of common stock for services
at $.04 to $.06 per share 2,780,000 28 148,772 - 148,800
Conversion of debentures payable plus accrued interest
at $.04 to $.05 per share (Note 4) 18,536,784 185 836,375 - 836,560
Value of warrants issued - - 1,735,650 - 1,735,650
Net loss - - - (3,888,299) (3,888,299)
- ----------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 2003 106,547,807 $ 1,066 $ 44,281,210 $ (45,694,040) $ (1,411,764)
- ----------------------------------------------------------------------------------------------------------------------------
See accompanying reports of independent certified public accountants,
summary of accounting policies and notes to consolidated financial
statements.
(1) Additional Paid-In Capital included a note receivable of $80,000 and
additional paid-in capital of $37,320,503 at May 31, 2001 and $41,440,101
at May 31, 2002.
F-6
PATRIOT SCIENTIFIC CORPORATION
Consolidated Statements of Cash Flows
- -------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Years Ended May 31, 2003 2002 2001
- -------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net loss $ (3,888,299) $ (5,487,051) $ (4,968,903)
Adjustments to reconcile net loss
to cash used in operating activities:
Amortization and depreciation 258,915 285,759 260,316
Provision for doubtful accounts 24,000 76,000 49,000
Provision for inventory obsolescence - 149,433 100,000
Common stock, options and warrants issued for
services 148,800 99,000 119,565
Non -cash interest expense related to convertible
debentures, notes payable and warrants 1,304,957 1,324,431 -
Changes in:
Accounts receivable (33,346) (45,973) (242,405)
Inventories - 73,960 (252,229)
Prepaid and other assets 216,195 (83,334) (2,563)
Accounts payable and accrued expenses 83,016 (24,759) 98,039
- -------------------------------------------------------------------------------------------------------
Net cash used in operating activities (1,885,762) (3,632,534) (4,839,180)
- -------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Note receivable (Note 3) 60,000 - (80,000)
Web site development costs - - (25,000)
Purchase of property, equipment and patents, net (62,194) (146,156) (388,557)
- -------------------------------------------------------------------------------------------------------
Net cash used in investing activities (2,194) (146,156) (493,557)
- -------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Proceeds from issuance of secured notes payable 180,000 1,790,000 -
Payments for capital lease obligations (5,116) (3,148) -
Proceeds from issuance of convertible debentures 1,507,000 508,000 -
Proceeds from issuance of common stock 120,350 879,605 3,342,197
Proceeds from exercise of common stock warrants
and options - 73,833 289,073
Proceeds from sale of accounts receivable 30,277 154,158 65,575
- -------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 1,832,511 3,402,448 3,696,845
- -------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (55,445) (376,242) (1,635,892)
CASH AND CASH EQUIVALENTS, beginning of year 88,108 464,350 2,100,242
- -------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of year $ 32,663 $ 88,108 $ 464,350
- -------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Convertible debentures, notes payable and accrued
interest exchanged for common stock $ 836,560 $ 1,154,725 $ -
Cash payments for interest $ 15,083 $ 19,719 $ -
Common stock issued for prepaid services $ - $ 198,000 $ -
Warrants and options paid issued for prepaid
services - $ 117,500 $ 10,574
Write-off of inventory $ - $ 38,052 $ 177,000
Capital lease obligation $ - $ 24,996 $ -
Debt discount $ 1,763,816 $ 1,308,423 $ -
Debt discount cancelled $ 527,067 $ - $ -
- -------------------------------------------------------------------------------------------------------
See accompanying report of independent certified public accountants,
summary of accounting policies and notes to consolidated financial
statements.
F-7
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Patriot Scientific Corporation (the "Company") is engaged in the development,
marketing, and sale of patented microprocessor technology and the sale of
high-performance high-speed data communication products. The Company also owns
innovative radar technology. The Company sold its antenna technology in August
1999.
BASIS OF PRESENTATION AND CONSOLIDATION
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and include the accounts of the
Company, its majority owned subsidiaries, Metacomp, Inc. ("Metacomp") and Plasma
Scientific Corporation. All material intercompany transactions and balances have
been eliminated in consolidation.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2002 and 2001 financial
statements in order for them to conform to the 2003 presentation. Such
reclassifications have no impact on the Company's financial position or results
of operations.
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of temporary cash investments and trade accounts
receivable.
The Company's cash equivalents are placed in high quality money market accounts
with major financial institutions and high grade short-term commercial paper.
The investment policy limits the Company's exposure to concentrations of credit
risk. Money market accounts are federally insured; however, commercial paper is
not insured. The Company has not experienced any losses in such accounts.
Concentrations of credit risk with respect to accounts receivable are limited
due to the wide variety of customers and markets which comprise the Company's
customer base, as well as their dispersion across many different geographic
areas. The Company routinely assesses the financial strength of its customers
and, as a consequence, believes that its accounts receivable credit risk
exposure is limited. Generally, the Company does not require collateral or other
security to support customer receivables.
The carrying value of financial instruments including cash, cash equivalents,
accounts receivable, accounts payable and accrued liabilities approximate fair
value because of the immediate or short-term maturity of these instruments. With
respect to long-term debt, the carrying amounts approximate fair value due to
the relative consistency in interest rates and the short term nature of the
debt, with all debt maturing within two years of issuance.
F-8
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
PROPERTY, EQUIPMENT AND DEPRECIATION
Property and equipment are stated at cost. Depreciation is computed over the
estimated useful life of three to five years using the straight-line method. The
Company follows the provisions of the Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment of Long-lived Assets." Long-lived assets and
certain identifiable intangibles to be held and used by the Company are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. The Company continuously
evaluates the recoverability of its long-lived assets based on estimated future
cash flows from and the estimated fair value of such long-lived assets, and
provides for impairment if such undiscounted cash flows are insufficient to
recover the carrying amount of the long-lived asset.
PATENTS AND TRADEMARKS
Patents and trademarks are carried at cost less accumulated amortization and are
amortized over their estimated useful lives of four years. The carrying value of
patents and trademarks is periodically reviewed and impairments, if any, are
recognized when the expected future benefit to be derived from individual
intangible assets is less than its carrying value determined based on the
provisions of SFAS No. 144 as discussed above.
REVENUE RECOGNITION
We recognize revenue on the shipment to our customers of communication products,
microprocessor integrated chips and evaluation boards. We also derive revenue
from fees for the transfer of proven and reusable intellectual property
components or the performance of engineering services. We enter into licensing
agreements that will provide licensees the right to incorporate our intellectual
property components in their products with terms and conditions that will vary
by licensee. Generally, these payments will include a nonrefundable technology
license fee, which will be payable upon the transfer of intellectual property,
or a nonrefundable engineering service fee, which generally will be payable upon
achievement of defined milestones. In addition, we anticipate these agreements
will include royalty payments, which will be payable upon sale of a licensee's
product, and maintenance and limited support fees. We will classify all revenue
that involves the future sale of a licensee's products as royalty revenue.
