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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 21, 1999
REGISTRATION NO. 333-76275
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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PRE-EFFECTIVE AMENDMENT NO. 1
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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PATRIOT SCIENTIFIC CORPORATION
(Name of small business issuer in its charter)
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DELAWARE 3674 84-1070278
(State or Jurisdiction of (Primary Standard (I.R.S. Employer
Incorporation or Organization) Industrial Classification Identification Number)
Code Number)
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10989 VIA FRONTERA
SAN DIEGO, CALIFORNIA 92127
(619) 674-5000
(Address and telephone number of principal executive
offices and principal place of business)
ROBERT PUTNAM, SECRETARY
PATRIOT SCIENTIFIC CORPORATION
10989 VIA FRONTERA
SAN DIEGO, CALIFORNIA 92127
(619) 674-5000
(Name, address and telephone number of agent for service)
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COPIES TO:
OTTO E. SORENSEN, ESQ.
STEVEN J. DAVIS, ESQ.
LUCE, FORWARD, HAMILTON & SCRIPPS LLP
600 WEST BROADWAY, SUITE 2600
SAN DIEGO, CALIFORNIA 92101
(619) 236-1414
(619) 232-8311 (FAX)
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APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: AS SOON AS
PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
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If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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Pursuant to Rule 416, there are also being registered such additional
shares and warrants as may become issuable pursuant to anti-dilution provisions
contained in common stock purchase warrants, the underlying shares of which are
registered hereby.
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The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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CALCULATION OF REGISTRATION FEE
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Proposed
Maximum Proposed
Title of Each Class of Offering Maximum Amount of
Securities Amount to be Price Per Aggregate Registration
to be Registered Registered Security(1) Offering Price Fee
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Common Stock, $.00001 par value 12,091,749 $0.49 $5,924,957 $1,647.14
- ------------------------------------------------------------------------------------------------------
Common Stock, $.00001 par
value(2) 3,507,021 $0.49 $1,718,440 $ 477.73
- ------------------------------------------------------------------------------------------------------
TOTAL 15,598,770 $0.49 $7,643,397 $2,124.87
======================================================================================================
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(1) Estimated solely for purposes of calculating the registration fee in
accordance with Rule 457(c) under the Securities Act of 1933, as amended
(the "Act"), based on the average of the closing bid and asked prices for
the Registrant's Common Stock (the "Common Stock") as reported on the OTC
Electronic Bulletin Board on June 14, 1999.
(2) Issuable upon the exercise of Common Stock Purchase Warrants issued or
issuable to Selling Shareholders.
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The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
Subject to Completion, Dated June 21, 1999
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P R O S P E C T U S
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PATRIOT SCIENTIFIC CORPORATION
THE RESALE OF 15,598,770 SHARES OF COMMON STOCK
The selling price will be determined by market factors at the time of their
resale.
Patriot Scientific Corporation
10989 Via Frontera
San Diego, California 92127
(619) 674-5000
THE OFFERING
This prospectus relates to the resale by the selling shareholders of up to
15,598,770 shares of common stock. The selling shareholders may sell the stock
from time to time in the over-the-counter market at the prevailing market price
or in negotiated transactions. Of the shares offered:
- 1,656,966 shares are presently outstanding,
- up to 10,434,783 shares are issuable to Swartz Private Equity,
LLC based on an investment agreement dated February 24, 1999,
- up to 1,565,217 shares are issuable upon the exercise of
warrants issuable to Swartz under the investment agreement, and
- 1,941,804 shares are issuable upon the exercise of warrants
issuable to other selling shareholders.
We will receive no proceeds from the sale of the shares by the selling
shareholders. However, we have received proceeds from the sale of shares
currently outstanding and may receive proceeds from the sale of shares to Swartz
and, if exercised, will receive proceeds from the sale of shares issuable upon
the exercise of warrants by Swartz and certain other selling shareholders.
Trading Symbol
PTSC
(Over-the-counter Electronic Bulletin Board)
THIS INVESTMENT INVOLVES A HIGH DEGREE OF RISK.
PLEASE REFER TO RISK FACTORS BEGINNING ON PAGE 7
The Securities and Exchange Commission (SEC) and state securities regulators
have not approved these securities or determined if this prospectus is truthful
or complete. Any representation to the contrary is a criminal offense and should
be reported immediately to the SEC by calling 1-800-SEC-0330.
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PATRIOT SCIENTIFIC CORPORATION PROSPECTUS
Please read this prospectus carefully. It describes our company, finances and
products. Federal and state securities laws require that we include in this
prospectus all the important information that you will need to make an
investment decision.
You should rely only on the information contained in this prospectus to make
your investment decision. We have not authorized anyone to provide you with
information that is different from what is contained in this prospectus.
The following table of contents has been designed to help you find important
information contained in this prospectus. We have included subheadings to aid
you in searching for particular information you might want to return to. We
encourage you to read the entire prospectus.
TABLE OF CONTENTS
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PROSPECTUS SUMMARY 5
About Our Company 5
About Our Products and Market 5
About Our Investment Agreement 6
Additional Shares We are Registering 6
Key Facts 6
RISK FACTORS 7
Our Major Product Line has had Limited Revenues 7
We Have Incurred Significant Losses and May Continue To
Do So 7
We Will Require Additional Financing 8
Our Products May Not Be Completed On Time 8
The Market in Which We Operate is Highly Competitive 8
Protection of our Intellectual Property is Limited; There
is a Risk of Claims for Infringement 9
We are a Defendant in a Pending Lawsuit 10
Our Products are Dependent on the Internet, ISDN, Java
and Government Funding 10
Forward-Looking Statements 11
PLAN OF DISTRIBUTION 12
SELLING SHAREHOLDERS 13
Investment Agreement 13
Overview 13
Put Rights 13
Warrants 13
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Limitations and Conditions Precedent to Our Put
Rights 14
Short Sales 14
Cancellation of Puts 14
Shareholder Approval 14
Termination of Investment Agreement 14
Restrictive Covenants 14
Right of First Refusal 15
Swartz's Right of Indemnification 15
Additional Shares Being Registered 15
Common Stock 15
Warrants 16
Selling Shareholders 17
THE COMPANY 18
General 18
Background 18
Business 19
Available Information 19
Organization and Corporate Development 20
Internet Growth and the Emergence of the Java
Programming Language 21
ShBoom Microprocessor Technology 22
General Background 22
Industry Background 23
Technology Description 24
The PSC1000 Microprocessor as a Java Processor 25
Stage of Development 25
Business Strategy 27
Competition 28
High Speed Data Communications Products 29
General Background 29
ISDN and Digital Communications Description 29
Major Communications Division Products 29
Production and Marketing Strategy 31
Competition 31
Radar and Antenna Technology 31
General Background 31
Gas Antenna Technology Description 31
Ground Penetrating Radar Technology
Description 32
Stage of Development 33
Business Strategy 33
Competition 33
Research and Development 34
Licenses, Patents, Trade Secrets and Other Proprietary
Rights 34
Marketing and Distribution 37
Dependence Upon Single Customers 37
Facilities 37
Employees 38
Government Regulation 38
USE OF PROCEEDS 38
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LITIGATION 40
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 40
Results of Operations for the Years Ended
May 31, 1998 and 1997 41
Results of Operations for the Nine Months Ended
February 28, 1999 and 1998 42
Liquidity and Capital Resources 43
New Accounting Pronouncements 44
Tax Loss Carry-forwards 45
Year 2000 Compliance 45
MANAGEMENT 46
Identification of Directors and Executive Officers 46
Biographical Information 47
General Conflicts of Interest 49
Indemnification of Officers, Directors and Others 50
Exclusion of Director Liability 50
Executive Compensation 50
Option Grants 52
Aggregated Option Exercises and Fiscal Year-End Values 52
Compensation of Directors 53
Employee Contracts 53
PRINCIPAL SHAREHOLDERS 55
CERTAIN TRANSACTIONS 56
TRADING MARKET AND RELATED MATTERS 58
DESCRIPTION OF SECURITIES 59
LEGAL MATTERS 60
EXPERTS 60
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS F-1
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PROSPECTUS SUMMARY
ABOUT OUR COMPANY
Our company is engaged in the development, marketing, and sale of patented
microprocessor technology and high-performance digital communication products.
These products have applications in the Internet and computer, networking and
telecommunications markets. We also own and are developing radar and antenna
technology. Our strategy is to exploit our technologies and products through
product sales, licensing, strategic alliances and government contracting.
ABOUT OUR PRODUCTS AND MARKET
The market for digital communication products and microprocessors is
experiencing significant growth due in part to the Internet. The Internet
provides organizations and individuals with new means to conduct business. The
growth of the Internet is creating a demand for hardware, software and
peripherals. The large number of users connecting to the Internet is creating a
demand for traditional analog modems and higher speed digital modems. Java is a
programming language for the Internet. With Java, data and programs do not have
to be stored on the user's computer; they can reside anywhere on the Internet to
be called upon as needed. Java can run on a variety of computer operating
systems, thus avoiding the problem of incompatibility across networks, and Java
offers a high degree of data security. Because of Java's useful features, we
believe that it may also become a popular programming language for embedded
control applications.
