Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X]

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

For the quarterly period ended February 28, 2017

[_]

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

For the transition period from ___________ to _______________

Commission File Number 0-22182

PATRIOT SCIENTIFIC CORPORATION

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of

incorporation or organization)

84-1070278

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

2038 Corte Del Nogal, Suite 141, Carlsbad, California

(Address of principal executive offices)

92011

(Zip Code)

(Registrant’s telephone number, including area code): (760) 795-8517

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

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

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

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

Smaller reporting company [X]

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

On April 10, 2017, 401,392,948 shares of common stock, par value $0.00001 per share were outstanding.

INDEX

		Page
PART I. FINANCIAL INFORMATION

ITEM 1 . Financial Statements

Condensed consolidated Balance Sheets as of February 28, 2017 (unaudited) and May 31, 2016		3

Condensed consolidated Statements of Operations for the three and nine months ended February 28, 2017 and February 29, 2016 (unaudited)		4

Condensed consolidated Statements of Cash Flows for the nine months ended February 28, 2017 and February 29, 2016 (unaudited)		5

Notes to condensed consolidated Financial Statements (unaudited)		6-17

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18-25

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk		26

ITEM 4. Controls and Procedures		26

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings		26

ITEM 1A. Risk Factors		26

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds		26

ITEM 3. Defaults Upon Senior Securities		26

ITEM 4. Mine Safety Disclosures		26

ITEM 5. Other Information		26

ITEM 6. Exhibits		27-29

SIGNATURES		30

PART I- FINANCIAL INFORMATION

Item 1. Financial Statements

Patriot Scientific Corporation

Condensed Consolidated Balance Sheets

	February 28, 2017			May 31, 2016
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,815,707		$	1,159,576
Restricted cash and cash equivalents		21,416			21,336
Marketable securities		1,502,436			1,955,493
Prepaid income tax		2,285			2,385
Prepaid expenses and other current assets		49,748			13,788
Total current assets		3,391,592			3,152,578

Property and equipment, net		2,102			–
Marketable securities, net of current portion		250,583			500,409
Investment in affiliated company		446,503			170,357
Total assets	$	4,090,780		$	3,823,344

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	7,717		$	33,215
Accrued expenses and other		51,198			40,297
Total current liabilities		58,915			73,512
Total liabilities		58,915			73,512

Commitments and contingencies

Stockholders’ equity:
Preferred stock, $0.00001 par value; 5,000,000 shares authorized: none outstanding		–			–
Common stock, $0.00001 par value: 600,000,000 shares authorized: 438,242,618 shares issued and 401,392,948 shares outstanding at February 28, 2017 and May 31, 2016		4,382			4,382
Additional paid-in capital		77,444,062			77,444,062
Accumulated deficit		(58,790,711	)		(59,072,744	)
Common stock held in treasury, at cost – 36,849,670 shares at February 28, 2017 and May 31, 2016		(14,625,868	)		(14,625,868	)
Total stockholders’ equity		4,031,865			3,749,832
Total liabilities and stockholders’ equity	$	4,090,780		$	3,823,344

See accompanying notes to unaudited condensed consolidated financial statements

Patriot Scientific Corporation

Condensed Consolidated Statements of Operations

(Unaudited)

	Three Months Ended						Nine Months Ended
	February 28, 2017			February 29, 2016			February 28, 2017		February 29, 2016
Operating expenses:
Selling, general and administrative	$	281,265		$	405,242		$	887,881	$	1,145,606
Total operating expenses		281,265			405,242			887,881		1,145,606

Other income (expense):
Interest income		4,081			3,930			12,568		10,421
Equity in earnings (loss) of affiliated company		(32,139	)		(130,553	)		1,159,746		444,070
Total other income (expense), net		(28,058	)		(126,623	)		1,172,314		454,491

Income (loss) before income taxes		(309,323	)		(531,865	)		284,433		(691,115	)

Provision for income taxes		–			–			2,400		2,400

Net income (loss)	$	(309,323	)	$	(531,865	)	$	282,033	$	(693,515	)

Basic income (loss) per common share	$	–		$	–		$	–	$	–

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

Weighted average number of common shares outstanding-basic		398,548,318			398,548,318			398,548,318		398,548,318

Weighted average number of common shares outstanding-diluted		398,548,318			398,548,318			401,398,948		398,548,318

See accompanying notes to unaudited condensed consolidated financial statements

Patriot Scientific Corporation

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended
	February 28, 2017			February 29, 2016

Operating activities:
Net income (loss)	$	282,033		$	(693,515	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation		601			1,237
Accrued interest income added to investments		2,803			(494	)
Equity in earnings of affiliated company		(1,159,746	)		(444,070	)
Changes in operating assets and liabilities:
Prepaid expenses and other current assets		(35,960	)		(57,623	)
Prepaid income tax		100			2,400
Accounts payable, accrued expenses and other		(14,597	)		(26,138	)
Net cash used in operating activities		(924,766	)		(1,218,203	)

Investing activities:
Proceeds from sales of marketable securities		2,450,000			1,950,000
Purchases of marketable securities		(1,750,000	)		(1,950,000	)
Purchase of property and equipment		(2,703	)		–
Distributions from affiliated company		883,600			58,000
Net cash provided by investing activities		1,580,897			58,000

Net increase (decrease) in cash and cash equivalents		656,131			(1,160,203	)
Cash and cash equivalents, beginning of period		1,159,576			2,679,360
Cash and cash equivalents, end of period	$	1,815,707		$	1,519,157

Supplemental Disclosure of Cash Flow Information:
Cash paid for income taxes	$	2,300		$	–

See accompanying notes to unaudited condensed consolidated financial statements.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation and Summary of Significant Accounting Policies

The unaudited condensed consolidated financial statements of Patriot Scientific Corporation (the “Company”, “PTSC”, “Patriot”, “we”, “us” or “our”) presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in our Report on Form 10-K for our fiscal year ended May 31, 2016.

In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the results for the interim period presented. Operating results for the nine month period ended February 28, 2017 are not necessarily indicative of the results that may be expected for the year ending May 31, 2017.

Basis of Consolidation

The condensed consolidated balance sheets at February 28, 2017 and May 31, 2016 and condensed consolidated statements of operations for the three and nine months ended February 28, 2017 and February 29, 2016, and condensed consolidated statements of cash flows for the nine months ended February 28, 2017 and February 29, 2016 include our accounts and those of our inactive subsidiaries: Patriot Data Solutions Group, Inc. (“PDSG”) which includes Crossflo Systems, Inc. (“Crossflo”), and Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated.