Royalty revenue will be generally recognized in the quarter in which a report is
received from a licensee detailing the shipments of products incorporating our
intellectual property components (i.e., in the quarter following the sale of
licensed product by the licensee). We will classify all revenue that does not
involve the future sale of a licensee's products, primarily license fees and
engineering service fees and maintenance and support fees, as contract revenue.
License fees will be recognized upon the execution of the license agreement and
transfer of intellectual property, provided no further significant performance
obligations exist and collectibility is deemed probable. Fees related to
engineering services contracts, which will be performed on a best efforts basis
and for which we will receive periodic milestone payments, will be recognized as
revenue over the estimated development period, using a cost-based percentage of
completion method. Annual maintenance and support fees, which will be renewable
by the licensee, will be classified as contract revenue and will be amortized
over the period of support, generally 12 months.
F-9
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
ADVERTISING
The Company expenses advertising costs as incurred. Advertising expenses were
approximately $3,400, $9,000 and $7,400 for the years ended May 31, 2003, 2002
and 2001, respectively.
INCOME TAXES
The Company accounts for income taxes under SFAS No. 109, "Accounting for Income
Taxes". Deferred income taxes are recognized 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. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense is the combination of the tax payable for the year and the
change during the year in deferred tax assets and liabilities.
NET LOSS PER SHARE
The Company applies SFAS No. 128, "Earnings Per Share" for the calculation of
"Basic" and "Diluted" earnings (loss) per share. Basic earnings (loss) per share
includes no dilution and is computed by dividing income (loss) available to
common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings (loss) per share reflect the potential dilution
of securities that could share in the earnings (loss) of an entity.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
During the year ended May 31, 2002, based upon information then available, the
Company
revised its estimates regarding the recovery of certain inventories. As a
result, the Company increased existing reserves for obsolescence by $111,381.
INVENTORIES
Inventories consist of raw materials, work in process and finished goods and are
valued at the weighted average cost method, which approximates cost on a
first-in, first-out basis, not in excess of market value. As of May 31, 2003 and
2002 both inventory amounts were fully reserved.
F-10
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
SALE OF ACCOUNTS RECEIVABLE
The Company has adopted SFAS No. 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" ("SFAS 140"). SFAS 140
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. A $400,000 factoring
line established by the Company with a bank enables the Company to sell selected
accounts receivable invoices to the bank with full recourse against the Company.
These transactions qualify for a sale of assets since (1) the Company has
transferred all of its right, title and interest in the selected accounts
receivable invoices to the bank, (2) the bank may pledge, sell or transfer the
selected accounts receivable invoices, and (3) the Company has no effective
control over the selected accounts receivable invoices since it is not entitled
to or obligated to repurchase or redeem the invoices before their maturity and
it does not have the ability to unilaterally cause the bank to return the
invoices. Under SFAS 140, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, derecognizes financial assets when control has been surrendered,
and derecognizes liabilities when extinguished. During fiscal 2003 and 2002, the
Company sold approximately $38,000 and $193,000, respectively, of its accounts
receivable to a bank under a factoring agreement for approximately $30,000 and
$177,000, respectively. Pursuant to the provisions of SFAS 140, the Company
reflected the transaction as a sale of assets and established an accounts
receivable from the bank for the retained amount less the costs of the
transaction and less any anticipated future loss in the value of the retained
asset. The retained amount is equal to 20% of the total accounts receivable
invoice sold to the bank less 1% of the total invoice as an administrative fee
and 1.75% per month of the total outstanding accounts receivable invoices as a
finance fee. The estimated future loss reserve for each receivable included in
the estimated value of the retained asset is based on the payment history of the
accounts receivable customer. At May 31, 2003, accounts receivable invoices
totaling $3,811 were outstanding and $396,189 was available for future factoring
of accounts receivable invoices.
STOCK OPTIONS
The Company applies Accounting Principles Board ("APB") Opinion 25, "Accounting
for Stock Issued to Employees," and related Interpretations in accounting for
all stock option plans. Under APB Opinion 25, compensation cost has been
recognized for stock options granted to employees when the option price is less
than the market price of the underlying common stock on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation," and SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and disclosure," require the
Company to provide pro forma information regarding net income as if compensation
cost for the Company's stock option plans had been determined in accordance with
the fair value based method prescribed in SFAS No. 123. To provide the required
pro forma information, the Company estimates the fair value of each stock option
at the grant date by using the Black-Scholes option-pricing model. SFAS No. 148
also provides for alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
The Company has elected to continue to account for stock based compensation
under APB No. 25.
The Company applies SFAS No. 123 in valuing options granted to consultants and
estimates the fair value of such options using the Black-Scholes option-pricing
model. The fair value is recorded as
F-11
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
consulting expense as services are provided. Options granted to consultants for
which vesting is contingent based on future performance are measured at their
then current fair value at each period end, until vested.
Under the accounting provisions for SFAS No. 123, the Company's net loss per
share would have been increased by the pro forma amounts indicated below:
2003 2002 2001
- ----------------------------------------------------------------------------------------------------
Net loss as reported $ (3,888,299) $ (5,487,051) $ (4,968,903)
Compensation expense (289,023) (567,010) (379,626)
------------------- ------------------- -------------------
Net loss pro forma $ (4,177,322) $ (6,054,061) $ (5,348,529)
=================== =================== ===================
As reported per share
Basic and diluted loss $ (0.04) $ (0.08) $ (0.09)
=================== =================== ===================
Pro forma per share
Basic and diluted loss $ (0.04) $ (0.09) $ (0.10)
=================== =================== ===================
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No.
123." SFAS No. 148 amends the disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. SFAS No. 148 is effective
for fiscal years ending after December 15, 2002 and is effective for interim
periods beginning after December 15, 2002. The Company's adoption of SFAS No.
148 did not have a material effect on the Company's financial position or
results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." This interpretation elaborates on the disclosures
required in financial statements concerning obligations under certain
guarantees. It also clarifies the requirements related to the recognition of
liabilities by a guarantor at the inception of certain guarantees. The
disclosure requirements of this interpretation were effective on December 31,
2002. We adopted the recognition provisions of the interpretation in the quarter
ended February 28, 2003. The adoption of this interpretation did not impact our
financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51." This
interpretation provides guidance on: 1) the identification of entities for which
control is achieved through means other than through voting rights, known as
"variable interest entities" (VIEs); and 2) which business enterprise is the
primary beneficiary and when it should consolidate the VIE. This new model for
consolidation applies to entities: 1) where the equity investors (if any) do not
have a controlling financial interest; or 2) whose equity investment at risk is
insufficient to finance that entity's activities without receiving additional
subordinated financial support from other parties. In addition, this
interpretation requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. This interpretation is effective for all new VIEs created or
acquired after January 31, 2003. For VIEs created or acquired prior to February
1, 2003, the provisions of the interpretation must be applied no later than the
beginning of the first interim or annual reporting period beginning after June
15, 2003. Certain disclosures are effective immediately. The adoption of this
interpretation did not impact our financial position or results of operations.