A microprocessor is the computer chip that provides intelligence for
electronic devices. Our microprocessor technology, trade named ShBoom, uses a
proprietary architecture in a high-performance microprocessor integrated on a
single silicon chip. Our first ShBoom-architecture microprocessors, the PSC1000
family, are targeted as Java programming language processors, for internally
developed digital communication products and for use as the computer on embedded
controllers. Embedded controllers are used in sophisticated products, such as
laser printers, motion and industrial controllers, cable and satellite modems
and television set-top boxes. We are also licensing the ShBoom core technology
for use by others in multi-function microprocessors. Our CyberShark digital
modem provides consumers with a high-performance interface between a computer
and telephone lines. Our communications division also offers original equipment
manufacturers, systems integrators and value added resellers products for high
speed access to the Internet, remote access drivers, video conferencing
equipment and digital telephony products. We are also engaged in developing
radar and antenna technologies. Our ground penetrating radar prototype has
demonstrated the ability to penetrate multiple solid objects (walls and
barriers) and in certain ground strata has been able to resolve objects of
six-inch size at approximately ten feet in depth.
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ABOUT OUR INVESTMENT AGREEMENT
We have entered into an investment agreement with Swartz Private Equity,
LLC to raise up to $5 million through a series of sales of our common stock. The
dollar amount of each sale is limited by our common stock's trading volume and a
minimum period of time since the last sale. Each sale will be to Swartz. In
turn, Swartz will either sell our stock in the open market, place our stock
through negotiated transactions with other investors, or hold our stock in their
own portfolio. This prospectus covers the resale of our stock by Swartz either
in the open market or to other investors.
ADDITIONAL SHARES WE ARE REGISTERING
Recently, we sold common stock to private investors and issued short-term
notes (with warrants attached) payable to private investors. The resale of the
common stock by these private investors, either already bought or obtainable on
the exercise of the warrants, is included in this registration.
KEY FACTS
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Shares being offered for resale to the public 15,598,770
Total shares outstanding prior to the offering 40,861,120 as of June 14, 1999
Total shares outstanding after the offering 54,802,924
Total shares outstanding after the offering and
exercise of all options/warrants 59,109,283
Price per share to the public Market price at time of
resale
Total proceeds raised by offering None, however, up to $5 million
may be received from Swartz under
the investment agreement and
additional amounts may be received
from the exercise of warrants
Investment agreement Our agreement with Swartz is included
as an exhibit to our Form 10-QSB/A
filed with the SEC on March 5, 1999
Dividend Policy No dividends expected
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RISK FACTORS
The common shares being offered for resale by the selling shareholders are
highly speculative in nature, involve a high degree of risk and should be
purchased only by persons who can afford to lose the entire sum invested in the
common shares. Before purchasing any of the common shares, you should carefully
consider the following factors relating to our business and prospects.
OUR MAJOR PRODUCT LINE HAS HAD LIMITED REVENUES
We are in the pre-production stage of development on our major product
line, the microprocessor, which has had limited revenues. Our other product
lines have not generated enough revenue to support our company. Therefore, we
have limited financial results upon which you may base an assessment of our
potential. There is no assurance that we will become profitable. We have
experienced in the past and may experience in the future many of the problems,
delays and expenses encountered by any early stage business, many of which are
beyond our control. These include:
- substantial delays and expenses related to testing and
development of our new products,
- production and marketing problems encountered in connection with
our new and existing products and technologies,
- competition from larger and more established companies, and
- lack of market acceptance of our new products and technologies.
WE HAVE INCURRED SIGNIFICANT LOSSES AND MAY CONTINUE TO DO SO
We expect to incur operating losses in the future. There is no assurance
that sales of our products will ever generate sufficient revenues to fund our
continuing operations, that we will generate positive cash flow or that we will
attain or sustain profitability. To date, we have incurred significant losses.
As of February 28, 1999, our accumulated deficit was $22,900,135 and our working
capital deficit was $1,013,056. For the fiscal year ended May 31, 1998, we
incurred a net loss of $7,514,785 and for the previous fiscal year a net loss of
$2,188,792. For the nine months ended February 28, 1999, we incurred a net loss
of $3,315,512. These losses have resulted primarily from:
- significant costs associated with the development of our
products,
- marketing of those products,
- the interest charges and expenses related to previous equity and
debt financings, and
- compensation costs related to the earnout of escrowed common
shares.
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WE WILL REQUIRE ADDITIONAL FINANCING
The lack of additional funding could force us to substantially curtail or
cease our operations, which would have a material adverse effect on our
business. Based on our potential rate of cash operating expenditures and our
current plans, we anticipate our cash requirements for the next twelve months
may need to come primarily from the proceeds of the investment agreement.
However, our ability to raise funds under the investment agreement is subject to
certain conditions. These conditions include the effectiveness of a registration
statement covering the resale of the shares sold under the investment agreement
and a limitation on our ability to issue shares based on the volume of trading
in the common stock. We anticipate that our future cash requirements may be
supplemented by improved product sales, the sale of additional equity
securities, debt financing and/or the sale or licensing of certain of our
technologies. However, there can be no assurance that any future funds required
in excess of the proceeds of the investment agreement will be generated from
operations or from the aforementioned or other potential sources. Further, there
can be no assurance that any such required funds, if available, will be
available on attractive terms or that they will not significantly dilute our
existing shares.
OUR PRODUCTS MAY NOT BE COMPLETED ON TIME
Our technologies and products are in various stages of development.
These development stage products may not be completed in time to allow
production or marketability due to the inherent risks of new product and
technology development, limitations on financing, competition, obsolescence,
loss of key personnel and other factors. Although we may be able to license some
of our technology at its current stage of development, there can be no assurance
thereof. Unanticipated technical obstacles can arise at any time and result in
lengthy and costly delays or in a determination that further development is not
feasible. Discovery of microprocessor design errors, frequent in the industry
prior to and after production, could result in lengthy and costly redesign,
fabrication (production) and testing in an industry where new technology rapidly
eclipses prior innovations.
The development of our technologies has taken longer than anticipated
and could be additionally delayed. Therefore, there can be no assurance of
timely completion and introduction of improved products on a cost-effective
basis, or that such products, if introduced, will achieve market acceptance such
that, in combination with existing products, they will sustain us or allow us to
achieve profitable operations.
THE MARKET IN WHICH WE OPERATE IS HIGHLY COMPETITIVE
Our products could be rendered noncompetitive or obsolete.
Technological competition from larger and more established microprocessor,
digital communication and radar and antenna companies is significant and
expected to increase. Most of the companies with which we compete and expect to
compete have far greater capital resources and more significant research and
development staffs, marketing and distribution programs and facilities, and many
of them have substantially greater experience in the production and marketing of
products. Our ability to compete effectively may be adversely affected by the
ability of these competitors to
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devote greater resources to the sale and marketing of their products than we
can. In addition, one or more of our competitors may succeed or may already have
succeeded in developing technologies and products that are more effective than
any of those we currently offer or are developing.
PROTECTION OF OUR INTELLECTUAL PROPERTY IS LIMITED; THERE IS A RISK OF CLAIMS
FOR INFRINGEMENT
A successful challenge to our ownership of our technology could have a
material adverse effect on our business prospects. There can be no assurance
that any application of our technologies will not infringe upon the proprietary
rights of others or that licenses required by us from others will be available
on commercially reasonable terms, if at all. We rely on a combination of
patents, trademarks, copyrights, trade secret laws, confidentiality procedures
and licensing arrangements to protect our intellectual property rights. We
currently have nine U.S. patents issued and five U.S. patents pending. We have
one patent pending in Europe and Japan and have filed an application for another
patent in Europe, Japan and elsewhere. Any issued patent may be challenged and
invalidated. Patents may not issue from any of our pending applications. Any
claims allowed from existing or pending patents may not be of sufficient scope
or strength to provide significant protection for our products. Patents may not
be issued in all countries where our products can be sold so as to provide
meaningful protection or any commercial advantage to us. Our competitors may
also be able to design around our patents.
Vigorous protection and pursuit of intellectual property rights or
positions characterize the fiercely competitive semiconductor industry, which
has resulted in significant and often protracted and expensive litigation. There
can be no assurance, therefore, that our competitors will not assert that our
technologies or products infringe on their patents or proprietary rights.
Problems with patents or other rights could increase the cost of our products or
delay or preclude new product development and commercialization by us. If
infringement claims against us are deemed valid, 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.
We did not develop the basic ShBoom technology. We acquired the rights
in this technology through a series of agreements from two co- inventors. There
can be no assurance that we will not be subject to claims from such prior
parties related to the technology or that any such parties will not attempt to
exploit the technology independently of our rights to do so. One of the
co-inventors of this technology has filed a lawsuit against another prior owner
and us. He is seeking, among other things, a return of the technology. This
lawsuit is further discussed in this prospectus under "Litigation". The asset
purchase agreement and plan of reorganization between Patriot, nanoTronics
Corporation and Helmut Falk was the agreement under which we acquired the basic
ShBoom technology. The agreement also contained a number of warranties and
indemnities related to the ownership of the technology and other matters. We
believe nanoTronics
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Corporation has been liquidated and, due to Mr. Falk's death in July 1995, our
ability to obtain satisfaction for any future claims as a result of a breach of
the agreement may be limited.
