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, 2019. The condensed consolidated balance sheet at May 31, 2019 has been derived from audited
financial statements at that date.
The accompanying condensed consolidated
financial statements have been prepared assuming the Company will continue as a going concern. 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 three and nine month periods ended February 29, 2020
may not necessarily be indicative of the results that may be expected for the full fiscal year ending May 31, 2020.
Basis of Consolidation
The unaudited condensed consolidated financial
statements include the accounts of Patriot Scientific Corporation and those of our inactive subsidiary, Patriot Data Solutions
Group, Inc. (“PDSG”) which includes Crossflo Systems, Inc. (“Crossflo”). All intercompany accounts and
transactions among the consolidated entities have been eliminated in the unaudited condensed consolidated financial statements.
Liquidity and Management’s Plans
The accompanying condensed consolidated
financial statements have been prepared assuming the Company will continue as a going concern. At February 29, 2020, the Company
has an accumulated deficit of $62,083,667, and has incurred recurring losses and used significant amounts of cash in its operations.
As of February 29, 2020, the Company had cash and cash equivalents of approximately $749,000 and working capital of approximately
$704,000.
Historically, we have been a licensing
company and have entered into a number of agreements in our pursuit of unlicensed users of our intellectual property. On November
4, 2019, we announced that the Supreme Court of the United States denied our petition for a writ of certiorari with respect to
patent litigation previously before the United States Court of Appeals for the Federal Circuit that alleged infringement of the
US 5,809,336 patent (the “‘336 patent”) against multiple defendants (see Note 6). As result of this adverse decision,
we have halted all licensing efforts as we evaluate the future direction of the Company and a potential new line of business. Currently,
we do not have any potential sources of revenue and our joint venture, Phoenix Digital Solutions, LLC (“PDS”) has not
generated significant license revenues since September 2013.
In addition, there are a number of uncertainties
associated with our financial projections that could increase or expedite our projected expenses, which could negatively impact
our cash on hand. Additionally, we do not expect to generate any revenue over the foreseeable future and we will be required to
seek additional financing to continue our operations. We will also require additional financing to develop or acquire new lines
of business. We have no current arrangements with respect to any additional financing. Consequently, there can be no assurance
that any additional financing on commercially reasonable terms, or at all, will be available when needed. Further, any additional
equity financing, if secured, may involve substantial dilution to our then existing stockholders.
One opportunity we are evaluating is the
potential of establishing a company that develops a data capturing platform that could be implemented throughout the drug development
process utilizing blockchain technologies in collaboration with Artius Bioconsulting LLC (“Artius”), under an agreement
signed on April 12, 2019. During the quarter ended November 30, 2019, Artius completed and submitted their feasibility report to
us and we are currently evaluating next steps. However, there are no assurances that we will be successful in developing this blockchain
based business. Further, in the event the next steps in the development of a blockchain-based business are undertaken, it is expected
that significant additional funding from external sources will be required. If we are unable to develop or acquire new lines of
business, such as those involving blockchain technologies, and/or we are unable to raise additional capital, we will be forced
to liquidate the Company in a dissolution under Delaware law or seek protection under the provisions of the U.S. Bankruptcy Code.
We currently anticipate, based on current operations, that our cash on hand will not satisfy our operational and capital requirements
through twelve months from the date of filing on this Form 10-Q.
The above matters raise substantial doubt
regarding our ability to continue as a going concern.
Investment in Affiliated Companies
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 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 the decline in value
is deemed to be other than temporary, we would recognize an impairment loss.
We own 100% of the preferred stock of Holocom
(see Note 3). Prior to impairment, this investment was accounted for at cost since we do not have the ability to exercise significant
influence over the operating and financial policies of Holocom.
Income (Loss) Per Share
Basic income (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 per share reflect the potential dilution of securities that could share in
the earnings of an entity.