In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133,
F-12
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
"Accounting for Derivative Instruments and Hedging Activities." SFAS No.
149 requires that contracts with comparable characteristics be accounted
for similarly. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003, and for hedging relationships designated
after June 30, 2003. The adoption of this Statement is not expected to have
a material effect on the consolidated financial statements
In May 2003 the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003, except for mandatorily redeemable financial instruments of
nonpublic entities. The adoption of this Statement is not expected to have a
material effect on the consolidated financial statements.
F-13
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. CONTINUED EXISTENCE AND MANAGEMENT'S PLAN
Our consolidated financial statements are presented on the going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. Our ability to continue as a going concern is
contingent upon our obtaining sufficient financing to sustain our operations. We
incurred a net loss of $3,888,299, $5,487,051, and $4,968,903 and negative cash
flow from operations of $1,885,762, $3,632,534, and $4,839,180 in the years
ended May 31, 2003, 2002 and 2001, respectively. At May 31, 2003, we had deficit
working capital of $1,457,003 and cash and cash equivalents of $32,663. We have
historically funded our operations primarily through the issuance of securities
and debt financings. Cash and cash equivalents decreased $55,445 during the year
ended May 31, 2003.
We estimate our current cash requirements to sustain our operations through
August 2004 to be $2.1 million. Since we are no longer supporting the
communications product line, we are assuming that there will be no
communications product revenue. We have a note payable to Swartz Private Equity,
LLC ("Swartz") of $635,276 at May 31, 2003 which is due March 1, 2004. We also
have convertible debentures with a group of investors as of May 31, 2003
aggregating $1,165,000 and advances of $50,000 on a convertible debenture that
closed subsequent to May 31, 2003. At the option of the debenture holders, they
may purchase additional debentures up to $1 million at any time during the next
two years as long as the price of our common stock is in excess of $0.20 per
share. During the year ended May 31, 2003, we obtained $120,350 from the sale of
equity to several private investors and $180,000 from short term notes entered
into with a related party. . Subsequent to May 31, 2003, we obtained an
additional $422,500 from the issuance of convertible debentures net of advances
discussed above, $50,100 from the exercise of a warrant, $10,000 from a loan
issued to a related party, and $31,000 from the sale of common stock.
If the optional amounts under the convertible debentures are not raised in
sufficient amounts, then we may not have funds sufficient to meet our cash
requirements. In such circumstances, we may need to secure additional short-term
debt, private placement debt and/or equity financings with individual or
institutional investors. In addition, we may need to make additional cost
reductions if our cash requirements cannot be met from external sources. We
expect that the $2.1 million requirement will be provided by:
o additional debt and/or equity financings; and
o proceeds from the exercise of outstanding stock options and warrants.
In addition, we have formulated additional cost reduction plans which can be
implemented if the required funds are not obtainable. We also have a $400,000
accounts receivable factoring agreement with our bank. As of May 31, 2003 there
was a balance due under the factoring agreement of $3,811.
F-14
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
We anticipate our future revenue to be derived primarily from the sale of
licenses and royalties. To receive this revenue, we may require additional
equipment, fabrication, components and supplies during the next twelve months to
support potential customer requirements and further develop our technologies.
Product introductions such as those currently underway for the Ignite I may
require significant product launch, marketing personnel and other expenditures
that cannot be currently estimated. Further, if expanded development is
commenced or new generations of microprocessor technology are accelerated beyond
current plans, additional expenditures we cannot currently estimate, may be
required. It is possible therefore, that higher levels of expenditures may be
required than we currently contemplate resulting from changes in development
plans or as required to support new developments or commercialization activities
or otherwise.
If we are unable to obtain the necessary funds, we could be forced to
substantially curtail or cease operations which would have a material adverse
effect on our business. Further, there can be no assurance that we will be able
to timely receive shareholder approval to increase the number of authorized
shares or that required funds, if available, will be available on attractive
terms or that they will not have a significantly dilutive effect on our existing
shareholders. As such, there is substantial doubt about our ability to continue
as a going concern. The consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from our possible inability to continue as a going concern.
2. PROPERTY AND Property and equipment consisted of the following:
EQUIPMENT
May 31,
-----------------------------------
2003 2002
-----------------------------------------------------------------------------------------
Computer equipment and software $ 1,660,707 $ 1,660,707
Furniture and fixtures 499,274 499,274
Laboratory equipment 205,594 205,594
------------------ ------------------
2,365,575 2,365,575
Less accumulated depreciation and amortization 2,212,045 2,080,087
------------------ ------------------
Net property and equipment $ 153,530 $ 285,488
-----------------------------------------------------------------------------------------
Depreciation expense was $131,958, $211,850 and $186,621
for the years ended May 31, 2003, 2002 and 2001.
F-15
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. NOTE RECEIVABLE
In June 2000, the Company entered into a three-year, $80,000 Secured Promissory
Note Receivable with an individual who was, at the time of the issuance of the
note, an executive officer of the Company. The note had an interest rate of 6%
per annum with interest payments due semi-annually and the principal due at the
maturity of the note. The individual pledged 100,000 shares of the Company's
common stock that he held on the date of issuance as security for this note. In
April 2003, the Company negotiated an early payment discount and the individual
paid $60,000 to retire this note. The balance of $20,000 was written off to bad
debt expense during the year ended May 31, 2003.
4. SECURED NOTE PAYABLE
On March 12, 2002, we replaced and superceded a previously issued Secured
Promissory Note with Swartz with an Amended Secured Promissory Note and
Agreement with an effective date of October 9, 2001, an Addendum to Amended
Secured Promissory Note dated March 12, 2002 and an Antidilution Agreement and
Addendum to Warrants dated March 19, 2003. The amended note, which originally
was to mature on January 9, 2003, has been extended to March 1, 2004 and amounts
outstanding under the note bear interest at the rate of 5% per annum. Per the
antidilution agreement, principal and interest payments are deferred until March
1, 2004.