Liquidity and Management’s Plans

Cash shortfalls currently experienced by Phoenix Digital Solutions, LLC (“PDS”) will have an adverse effect on our liquidity. To date, we have determined that it is in the best interests of the Moore Microprocessor Patent (“MMP”) licensing program that we provide our 50% share of capital to provide for PDS expenses including legal retainers, and litigation related payments in the event license revenues received by PDS are insufficient to meet these needs. We believe it is likely that contributions to PDS to fund working capital will continue to be required.

PDS had been incurring significant third-party costs for expert testimony, depositions and other related litigation costs. We could be required to make capital contributions to PDS for any future litigation related costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.

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

On March 20, 2013, Technology Properties Limited, Inc. (“TPL”) filed a petition under Chapter 11 of the United States Bankruptcy Code. We have been appointed to the creditors’ committee and have been closely monitoring the progress in this matter as it relates to our interest in PDS. A Joint Plan of Reorganization (the “Joint Plan”) between TPL and the creditor’s committee was confirmed by the

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Liquidity and Management’s Plans (continued)

Bankruptcy Court on February 11, 2015 with the entered confirmation order becoming final on April 2, 2015. In the event we are required to provide funding to PDS that is not reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our condensed consolidated financial statements.

Investments in Marketable Securities

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

Investment in Affiliated Company

We have a 50% interest in PDS (see Note 3). We account for our investment using the equity method of accounting since the investment provides us the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee’s Board of Directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the investee and is recognized in the condensed consolidated statements of operations in the caption “Equity in earnings (loss) of affiliated company” and also is adjusted by contributions to and distributions from PDS.

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

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

Earnings (Loss) Per Share

Basic earnings per share includes no dilution and is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution of securities that could share in the earnings of an entity.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Earnings (Loss) Per Share (continued)

For the three months ended February 28, 2017, potential common shares of 2,600,000 related to our outstanding options were not included in the calculation of diluted loss per share as we recorded a loss. Had we reported net income for the three months ended February 28, 2017, no shares of common stock would have been included in the calculation of diluted income per share using the treasury stock method.

For the nine months ended February 28, 2017, potential common shares of 2,600,000 related to our outstanding options were not included in the calculation of diluted income per share as their inclusion would be anti-dilutive. For the nine months ended February 28, 2017 we included the PDSG escrow shares of 2,844,630 in the calculation of diluted income per share.

For the three and nine months ended February 29, 2016, potential common shares of 2,760,000 related to our outstanding options were not included in the calculation of diluted loss per share as we recorded a loss. Had we reported net income for the three and nine months ended February 29, 2016, no shares of common stock would have been included in the calculation of diluted income per share using the treasury stock method.

In connection with our acquisition of Crossflo, which is part of PDSG, we issued escrow shares that are contingent upon certain representations and warranties made by Crossflo at the time of the merger agreement (see Note 6). We exclude these escrow shares from the basic loss per share calculations and would have included the escrowed shares in the diluted income per share calculations if we reported net income.

Income Taxes

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

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

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

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

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Assessment of Contingent Liabilities

We are involved in various legal matters, disputes, and patent infringement claims which arise in the ordinary course of our business. We accrue for any estimated losses at the time when we can make a reliable estimate of such loss and it is probable that it has been incurred. By their very nature, contingencies are difficult to estimate. We continually evaluate information related to all contingencies to determine that the basis on which we have recorded our estimated exposure is appropriate.

Intellectual Property Rights

PDS, our investment in affiliated company, relies on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We have seven U.S., nine European, and three Japanese patents all of which expired between August 2009 and October 4, 2016. These patents, while expired, may have certain retrospective statutory benefits that will fully diminish six years after the patent expiration dates. The patent useful life for purposes of negotiating licenses is finite and these patents are subject to legal challenges, which in combination with the limited life, could adversely impact the stream of revenues. A successful challenge to the ownership of the technology or the proprietary nature of the intellectual property would materially damage business prospects. Any issued patent may be challenged and invalidated.

Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-15, "Presentation of Financial Statements – Going Concern." ASU 2014-15 provides guidance in generally accepted accounting principles about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for annual reporting periods ending after December 15, 2016 and for annual periods and interim periods thereafter (fiscal year 2017 for the Company). Early adoption is permitted. We adopted this guidance during the three months ended February 28, 2017, which did not have a significant impact on the condensed consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments.” ASU 2016-15 provides guidance intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The issue addressed in ASU 2016-15 that will affect the Company is classifying distributions received from equity method investments. The guidance provides an accounting policy election for classifying distributions received from equity method investments using either a cumulative earnings approach or a nature of distributions approach. ASU 2016-15 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years (fiscal 2019 for the Company). Early adoption is permitted. We have not yet determined the potential effects of the adoption of ASU 2016-15 on our condensed consolidated financial statements.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Recent Accounting Pronouncements (continued)

In November 2016, the FASB issued ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years (fiscal 2019 for the Company), with early adoption permitted. The Company is currently evaluating the effect ASU 2016-18 will have on our condensed consolidated statements of cash flows.

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

We consider all highly liquid investments acquired with a maturity of three months or less from the purchase date to be cash equivalents.

Restricted cash and cash equivalents at February 28, 2017 and May 31, 2016 consist of a savings account held as collateral for our corporate credit card account.

At February 28, 2017 and May 31, 2016, our short-term marketable securities in the amount of $1,502,436 and $1,955,493, respectively, consist of certificates of deposit with various financial institutions, with maturity dates between three months and twelve months from the purchase date.

At February 28, 2017 and May 31, 2016, our long-term marketable securities in the amount of $250,583 and $500,409, respectively, consist of certificates of deposit with various financial institutions, with maturity dates greater than twelve months from the purchase date.