At February 29, 2020 and February 28, 2019,
potential common shares of 1,000,000 and 1,600,000, respectively, underlying our outstanding stock options were excluded from the
calculation of diluted loss per common share as the impact is anti-dilutive during periods of net loss. As such, there was no difference
between basic and diluted loss per common share amounts for the three and nine months ended February 29, 2020 and February 28,
2019. Had we reported net income for the three and nine months ended February 29, 2020 and February 28, 2019, 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 became a part of PDSG, we issued 2,844,630 escrow shares that are contingent upon certain representations and warranties
made by Crossflo at the time of the merger agreement (see Note 6). We exclude these escrow shares from the basic loss per common
share calculations and would have included the escrowed shares in the diluted income per common 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.
With the exception for refundable alternative
minimum tax (“AMT”) credits, 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, and with
the exception for the aforementioned refundable tax credits, we have recorded a full valuation allowance against our deferred tax
assets.
On December 22, 2017, the United States
Government passed the Tax Cuts and Jobs Act (“Tax Cuts Act”) that, among other provisions, has lowered the corporate
tax rate from 35% to 21%. In addition to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income
we may have, the legislation affects the way we can use and carryforward net operating losses previously accumulated and results
in a revaluation of deferred tax assets and liabilities recorded on our condensed consolidated balance sheet. The Securities and
Exchange Commission staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance regarding accounting
for the income tax effects of the Tax Cuts Act, including the impact of the Tax Cuts Act on deferred tax assets and liabilities
for financial statements issued in the reporting period that includes the enactment date of December 22, 2017. Given that our current
deferred tax assets, with the exception of those representing certain refundable tax credits, are offset by a full valuation allowance,
these changes had no net impact on our condensed consolidated balance sheet as of May 31, 2019 and February 29, 2020. However,
if we become profitable, we will receive a reduced benefit from such deferred tax assets.
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,
has historically relied 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 2016. These patents, while expired, may have certain retrospective statutory
benefits that will fully diminish six years after the patent expiration dates. On November 4, 2019, we announced that the Supreme
Court of the United States denied our petition for a writ of certiorari with respect to patent litigation previously before the
United States Court of Appeals for the Federal Circuit that alleged infringement of the ‘336 patent against multiple defendants.
Based on this adverse decision, PDS has halted all licensing efforts as we evaluate the future direction of the Company.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU No.
2016-02, “Leases (Topic 842)”, as amended ("ASC 842"), which modifies lease accounting for lessees to increase
transparency and comparability by recording lease assets and liabilities for operating leases and disclosing key information about
leasing arrangements. ASC 842 is effective for fiscal years and interim periods within those fiscal years beginning after December
15, 2018. The Company adopted ASC 842 effective June 1, 2019 using a modified retrospective method and will not restate comparative
periods. As permitted under the transition guidance, the Company will carry forward the assessment of whether its contracts contain
or are leases, classification of its leases and remaining lease terms. Implementation of this guidance did not have a material
impact on the Company’s consolidated financial statements. We have elected the short-term lease recognition exemption for
all applicable classes of underlying assets. Short-term disclosures include only those leases with a term greater than one month
and less than twelve months. Short term leases are not recorded on the balance sheet and expense on short-term leases are recognized
on a straight-line basis over the lease term. The Company elected the “practical expedient package” as permitted under
ASC 842. Therefore, the Company has not reassessed whether any expired or existing contracts are, or contain, leases; the Company
has not reassessed the lease classification for any expired or existing leases; and the company has not reassessed initial direct
costs for any expired or existing leases. The Company currently leases office space on a month-to-month basis.
In August 2018, the FASB issued ASU No.
2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value
Measurement” (“ASU 2018-13”), which removes, modifies, and adds various disclosure requirements on fair value
measurements in Topic 820. ASU 2018-13 is effective for fiscal years and interim periods within those fiscal years beginning after
December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable
inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied
prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments
should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance
of this update. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this update and delay
adoption of the additional disclosures until their effective date. The Company does not expect a significant impact from adopting
this update on its consolidated financial statements.
2. Cash, Cash Equivalents and Restricted Cash
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).