WE ARE A DEFENDANT IN A PENDING LAWSUIT
In October 1998, we were sued in the District Court for Travis County, Texas by
a co-inventor of the original ShBoom technology. We removed the suit to the
United States District Court for the Western District of Texas, Austin Division,
where it was dismissed because the court did not have jurisdiction over us. The
suit has been refiled in the Superior Court of San Diego County, California. The
suit also names as defendants nanoTronics and Gloria Felcyn on behalf of the
Falk Family Trust. We purchased the technology from nanoTronics in 1994. The
suit seeks a judgment for damages based on royalties allegedly due the
co-inventor, a rescission of the technology transfer agreement between
nanoTronics and the co-inventor, and a restoration of the technology to the
co-inventor. A trial has been scheduled for December, 1999. We and the other
defendants intend to vigorously contest the plaintiff's allegations.
We do not believe the co-inventor is entitled to a return of the
original ShBoom technology or that we are obligated to pay any royalties on
aspects of the ShBoom technology specified in prior agreements between
nanoTronics and the co-inventor. We believe that, should there be royalties due
the co-inventor, the obligation is that of nanoTronics. However, if the
co-inventor receives a judgment affirming his claim to the technology, we would
probably be effectively precluded from selling any microprocessor incorporating
that technology. Additionally, we could become subject to unindemnified claims
relating to any failure by nanoTronics to pay any royalties that may be due to
the co-inventor. Also, we could be liable for up to $1,250,000 to nanoTronics
under certain indemnification provisions. Should we be required to make any
royalty payments or indemnification payments, such payments could adversely
impact our operating margins and sales volume.
OUR PRODUCTS ARE DEPENDENT ON THE INTERNET, ISDN, JAVA AND GOVERNMENT FUNDING
Our digital communication products and microprocessor products will
depend in large part upon a robust and growing industry and infrastructure for
providing Internet access and carrying Internet traffic and the emergence of
Java as a widespread programming language for the Internet or in embedded
applications. There can be no assurance that the infrastructure or complementary
products necessary to make the Internet a viable commercial marketplace will be
developed, or, if they are developed, that the Internet will become a viable
commercial marketplace. Even if the Internet continues its robust growth, there
can be no assurance of a market for our ISDN products given their dependence
upon telephone company policies and rates and the intense competition from other
access technologies such as cable modems and satellites. There also can be no
assurance that Java will become a widespread programming language for the
Internet or in embedded applications or that a market will develop for devices
to run Java efficiently. If the Internet does not become a viable commercial
marketplace, or if ISDN products become technologically obsolete, or if Java
applications for microprocessors do not develop, then our business, operating
results and financial condition will be materially and adversely affected.
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We received our initial contract for characterization of our antenna
technology in April 1997. We are devoting only limited development and marketing
efforts to our radar and antenna technologies and are seeking additional
government or other funding to further develop these technologies. Government
defense and other funding sources are facing serious cutbacks, and accordingly
our opportunity to develop new technologies with this type of funding has been
reduced. Successful funding requires significant efforts and long lead times. We
have limited experience in obtaining government funding, and we rely on
consultants and agents to assist us in our efforts in that regard. There can be
no assurance that we will be successful in our efforts to obtain additional
government assistance for any of our projects or technologies.
FORWARD-LOOKING STATEMENTS
This prospectus includes "forward-looking" statements within the
meaning of Section 27A of the Securities Act of 1933, Section 21E of the
Securities Exchange Act of 1934, and the Private Securities Litigation Reform
Act of 1995, and we desire to take advantage of the "safe harbor" provisions in
those laws. Therefore, we are including this statement for the express purpose
of availing ourselves of the protections of these safe harbor provisions with
respect to all of the forward-looking statements we make. The forward-looking
statements in this prospectus reflect our current views with respect to possible
future events and financial performance. These forward-looking statements are
subject to certain risks and uncertainties, including specifically the absence
of significant revenues, financial resources, a history of losses, a possibility
that technology cannot be completed or that its completion might be delayed,
significant competition, the uncertainty of patent and proprietary rights,
uncertainty as to royalty payments and indemnification risks, trading risks of
low-priced stocks and those other risks and uncertainties discussed herein that
could cause our actual results to differ materially from our historical results
or those we anticipate. In this prospectus, the words "anticipates," "believes,"
"expects," "intends," "future" and similar expressions identify certain
forward-looking statements. You are cautioned to consider the specific risk
factors described in "Risk Factors" and elsewhere in this prospectus and not to
place undue reliance on the forward-looking statements contained in this
prospectus, which speak only as of the date of this prospectus. We undertake no
obligation to publicly revise these forward-looking statements to reflect the
effect of events or circumstances that may arise after the date of this
prospectus. All written and oral forward-looking statements made subsequent to
the date of this prospectus and attributable to us or persons acting on our
behalf are expressly qualified in their entirety by this section.
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PLAN OF DISTRIBUTION
Each selling shareholder is free to offer and sell his or her common
shares at such times, in such manner and at such prices as he or she may
determine. The types of transactions in which the common shares are sold may
include transactions in the over-the-counter market (including block
transactions), negotiated transactions, the settlement of short sales of common
shares, or a combination of such methods of sale. The sales will be at market
prices prevailing at the time of sale or at negotiated prices. Such transactions
may or may not involve brokers or dealers. The selling shareholders have advised
us that they have not entered into any agreements, understandings or
arrangements with any underwriters or broker-dealers regarding the sale of their
securities. The selling shareholders do not have an underwriter or coordinating
broker acting in connection with the proposed sale of the common shares.
The selling shareholders may effect such transactions by selling common
stock directly to purchasers or to or through broker-dealers, which may act as
agents or principals. Such broker-dealers may receive compensation in the form
of discounts, concessions, or commissions from the selling shareholders. They
may also receive compensation from the purchasers of common shares for whom such
broker-dealers may act as agents or to whom they sell as principal, or both
(which compensation as to a particular broker-dealer might be in excess of
customary commissions).
Swartz Private Equity, LLC is, and each remaining selling shareholder
and any broker-dealer that acts in connection with the sale of common shares may
be deemed to be "underwriters" within the meaning of Section 2(11) of the
Securities Act. Any commissions received by such broker-dealers and any profit
on the resale of the common shares sold by them while acting as principals might
be deemed to be underwriting discounts or commissions. The selling shareholders
may agree to indemnify any agent, dealer or broker-dealer that participates in
transactions involving sales of the common shares against certain liabilities.
Because Swartz is and the remaining selling shareholders may be deemed
to be "underwriters" within the meaning of Section 2(11) of the Securities Act,
the selling shareholders will be subject to prospectus delivery requirements.
We have informed the selling shareholders that the anti-manipulation
rules of the SEC, including Regulation M promulgated under the Securities and
Exchange Act, may apply to their sales in the market and has provided the
selling shareholders with a copy of such rules and regulations.
Selling shareholders also may resell all or a portion of the common
shares in open market transactions in reliance upon Rule 144 under the
Securities and Exchange Act, provided they meet the criteria and conform to the
requirements of such Rule.
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SELLING SHAREHOLDERS
INVESTMENT AGREEMENT
OVERVIEW. On February 24, 1999, we entered into an investment agreement
with Swartz Private Equity, LLC. The investment agreement entitles us to issue
and sell our common stock for up to an aggregate of $5 million from time to time
during a three-year period through February 24, 2002. This is also referred to
as a put right.
PUT RIGHTS. In order to invoke a put right, we must have an effective
registration statement on file with the SEC registering the resale of the common
shares which may be issued as a consequence of the invocation of that put right.
Additionally, we must give at least ten but not more than twenty business days
advance notice to Swartz of the date on which we intend to exercise a particular
put right and we must indicate the number of shares of common stock we intend to
sell to Swartz. At our option, we may also designate a maximum dollar amount of
common stock (not to exceed $2 million) which we will sell to Swartz during the
put and/or a minimum purchase price per common share at which Swartz may
purchase shares during the put. The number of common shares sold to Swartz may
not exceed 20% of the aggregate daily reported trading volume during a period
which begins on the business day immediately following the day we invoked the
put right and ends on and includes the day which is twenty business days after
the date we invoked the put right.
For each common share, Swartz will pay us the lesser of:
- the market price for such put, minus $.05 or
- a percentage of the market price for the put, with that
percentage determined by the market price in effect on the
date we inform Swartz of the put.
If the market price is less than $1.00 per share, the percentage will
be 80%; if the market price is $1.00 or greater but less than $2.00 per share,
the percentage will be 85%, and if the market price is $2.00 or greater, the
percentage will be 90%. Market price is defined as the lowest intra-day trade
price for the common stock on its principal market for the six business days
immediately preceding the date of the applicable purchase notice for a put.
However, the market price may not be less than the designated minimum per share
price, if any, that we indicated in our notice.
WARRANTS. Within five business days after the end of each purchase
period, we are required to issue and deliver to Swartz a warrant to purchase a
number of shares of common stock equal to 15% of the common shares issued to
Swartz in the applicable put. Each warrant will be exercisable at a price which
will initially equal 110% of the market price on the last day of the applicable
purchase period. The warrants will have semi-annual reset provisions. Each
warrant will be immediately exercisable and have a term beginning on the date of
issuance and ending five years thereafter.