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

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

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

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

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

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

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

			Fair Value Measurements at February 28, 2017 Using
	Fair Value at February 28,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2017		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents:
Cash	$	84,564	$	84,564	$	–	$	–
Money market funds		580,119		580,119		–		–
Certificates of deposit		1,151,024		–		1,151,024		–
Restricted cash and cash equivalents		21,416		21,416		–		–
Marketable securities:
Short-term:
Certificates of deposit		1,502,436		–		1,502,436		–
Long-term:
Certificates of deposit		250,583		–		250,583		–
Total	$	3,590,142	$	686,099	$	2,904,043	$	–

			Fair Value Measurements at May 31, 2016 Using
	Fair Value at May 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2016		(Level 1)		(Level 2)		(Level 3)
Cash and cash equivalents:
Cash	$	113,803	$	113,803	$	–	$	–
Money market funds		795,600		795,600		–		–
Certificates of deposit		250,173		–		250,173		–
Restricted cash and cash equivalents		21,336		21,336		–		–
Marketable securities:
Short-term:
Certificates of deposit		1,955,493		–		1,955,493		–
Long-term:
Certificates of deposit		500,409		–		500,409		–
Total	$	3,636,814	$	930,739	$	2,706,075	$	–

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

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

We purchase certificates of deposit with varying maturity dates. The following table summarizes the purchase date maturities, gross unrealized gains or losses and fair value of the certificates of deposit as of February 28, 2017:

	February 28, 2017 (Unaudited)
	Cost		Gross Unrealized Gains/(Losses)		Fair Value
Maturity
Due in three months or less	$	1,151,024	$	–	$	1,151,024
Due in one year or less	$	1,502,436	$	–	$	1,502,436
Due in one year or more	$	250,583	$	–	$	250,583

	May 31, 2016
	Cost		Gross Unrealized Gains/(Losses)		Fair Value
Maturity
Due in three months or less	$	250,173	$	–	$	250,173
Due in one year or less	$	1,955,493	$	–	$	1,955,493
Due in one year or more	$	500,409	$	–	$	500,409

3. Investment in Affiliated Company

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

We and TPL each own 50% of the membership interests of PDS, and each member has the right to appoint one member of the three member management committee. The two appointees are required to select a mutually acceptable third member of the management committee. There had not been a third management committee member since May 2010; however, as a result of our initiation of arbitration seeking the appointment of a third member, on December 16, 2014, an independent manager to the PDS management committee was selected by the arbitrator. Pursuant to the LLC Agreement, we and TPL initially agreed to establish a working capital fund for PDS of $4,000,000, of which our contribution was $2,000,000. The working capital fund was increased to a maximum of $8,000,000 as license revenues are achieved. We and TPL are obligated to fund future working capital requirements at the discretion of the management committee of PDS in order to maintain working capital of not more than $8,000,000. If the management committee determines that additional capital is required, neither we nor TPL are required to contribute more than $2,000,000 in any fiscal year. No such contributions were made during the three and nine months ended February 28, 2017 and February 29, 2016. Distributable cash and allocation of profits and losses have been allocated to the members in the priority defined in the LLC Agreement.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

On July 11, 2012, we entered into the Program Agreement with PDS, TPL, and Alliacense, and an Agreement (the “TPL Agreement”) with TPL. Pursuant to the Program Agreement, PDS engaged Alliacense to negotiate MMP portfolio licenses and to pursue claims against violators of the MMP portfolio on behalf of PDS, TPL, and the Company. The Program Agreement continued through the useful life of the MMP portfolio patents. Pursuant to the TPL Agreement, we and TPL agreed to certain allocations of obligations in connection with the engagement of Alliacense. On July 24, 2014, the Program Agreement was amended with PDS and Alliacense entering into the Amended Alliacense Services and Novation Agreement (the “Novation Agreement”). Pursuant to the Novation Agreement certain performance goals and incentives were established for Alliacense. The Novation Agreement also provided for the addition of a second licensing company, which was engaged on October 10, 2014, to complement the MMP licensing commercialization. However, Alliacense fulfilled only a portion of its obligations under the Novation Agreement associated with the deployment of the second licensing company and on May 11, 2015, Alliacense was terminated by PDS.

On August 10, 2016, PDS entered into an agreement with Alliacense and MMP Licensing, LLC to settle matters relating to Alliacense’s non-performance under terms of the Novation Agreement. The August 10, 2016 agreement requires Alliacense to provide PDS’s second licensing company with certain materials and to cooperate with reasonable discovery requests relating to infringement litigation currently pending in the U.S. District Court for the Northern District of California. MMP Licensing, LLC will provide commercialization services to PDS for the MMP portfolio with respect to certain companies. PDS and Alliacense have agreed to cause the arbitration between the parties to be dismissed with prejudice. The August 10, 2016 agreement will expire on October 4, 2022. Terms of the settlement agreement required PDS to pay Alliacense $84,000 within 24 hours after delivery of materials to PDS’s second licensing agent and to pay Alliacense $84,000 out of subsequent recoveries. PDS paid Alliacense $84,000 on August 11, 2016 and October 3, 2016, respectively.

On October 3, 2016, Alliacense received proceeds of $600,000 earned on a licensing agreement entered into by PDS during the period ended August 31, 2016. This expense is recorded in the accompanying PDS statement of operations presented below.

During January 2013, TPL and Moore settled their litigation. Terms of the settlement include the payment by PDS to Moore of a consulting fee of $250,000 for four years or until the completion of all outstanding MMP litigation whichever comes first. Per terms of the agreement PDS paid Moore $150,000 on the settlement date and paid Moore $16,667 per month from August 2013 through January 2014 and paid Moore $20,833 per month from February 2014 through January 2017. During the three months ended February 28, 2017 and February 29, 2016, PDS expensed $41,676 and $62,499, respectively, pursuant to this commitment and during the nine months ended February 28, 2017 and February 29, 2016, PDS expensed $166,674 and $187,497, respectively, pursuant to this commitment. These expenses are recorded in the accompanying PDS statements of operations presented below.

Based on our analysis of current authoritative accounting guidance with respect to our investment in PDS, we continue to account for our investment in PDS under the equity method of accounting, and accordingly have recorded our share of PDS’s net income during the nine months ended February 28, 2017 and February 29, 2016 of $1,159,746 and $444,070, respectively, as an increase in our investment and we have recorded our share of PDS’s net loss during the three months ended February 28, 2017 and February 29, 2016 of $32,139 and $130,553 as an decrease in our investment. We received distributions of $883,600 and $58,000, respectively, from PDS during the nine months ended February 28, 2017 and February 29, 2016 and we have recorded these distributions as a decrease in our investment.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

We have recorded our share of PDS’s net income and loss for the three and nine months ended February 28, 2017 and February 29, 2016 as “Equity in earnings (loss) of affiliated company” in the accompanying condensed consolidated statements of operations.

During the three and nine months ended February 28, 2017, PDS entered into a licensing agreement with a third party, pursuant to which PDS received proceeds of $0 and $3,000,000, respectively.

During the three and nine months ended February 29, 2016, PDS entered into licensing agreements with third parties, pursuant to which PDS received aggregate proceeds of $0 and $1,450,000, respectively.