As part of the consideration for entering into the above amended note, we agreed
to issue warrants to Swartz related to each advance against the note. In
connection with each advance, we issued to Swartz a warrant to purchase a number
of shares of common stock equal to the amount of the advance multiplied by 8.25
at an initial exercise price equal to the lesser of (a) the factor of the
average of the volume weighted average price per share, as defined by Bloomberg
L.P., for each trading day in the period beginning on the date of the previous
advance and ending on the trading day immediately preceding the date of the
current advance multiplied by .70 or (b) the volume weighted average price per
share minus $0.05. In addition, we were obligated under the addendum to the note
to issue to Swartz warrants equal to 20% of the common stock issued between
March 12, 2002 and April 1, 2003 and we are obligated under the antidilution
agreement to issue to Swartz warrants equal to 30% of the common stock issued
subsequent to April 1, 2003 to any parties other than Swartz. In addition, we
agreed to extend the expiration date to December 31, 2006 on certain warrants
that were to expire previous to December 31, 2006. In exchange for these
concessions, Swartz agreed to extend the due date to March 1, 2004 on a note for
$635,276 net of accrued interest and unreserved 20,007,350 shares that have been
reserved for the exercise of warrants for a period the sooner of 1) March 19,
2004, or 2) 90 days after the date on which our common stock exceeds $0.375 for
10 consecutive trading days.
As of May 31, 2003 we issued warrants to purchase up to 18,243,712 shares of our
common stock in accordance with the amended note agreements and antidilution
agreement. The warrants issued were valued using the Black-Scholes pricing model
based on the expected fair value at issuance and the estimated fair value was
also recorded as debt discount.
F-16
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The note is secured by our assets.
All debt discounts were amortized as additional interest expense over the
initial term of the note payable. As of May 31, 2003, $1,107,238 had been
reflected as debt discount of which $189,516 and $917,722 was amortized to
interest expense during the years ended May 31, 2003 and 2002, respectively.
Advances against the note $1,790,000
Less amount applied against $30 million equity line of credit (227,800)
Less amount applied against $25 million equity line of credit (926,924)
-
Less debt discount
Total 1,107,238
Amount amortized to expense (1,107,238) -
----------- -----------
Note payable at May 31, 2003 $ 635,276
===========
On November 9, 2001, an offset of $227,800 from the sale of 2,500,000 shares of
common stock was applied against the final put under a $30 million equity line
of credit.
On May 30, 2002, an offset of $926,924 from the sale of 14,100,000 shares of
common stock was applied against the first and only put under the $25 million
equity line of credit discussed above
5. 8% CONVERTIBLE DEBENTURES
Overview. From April 23, 2002 through August 26, 2003, we sold an aggregate of
$2,437,500 of 8% convertible debentures to a group of eleven investors. The
convertible debentures entitle the debenture holder to convert the principal and
unpaid accrued interest into our common stock for two years from the date of
closing. In addition, the debenture holders received warrants exercisable into a
number of our common shares.
Number of Shares Debentures May Be Converted Into. The debentures can be
converted into a number of our common shares at conversion prices that initially
equaled $0.041 to $0.10289 per share.
Resets of Conversion Price and Conversion Shares. A reset date occurs on each
three month anniversary of the closing date of each debenture and on the date
the registration statement becomes effective, October 29, 2002 for the first
$1,000,000 of principal, March 7, 2003 for the second $605,000 of principal and
June 26, 2003 for the third $510,000 of principal. If the volume weighted
average price for our common stock for the ten days previous to the reset date
is less than the conversion price in effect at the time of the reset date, then
the number of common shares issuable to the selling shareholder on conversion
will be increased. If the conversion price is reset, the debenture can be
converted into a number of our common shares based on the following calculation:
the amount of the debenture plus any unpaid accrued interest divided by the
reset conversion price
F-17
PATRIOT SCIENTIFIC CORPORATION NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
which shall equal the volume weighted average price for our common stock for the
ten days previous to the reset date. On October 29, 2002, the date the
registration statement for the first $1,000,000 of principal became effective,
the conversion prices were reset to $0.04457 from initial conversion prices
ranging from $0.08616 to $0.10289. On March 7, 2003, the date the registration
statement for the second $605,000 of principal became effective, the conversion
prices were reset to $0.04722 from initial conversion prices ranging from
$0.05126 to $0.0727. On June 26, 2003, the date the registration statement for
the third $510,000 of principal became effective, the conversion prices for
debentures with initial conversion prices of $0.065 will reset to $0.06346.
Warrants. Concurrent with the issuance of the convertible debentures, we issued
to the debenture holders warrants to purchase up to 33,471,953 shares of our
common stock. These warrants are exercisable for five years from the date of
issuance at either initial negotiated exercise prices or prices equal to 115% of
the volume weighted average price for our common stock for the ten days previous
to the debenture date. The warrant exercise price is subject to being reset on
each six month anniversary of its issuance.
Options to Purchase Additional Debentures. Subject to the price of our common
stock being equal to or greater than $0.20 per share and a two year limitation,
the debenture holders may purchase additional debentures equal to the value of
their initial debentures. The price at which the optional additional debentures
could be converted would initially equal 115% of the volume weighted average
price for our common stock for the ten days previous to the date on which the
optional additional debentures were closed. The optional additional debentures
would carry the same warrant amounts and reset privileges as the initial
debentures.
Shareholder Approval. We may currently issue more than 20% of our outstanding
shares under the convertible debentures. If we become listed on the NASDAQ Small
Cap Market or NASDAQ National Market, then we must get shareholder approval to
issue more than 20% of our outstanding shares. Since we are currently a bulletin
board company, we do not need shareholder approval.
Restrictive Covenants. For a period of 18 months from the date of the
debentures, we are prohibited from certain transactions. These include the
issuance of any debt or equity securities in a private transaction which are
convertible or exercisable into shares of common stock at a price based on the
trading price of the common stock at any time after the initial issuance of such
securities; the issuance of any debt or equity securities with a fixed
conversion or exercise price subject to adjustment; and any private equity line
type agreements without obtaining the debenture holders' prior written approval.
Right of First Refusal. The debenture holders have a right of first refusal to
purchase or participate in any equity securities offered by us in any private
transaction which closes on or prior to the date that is two years after the
issue date of each debenture.
Registration Rights. We are responsible for registering the resale of the shares
of our common stock which will be issued on the conversion of the debentures. On
October 29, 2002, a registration
F-18
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
statement covering the first $1,000,000 of debentures was declared effective by
the Securities and Exchange Commission. On March 7, 2003, a registration
statement covering the second $605,000 of debentures was declared effective by
the Securities and Exchange Commission. On June 26, 2003, a registration
statement covering the third $510,000 of debentures was declared effective by
the Securities and Exchange Commission.
The convertible debentures are secured by our assets.