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<PAGE> 16
LIMITATIONS AND CONDITIONS PRECEDENT TO OUR PUT RIGHTS. Swartz is not
required to acquire and pay for any common shares with respect to any particular
put for which:
- we have announced or implemented a stock split or combination
of our common stock;
- we have paid a common stock dividend;
- we have made a distribution of our common stock or of all or
any portion of our assets between the put notice date and the
date the particular put closes; or
- we have consummated a major transaction (including a
transaction, which constitutes a change of control) between
the advance put notice date and the date the particular put
closes.
SHORT SALES. Swartz and its affiliates are prohibited from engaging in
short sales of our common stock unless they have received a put notice and the
amount of shares involved in a short sale does not exceed the number of shares
specified in the put notice.
CANCELLATION OF PUTS. We must cancel a particular put between the date
of the advance put notice and the last day of the pricing period if:
- we discover an undisclosed material fact relevant to Swartz's
investment decision;
- the registration statement registering resales of the common
shares becomes ineffective; or
- shares are delisted from the then primary exchange.
However, we will be required, at Swartz's option, to issue common shares equal
to the number of shares included in purchase notices delivered by Swartz on or
before the end of the applicable put cancellation date.
SHAREHOLDER APPROVAL. We may issue more than 20% of our outstanding
shares. If we become listed on the Nasdaq Small Cap Market or Nasdaq National
Market, then we must get shareholder approval to issue more than 20% of our
outstanding shares. Since we are currently a bulletin board company, we do not
need shareholder approval.
TERMINATION OF INVESTMENT AGREEMENT. We may also terminate our right to
initiate further puts or terminate the investment agreement by providing Swartz
with notice of such intention to terminate; however, any such termination will
not affect any other rights or obligations we have concerning the investment
agreement or any related agreement.
RESTRICTIVE COVENANTS. During the term of the investment agreement and
for a period of one-year thereafter, we are prohibited from certain
transactions. These include the issuance of any debt or equity securities in a
private transaction which are convertible or exercisable into shares of common
stock at a price based on the trading price of the common stock at any time
after the initial issuance of such securities or with a fixed conversion or
exercise
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<PAGE> 17
price subject to adjustment. We are also prohibited from entering into any
private equity line type agreements similar to the investment agreement without
obtaining Swartz's prior written approval.
RIGHT OF FIRST REFUSAL. Swartz has a right of first refusal to purchase
any variable priced securities offered by us in any private transaction which
closes on or prior to six months after the termination of the investment
agreement.
SWARTZ'S RIGHT OF INDEMNIFICATION. We are obligated to indemnify Swartz
(including their stockholders, officers, directors, employees and agents) from
all liability and losses resulting from any misrepresentations or breaches we
made in connection with the investment agreement, our registration rights
agreement, other related agreements, or the registration statement.
ADDITIONAL SHARES BEING REGISTERED
COMMON STOCK. The following table shows recent sales of common stock to
private investors.
<TABLE>
<CAPTION>
Name Date of Sale Number of Shares
---- ------------ ----------------
<S> <C> <C>
Robert Crawford December 4, 1998 100,000
December 16, 1998 100,000
April 26, 1999 200,000
April 28, 1999 100,000
James C. and Josephine M. Zolin December 29, 1998 130,435
January 29, 1999 50,000
Wayne Opperman January 29, 1999 50,000
Clifford E. Koerner February 1, 1999 100,000
Richard D. Daniels February 1, 1999 50,000
Luce, Forward, Hamilton
and Scripps LLP February 11, 1999 279,326
William G. Crawford April 28, 1999 100,000
Castle Creek Technology
Partners, LLC June 14, 1999 397,205
---------
Total additional shares being registered 1,656,966
---------
</TABLE>
The shares issued to Luce, Forward, Hamilton and Scripps LLP, our
general counsel, were in lieu of a cash payment for the services they provided
to us through December 31, 1998. The shares issued to Castle Creek Technology
Partners, LLC were a result of their decision to
15
<PAGE> 18
convert a short-term note payable plus accrued interest into common shares
rather than receiving cash.
WARRANTS. The following table shows the private investors and the
number of shares issuable upon the exercise of warrants we granted to them in
conjunction with short-term loans.
<TABLE>
<CAPTION>
Name Date of Grant Number of Shares Issuable
---- ------------- -------------------------
<S> <C> <C>
Castle Creek Technology
Partners, LLC November 19, 1998 50,000
March 20, 1999 25,000
April 20, 1999 40,000
May 20, 1999 60,000
James C. and Josephine M. Zolin February 25, 1999 85,714
March 8, 1999 57,143
April 29, 1999 200,000
June 14, 1999 67,568
Wayne Opperman February 25, 1999 42,857
March 8, 1999 28,571
April 29, 1999 100,000
Richard D. Daniels March 8, 1999 28,571
April 30, 1999 200,000
June 14, 1999 67,568
Robert Lewis, Jr. April 1, 1999 30,303
William J. Kalandros April 1, 1999 30,303
Victor Gabourel April 29, 1999 100,000
Wayne J. Coulon April 29, 1999 100,000
Craig Schilling April 29, 1999 100,000
Arthur D. Kinane April 29, 1999 100,000
Clifford E. Koerner April 30, 1999 100,000
Charles G.Moore May 21, 1999 200,000
Fortney Revocable Living Trust June 3, 1999 128,206
----------
Total shares issuable on exercise of warrants 1,941,804
---------
</TABLE>
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<PAGE> 19
SELLING SHAREHOLDERS
The following table sets forth certain information with respect to the
selling shareholders as of June 14, 1999. Except as set forth below, none of the
selling shareholders currently is an affiliate of ours, and none of them has had
a material relationship with us during the past three years. None of the selling
shareholders are or were affiliated with registered broker-dealers. An asterisk
indicates if their common stock ownership is less than one percent.
<TABLE>
<CAPTION>
Amount and
Percentage of
Beneficial Maximum Number Common Stock
Ownership of of Shares of After the Sale
Common Stock as Common Stock -----------------
Name of June 14, 1999 Offered for Sale Number %
---- ---------------- ---------------- ------ -
<S> <C> <C> <C> <C>
Swartz Private Equity, LLC 12,000,000 12,000,000 -- *
Robert Crawford 675,000 500,000 175,000 *
Richard D. Daniels 517,139 346,139 171,000 *
William J. Kalandros 30,303 30,303 -- *
Robert Lewis, Jr 30,303 30,303 -- *
Clifford E. Koerner 460,000 200,000 260,000 *
Luce, Forward, Hamilton & Scripps
LLP (general legal counsel to Patriot) 279,326 279,326 -- *
Wayne Opperman 314,428 221,428 93,000 *
Castle Creek Technology Partners,
LLC 572,205 572,205 -- *
James C. and Josephine M. Zolin 710,425 590,860 119,565 *
William G. Crawford 100,000 100,000 -- *
Victor Gabourel 100,000 100,000 -- *
Wayne J. Coulon 100,000 100,000 -- *
Craig Schilling 100,000 100,000 -- *
Arthur D. Kinane 100,000 100,000 -- *
Charles G. Moore 200,000 200,000 -- *
Fortney Revocable Living Trust 128,206 128,206 -- *
</TABLE>
17
<PAGE> 20
THE COMPANY
GENERAL
Patriot Scientific Corporation was organized under Delaware law on
March 24, 1992, as the successor by merger to Patriot Financial Corporation, a
Colorado corporation incorporated on June 10, 1987. Our address is 10989 Via
Frontera, San Diego, California 92127, and our telephone number is (619)
674-5000. Our home page can be located on the world wide web at
http://www.ptsc.com.
We are engaged in the development and marketing of patented
microprocessor technology and high speed data communication products. We also
own and are developing innovative radar and antenna technology. Our strategy is
to exploit our technologies through product sales, licensing, strategic
alliances or government contracting.
In 1997, we emerged from the development stage primarily as a result of
the acquisition of Metacomp Inc. There can be no assurance that we can achieve
profitable operations, and we may need additional financial resources during the
next twelve months.
BACKGROUND
In February 1989, we completed our initial public offering under a
registration statement on Form S-18 under the Securities Act of 1933. This
offering raised gross proceeds of $50,000 and net proceeds of approximately
$28,640 upon the sale of 2,500,000 units at $.02 per unit. Each unit sold in the
public offering consisted of one common share and one Class A common stock
purchase warrant exercisable to acquire one share of common stock and one Class
B common stock purchase warrant. All Class A and Class B warrants have since
been exercised or have lapsed.
On August 10, 1989, we acquired our ground penetrating radar technology
from the inventor, Mr. Elwood G. Norris, our Chairman. The details of that
acquisition and certain related agreements are described in more detail in
"Certain Transactions" below. A description of the ground penetrating radar
technology, certain information about the industry generally, and our
operational plans are discussed below under the caption "Business".
On May 12, 1992, we redomiciled ourselves from Colorado to Delaware by
merging into a wholly owned Delaware subsidiary, Patriot Scientific Corporation,
organized for that purpose. The reincorporation resulted in a reverse stock
split. Three shares of the Colorado corporation, par value $.00001, were
converted into one share of the Delaware corporation, par value $.00001. The
reincorporation also effected a change in our charter and bylaws and a name
change to Patriot Scientific Corporation.