On March 20, 2013, TPL filed a petition under Chapter 11 of the United States Bankruptcy Code. A Joint Plan of Reorganization (the “Joint Plan”) between TPL and the creditor’s committee was confirmed by the Bankruptcy Court on February 11, 2015 with the entered confirmation order becoming final on April 2, 2015. We have been appointed to the creditors’ committee and have been closely monitoring the progress in this matter as it relates to our interest in PDS. In the event we are required to provide funding to PDS that is not reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our condensed consolidated financial statements. If we determine that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their fair values at the date that we have the controlling financial interest.

PDS’s balance sheets at February 28, 2017 and May 31, 2016 and statements of operations for the three and nine months ended February 28, 2017 and February 29, 2016 are as follows:

Balance Sheets

Assets:

	February 28, 2017		May 31, 2016
	(Unaudited)		(Audited)
Cash	$	900,601	$	741,971
Prepaid expenses		2,629		26,295
Total assets	$	903,230	$	768,266

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Investment in Affiliated Company (continued)

Liabilities and Members’ Equity:

	February 28, 2017		May 31, 2016
	(Unaudited)		(Audited)
Payables	$	10,224	$	427,553
Members’ equity		893,006		340,713
Total liabilities and members’ equity	$	903,230	$	768,266

Statements of Operations

	Three Months Ended						Nine Months Ended
	February 28, 2017			February 29, 2016			February 28, 2017		February 29, 2016
	(Unaudited)			(Unaudited)			(Unaudited)		(Unaudited)
Revenues	$	–		$	–		$	3,000,000	$	1,450,000
Expenses		64,278			261,106			680,297		561,860
Income (loss) before provision for income taxes		(64,278	)		(261,106	)		2,319,703		888,140
Provision for income taxes		–			–			210		–
Net income (loss)	$	(64,278	)	$	(261,106	)	$	2,319,493	$	888,140

4 . Income Taxes

5. Stockholders’ Equity

Share-based Compensation

Summary of Assumptions and Activity

The fair value of share-based awards to employees and directors is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options.

The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the pricing term of the grant effective as of the date of the grant. The expected volatility is based on the historical volatilities of our common stock. These factors could change in the future, affecting the determination of share-based compensation expense in future periods.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Stockholders’ Equity (continued)

A summary of option activity as of February 28, 2017 and changes during the nine months then ended, is presented below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
Options outstanding at June 1, 2016		2,760,000		$	0.05
Options granted		–		$	–
Options exercised		–		$	–
Options forfeited/expired		(160,000	)	$	0.04

Options outstanding at February 28, 2017		2,600,000		$	0.06		2.63	$	–

Options vested and expected to vest at February 28, 2017		2,600,000		$	0.06		2.63	$	–

Options exercisable at February 28, 2017		2,600,000		$	0.06		2.63	$	–

The aggregate intrinsic value represents the differences in market price at the close of the quarter ($0.0051 per share on February 28, 2017) and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.0051 per share) on February 28, 2017.

6. Commitments and Contingencies

Litigation

Patent Litigation

We, TPL, and PDS (collectively referred to as “Plaintiffs”) are Plaintiffs in ongoing proceedings in the U.S. District Court for the Northern District of California where the Plaintiffs allege infringement of the US 5,809,336 patent (the “‘336 patent”) by: Huawei Technologies Co. Ltd., LG Electronics, Nintendo Co. Ltd., Samsung Electronics Co. Ltd., and ZTE Corporation. This litigation is proceeding in front of District Court Judge Vince Chhabria.

These ongoing proceedings relate to the proceedings filed by the Plaintiffs in February 2008 in the U.S. District Court for the Northern District of California alleging infringement of the US 5,440,749 patent (the “‘749 patent”), the US 5,530,890 patent (the “‘890 patent”) and the ‘336 patent against Amazon.com Inc., Barnes & Noble Inc., Garmin Ltd., Huawei Technologies Co. Ltd., Kyocera Corporation, LG Electronics, Nintendo Co. Ltd., Novatel Wireless Inc., Samsung Electronics Co. Ltd., Sierra Wireless Inc., and ZTE Corporation. We have settled with all defendants except those named in the first paragraph to this footnote.

On September 18, 2015, a Markman hearing was held before U.S. Magistrate Judge Grewal and, on September 22, 2015, he issued a claim construction report and recommendation. On September 25, 2015, as a result of the claim construction report and recommendation, Plaintiffs and defendants, with the exception of Huawei Technologies Co. Ltd., (“Huawei”) agreed to stay all proceedings pending resolution of Plaintiffs’ objections to the claim construction report and recommendation. Plaintiffs further stipulated that, under the claim construction provided by the report and recommendation, defendants’ products do not infringe the ‘336 patent, and, in the event that the Court does not materially modify the claim construction, Plaintiffs and defendants ask that the Court enter a final judgment of non-infringement. After Plaintiffs and Huawei filed opposing letter briefs with the Court, U.S. Magistrate Judge Grewal stayed the action against Huawei pending resolution of Plaintiffs’ objections to the claim construction. On October 6, 2015, Plaintiffs filed objections to the claim construction with District Court Judge Chhabria. Judge Chhabria rejected those objections on November 9, 2015. Based on that order, the parties stipulated to a judgment of non-infringement as to the ‘336 patent and such judgment was entered on November 13, 2015.

Patriot Scientific Corporation

Notes to Unaudited Condensed Consolidated Financial Statements

Commitments and Contingencies (continued)

On December 7, 2015, Plaintiffs filed notices of appeal with the U.S. Federal Circuit appealing the district court’s claim construction. Plaintiffs filed their opening appellate brief on March 10, 2016. Defendants filed their response brief on May 23, 2016, with Plaintiffs filing their reply brief on June 23, 2016. On March 3, 2017, the U.S. Court of Appeals for the Federal Circuit rendered its decision vacating the claims construction that was issued in September 2016 by the U.S. District Court for the Northern District of California and has remanded the matter to the District Court for further proceedings.

401(k) Plan

We have a retirement plan that complies with Section 401(k) of the Internal Revenue Code. All employees are eligible to participate in the plan. We match 100% of elective deferrals subject to a maximum of 4% of the participant’s eligible earnings. Our participants vest 33% per year over a three year period in their matching contributions. Our matching contributions during the three months ended February 28, 2017 and February 29, 2016 were $4,641 and $5,524, respectively. Our matching contributions during the nine months ended February 28, 2017 and February 29, 2016 were $15,469 and $15,459, respectively.