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 29, 2020 Using
|
|
|
|
Fair Value at
February 29, 2020
|
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
|
Significant Other Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
748,829
|
|
|
$
|
748,829
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Restricted cash and cash equivalents
|
|
|
177,247
|
|
|
|
177,247
|
|
|
|
–
|
|
|
|
–
|
|
Total
|
|
$
|
926,076
|
|
|
$
|
926,076
|
|
|
$
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
Fair Value Measurements at
May 31, 2019 Using
|
|
|
|
Fair Value at
May 31,
2019
|
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
|
Significant Other
Observable
Inputs
(Level 2)
|
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
49,149
|
|
|
$
|
49,149
|
|
|
$
|
–
|
|
|
$
|
–
|
|
Money market funds
|
|
|
237,937
|
|
|
|
237,937
|
|
|
|
–
|
|
|
|
–
|
|
Certificates of deposit
|
|
|
500,000
|
|
|
|
–
|
|
|
|
500,000
|
|
|
|
–
|
|
Restricted cash and cash equivalents
|
|
|
198,843
|
|
|
|
198,843
|
|
|
|
–
|
|
|
|
–
|
|
Investments in marketable securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit
|
|
|
750,000
|
|
|
|
–
|
|
|
|
750,000
|
|
|
|
–
|
|
Total
|
|
$
|
1,735,929
|
|
|
$
|
485,929
|
|
|
$
|
1,250,000
|
|
|
$
|
–
|
|
We purchase certificates of deposit with
varying maturity dates. The following tables summarize the purchase date maturities, gross unrealized gains or losses and fair
value of the certificates of deposit as of May 31, 2019:
|
|
May 31, 2019
|
|
|
|
Cost
|
|
|
Gross Unrealized Gains/(Losses)
|
|
|
Fair
Value
|
|
Maturity
|
|
|
|
|
|
|
|
|
|
Due in three months or less
|
|
$
|
500,000
|
|
|
$
|
–
|
|
|
$
|
500,000
|
|
Due in greater than three months
|
|
|
750,000
|
|
|
|
–
|
|
|
|
750,000
|
|
|
|
$
|
1,250,000
|
|
|
$
|
–
|
|
|
$
|
1,250,000
|
|
There were no outstanding certificates
of deposit as of February 29, 2020.
3. Investment in Affiliated Companies
Phoenix Digital Solutions, LLC
On June 7, 2005, we entered into a Master
Agreement (the “Master Agreement”) with TPL, and Charles H. Moore (“Moore”), the co-inventor of the technology
which is the subject of the MMP portfolio of microprocessor patents, pursuant to which the parties resolved all legal disputes
between them. Pursuant to the Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of PDS
(the “LLC Agreement”) into which we and Moore contributed our rights to certain of our technologies.
We and TPL each own 50% of the membership
interests of PDS, and each 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 29, 2020 and February 28, 2019. Distributable cash and allocation of profits and losses have been allocated to the
members in the priority defined in the LLC Agreement.
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 required Alliacense to provide PDS’s second licensing company, Dominion
Harbor Group (“DHG”), with certain materials and to cooperate with reasonable discovery requests relating to infringement
litigation 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, and the agreement retaining DHG as PDS’s
second licensing company, will both 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 each of August 11, 2016 and October 3, 2016.
During January 2013, TPL and Moore settled
their litigation. Terms of the settlement included 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 came 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 $20,833 per month beginning February
2014 through January 2017.
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 loss during the three and nine months ended February
29, 2020 of $139 and $73,458, respectively, and $33,888 and $63,411, respectively, for the three and nine months ended February
28, 2019, as a decrease in our investment as “Equity in loss of affiliated company” in the accompanying condensed consolidated
statements of operations.