In May 1993, we registered under the Securities Act of 1933 a total of
7,631,606
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<PAGE> 21
shares issuable upon the exercise of outstanding Class A and Class B common
stock purchase warrants. We received net proceeds of $3,343,915 upon the
exercise of those warrants and the issuance of 7,538,102 common shares. None of
such warrants remain outstanding.
Effective May 31, 1994, we entered into an asset purchase agreement and
plan of reorganization with nanoTronics Corporation located in Eagle Point,
Oregon and Helmut Falk. We issued a total of 10,000,000 restricted common shares
to nanoTronics to acquire certain microprocessor technology of nanoTronics. The
technology acquired, the ShBoom technology, is being used to develop a
sophisticated yet low cost microprocessor. 5,000,000 of the shares were issued
on a non-contingent basis, and the remaining 5,000,000 shares are subject to the
terms of an earnout escrow arrangement. 2,000,000 of these restricted shares had
been released from escrow as of June 14, 1999.
Effective December 26, 1996, we acquired 96.9% of the outstanding
shares of Metacomp, Inc., a California corporation, from 56 shareholders in
exchange for the issuance of 1,272,068 shares of our common stock. Based on the
closing price of our common stock of $1.375 on the date of the acquisition, the
price of the acquisition was $1,749,094. This business combination was accounted
for as a pooling-of-interests.
BUSINESS
AVAILABLE INFORMATION. We file reports, proxy statements and other
information with the SEC, and these reports may be inspected and copied at the
public reference facilities maintained by the SEC at 450 Fifth Street, N.W.,
Judiciary Plaza, Washington, D.C. 20549. You may obtain information on the
operation of the public reference room by calling the SEC at 1-800-SEC-0330. The
same information may be obtained at the following Regional Offices of the SEC:
75 Park Place, New York, New York 10007, and the Northwest Atrium Center, 500
West Madison Street, Suite 1400, Chicago, Illinois 60621. Copies of such
material may be obtained from the Public Reference Section of the SEC's
Washington, D.C. office at prescribed rates.
We mail a copy of our audited Annual Report on Form 10-KSB along with a
proxy statement to our shareholders prior to our annual meeting.
We have filed a registration statement on Form SB-2, of which this
prospectus is a part, with the SEC. This registration statement or any part
thereof may also be inspected and copied at the public reference facilities of
the SEC.
Our filings may also be accessed through the SEC's web site
(http://www.sec. gov) or by visiting our web site at (http://www.ptsc.com) and
linking to the SEC's site.
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<PAGE> 22
ORGANIZATION AND CORPORATE DEVELOPMENT. Our business involves three
technologies:
- PSC1000 microprocessor technology,
- high-speed data communications technology, and
- radar and antenna technology.
The stages of development of the three major technologies is as follows:
- PSC1000 Microprocessor. This technology is generating minor
amounts of revenue from the sale of evaluation boards and
microprocessors. Also, during the current fiscal year we have
recognized non-recurring engineering revenue and initial
license fees related to the microprocessor application. We are
continuing our efforts to debug our 0.35 micron
microprocessor, which is currently at the foundry stage. We
are also engaged in continuing efforts to port an operating
system and the personalJava application to the microprocessor.
Although we anticipate the microprocessor to be our main
product line, it currently accounts for only 33% of our
revenue.
- High-speed data communications. Revenue from this technology
is being generated primarily from mature communication
products that are nearing the end of their life cycles. New
communication products have yet to penetrate the market place.
We are continuing our efforts to introduce our newer products
to the market. This product line currently accounts for 65% of
our revenue.
- Radar and antenna. We have generated revenue from two U.S.
Navy contracts under which we are to provide proof of concept
and characterization of our gas plasma antenna. We have
suspended our development of this product line until we obtain
additional third party funding. This product line currently
accounts for 2% of our revenue.
We anticipate that the PSC1000 family of microprocessors will benefit our radar
and antenna and high-speed data communications technologies, in that the PSC1000
microprocessor may provide a low-cost, high performance alternative to existing
microprocessors. Due to our small size and staffing overlaps among the
technologies, certain personnel work on more than one of the technologies from
time to time.
During at least the last three years, we have focused the majority of
our efforts on the PSC1000 and high-speed data communications technologies. The
PSC1000 technology and our initial microprocessors, the PSC1000 family, are
targeted for the embedded controller and Java language processor marketplaces.
In reviewing markets for the PSC1000 technology, we identified within
the communications markets a possible opportunity for a product we offer based
on ISDN (which
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<PAGE> 23
stands for integrated services digital network, a high-speed method of
transmitting data over the Internet). Our product is a computer compatible
plug-in card allowing high-speed, cost-effective digital ISDN access to the
Internet and other networks. This product, the CyberShark high-speed data modem,
is being marketed to Internet providers, distributors, value-added resellers and
original equipment manufacturers and has been integrated with Metacomp's high
speed data communication products.
In 1994, during the course of our ground penetrating radar development,
we identified certain antenna technology employing ionized gas as the conducting
element. In May 1997, we received a $19,000 contract from the U.S. Navy for a
proof of concept for an ionized gas antenna. In October 1997, we received a
phase I $62,000 contract from the Office of Naval Research under the Small
Business Innovation Research Program. The purpose of this funding was to
evaluate and characterize the gas antenna technology. Both of these contracts
have been completed and revenue has been recognized. Currently, there is no
follow-on funding from either of these two Navy sources. We believe this
technology could have applications in private industry as well as in military
communications and radar. However, we have no present plans to devote
significant resources to this technology other than from outside funding, if
available.
INTERNET GROWTH AND THE EMERGENCE OF THE JAVA PROGRAMMING LANGUAGE. The
Internet is a rapidly growing global web of computer networks. Developed over 25
years ago, this "network of networks" allows computers connected to the Internet
to "talk" to one another. The Internet provides organizations and individuals
with new means to conduct business. Commercial uses of the Internet include
business-to-business and business-to-consumer transactions, product marketing,
advertising, entertainment, electronic publishing, electronic services and
customer support. We believe that organizations will also increasingly use the
Internet and private Intranet networks to improve communications, distribute
information, lower operating costs and change operations. Use of the Internet
has grown rapidly since its commercialization in the early 1990's, impacting
computer hardware, software and peripheral industries. The rapid growth in
popularity of the Internet is in part due to continuing penetration of computers
and modems into U.S. households, growth of the informational, entertainment and
commercial applications and resources of the Internet and the growing awareness
of such resources among individuals, and the increasing availability of
user-friendly navigational and utility tools which enable easier access to the
Internet's resources.
The growth of the Internet and corporate Intranets is creating a demand
for hardware, software and peripherals. The large and growing number of users
connecting to the Internet is creating a demand for traditional analog and ISDN
digital modems, such as our CyberShark, and other high-speed data communication
devices. New software, such as Java, is emerging to serve the requirements of
Internet users.
Java is a programming language that was originally developed for
personal digital assistant devices and television set top boxes. It was formally
announced as an object-oriented language for the Internet in May 1995 by Sun
Microsystems Inc. A large number of major computer, software, browser and
on-line service provider companies have licensed the Java
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<PAGE> 24
language. Accordingly, although no assurance can be given, Java appears to be
emerging as a fundamental platform for Internet related applications. A growing
number of Java applications, or applets, are now available on the Internet.
These applications not only enhance web pages but also perform many functions of
traditional computer software programs. Our PSC1000 technology lends itself to
potential markets in which the use of Java is prevalent.
With Java, data and programs do not have to be stored on the user's
computer, but can reside anywhere on the Internet to be called upon as needed.
Among its various attributes, two key features of Java are (1) its ability to
run on a variety of computer operating systems thus avoiding the problem of
incompatibility across networks, and (2) security, because Java enables the
construction of virus-resistant, tamper-resistant systems by using
resource-access control and public-key encryption. Because of Java's useful
features, it may also become a popular programming language for embedded
applications.
Since Java is designed to run on multiple types of devices and
operating systems, it allows developers to write a program once for many types
of operating systems, instead of having to write new versions for each type.
Java does this by interpreting a program's commands into something a particular
type of computer can understand. This interpretive design runs programs slower
than if they were tailored for each type of computer and is resulting in a need
for specialized microprocessors and compilers to increase Java's speed.
The growth of Java is causing a number of companies to consider it as a
basis for a new style of computing tailored to the Internet and not encumbered
by the limitations of, or requiring, traditional computer operating systems
(such as Microsoft DOS). The concept is to design inexpensive access devices to
communicate via the Internet. Major companies such as Oracle and Sun
Microsystems Inc have made public announcements of such devices.
ShBoom MICROPROCESSOR TECHNOLOGY.
General Background. In 1991, nanoTronics Corporation was formed and
acquired the ShBoom technology, a base technology for an advanced microprocessor
integrated on a single computer chip. nanoTronics subsequently engaged in
substantial technical development and fabricated a first-generation
microprocessor in early 1994.
Since the acquisition of the ShBoom technology from nanoTronics,
effective May 31, 1994, we have been engaged in correcting errors in the
microprocessor design, adding additional technical features to further modernize
the design, and improving and testing the new design. We initially fabricated a
prototype 0.8-micron microprocessor in late May 1996. The next generation of the
PSC1000 family was a 0.5 micron microprocessor that was delivered in September
1997. The 0.5 micron microprocessor is being employed in demonstrations for
prospective customers and is currently being shipped in limited numbers to
customers as an embedded microprocessor. A 0.35 micron production microprocessor
is currently being debugged and features reduced size and improved performance.