Convertbile debenture dated April 23, 2002 $ 225,000
Convertbile debentures dated June 10, 2002 775,000
Convertbile debenture dated August 23, 2002 175,000
Convertbile debentures dated October 29, 2002 180,000
Convertbile debenture dated December 16, 2002 100,000
Convertbile debenture dated January 24, 2003 150,000
Convertbile debenture dated March 24, 2003 162,500
Convertbile debenture dated April 15, 2003 10,000
Convertbile debenture dated May 20, 2003 187,500
Advances against debenture issued subsequent to May 31, 2003 50,000
Less amounts converted to common stock (800,000)
Less debt discount
Total discounts recorded $ 1,965,000
Amount amortized to expense (624,922)
Amount cancelled on conversion (527,067) (813,011)
------------- ----------------
Convertible debentures at May 31, 2003 401,989
Less current portion 121,879
----------------
Long term portion $ 280,110
================
6. INVESTMENT AGREEMENT
$25 Million Equity Line of Credit Agreement
Overview. On September 17, 2001, we entered into an investment agreement with
Swartz. The investment agreement entitles us to issue and sell our common stock
to Swartz for up to an aggregate of $25 million from time to time during a
three-year period following the effective date of the registration statement.
This is also referred to as a put right. We filed a registration statement on
Form S-1 on October 11, 2001 that was declared effective on November 5, 2001 for
15,000,000 shares of our common stock which we issued to Swartz during the
fiscal year ended May 31, 2002. There remains approximately $24 million
available under this line conditioned on us filing one or more additional
registration statements. As of May 31, 2003, we have not filed a statement
requesting the registration of additional shares to put to Swartz under the $25
million equity line of credit.
Put Rights. In order to invoke a put right, we must have an effective
registration statement on file with the SEC registering the resale of the common
shares which may be issued as a consequence of the invocation of that put right.
Additionally, we must give at least ten but not more than twenty
F-19
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
business days advance notice to Swartz of the date on which we intend to
exercise a particular put right, and we must indicate the number of shares of
common stock we intend to sell to Swartz. At our option, we may also designate a
maximum dollar amount of common stock (not to exceed $3 million) which we will
sell to Swartz during the put and/or a minimum purchase price per common share
at which Swartz may purchase shares during the put. The number of common shares
sold to Swartz may not exceed 20% of the aggregate daily reported trading volume
during each of two consecutive ten business day periods beginning on the
business day immediately following the day we invoked the put right.
The price Swartz will pay for each share of common stock sold in a put is equal
to the lesser of (i) the market price for each of the two consecutive ten
business day periods beginning on the business day immediately following the day
we invoked the put right minus $0.10, or (ii) X percent of the market price for
each of the two ten day periods, where, X is equal to 90% if the market price is
below $2.00 and 93% if market price is equal to or greater than $2.00. Market
price is defined as the lowest closing bid price for the common stock during
each of the two consecutive ten business day periods. However, the purchase
price may not be less than the designated minimum per share price, if any, that
we indicated in our notice.
Limitations and Conditions Precedent to Our Put Rights. We may not initiate a
put if, as of the proposed date of such put:
o we have issued shares of our common stock that have been paid for
by Swartz and the amount of proceeds we have received is equal to
the maximum offering amount;
o the registration statement covering the resale of the shares
becomes ineffective or unavailable for use;
o our common stock is not actively trading on the OTC Bulletin
Board, the Nasdaq Small Cap Market, the Nasdaq National Market,
the American Stock Exchange, or the New York Stock Exchange, or
is suspended or delisted with respect to the trading on such
market or exchange.
If any of the following events occur during the pricing period for a put, the
volume accrual shall cease. For the put, the pricing period shall be adjusted to
end 10 business days after the date that we notify Swartz of the event, and any
minimum price per share we specified shall not apply to the put:
o we have announced or implemented a stock split or combination of
our common stock between the advanced put notice date and the end
of the pricing period;
o we have paid a common stock dividend or made any other
distribution of our common stock between the advanced put notice
date and the end of the pricing period;
F-20
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
o we have made a distribution to the holders of our common stock or
of all or any portion of our assets or evidences of indebtedness
between the put notice date and the end of the pricing period;
o we have consummated a major transaction (including a transaction,
which constitutes a change of control) between the advance put
notice date and the end of the pricing period, the registration
statement covering the resale of the shares becomes ineffective
or unavailable for use, or our stock becomes delisted for trading
on our then primary exchange; or
o we discover the existence of facts that cause us to believe that
the registration statement contains an untrue statement or omits
to state a material fact.
Short Sales. Swartz and its affiliates are prohibited from engaging in short
sales of our common stock unless they have received a put notice and the amount
of shares involved in a short sale does not exceed the number of shares
specified in the put notice.
Shareholder Approval. We may currently issue more than 20% of our outstanding
shares under the investment agreement. If we become listed on the Nasdaq Small
Cap Market or Nasdaq National Market, then we must get shareholder approval to
issue more than 20% of our outstanding shares. Since we are currently a bulletin
board company, we do not need shareholder approval.
Termination of Investment Agreement. We may also terminate our right to initiate
further puts or terminate the investment agreement by providing Swartz with
notice of such intention to terminate; however, any such termination will not
affect any other rights or obligations we have concerning the investment
agreement or any related agreement.
Restrictive Covenants. During the term of the investment agreement and for a
period of two months thereafter, we are prohibited from certain transactions.
These include the issuance of any debt or equity securities in a private
transaction which are convertible or exercisable into shares of common stock at
a price based on the trading price of the common stock at any time after the
initial issuance of such securities or with a fixed conversion or exercise price
subject to adjustment without obtaining Swartz's prior written approval.
Right of First Refusal. Swartz has a right of first refusal to purchase any
variable priced securities offered by us in any private transaction which closes
on or prior to two months after the termination of the investment agreement and
a right of participation for any equity securities offered by us in any private
transaction which closes on or prior to two months after the termination of the
investment agreement.
Swartz's Right of Indemnification. We are obligated to indemnify Swartz
(including their stockholders, officers, directors, employees and agents) from
all liability and losses resulting from
F-21
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
any misrepresentations or breaches we made in connection with the investment
agreement, our registration rights agreement, other related agreements, or the
registration statement.
Waiver and Agreement. On March 12, 2002, we entered into an amended waiver and
agreement with Swartz which replaced and superseded all previous waivers and
agreements. This amended waiver and agreement extended the time of the put
beyond twenty days and redefined the price of the put to be the lesser of the
factor of (a) the volume weighted average price per share, as defined by
Bloomberg L.P., for each day of the put multiplied by .70 or (b) the volume
weighted average price per share minus $0.05 multiplied by 20% of the acceptable
daily volume as defined in the waiver. At the discretion of Swartz, the 20%
daily volume limitation could be increased up to 30% of the daily volume. In
addition, the amended waiver and agreement increased the intended put share
amount for the first put to 14,100,000 shares, which is the total number of
shares we had registered so far under the $25 million equity line of credit. On
May 30, 2002 we closed the first put under the $25 million equity line of credit
by applying the proceeds of $926,924 to the secured note payable discussed in
Note 4.