Guarantees and Indemnities

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

Escrow Shares

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

7. Subsequent Events

We have evaluated subsequent events after the balance sheet date and based on our evaluation, management has determined that no subsequent events have occurred that would require recognition in the accompanying condensed consolidated financial statements or disclosure in the notes thereto other than as disclosed in the accompanying notes.

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

THE FOLLOWING DISCUSSION AND THE REST OF THIS QUARTERLY REPORT ON FORM 10-Q INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS". SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31, 2016.

Overview

In June 2005, we entered into a series of agreements with TPL and others to facilitate the pursuit of unlicensed users of our intellectual property. Over the years we, TPL and TPL’s affiliate, Alliacense, have entered into various agreements regarding licensing and litigation of the MMP portfolio. Pursuant to a July 2014 Novation Agreement with Alliacense PDS engaged a second licensing agent for the MMP portfolio in October 2014 and on May 11, 2015, PDS terminated Alliacense as licensing agent due to the inability of Alliacense to fulfill its obligations under the Novation Agreement. In August 2016, PDS and Alliacense entered into an agreement which requires Alliacense to: cooperate with reasonable discovery requests, provide support to litigation counsel, and deliver certain materials to PDS’s second licensing agent. Pursuant to the August 2016 agreement, MMP Licensing, LLC will provide MMP portfolio commercialization services to PDS for certain companies. PDS is currently pursuing a litigation strategy, which includes an action in the U.S. District Court against multiple companies alleged to be infringers of the MMP portfolio. We continue to believe that the significant investment in legal effort and costs incurred to date at PDS is necessary for the protection of our interests in the MMP portfolio and its future success, although to date it has generated mixed results.

Management expects to continue to incur significant legal expenses for the continued operation of PDS. PDS had been incurring significant third-party costs for expert testimony, depositions and other related legal costs pursuant to litigation in U.S. District Court. We could be required to make capital contributions to PDS for any future litigation related costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.

To the extent MMP portfolio license proceeds are insufficient; we expect working capital contributions may need to be made to PDS in the future. Cash shortfalls currently experienced by PDS will have an adverse effect on our liquidity. To date, we have determined that it is in the best interests of the MMP licensing program that we contribute our 50% share of additional capital to PDS in the event license revenues received by PDS are insufficient.

On April 10, 2017, PDS’s cash balance was $897,111. Management’s plans for the continued operation of PDS rely on the ability of PDS to obtain license agreements to cover its operational costs. PDS has experienced a decline in licensing revenues and has not obtained significant license revenues since September 2013 and it is unclear when any additional licensing revenues may be generated.

Critical Accounting Policies and Estimates

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

1.	Investments in Marketable Securities

We classify our investments in marketable securities in certificates of deposit at the time of purchase as held-to-maturity and reevaluate such classifications at each balance sheet date. Held-to-maturity investments consist of securities that we have the intent and ability to retain until maturity. These securities are recorded at cost and adjusted for the amortization of premiums and discounts, which approximates fair value. Cash inflows and outflows related to the sale and purchase of investments are classified as investing activities in our condensed consolidated statements of cash flows.

2.	Investment in Affiliated Company

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

3.	Income Taxes

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

4.	Assessment of Contingent Liabilities

Results of Operations

Comparison of the Three Months Ended February 28, 2017 and Three Months Ended February 29, 2016.

	Three months ended
	February 28, 2017		February 29, 2016
Selling, general and administrative	$	281,265	$	405,242

Selling, general and administrative expenses decreased from approximately $405,000 for the three months ended February 29, 2016 to approximately $281,000 for the three months ended February 28, 2017. The decrease consisted primarily of approximately $72,000 in legal fees due to little activity on the TPL bankruptcy matter and PDS Northern District of California cases in the current quarter.

	Three months ended
	February 28, 2017			February 29, 2016
Other income (expense):
Interest income	$	4,081		$	3,930
Equity in loss of affiliated company		(32,139	)		(130,553	)
Total other (expense), net	$	(28,058	)	$	(126,623	)

Our other expense for the three months ended February 28, 2017 and February 29, 2016 included equity in the loss of PDS of approximately $32,000 and $131,000, respectively. Our investment in PDS is accounted for in accordance with the equity method of accounting for investments. The change in the earnings of PDS is due to the decrease in PDS’s operating expenses during the three months ended February 28, 2017 as compared to the prior period.

	Three months ended
	February 28, 2017			February 29, 2016
Loss before income taxes	$	(309,323	)	$	(531,865	)

Loss before income taxes decreased from approximately $(532,000) for the three months ended February 29, 2016 to approximately $(309,000) for the three months ended February 28, 2017 because of the decrease in our operating expenses and the decrease in our equity loss in PDS.

Net loss

Our net loss for the three months ended February 28, 2017 and February 29, 2016 was $(309,323) and $(531,865) respectively.

Comparison of the Nine Months Ended February 28, 2017 and Nine Months Ended February 29, 2016.

	Nine months ended
	February 28, 2017		February 29, 2016
Selling, general and administrative	$	887,881	$	1,145,606

Selling, general and administrative expenses decreased from approximately $1,146,000 for the nine months ended February 29, 2016 to approximately $888,000 for the nine months ended February 28, 2017. The decrease consisted primarily of approximately $150,000 in legal fees due to decreased activity in the TPL bankruptcy matter and PDS Northern District of California cases, approximately $34,000 in salaries and benefits due to a staffing reduction, and approximately $26,000 in D&O insurance expense. In addition to these decreases, the overall decrease in operating expenses is due to our office relocation.

	Nine months ended
	February 28, 2017		February 29, 2016
Other income:
Interest income	$	12,568	$	10,421
Equity in earnings of affiliated company		1,159,746		444,070
Total other income, net	$	1,172,314	$	454,491

Our other income for the nine months ended February 28, 2017 and February 29, 2016 included equity in the earnings of PDS of approximately $1,160,000 and $444,000, respectively. Our investment in PDS is accounted for in accordance with the equity method of accounting for investments. The change in the earnings of PDS is due to the increase in licensing revenues during the nine months ended February 28, 2017 as compared to the prior period.

	Nine months ended
	February 28, 2017		February 29, 2016
Income (loss) before income taxes	$	284,433	$	(691,115	)

Loss before income taxes was approximately $(691,000) for the nine months ended February 29, 2016 and income before income taxes was approximately $284,000 for the nine months ended February 28, 2017 because of the increase in equity in earnings of PDS.

Provision for income taxes

During the nine months ended February 28, 2017 and February 29, 2016, we recorded a provision for income taxes related to federal and California taxes of $2,400 and $2,400, respectively.