We are currently contemplating, but have not expended funds, on future
enhancements and generations or modifications of microprocessors employing the
ShBoom
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technology.
Industry Background. The semiconductor logic market has three major
sectors:
- standard logic products,
- application specific standard products, and
- application specific integrated circuits.
Standard logic products, such as the Intel's X86 and Pentium and
Motorola's 680X0 microprocessor families, are neither application nor customer
specific. They are intended to be utilized by a large group of systems designers
for a broad range of applications. Because they are designed to be used in a
broad array of applications, they may not be cost effective for specific
applications. Application specific integrated circuits are designed to meet the
specific application of one customer. While cost effective for that application,
application specific integrated circuits require large sales volumes of that
application to recover their development costs. Application specific standard
processors are developed for one or more applications but are not generally
proprietary to one customer. Examples of these applications include modems,
cellular telephones, wireless communications, multimedia applications, facsimile
machines and local area networks. We have designed our microprocessor to be
combined with application-specific software to serve as an embedded control
product for the application specific standard processor market sector.
Application specific standard processors are typically used in embedded
control systems by manufacturers to provide an integrated solution for
application specific control requirements. Such systems usually contain a
microprocessor or microcontroller, logic circuitry, memory and input/output
circuitry. Electronic system manufacturers combine one or more of these elements
to fit a specific application. The microprocessor provides the intelligence to
control the system. The logic circuitry provides functions specific to the end
application. The input/output circuitry may also be application specific or an
industry standard component. The memory element, if not on the microprocessor,
is usually a standard product used to store program instructions and data. In
the past, these functions have been executed through multiple integrated
circuits assembled on a printed circuit board. The requirements for reduced cost
and improved system performance have created market opportunities for
semiconductor suppliers to integrate some or all of these elements into a single
application specific standard processor or chip set, such as the PSC1000 family
of microprocessors which are based on the ShBoom-architecture. The PSC1000
family provides close integration of the microprocessor and input/output
function with the logic circuitry, thereby providing an advanced application
specific standard processor.
Embedded control systems enable manufacturers to differentiate their
products, replace less efficient electromechanical control devices, add product
functionality and reduce product costs. In addition, embedded control systems
facilitate the emergence of completely new classes of products. Embedded control
systems have been incorporated into thousands of products and subassemblies
worldwide, including automotive systems, remote controls, appliances, portable
computers and devices, cordless and cellular telephones, motor controls and many
other systems.
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<PAGE> 26
Microprocessors are generally available in 4-bit through 64-bit
architectures, which refers to the amount of data they can process. 4-bit
microprocessors are relatively inexpensive, typically less than $1.00 each.
Although they lack certain performance and features, they account for more than
40% of worldwide microcontroller volume. Also in general use today are 8-bit
architectures, generally costing $1.00 to $10.00 each and accounting for an
additional 40% of worldwide microcontroller volume. To date 16-bit, 32-bit and
64-bit architectures, with typical costs of over $10.00 each, have offered very
high performance, but are generally considered to be expensive for high-volume
embedded control applications. The use of 16-bit , 32-bit and 64-bit
architectures offers fewer internal limitations, making programming easier and
providing higher performance. Although generally more expensive per unit and
requiring more support logic and memory, these devices offer many advantages for
more sophisticated embedded control systems.
Electronic system designers, driven by competitive market forces, seek
semiconductor products with more intelligence, functionality and control that
can be used to reduce system costs and improve performance. For these needs, the
ShBoom architecture was designed to be a sophisticated 32-bit reduced
instruction set computer microprocessor with advanced features, including the
most commonly needed support logic, but at a low cost; thereby providing
improved performance to existing embedded control applications and creating the
opportunity for the development of new, cost-effective applications.
Technology Description. Conventional high-performance microprocessors
are register-based with large register sets. These registers are directly
addressable storage locations requiring a complex architecture that consumes
costly silicon. This conventional architecture provides processing power for
computer applications but complicates and slows the execution of individual
instructions and increases silicon size, thereby increasing the microprocessor
cost.
Our technology is fundamentally different from most other
microprocessors because it is stack-oriented, in that the data is stored in
groups. Our microprocessor employs certain features of both register and stack
designs. The resultant merged stack-register architecture improves program
execution for a wide range of embedded applications. Our design combines two
processors in one highly integrated package, a microprocessing unit for
performing conventional processing tasks, and an input-output processor for
performing input-output functions. This replaces many dedicated peripheral
functions supplied with other processors. The microprocessor's design simplifies
the manipulation of data. ShBoom's architecture employs instructions that are
shrunk from 32-bits to 8-bits. This simplified instruction scheme improves
execution speed for computer instructions. Our architecture incorporates many
on-chip system functions, thus eliminating the requirement of support
microprocessors and reducing system cost to users.
The 0.8 micron microprocessor has been designed to operate at a speed
of 50Mhz; the 0.5 micron microprocessor at a speed of 100Mhz; and the 0.35
micron microprocessor at 150 MHz. They are all compatible with a wide range of
memory technology from low cost dynamic random-access memory to high-speed
static random access memory. The microprocessors can be packaged in various
surface-mount and die-form packaging. There can be no assurance that the
24
<PAGE> 27
designed speed will be achieved with production models of the 0.5 and 0.35
micron microprocessors or future versions or that all of the desired functions
will perform as anticipated.
The ShBoom technology is not designed or targeted to compete with
high-end processors for use in personal computers. It is targeted for embedded
control applications. We believe that the features described above differentiate
the PSC1000 family from other 8-bit to 64-bit microprocessors targeted for
embedded control applications. Considering the reduced requirement for support
microprocessors, the PSC1000 family is intended to be available at a high volume
price that should be price competitive with high-end 8-bit microprocessor and
general 16-bit microprocessor systems but with higher performance (speed and
functional capability). The PSC1000 family has been designed to allow high-speed
and high-yield fabrication using generally available wafer fabrication
technology and facilities.
The PSC1000 Microprocessor as a Java Processor. We believe the PSC1000
microprocessor architecture is capable of being an efficient and cost-effective
Java programming language processor, because Java is designed to run on a
stack-oriented architecture and the stack-oriented ShBoom architecture executes
the virtual stack machine internal to Java efficiently. Many Java operation
codes or instructions require only a single 8-bit PSC1000 family instruction to
be executed, providing a performance advantage over other more expensive
processors that require six or more 32-bit instructions to do the same task.
This feature allows the execution of Java programs with increased speed and
reduced code size thereby enabling lower system memory costs. In addition, the
incorporation of many on-chip system functions is expected to allow the PSC1000
family to perform most of the other functions required of an Internet computer
device or Java accelerator, thereby eliminating components. Since Internet
computers are designed to be inexpensive appliances for Internet access, cost,
speed and performance are expected to be key requirements for designers. We
believe the ShBoom technology can compete favorably on the basis of such
requirements, although there can be no assurance we can successfully exploit
Java related applications or that competitors will not create superior Java
processors.
We have ported the Java operating environment to the PSC1000 family,
which currently uses the C programming language for software support. We are a
licensee of Sun Microsystems Inc. This enables us to develop and distribute
products based on Sun's JavaOS Technologies. We recently exercised an option to
license from Sun Microsystems Inc., personal Java, a platform on which to run
Java applications. We also licensed from Wind River an operating system,
VXWorks, and entered into a relationship with Forth Inc. whereby Forth will
provide software support and operating system development tools for the Forth
Programming language. We expect that successful implementation of this software
should result in a microprocessor which is competitive in the Java virtual
machine and embedded applications markets. We believe that, if the
implementation is successfully completed, the PSC1000 family will be competitive
with Java microprocessors announced by competitors. However, there can be no
assurance of successful implementation of this package of software or of a
market for a PSC1000 family Java microprocessor.
Stage of Development. In early 1994, nanoTronics initiated production
of a first
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generation of wafers at a contract fabrication facility using 6-inch wafers
employing 0.8 micron double-metal CMOS technology. After the May 31, 1994
acquisition, we improved the original design, added new features and performed
simulations and tests of the improved designs. In October 1995, a run of six
wafers of second-generation 0.8 micron microprocessors was fabricated by a
contract fabrication facility. Subsequently, we tested these microprocessors,
while completing a C computer language compiler and preparing application
development tools. The compiler and application development tools are necessary
to enable system designers to program the PSC1000 family for specific
applications. We made corrections to the design suggested by the testing of
prototype units and produced an additional run of second-generation
microprocessors from remaining wafers in May 1996. In July 1996, we employed
these microprocessors in demonstration boards for use by developers and
prospective customers and licensees.
In December 1997, we completed development of and started shipping a
0.5-micron microprocessor based on the PSC1000 technology and found that
0.5-micron double-metal CMOS technology improved operating speed, reduced power
requirements, reduced physical size and reduced fabrication cost. In May 1998,
we began a production run of a 0.35-micron microprocessor that we anticipate
will further increase operating speed and cost-performance over the previous
generations of the PSC1000 family of microprocessors.