Warrants. In connection with closing the $25 million equity line of credit, we
issued to Swartz a commitment warrant to purchase 900,000 shares of our common
stock. This warrant was valued on the issuance date using the Black-Scholes
pricing model and the value was recorded as a debt discount.
7. STOCKHOLDERS' EQUITY (DEFICIT)
PRIVATE OFFERINGS AND WARRANTS
During fiscal 2003, 3,765,266 restricted shares of common stock were issued to a
group of individual investors for $120,350; 2,000,000 shares of common stock
were issued to a consultant in exchange for services valued at $110,000; and
400,000 shares valued at $16,000 were issued to a former executive of the
company as partial settlement of a legal action. The fair value (as determined
by the quoted market price) for the consulting services and legal settlement
were recorded as additional general and administrative expense during the year
ended May 31, 2003. Also, during fiscal 2003, the Company issued 380,000 shares
of common stock to a vendor in satisfaction of $22,800 of trade accounts
payable.
At May 31, 2003, the Company had warrants outstanding to purchase 58,992,468
common shares at exercise prices ranging from $0.033 to $1.12 per share expiring
beginning in 2004 through 2008.
During fiscal 2003, the Company issued warrants to purchase 35,005,013 common
shares of stock at exercise prices ranging from $0.04 to $0.065 per share. Of
this amount, warrants to purchase 5,355,562 common shares of stock were issued
to Swartz related to the Addendum to Amended Secured Promissory Note dated March
12, 2002 and an Antidilution Agreement and Addendum to Warrants dated March 19,
2003 discussed in Note 4, warrants to purchase 28,649,451 common
F-22
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
shares of stock were issued to a group of eleven individual and institutions
investors related to the 8% Convertible Debentures discussed in Note 5, and
warrants to purchase 1,000,000 common shares of stock were issued to two
consultants.
During fiscal 2002, the Company issued warrants to purchase 23,197,201 common
shares of stock at exercise prices ranging from $0.048 to $0.54 per share. Of
this amount, warrants to purchase 3,113,302 common shares of stock were issued
to Swartz related to a $30 million investment agreement, a warrant to purchase
900,000 common shares of stock was issued to Swartz related to the $25 million
investment agreement, warrants to purchase 16,519,090 common shares of stock
were issued to Swartz related to the 5% Secured Note Payable of which 3,630,940
were cancelled, a warrant to purchase 2,514,809 common shares of stock was
issued to Lincoln Ventures LLC related to the first funding under the 8%
Convertible Debenture and a warrant to purchase 150,000 common shares of stock
was issued to a consultant. See Notes 4, 5 and 6 for further discussion.
Also, during fiscal 2002, the Company's shareholders approved an increase in the
authorized number of common shares from 100,000,000 to 200,000,000.
1992 INCENTIVE STOCK OPTION PLAN ("ISO")
The Company has an ISO Plan which expired March 20, 2002. The ISO Plan provided
for grants to either full or part time employees, at the discretion of the board
of directors, to purchase common stock of the Company at a price not less than
the fair market value of the shares on the date of grant. In the case of a
significant stockholder, the option price of the share could not be less than
110 percent of the fair market value of the share on the date of grant. Any
options granted under the ISO Plan must be exercised within ten years of the
date they were granted (five years in the case of a significant stockholder). At
May 31, 2003, options to purchase up to 17,500 shares of common stock remained
outstanding and will expire in 2005.
1992 NON-STATUTORY STOCK OPTION PLAN("NSO")
The Company has an NSO Plan which expired March 20, 2002. The NSO Plan provided,
at the discretion of the board of directors, for grants to either full or part
time employees, directors and consultants of the Company to purchase common
stock of the Company at a price not less than the fair market value of the
shares on the date of grant. Any options granted under the NSO Plan must be
exercised within ten years of the date they were granted. At May 31, 2003,
options to purchase up to 50,000 shares of common stock remained outstanding and
will expire in 2005.
1996 STOCK OPTION PLAN
Effective March 1996, the Company adopted the 1996 Stock Option Plan, which was
amended by the Stockholders in December 1997, expiring March 24, 2006, reserving
for issuance 4,000,000 shares of the Company's common stock. The 1996 Stock
Option Plan provides, at the discretion of the board of directors, for grants to
either full or part time employees, directors and consultants of
F-23
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the Company to purchase common stock of the Company 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 1996 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, 2003 and 2002,
the Company granted options to purchase 340,500 and 1,000,000 shares of stock at
market value.
2001 STOCK OPTION PLAN
Effective February 2001, the Company adopted the 2001 Stock Option Plan,
expiring February 21, 2011, reserving for issuance 3,000,000 shares of the
Company's common stock. The 2001 Stock Option Plan provides, at the discretion
of the board of directors, for grants to either full or part time employees,
directors and consultants of the Company to purchase common stock of the Company
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). During the
fiscal years ended May 31, 2003 and 2002, the Company granted options to
purchase 875,000 and 3,145,000 shares of stock at market value.
During fiscal 2000, the Company repriced a stock option to purchase 36,000
shares of common stock at an exercise prices originally of $0.40 using fixed
accounting rules in effect at the time. The stock option was repriced to an
exercise price of $.32 and no additional compensation expense was recorded.
Subsequent to the repricing, the Company adopted accounting principles generally
accepted in the United States of America that require stock options that have
been modified to reduce the exercise price to be accounted for using variable
accounting. Accordingly, if the market price of the Company's stock increases
subsequent to July 1, 2000, it will recognize additional compensation expense
that it otherwise would not have incurred. As of May 31, 2003, there was no
additional compensation expense recorded because the market price of the
Company's common stock was lower than the price at July 1, 2000. However, the
ultimate impact cannot be determined as it is dependent on the change in the
market price of the stock from July 1, 2000 until the stock option is exercised,
forfeited or expires unexercised.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net loss and net loss per share as if
compensation costs for the Company's stock option plans and other stock awards
had been determined in accordance with the fair value based method prescribed in
SFAS No. 123. The Company estimates the fair value of each stock award at the
grant date by using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for the three years ended May 31, 2003, 2002,
and 2001 respectively: dividend yield of zero percent for all years; expected
volatility of 100 to 120, 90 and
F-24
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
90 percent; risk-free interest rates of 2.3 to 4.3, 3.5 to 4.8, and 4.8 to 6.4
percent; and expected lives of 3 to 5 years for all years.