Net income (loss)

Our net income (loss) for the nine months ended February 28, 2017 and February 29, 2016 was $282,033 and $(693,515) respectively.

Liquidity and Capital Resources

Liquidity

Our cash and cash equivalents and short-term investment balances increased from approximately $3,115,000 as of May 31, 2016 to approximately $3,318,000 as of February 28, 2017. We also have a restricted cash balance amounting to approximately $21,000 as of May 31, 2016 and February 28, 2017. Total current assets increased from approximately $3,153,000 as of May 31, 2016 to approximately $3,392,000 as of February 28, 2017. Total current liabilities amounted to approximately $74,000 and approximately $59,000 as of May 31, 2016 and February 28, 2017, respectively. The change in our working capital position as of February 28, 2017 as compared with May 31, 2016 results primarily from our receipt of a distribution from PDS during the prior quarter.

Cash shortfalls currently experienced by PDS will have an adverse effect on our liquidity. To date we have determined that it is in the best interests of the MMP licensing program that we provide our 50% share of capital to provide for PDS expenses including legal retainers and litigation related payments in the event license revenues received by PDS are insufficient to meet these needs. We believe it is likely that contributions to PDS to fund working capital will continue to be required.

On March 20, 2013, TPL filed a petition under Chapter 11 of the United States Bankruptcy Code. We have been appointed to the creditors’ committee and have been closely monitoring the progress in this matter as it relates to our interest in PDS. A Joint Plan of Reorganization (the “Joint Plan”) between TPL and the creditor’s committee was confirmed by the Bankruptcy Court on February 11, 2015 with the entered confirmation order becoming final on April 2, 2015. In the event we are required to provide funding to PDS that is not reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our condensed consolidated financial statements.

Cash Flows From Operating Activities

Cash used in operating activities was approximately $925,000 and $1,218,000 for the nine months ended February 28, 2017 and February 29, 2016, respectively. The principal components of the current period amount were net income of approximately $282,000 offset by the equity in income of affiliated company of approximately $1,160,000. The principal components of the prior period are the prior period net loss, changes in prepaid expenses and other current assets and equity in earnings of affiliated company.

Cash Flows From Investing Activities

Cash provided by investing activities for the nine months ended February 28, 2017 and February 29, 2016 was approximately $1,581,000 and $58,000 respectively. Cash activities for the current and prior periods were primarily attributable to sales and purchases of marketable securities and distributions from PDS.

Capital Resources

Inflation

We do not believe that inflation has a material effect on our results of operations.

Off Balance Sheet Arrangements

We do not currently have any off balance sheet arrangements.

Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-15, "Presentation of Financial Statements – Going Concern." ASU 2014-15 provides guidance in generally accepted accounting principles about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for annual reporting periods ending after December 15, 2016 and for annual periods and interim periods thereafter (fiscal year 2017 for the Company). Early adoption is permitted. We adopted this guidance during the three months ended February 28, 2017, which did not have a significant impact on the condensed consolidated financial statements.

Risk Factors

We urge you to carefully consider the following discussion of risks as well as other information regarding our common stock. We believe the following to be our most significant risk factors as of the date this report is being filed. The risks and uncertainties described below are not the only ones we face. Please refer to our risk factors contained in our Form 10-K for the year ended May 31, 2016 for additional risk factors.

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

On March 20, 2013 TPL filed a petition under Chapter 11 of the United States Bankruptcy Code. While TPL’s bankruptcy and reorganization does not at present affect the licensing agreement between PDS and its licensing companies, PDS has incurred significant legal costs in ongoing matters before the U.S. District Court. If PDS does not receive sufficient licensing revenues to pay these expenses, we may be required to pay these expenses. In the event the cost of legal actions exceeds our ability to fund these efforts, our options for additional sources of financing may be limited.

The Impact Of TPL’s Bankruptcy And Reorganization On PDS And The Future Success Of The Licensing Program Is Uncertain.

While TPL’s bankruptcy and reorganization does not appear to affect the licensing agreement between PDS and its licensing companies, the consequences should the reorganization under Chapter 11 be unsuccessful, which could include lawsuits from creditors or a motion to convert the case to Chapter 7, would be uncertain and potentially adverse to PDS and the licensing program. For example, if the case is converted, a trustee may propose the sale of TPL’s interest in PDS to be sold to an unknown third party if allowed by applicable law and approved by the bankruptcy court. It is unclear how that may affect the operation of PDS or the licensing program, but it may be adverse.

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

We have entered into license agreements through our joint venture with TPL and have reported income from the joint venture for the fiscal years 2006 to 2011, 2013 to 2014 and 2016 and the nine months ended February 28, 2017. However, the joint venture has not generated significant licensing revenues since September 2013. Because of the uncertain nature of the negotiations that lead to license revenues, pending litigation with companies which we allege have infringed on our patent portfolio, the possibility of legislative action regarding patent rights, the possible effect of new judicial interpretations of patent laws, and delays in obtaining information necessary for the successful deployment of licensing companies to represent the MMP Portfolio, we may not receive revenues from such agreements in the future consistent with amounts received in the past, and we may not receive future revenues from license agreements at all.

We Are Dependent Upon A Joint Venture For Substantially All Of Our Income.

In June 2005, we entered into the PDS joint venture with TPL, which as a result of agreements entered into in June 2005, July 2012 and July 2014, TPL and its licensing company affiliate Alliacense had been responsible for the licensing and enforcement of our microprocessor patent portfolio. This joint venture has been the source of substantially all of our income since June 2005. Therefore, in light of the absence of significant revenue from other sources we should be regarded as highly dependent on the success or failure of licensing and settlements occurring in conjunction with existing litigation efforts.

We Have Been Involved In Multiple Disputes With Our Joint Venture Partner.

We have been involved in multiple disputes with our joint venture partner TPL and its affiliate Alliacense. During times when there are only two appointed managers of the joint venture, a deadlock can exist on important issues that may not be resolved quickly. In the event of a protracted deadlock, the joint venture may not be able to take actions when appropriate or necessary. Previously we have had to initiate formal arbitration proceedings seeking the appointment of an independent manager to the management committee of the joint venture. Although an independent manager is currently in place, we have concluded that any future absences of an independent manager may have a negative impact on the licensing program and PDS’s business.

Our Joint Venture Is At Risk For Going Concern And An Inability To Meet Certain Obligations.

PDS, our joint venture with TPL, which received a going concern opinion since its May 31, 2011 financial statements, has experienced significant declines in revenues while at the same time incurring significant legal costs associated with pending litigation with companies which we allege have infringed on our patent portfolio.