At each stage of development, microprocessors require extensive testing
to ascertain performance limitations and the extent and nature of errors (bugs),
if any. When significant limitations or errors are discovered, additional rounds
of design modifications and fabrication are required prior to having functional
and demonstrable microprocessors for prospective customers and licensees.
Although our 0.5 micron microprocessor has been sent to prospective customers in
anticipation of production orders, there can be no assurance that we, during our
continued testing of these products, will not identify errors requiring
additional rounds of design and fabrication prior to commercial production.
Additional delays could have an adverse effect on the marketability of our
technology and financial condition.
We have developed marketing materials, product manuals and application
development tools for use by licensees and customers. The manuals and tools are
necessary to enable system designers to quickly and easily program the PSC1000
family for specific applications.
We believe that the PSC1000 family is ready for licensing or sale and
that any additional changes encountered in current testing will be minor and can
be made during initial production runs of PSC1000 family microprocessors for
customers, when and if orders are obtained. We also believe the ShBoom core
technology is ready for licensing for use by others to develop custom multiple
function microprocessors. An initial licensing agreement was entered into in
December 1998. This agreement establishes a library arrangement with Venture
System LSI Assist Center, (or VSAC), a Japanese quasi-governmental unit. VSAC
allows our core license to be made available to qualified Japanese entities for
their evaluation and review. To be qualified, the Japanese entity must have
total capital of less than 100 million yen, have less than
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300 employees, and be a Japanese legal entity. Every qualified company that
attains a volume of 1,000 units must enter into a sub-license agreement with us.
In April 1998, we entered into a contract with Olea Exhibits and
Displays, Inc. to incorporate the PSC1000 microprocessor as a main component on
a digital video disk controller card. The controller card will be used in a
kiosk application (an interactive, automated travel brochure) for the Mexican
travel industry. The value of the initial contract is $3,355,000. The contract
is subject to Olea receiving funds from the Mexican Department of Tourism.
Product shipments, which were to have started in late 1998, have been delayed
pending the receipt of those funds and the completion of the DVD by those who
will be advertising on the kiosks. It is now anticipated that we will receive
funding from Olea and start shipping our product during the first calendar
quarter of our fiscal year 2000 (June 1, 1999 to August 31, 1999) and we will
complete shipping the contract during the balance of fiscal year 2000.
Business Strategy. The increasing demand for embedded control has made
the market for microprocessors one of the largest segments of the semiconductor
logic market. Forbes magazine in July 1998 estimated that the embedded systems
market would be worth $27 billion by the year 2000. This type of demand will
drive the need for embedded processors. Our strategy does not entail competing
directly with suppliers who have multiple microprocessor types addressing all
parts of the embedded systems market, but on identifying certain market niches
that the PSC1000 would best address due to its low cost, low power and ability
to run Java efficiently.
Because of the above factors, we intend to focus the majority of our
efforts on the Java microprocessor business, a new but relatively unpenetrated
market without an established base of microprocessor products and for which we
believe the PSC1000 has desirable technical and market advantages.
We believe that the ShBoom architecture is suited for controller
applications requiring high-performance and low system cost, such as kiosks,
laser printers, dot-matrix printers, video terminals, robotics, motion
controllers, industrial controllers, digital communication devices, video games,
cable and satellite modems and TV set-top boxes. We expect that early licensing
of the technology and product applications will focus on embedded control.
We have appointed eight international distributors for foreign markets.
We also have a full-time Vice President of Sales and Marketing to lead marketing
of the PSC1000 family.
We believe the appropriate approach for us initially lies in a balanced
effort of cultivating licensees and developing specific product enhancement
partnerships, producing original equipment manufactured products, developing
innovative in-house products, and providing technical support to third parties
on a contract basis. The overall balance of these approaches will be monitored
and modified as we attempt to ascertain and capitalize on the highly dynamic and
competitive embedded microprocessor market. There can be no assurance that we
can successfully exploit our PSC1000 microprocessor technology.
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<PAGE> 30
Subject to the availability of financial and personnel resources, while
we are commercializing the PSC1000 family and the ShBoom core technology, our
strategy is to also design and develop future versions of the microprocessor
with more demanding sub-micron technology and with more features. However, our
resources are limited, and there can be no assurance that we will be able to
continue microprocessor enhancement.
Initial fabrications of the 0.8 micron and 0.5 micron processors were
performed by contract fabrication facilities. The 0.35-micron microprocessor is
being fabricated by a contract fabrication facility that has agreed to provide
production quantities for our customers. There can be no assurance fabrication
facilities will be available to produce the PSC1000 family in the future.
However, since there are a large number of fabrication facilities with the
capability to produce the PSC1000 family of microprocessors, we believe
microprocessors can be produced on a contract basis. Industry shortages of
fabrication facilities that may exist and are predicted to exist in the future
are generally limited to the more demanding architectures. If a shortage of
fabrication facilities develops, it could have a material adverse effect on our
financial condition.
Competition. The semiconductor industry is intensely competitive and
has been characterized by price erosion, rapid technological change and foreign
competition in many markets. The industry consists of major domestic and
international semiconductor companies, most of which have greater financial,
technical, marketing, distribution, development and other resources than ours.
The market for microprocessors and for embedded control applications is at least
as competitive.
While our strategy is to target high-volume licensees and
microprocessor customers requiring more sophisticated but low-cost devices, we
can still expect significant competition. We may also elect to develop embedded
control system products utilizing the ShBoom architecture for ourselves or by
contract for other manufacturers.
We expect that the PSC1000 family, if successfully commercialized in
the embedded controller market, will compete with a variety of 16/64-bit
microprocessors including ARM, MIPS and the PowerPC. As a Java processor, we
expect our PSC1000 family will compete with a broad range of microprocessors
including licensees of Sun Microsystems, Inc.'s PicoJava. The producers of these
microprocessors have significantly greater resources than ours.
A new entrant, such as ours, is at a competitive disadvantage compared
to these and other established producers. A number of factors contribute to
this, including:
- the lack of product performance experience,
- lack of experience by customers in using application
development systems,
~ no record of technical service and support, and
- limited marketing and sales capabilities.
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HIGH SPEED DATA COMMUNICATIONS PRODUCTS.
General Background. Starting in fiscal 1995, we initiated the
development of a computer compatible plug-in card allowing high-speed,
cost-effective digital ISDN access to the Internet and other networks. In
December 1996, we acquired 96.9% of Metacomp to create a communications division
including engineering, assembly, marketing and distribution. The acquisition of
Metacomp expanded the product line and added high-speed data communications
revenue and a customer base.
Metacomp, founded in 1978, was a high technology company that designed,
assembled, and sold a wide range of high performance data and telecommunications
solutions for wide area networking and high-speed data communications
requirements.
The business combination with Metacomp was treated as a
pooling-of-interests, and the Metacomp product line was combined with our ISDN
product to form the communications division.
ISDN and Digital Communications Description. The Integrated Services
Digital Network (ISDN) is a set of digital transmission protocols that virtually
all of the world's communications carriers have adopted as a standard. ISDN
brings the digital network to the individual user by turning the twisted-pair
copper telephone line into a high-speed, high-capacity ISDN line with the
capacity for two transmissions (one voice, fax or computer conversation and one
data conversation) to happen at the same time. Further, up to eight separate
devices (telephones, computers, fax machines, etc.) can be connected to the same
ISDN line and each given separate telephone numbers. In many home and business
applications, the use of an ISDN line provides dramatically increased speed and,
by allowing multiple uses of one line, improved economics over multiple lines.
ISDN service is easily connected by local telephone companies.
In addition to ISDN products, our communications division also provides
high speed communication products that can be customized to meet the customer's
specific needs. This is done via software tailored for each customer. These
products are often used by businesses for wide area network applications or
other high speed industrial communication systems.
Major Communications Division Products. We have a line of ISDN
interface products for high speed, cost effective digital communications through
telephone networks. These products include:
CyberShark Family
CyberShark - This low-cost basic rate ISDN adapter card has been
designed to allow small businesses and telecommuters to access
corporate networks and the Internet via ISDN. The card includes an
analog phone jack that allows the user to connect his existing analog
phone or fax machines for simultaneous voice conversation.
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CyberShark/HSET - This basic rate adapter card is designed to be used
with a headset/handset used by distributed call centers and remote
agents. It offers access to and supports domestic as well as European
telecommunication protocols. The CyberShark/HSET can be used on
Windows/95, Windows/NT, and Linux operating systems.
CyberShark/PRI - This primary rate ISDN adapter card provides
intelligent support of up to 23 simultaneous digital connections
allowing easy integration into third-party voice, analog modem, or
video conferencing. The CyberShark/PRI is also available to support T1,
an advanced North American communication system, and E1, the European
equivalent to the T1. The CyberShark/PRI can be used on the Windows/NT
operating system.
FlagShip Family
FlagShip/PRI-2 - This ISDN product is a dual-span primary rate adapter
card that supports up to 46 simultaneous digital connections.
NetShark - This ISDN product is a high-density two-card set that
combines a primary rate ISDN interface card with a modem card
containing up to 60 modems. NetShark provides dial-in access to remote
users using either 64 Kbps ISDN or 56 Kbps V.90 connections and
operating under control of Windows NT's built in Remote Access Server
or Routing and Remote Access Server software.