A summary of the status of the Company's stock option plans and warrants as of
May 31, 2003, 2002 and 2001 and changes during the years ending on those dates
is presented below:
F-25
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Options Warrants
--------------------------------- -------------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, June 1, 2000 1,431,324 $ 0.38 4,756,181 $ 0.40
Granted 2,092,500 1.16 836,698 0.74
Cancelled (580,000) 0.72 - -
Exercised (366,000) 0.32 (631,416) 0.27
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, May 31, 2001 2,577,824 0.92 4,961,463 0.42
- ---------------------------------------------------------------------------------------------------------------------------
Granted 4,145,000 0.21 23,197,201 0.09
Cancelled (2,281,419) 0.67 (3,630,940) 0.10
Exercised (191,666) 0.32 (50,000) 0.25
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, May 31, 2002 4,249,739 $ 0.39 24,477,724 $ 0.11
- ---------------------------------------------------------------------------------------------------------------------------
Granted 1,215,500 0.05 35,005,013 0.05
Cancelled (411,239) 0.81 (490,269) 0.30
Exercised - 0 - -
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding, May 31, 2003 5,054,000 $ 0.28 58,992,468 $ 0.06
- ---------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------
Exercisable, May 31, 2001 1,200,158 $ 0.68 4,961,463 $ 0.42
- ---------------------------------------------------------------------------------------------------------------------------
Exercisable, May 31, 2002 2,418,072 $ 0.48 24,477,724 $ 0.11
- ---------------------------------------------------------------------------------------------------------------------------
Exercisable, May 31, 2003 4,138,633 $ 0.29 57,992,468 $ 0.06
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average fair value of options and warrants
granted during the year ended May 31, 2001 $ 0.86 $ 0.44
Weighted average fair value of options and warrants
granted during the year ended May 31, 2002 $ 0.07 $ 0.11
Weighted average fair value of options and warrants
granted during the year ended May 31, 2003 $ 0.04 $ 0.05
- ---------------------------------------------------------------------------------------------------------------------------
Included in the above table are certain options for which vesting is contingent
based on various future performance measures.
The following table summarizes information about stock options and warrants
outstanding at May 31, 2003:
F-26
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Outstanding Exercisable
---------------------------------------------- -------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- -----------------------------------------------------------------------------------------------------
OPTIONS
$ 0.0425-0.059 850,000 4.74 $ 0.05 525,000 $ 0.04
0.07-0.09 1,365,500 3.89 0.08 1,213,467 0.08
0.11-0.1325 1,885,000 3.36 0.11 1,530,000 0.11
0.32-0.69 291,000 1.53 0.64 291,000 0.64
1.16-1.325 662,500 2.04 1.26 579,166 1.25
- -----------------------------------------------------------------------------------------------------
$ 0.0425-1.325 5,054,000 3.46 $ 0.28 4,138,633 $ 0.29
WARRANTS
$ 0.033-0.495 38,464,610 4.07 $ 0.04 38,464,610 $ 0.04
0.05-0.0592 8,013,741 3.84 0.06 7,013,741 0.06
0.0616-0.0715 9,806,840 3.76 0.07 9,806,840 0.07
0.25-0.40 2,607,277 1.36 0.28 2,607,277 0.28
0.59-1.12 100,000 1.64 0.68 100,000 0.68
- -----------------------------------------------------------------------------------------------------
$ 0.033-1.12 58,992,468 3.86 $ 0.06 57,992,468 $ 0.06
8. NET LOSS PER SHARE
The Company has implemented Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share." SFAS No. 128 provides for the calculation of
"Basic" and "Diluted" earnings per share ("EPS"). Basic EPS includes no dilution
and is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution of securities that could share in the earnings
of an entity. The Company's net losses for the periods presented cause the
inclusion of potential common stock instruments outstanding to be antidilutive
and, therefore, in accordance with SFAS No. 128, the Company is not required to
present a diluted EPS. During the years ended May 31, 2003, 2002 and 2001,
common stock options and warrants convertible or exercisable into approximately
64,046,468, 28,727,463, and 7,539,287 shares of common stock were not included
in diluted loss per share as the effect was antidilutive due to the Company
recording losses in each of those years.
F-27
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES The net deferred tax asset recorded
and its approximate tax effect consisted of the
following:
May 31,
------------------------------
2003 2002
--------------------------------------------------------------------------
Net operating loss carryforwards $ 12,073,000 $ 11,030,000
Purchased technology 420,000 470,000
Depreciation and amortization 1,607,000 1,754,000
Other, net 191,000 192,000
------------------------------------------------------- -----------------
14,291,000 13,446,000
Valuation allowance 14,291,000 13,446,000
------------------------------------------------------- -----------------
Net deferred tax asset $ - $ -
--------------------------------------------------------------------------
As of May 31, 2003 and 2002, valuation allowances equal to the net deferred tax
asset recognized have been recorded, as Management has not determined that it is
more likely than not that the deferred tax asset will be realized. No current
tax provision was recorded for fiscal 2003, 2002 and 2001 due to reported
losses. The valuation allowance increased $845,000 for the year ended May 31,
2003 and $1,457,00 for the year ended May 31, 2002.
At May 31, 2003, the Company has federal net operating loss carryforwards of
approximately $31,814,000 that expire through 2022 and are subject to certain
limitations under the Internal
F-28
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Revenue Code of 1986, as amended. As such, certain federal net operating loss
carryforwards may expire unused.
At May 31, 2003, the Company has state net operating loss carryforwards of
approximately $20,927,000 that expire through 2010. The state of California has
suspended the utilization of net operating losses for 2002 and 2003.
10. PROFIT-SHARING PLAN
Effective July 1, 1993, the Company adopted a savings and profit-sharing plan
that allows participants to make contributions by salary reduction pursuant to
Section 401(k) of the Internal Revenue Code. At the Company's discretion, the
Company may match contributions at 20% of the employee's contribution up to 6%
of the employee's salary. The Company contributions are vested 20% per year
beginning with the first year of service. The Company made no matching
contribution in fiscal 2003, 2002 or 2001.
11. COMMITMENTS AND CONTINGENCIES
In January 1999, we were sued in the Superior Court of San Diego County,
California by the Fish Family Trust, a co-inventor of the original ShBoom
technology. The suit also named as defendants nanoTronics and Gloria Felcyn on
behalf of the Falk Family Trust. The suit sought a judgment for damages, a
rescission of the Technology Transfer Agreement and a restoration of the
technology to the co-inventor. In March 1999, we joined with nanoTronics and
Gloria Felcyn and filed our response and cross-complaint against the Fish Family
Trust. In November 2000, the judge issued a summary ruling in favor of the
defendants on all counts. The Fish Family Trust filed an appeal in January 2001.