On March 20, 2013, TPL filed a petition
under Chapter 11 of the United States Bankruptcy Code. On March 5, 2018, TPL’s Motion for Entry of Final Decree Closing Chapter
11 was granted. 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 29, 2020 and May 31,
2019 and statements of operations for the three and nine months ended February 29, 2020 and February 28, 2019 are as follows:
Balance Sheets
Assets:
|
|
February 29, 2020
|
|
|
May 31, 2019
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
68,806
|
|
|
$
|
237,655
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
68,806
|
|
|
$
|
237,655
|
|
Liabilities and Members’ Equity:
|
|
February 29, 2020
|
|
|
May 31, 2019
|
|
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payables
|
|
$
|
–
|
|
|
$
|
21,933
|
|
Members’ equity
|
|
|
68,806
|
|
|
|
215,722
|
|
Total liabilities and members’ equity
|
|
$
|
68,806
|
|
|
$
|
237,655
|
|
Statements of Operations:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
February 29, 2020
|
|
|
February 28, 2019
|
|
|
February 29, 2020
|
|
|
February 28, 2019
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
$
|
278
|
|
|
$
|
67,778
|
|
|
$
|
146,916
|
|
|
$
|
126,823
|
|
Net loss
|
|
$
|
(278
|
)
|
|
$
|
(67,778
|
)
|
|
$
|
(146,916
|
)
|
|
$
|
(126,823
|
)
|
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.
Holocom, Inc.
We currently own 2,100,000 shares of preferred
stock, equivalent to an approximate 46% ownership interest on an after converted basis, in Holocom, Inc. (“Holocom”),
a California corporation that manufactures products that protect information transmitted over secure networks. The shares are convertible
at our option into shares of Holocom’s common stock on a one-to-one basis. The preferred stock entitles us to receive non-cumulative
dividends at the per annum rate of $0.04 per share, when and if declared by the Board of Directors of Holocom, as well as a liquidation
preference of $0.40 per share, plus an amount equal to all declared but unpaid dividends.
In 2010, we determined that the inability
of Holocom to meet its business plan, raise capital, and the general economic environment were indicators of impairment on our
investment and we wrote-off our cost basis investment in Holocom. At February 29, 2020 and May 31, 2019, our investment in Holocom
was valued at $0.
4. Income Taxes
On December 22, 2017, the United States
Government passed the Tax Cuts and Jobs Act (“Tax Cuts Act”) that, among other provisions, has lowered the corporate
tax rate from 35% to 21%. In addition to applying the new lower corporate tax rate in 2018 and thereafter to any taxable income
we may have, the legislation affects the way we can use and carryforward net operating losses previously accumulated and results
in a revaluation of deferred tax assets and liabilities recorded on our condensed consolidated balance sheet. The Securities and
Exchange Commission staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provides guidance regarding accounting
for the income tax effects of the Tax Cuts Act, including the impact of the Tax Cuts Act on deferred tax assets and liabilities
for financial statements issued in the reporting period that includes the enactment date of December 22, 2017. Given that our current
deferred tax assets, with the exception of those representing certain refundable tax credits, are offset by a full valuation allowance,
these changes had no net impact on our condensed consolidated balance sheet. However, if we become profitable, we will receive
a reduced benefit from such deferred tax assets.
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.
A summary of option
activity as of February 29, 2020 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, 2019
|
|
|
1,600,000
|
|
|
$
|
0.03
|
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
Options exercised
|
|
|
–
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
Options forfeited/expired
|
|
|
(600,000
|
)
|
|
$
|
0.03
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at February 29, 2020
|
|
|
1,000,000
|
|
|
$
|
0.03
|
|
|
|
0.18
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options vested and expected to vest at February 29, 2020
|
|
|
1,000,000
|
|
|
$
|
0.03
|
|
|
|
0.18
|
|
|
$
|
–
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at February 29, 2020
|
|
|
1,000,000
|
|
|
$
|
0.03
|
|
|
|
0.18
|
|
|
$
|
–
|
|
The aggregate
intrinsic value represents the differences in market price per share at the close of the quarter ($0.0018 per share as of February
28, 2020) and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.0018 per share)
on February 29, 2020.
6. Commitments and Contingencies
Litigation
Patent Litigation
We, TPL, and PDS (collectively referred
to as “Plaintiffs”) are Plaintiffs were in 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 (collectively referred to as the
“Defendants”). This litigation was proceeding in front of District Court Judge Vince Chhabria.