PDS’s licensing revenues have declined over recent years to a point where PDS’s ability to make future payments is in substantial doubt unless licensing revenues substantially increase in the near term. In the event that PDS does not have the funds to pay one or more of the aforementioned costs, we and TPL must decide whether to contribute additional capital to PDS to fund such payments and due to TPL’s bankruptcy and reorganization, we may be required to pay these expenses without any contribution from TPL.

Our Microprocessor Patents Have Expired.

We have seven U.S., nine European, and three Japanese patents that expired between August 2009 and October 4, 2016. While expired patents may have certain retrospective statutory benefits, their value as assets for licensing and cash generation is significantly diminished.

A Successful Challenge To Our Intellectual Property Rights Could Have A Significant And Adverse Effect On Us.

A successful challenge to our ownership of our technology or the proprietary nature of our intellectual property could materially damage our business prospects. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. Any issued patent may be challenged and invalidated. Any claims allowed from existing patents may not be of sufficient scope or strength to provide significant protection. Our competitors may also be able to design around our patents.

Vigorous protection and pursuit of intellectual property rights or positions characterize the fiercely competitive semiconductor industry, which has resulted in significant and often protracted and expensive litigation. Therefore, our competitors and others may assert that our technologies infringe on their patents or proprietary rights. Persons we believe are infringing our patents are likely to vigorously defend their actions and assert that our patents are invalid. Problems with patents or other rights could result in significant costs, and limit future license revenue. If infringement claims against us are deemed valid or if our infringement claims are successfully opposed, we may not be able to obtain appropriate licenses on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our future patent and/or technology license positions or to defend against infringement claims. From time to time parties have petitioned the USPTO to re-examine certain of our patents. In addition, parties may use the inter partes review (“IPR”) process with the USPTO, created under the 2011 America Invents Act, to challenge our patents. An adverse decision in litigation, the re-examination process, or the IPR process could have a very significant and adverse effect on our business.

We are party to a lawsuit regarding the MMP portfolio and have had mixed results in our litigation efforts to date. See footnote 6 to our condensed consolidated financial statements and Part II, Item 1. “Legal Proceedings” in this quarterly report on Form 10-Q for more information.

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

Changes In U.S. Patent Law Could Diminish The Value Of Patents In General, Thereby Impairing Our Ability To Protect Our Products.

The United States has enacted and is currently implementing the America Invents Act of 2011, wide-ranging patent reform legislation. The United States Supreme Court has ruled on several patent cases in recent years, either narrowing the scope of patent protection available in certain circumstances or weakening the rights of patent owners in certain situations. This combination of events has created uncertainty with respect to the value of patents, once obtained. Depending on decisions by the U.S. Congress, the federal courts, and the USPTO, the laws and regulations governing patents could change in unpredictable ways that would weaken our ability to enforce our existing patents and patents that we might obtain in the future.

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

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

A Change In Our Relationship With PDS Could Change The Way We Account For Our Interest In The Future.

Our investment in PDS is accounted for under the equity method, we record as part of other income or expense our share of the increase or decrease in the equity of this company in which we have invested. It is possible that, in the future, our relationships and/or our interests in or with this equity method investee could change. Such potential future changes could result in consolidation of such entity which could result in changes in our reported results.

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

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

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

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

Our Delisting Could Adversely Affect The Market Price And Liquidity Of Our Common Stock.

On June 13, 2016, we received notice from the OTC Markets Group that our 180 day grace period to cure our bid price deficiency had expired and that we would no longer be listed on the OTCQB marketplace.

Our common stock is now quoted on OTC Pink Current Information, which is a more limited market than the OTCQB marketplace. The quotation of our shares on such marketplace may result in a less liquid market available for existing and potential stockholders to trade shares of our common stock, could depress the trading price of our common stock and could have a long-term adverse impact on our ability to raise capital in the future.

There can be no assurance that there will be an active market for our shares of common stock either now or in the future or that stockholders will be able to liquidate their investment or liquidate it at a price that reflects the value of the business. As a result, our stockholders may not find purchasers for our securities should they to desire to sell them.

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

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

Our Share Price Could Decline As A Result Of Short Sales.

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

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

As required by Rule 13a-15(b) under the Exchange Act, as of February 28, 2017, the end of the period to which this quarterly report relates, we have carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our management, including our Interim Chief Executive Officer and our Chief Financial Officer.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the Interim Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of February 28, 2017, our management, with the participation of our Interim Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

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

PART II- OTHER INFORMATION

Item 1. Legal Proceedings

Patent Litigation

Our patent litigation with TPL and PDS in the United States District Court for the Northern District of California against Huawei Technologies Co. Ltd., LG Electronics, Nintendo Co. Ltd., Samsung Electronics Co. Ltd., and ZTE Corporation, as described in Item 3 – “Legal Proceedings” in our Annual Report on Form 10-K for the year ended May 31, 2016, is still ongoing.

On March 3, 2017, the U.S. Court of Appeals for the Federal Circuit rendered its decision vacating the claims construction that was issued in September 2016 by the U.S. District Court for the Northern District of California and has remanded the matter to the District Court for further proceedings.

Item 1A. Risk Factors

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

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

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits

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

Those exhibits marked with a cross (†) refer to management contracts or compensatory plans or arrangements.

Exhibit No.	Document

2.1	Agreement and Plan of Merger dated August 4, 2008, among Patriot Scientific Corporation, PTSC Acquisition 1 Corp, Crossflo Systems, Inc. and the Crossflo principal officers, incorporated by reference to Exhibit 99.1 to our Current Report on Form 8-K filed August 11, 2008 (Commission file No. 000-22182)

3.1	Original Articles of incorporation of Patriot Scientific Corporation’s predecessor, Patriot Financial Corporation, incorporated by reference to Exhibit 3.1 to Registration Statement on Form S-18, (Commission file No. 33-23143-FW)

3.2	Articles of Amendment of Patriot Financial Corporation, as filed with the Colorado Secretary of State on July 21, 1988, incorporated by reference to Exhibit 3.2 to Registration Statement on Form S-18, (Commission file No. 33-23143-FW)

3.3	Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on March 24, 1992, incorporated by reference to Exhibit 3.3 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)

3.3.1	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on April 18, 1995, incorporated by reference to Exhibit 3.3.1 to our Annual Report on Form 10-KSB for the fiscal year ended May 31, 1995 (Commission file No. 000-22182)