In June 2003, the Appellate Court confirmed the trial court's ruling, thereby,
bringing the dispute to a favorable conclusion.
The Company is obligated under employment contracts with certain key employees
to pay severance upon termination under certain defined conditions. Generally,
unless relieved of their duties for cause, the executive officers are entitled
to severance pay equal to four months of their then current monthly salary. In
the case of a change in control, generally, the executive officers are entitled
to severance pay equal to twelve months of their then current monthly salary
unless they continue to work for the new controlling interest in the same
function as previous to the change.
The Company granted a lien and security interest in substantially all of its
assets to the bank under the accounts receivable factoring line and to investors
under its notes payable and convertible debentures.
F-29
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company has a non-cancellabe operating lease for its office and
manufacturing facilities located in San Diego, California.
Future minimum lease payments required under the operating lease are as
follows:
Years ending May 31,
----------------------------------------------------------------------------------------------
Gross Sublease Net
Payments Income Payments
2004 $ 129,250 $ 68,850 $ 60,400
2005 135,454 70,470 64,984
2006 141,658 72,540 69,118
2007 23,782 12,150 11,632
----------------------------------------------------------------------------------------------
Total minimum lease payments $ 430,144 $ 224,010 $ 206,134
----------------------------------------------------------------------------------------------
Rent expense for fiscal 2003, 2002 and 2001 was $189,423, $147,373, and
$149,494, respectively.
The Company has one capital lease at May 31, 2003.
Future minimum lease payments are as follows:
Year ending May 31,
2004 $ 9,562
2005 9,562
2006 2,391
- ------------------------------------------------------------------
Total minimum lease payments 21,515
Amount representing interest 4,784
- ------------------------------------------------------------------
Present value of minimum lease payments 16,731
Total obligation 16,731
Less current portion (6,405)
- ------------------------------------------------------------------
Long-term portion $ 10,326
- ------------------------------------------------------------------
Capital leases included in fixed assets at May 31, 2003 and 2002, were $11,803
and $20,135, net of an allowance for depreciation of $13,192 and $4,860.
Depreciation expense related to the capitalized lease was $8,332 and $4,860 for
the years ended May 31, 2003 and 2002.
12. SEGMENT INFORMATION
EXPORT SALES
The Company is engaged in one business segment, the development and marketing of
microprocessor technology related products and licenses. Telecommunication
products have
F-30
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
reached the end of their life cycles and no longer provide any significant
sales. During the fiscal years ended May 31, 2003, 2002 and 2001, the Company's
product sales of high technology computer products and licenses were $31,340,
$9,625, and $50,511 and telecommunication products and licenses were $92,563,
$349,184, and $286,173.
For the purpose of allocating revenues by geographic location, the Company uses
the physical location of its customers as its basis. During the fiscal years
ended May 31, 2003, 2002 and 2001, the Company's sales by geographic location
consisted of the following:
2003 2002 2001
------------- ------------- --------------
Domestic sales $ 113,000 $ 355,000 $ 253,000
Foreign sales:
Europe 11,000 4,000 19,000
North America - - 40,000
Asia - - 25,000
--------------------------------------------------
Total foreign sales 11,000 4,000 84,000
--------------------------------------------------
Total net product sales $ 124,000 $ 359,000 $ 337,000
==================================================
The Company has no foreign assets.
SALES TO MAJOR CUSTOMERS
During the fiscal years ended May 31, 2003, 2002 and 2001, revenues from
significant customers consisted of the following:
2003 2002 2001
------------------------------- --------------------------------- -----------------------------
Customer Sales Percent Sales Percent Sales Percent
--------
--------------- ------------- ------------------ ------------ -------------- ------------
A $ 43,000 34.3% $ - - $ - -
B 23,000 18.6% - - - -
C 15,000 11.9% - - - -
D 15,000 11.9% 151,000 42.0% - -
E - - - - - -
F - - 59,000 16.4% - -
G - - - - 88,000 26.1%
H - - - - 41,000 12.2%
I - - - - 40,000 11.9%
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PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. RELATED PARTY TRANSACTIONS
During fiscal years 2002 and 2001, the Company contracted with a company, which
was owned by the daughter of our previous President, Chairman and CEO, for web
site development, marketing support and other various services. The Company paid
$70,292 and $139,253, respectively, in fiscal years 2002 and 2001 to the related
party for these services. No such related party transactions occurred during
fiscal year 2003.
14. SUBSEQUENT EVENTS
Subsequent to year end, we concluded additional fundings of our 8% Convertible
Debentures. We received advances against these closings of $50,000 as of May 31,
2003 and the balance of $295,000 subsequent to year end from a group of four
investors. In conjunction with the debentures we also issued warrants to
purchase up to 7,870,191 shares of our common stock at initial exercise prices
of $0.03 to $0.065 per share, subject to being reset at each six month
anniversary to the closings.
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PATRIOT SCIENTIFIC CORPORATION
SCHEDULE II- VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts
Balance at Charged to Balance at
beginning of costs and end of
Description period expenses Deductions period
Year ended May 31, 2003 $ 6,000 $ 24,000 $ 20,000 $ 10,000
Year ended May 31, 2002 $ 54,000 $ 76,027 $ 124,027 $ 6,000
Year ended May 31, 2001 $ 5,000 $ 49,000 $ - $ 54,000
Reserve for Inventory Obsolescence
Balance at Charged to Balance at
beginning of costs and end of
Description period expenses Deductions period
Year ended May 31, 2003 $ 373,381 $ - $ 301,343 $ 72,038
Year ended May 31, 2002 $ 262,000 $ 149,433 $ 38,052 $ 373,381
Year ended May 31, 2001 $ 339,000 $ 100,000 $ 177,000 $ 262,000
F-33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, 2003 PATRIOT SCIENTIFIC CORPORATION
By: /s/ LOWELL W. GIFFHORN
----------------------
Lowell W. Giffhorn
Executive Vice President, Chief Financial
Officer and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/JEFFREY E. WALLIN President and Chief Executive August 29, 2003
-------------------- Officer
Jeffrey E. Wallin
/s/LOWELL W. GIFFHORN Chief Financial Officer, Principal August 29, 2003
--------------------- Financial Officer, Principal
Lowell W. Giffhorn Accounting Officer, Secretary
and Director
/s/DAVID POHL Director August 29, 2003
-------------
David Pohl
/s/CARLTON JOHNSON Director August 29, 2003
-------------------
Carlton Johnson
/s/DONALD BERNIER Chairman of the Board and August 29, 2003
----------------- Director
Donald Bernier
/s/HELMUT FALK JR. Director August 29, 2003
------------------
Helmut Falk Jr.
/s/GLORIA FELCYN Director August 29, 2003
----------------
Gloria Felcyn