These 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.
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 modifying the claim
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.
On May 23, 2017, a case management conference
was held in front of District Court Judge Chhabria, who ordered that Plaintiffs amend their infringement contentions on or before
June 16, 2017. Judge Chhabria further ordered that Defendants submit any motion for summary judgment based on the amended infringement
contentions and the modified claim construction by August 1, 2017. On June 5, 2017, the law firm of Banys, P.C., who had served
as local counsel for PDS, withdrew as counsel. PDS continued to be represented by the law firm of Nelson Bumgardner, P.C. On June
16, 2017, Plaintiffs timely amended their infringement contentions. On July 13, 2017, all remaining counsel for each of Patriot,
TPL, and PDS moved to withdraw as counsel and further moved to extend all currently pending case deadlines by 60 days for Plaintiffs
to seek new counsel.
On September 13, 2017, the law firm of Bunsow De Mory LLP was
entered before the U.S. District Court for the Northern District of California as successor counsel in representation of Patriot,
PDS, and TPL.
The Defendants moved for summary judgment
of non-infringement on September 29, 2017, and the Court held a hearing on Defendants’ motion on November 30, 2017. The Court
granted Defendants’ motion and entered judgment of non-infringement on December 13, 2017.
Defendant Samsung submitted a bill of costs
seeking $30,170 in taxable costs in the underlying district court proceedings; Plaintiffs filed an objection to significant portions
of that request. On March 1, 2018, the Clerk of the District Court taxed costs in the amount $829.
Plaintiffs filed notices of appeal in these
district court matters on January 5, 2018. The appeals were docketed and consolidated under lead case No. 18-1439, captioned as
Technology Properties Limited v. Huawei Technologies Co., Ltd in the United States Court of Appeals for the Federal Circuit. Oral
argument proceeded on February 4, 2019. The Court affirmed the lower court’s determination without written opinion pursuant
to Federal Circuit Rule 36 on February 6, 2019. Plaintiffs filed a Petition for Rehearing En Banc on March 8, 2019 which was denied
by the Court on April 10, 2019.
On September 6, 2019 Plaintiffs filed a
petition for a writ of certiorari with the Supreme Court of the United States as a result of the United States Court of Appeals
outcome.
On November 4, 2019, we announced that
the Supreme Court of the United States denied our petition for a writ of certiorari with respect to patent litigation previously
before the United States Court of Appeals for the Federal Circuit that alleged infringement of the ‘336 patent against the
Defendants (see Note 1).
Employment Contracts
In connection with Cliff Flowers’
appointment as the Chief Financial Officer of the Company, and commencing on September 17, 2007, we entered into an employment
agreement with Mr. Flowers for an initial 120-day term if not terminated pursuant to the agreement, with an extension period of
one year and on a continuing basis thereafter. On December 30, 2016, we entered into an amended and restated employment agreement
with Mr. Flowers. Pursuant to the amended December 30, 2016 agreement, if Mr. Flowers was terminated without cause or resigns with
good reason any time after two years of continuous employment, he was entitled to receive an amount equal to 1.25 times his annual
base salary. Mr. Flowers was also entitled to certain payments upon a change of control of the Company if the surviving corporation
did not retain him. All such payments were conditional upon the execution of a general release. On October 1, 2019, Mr. Flowers
and the Company signed a Separation Agreement and General Release of all Claims (“Separation Agreement”). Pursuant
to the Separation Agreement, Mr. Flowers resigned on September 30, 2019 and agreed to severance compensation of $327,750, in lieu
if any amounts owed under his amended and restated employment agreement, payable in seven equal monthly installments commencing
October 30, 2019. As of February 29, 2020, we have a remaining liability of $97,765 included in Accrued expenses and other
in the accompanying unaudited condensed consolidated financial statements. There were no known disagreements with Mr. Flowers regarding
our operations, policies or practices. The Board appointed Carlton M. Johnson to assume all management roles on an interim basis.
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.