3.3.2	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on June 24, 1997, incorporated by reference to Exhibit 3.3.2 to our Annual Report on Form 10-KSB for the fiscal year ended May 31, 1997, filed July 18, 1997 (Commission file No. 000-22182)

3.3.3	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on April 28, 2000, incorporated by reference to Exhibit 3.3.3 to Registration Statement on Form S-3 filed May 5, 2000 (Commission file No. 333-36418)

3.3.4	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on May 6, 2002, incorporated by reference to Exhibit 3.3.4 to our Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)

3.3.5	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on October 16, 2003, incorporated by reference to Exhibit 3.3.5 to Registration Statement on Form SB-2 filed May 21, 2004 (Commission file No. 333-115752)

3.3.6	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on April 29, 2005, incorporated by reference to Exhibit 3.3.6 to our Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)

3.3.7	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on November 14, 2005, incorporated by reference to Exhibit 3.3.7 to our Quarterly Report on Form 10-Q for the quarterly period ended February 28, 2009, filed April 9, 2009 (Commission file No. 000-22182)

3.3.8	Certificate of Amendment to the Certificate of Incorporation of Patriot Scientific Corporation, as filed with the Delaware Secretary of State on March 18, 2009, incorporated by reference to Exhibit 3.3.8 to our Annual Report on Form 10-K for the year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)

3.4	Articles and Certificate of Merger of Patriot Financial Corporation into Patriot Scientific Corporation dated May 1, 1992, with Agreement and Plan of Merger attached thereto as Exhibit A, incorporated by reference to Exhibit 3.4 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)

3.5	Certificate of Merger issued by the Delaware Secretary of State on May 8, 1992, incorporated by reference to Exhibit 3.5 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)

3.6	Certificate of Merger issued by the Colorado Secretary of State on May 12, 1992, incorporated by reference to Exhibit 3.6 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)

3.7	Bylaws of the Company, incorporated by reference to Exhibit 3.7 to our Current Report on Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)

3.7.1	Amendment to bylaws of the Company, incorporated by reference to Exhibit 3.7.1 to our Current Report on Form 8-K dated November 4, 2010 (Commission file No. 000-22182)

4.1	Specimen common stock certificate, incorporated by reference to Exhibit 4.1 Form 8-K dated May 12, 1992 (Commission file No. 33-23143-FW)

4.2†	2006 Stock Option Plan of the Company as amended and restated, incorporated by reference to Appendix C to the Company Proxy Statement filed September 22, 2008 (Commission file No. 000-22182)

10.1	Master Agreement, dated as of June 7, 2005, by and among the Company, Technology Properties Limited Inc., a California corporation and Charles H. Moore, an individual, incorporated by reference to Exhibit 10.40 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)

10.2	Commercialization Agreement dated as of June 7, 2005 by and among the JV LLC, Technology Properties Limited Inc., a California corporation, and the Company, incorporated by reference to Exhibit 10.41 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)

10.3	Limited Liability Company Operating Agreement of JV LLC, a Delaware limited liability company, dated as of June 7, 2005, incorporated by reference to Exhibit 10.42 to Form 8-K filed June 15, 2005 (Commission file No. 000-22182)

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

10.5	Form of Indemnification Agreement by and between the Company and the Board of Directors, incorporated by reference to Exhibit 10.6 to Form 10-K filed August 29, 2011 (Commission file No. 000-22182)

10.6	Licensing Program Services Agreement effective July 11, 2012 among Phoenix Digital Solutions, LLC, Alliacense Limited, LLC, Technology Properties Limited, LLC, and the Company, incorporated by reference to Exhibit 10.7 to our Current Report on Form 8-K dated July 11, 2012 (Commission file No. 000-22182) (Confidential treatment has been requested with respect to portions of this agreement)

10.7	Agreement effective July 11, 2012 between Technology Properties Limited, LLC and the Company, incorporated by reference to Exhibit 10.8 to our Current Report on Form 8-K dated July 11, 2012 (Commission file No. 000-22182)(Confidential treatment has been requested with respect to portions of this agreement)

10.8	Agreement effective July 17, 2012 among Phoenix Digital Solutions, LLC, Alliacense Limited, LLC, Technology Properties Limited, LLC, and the Company, incorporated by reference to Exhibit 10.9 to our Current Report on Form 8-K dated July 11, 2012 (Commission file No. 000-22182) (Confidential treatment has been requested with respect to portions of this agreement)

10.9	Agreement effective July 24, 2014 among Phoenix Digital Solutions, LLC and Alliacense Limited, LLC, incorporated by reference to Exhibit 10.10 to Form 8-K filed July 30, 2014 (Commission file No. 000-22182) (Confidential treatment has been requested with respect to portions of this agreement)

10.10	Letter agreement dated October 10, 2014 between Phoenix Digital Solutions, LLC and Dominion Harbor Group, LLC, incorporated by reference to Exhibit 10.10 to Form 10-Q filed April 14, 2015 (Commission file No. 000-22182) (Confidential treatment has been requested with respect to portions of this agreement.)

10.11	Agreement effective August 10, 2016 among Phoenix Digital Solutions, LLC, MMP Licensing LLC and Alliacense Limited, LLC, incorporated by reference to Exhibit 10.1 to Form 8-K filed August 16, 2016 (Commission file No. 000-22182) (Confidential treatment has been requested with respect to portions of this agreement.)

10.12†

Amended and Restated Employment Agreement dated December 30, 2016 by and between the Company and Clifford L. Flowers, incorporated by reference to Exhibit 10.1 to Form 8-K filed January 6, 2017 (Commission file No. 000-22182)

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

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

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

99.1	Form of Incentive Stock Option Agreement to the Company’s 2006 Stock Option Plan incorporated by reference to Exhibit 99.10 on Form 10-K for the fiscal year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)

99.2	Form of Non-Qualified Stock Option Agreement to the Company’s 2006 Stock Option Plan incorporated by reference to Exhibit 99.11 on Form 10-K for the fiscal year ended May 31, 2009, filed August 14, 2009 (Commission file No. 000-22182)

101.INS	XBRL Instance Document

101.SCH	XBRL Schema Document

101.CAL	XBRL Calculation Linkbase Document

101.DEF	XBRL Definition Linkbase Document

101.LAB	XBRL Label Linkbase Document

101.PRE	XBRL Presentation Linkbase Document

SIGNATURES

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

DATED: April 13, 2017	PATRIOT SCIENTIFIC CORPORATION


	/S/ CLIFFORD L. FLOWERS
	Clifford L. Flowers
	Interim Chief Executive Officer and Chief Financial Officer (Duly Authorized and Principal Financial Officer)

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