Other
VME Product Line - We also offer a line of intelligent high-speed
communications engines in a virtual memory European form factor. Some
of our customers for these products include the military as well as
large satellite based data communications companies.
Atcomm2/4 Product Line - We also market an intelligent two or four
channel product that is used for high-speed data communications.
Engineering and Development - The communications division also obtains
revenue from providing contract engineering and software development
for customers. From time to time we are able to retain a proprietary
interest in developed products and in such circumstances retain a
license/royalty interest.
Our product strategy is to continue to provide data communication
solutions through improving current products and introducing new products. We
have three research and development personnel assigned to high speed data
communication product development and enhancement. These activities include
customer specific development for original equipment
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manufacturers, value added resellers and others as well as new proprietary
product development and enhancement.
Production and Marketing Strategy. Our strategy is to have our
high-speed data communication products manufactured on a sub-contract basis
with, in some instances, final assembly at our facility. We test and distribute
the products. An in-house marketing staff manages the marketing of our
high-speed data communications products. Our telecommunication products and ISDN
products (other than CyberShark) are targeted for original equipment
manufacturers, systems integrators, value added resellers, and sophisticated end
users.
Competition. There are a number of ISDN board-level products
competitive to CyberShark offered by competitors including NetAccess, ISDN-tek,
Inc., Zyxel, Digi International and U.S. Robotics. These companies have
substantially greater resources than ours. Although not all of these companies
offer personal computer plug-in card terminal adapters directly competitive with
our product, additional direct competitors may introduce competitive products.
We believe our products are competitive on both features and price with
the products currently in the marketplace or those known by us to have been
announced. ISDN modems also compete with traditional analog modems and with
other interface technologies such as cable modems. Accordingly this field is
subject to rapid technological change and fierce competition.
We do not believe we can avail ourselves of patent protection on most
of our high-speed data communication products in development. However, we rely
on trade secret laws and copyrights to protect our high-speed data
communications products.
RADAR AND ANTENNA TECHNOLOGY.
General Background. During the period from 1980-1983, Mr. Norris, our
Chairman, developed a technique employing microwave radiation to penetrate the
earth's surface. This radar technology relates to ground penetrating radar. This
technology is one of many of a family of geophysical tools and sensing
technologies that include seismic, electromagnetics, gravity, borehole sampling
and other techniques. Ground penetrating radar is a technique for producing
profiles of subsurface strata and features by emitting radar waves and recording
the reflected signals.
We commenced active development of our ground penetrating radar
technology in April 1992. By May 1993, we were able to demonstrate the sensing,
processing and crude visualization of images from our technology, and by May
1994 we had completed our prototype device. Since May 1994, we have focused our
efforts and limited financial resources on the PSC1000 technology and
communication products, effectively suspending development and most marketing
efforts related to ground penetrating radar.
Gas Antenna Technology Description. In September 1994, we filed a
patent
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application on certain gas antenna technology invented during our ground
penetrating radar development. Immediately upon receiving notice of allowance in
June, 1995, the invention was classified secret by the U.S. Department of
Commerce at the request of a defense agency. This technology is not currently
used in and is separate and apart from the ground penetrating radar technology,
although it may be employed in the ground penetrating radar technology in the
future.
In January 1996, we filed an application seeking declassification of
the technology, and in June 1996, we were advised that de-classification had
been approved. The U.S. patent was issued in January 1997. The de-classification
allows us to exploit the technology for both governmental and commercial
purposes.
Our gas antenna technology employs ionized gas as the conducting
element of an antenna. This is a fundamental change from traditional antenna
design that generally employs solid wires as the conducting element. We believe
ionized gas is an efficient conducting element with a number of advantages.
Since the gas is ionized only for the precise time of transmission or reception,
ringing and associated effects of solid wire antenna design are reduced. The
design allows for extremely short pulses, important to many forms of digital
communication and radar. The design further provides the opportunity to
construct an antenna that can be dynamically reconfigured for frequency,
direction, bandwidth, gain and beamwidth. We believe antennas can be designed
that are low in weight, small in size and lower in power consumption than
traditional solid wire antennas.
We obtained two U.S. Navy contracts to evaluate a prototype of the gas
plasma antenna technology. There can be no assurance that we will obtain
additional development funds or that we can successfully exploit this
technology.
Ground Penetrating Radar Technology Description. We have developed
sensors (wave generators and antenna) and techniques for the processing,
conversion, compression, storage, and visualization (collectively, computer
processing) of ground penetrating radar data. We have developed proprietary
techniques for wave generation and proprietary antenna for the sending and
receiving of data. We use proprietary methods to capture and process returned
signals.
We have assembled a mobile prototype version of our ground penetrating
radar technology. This prototype encompasses a blending of laboratory equipment
(with internal software and hardware custom configured and modified to function
as desired) and specialized components including antenna, power generators and
amplifiers. The prototype has demonstrated the ability to penetrate multiple
solid objects (walls and barriers) and identify return signals from additional
objects such as walls, persons and manmade barriers. In certain ground strata,
we have been able to resolve objects of six-inch size at approximately ten feet
in depth. Our device does not require contact with the ground, providing
enhanced mobility, extended area coverage and the ability to look sideways (for
example through walls and in mine shafts).
We have one U.S. patent on antenna technology for our ground
penetrating radar.
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Other aspects of the ground penetrating radar system are maintained as trade
secrets, although additional patent applications may be filed in the future.
Stage of Development. Our prototype system is used for limited
prospective customer and user evaluations of the technology. We have
demonstrated using the technology to detect plastic mines, side viewing through
walls and solid structures for detection of bodies or other objects, and viewing
plastic pipes and other underground objects.
We believe that most prospective users will require more specifically
tailored equipment and multiple devices. Commercialization of the ground
penetrating radar technology will require additional development to improve
visualization software and to replace the current system with specifically
designed components to minimize cost and weight and improve portability.
There can be no assurance that a commercially viable device will or can
be produced, and we have no existing users or customers who use the ground
penetrating radar technology. There can be no assurance any prospective users
will select our device over competitive devices, if any.
Business Strategy. We have limited resources to pursue further
development to commercialize a ground penetrating radar system for the above
markets and to exploit the gas plasma antenna technology. Our strategy is to use
our ground penetrating radar and gas plasma antenna prototypes to demonstrate to
prospective users our capabilities and to seek partnering arrangements to
develop custom commercial devices for specific applications. Our marketing
activities to date have been very limited and are focused primarily towards
governmental agencies and major prime contractors to the U.S. government. The
strategy is to seek sponsorship to assist in further development and
commercialization of the present technology. There can be no assurance that we
can obtain any outside assistance or successfully complete development and
commercially exploit our ground penetrating radar or gas plasma antenna
technology.
Competition. The segment of the electronics industry that involves the
manufacture and sale of ground penetrating radar equipment is not large or
cohesive enough to be referred to as an "industry." Further, it is a specialized
subset of geophysical tools that include seismic equipment and other geophysical
and scientific instruments. The antenna industry consists of a large number of
companies with substantial resources, a large installed base, established
government and commercial relationships, and large research and development
staffs. It is possible that any such technology owned or developed by others may
be further advanced than our technology.
We have not yet developed a commercially marketable prototype of our
ground penetrating radar or gas plasma antenna technology. Most of our potential
competitors are actively engaged in operations and have had time to develop
product recognition and market share and have greater financial and other
resources than ours.
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RESEARCH AND DEVELOPMENT. Our current development efforts are focused
on the introduction of the PSC1000-family microprocessor and high-speed data
communication products. The development of our technologies has taken longer
than anticipated and could be subject to additional delays. Therefore, there can
be no assurance of timely or successful marketing of the PSC1000-family or of
continued market acceptance of existing and proposed high speed data
communication products.
We incurred research and development expenditures of $1,607,828 for our
fiscal year ended May 31, 1998 and $1,367,937 for the fiscal year ended May 31,
1997. The majority of our expenditures in fiscal 1998 and 1997 have been devoted
to our PSC1000 and high-speed data communications technologies. To date, we have
expensed internal software development costs as incurred. We believe that
technical advances are essential to our success and expect that we will continue
to expend substantial funds on research and development of our technologies.
However, there can be no assurance that such research and development efforts
will result in the design and development of competitive technologies in a
timely manner.
LICENSES, PATENTS, TRADE SECRETS AND OTHER PROPRIETARY RIGHTS. We rely
on a combination of patents, copyright and trademark laws, trade secrets,
software security measures, license agreements and nondisclosure agreements to
protect our proprietary technologies. Our policy is to seek the issuance of
patents that we consider important to our business to protect inventions and
technology that support our microprocessor and radar and antenna technologies.
We have six U.S. patents issued and five U.S. patents pending, most
dating back to 1989, on the ShBoom microprocessor technology. We have one ShBoom
technology patent pending in five European countries and Japan and may file
additional applications under international treaties depending on an evaluation
of the costs and anticipated benefits that may be obtained by expanding possible
patent coverage.
In addition to such factors as innovation, technological expertise and
experienced personnel, we believe that a strong patent position is becoming
increasingly important to compete effectively in the semiconductor industry. It
may become necessary or desirable in the future for us to obtain patent and
technology licenses from other companies relating to certain technology that may
be employed in future products or processes. To date, we have not received
notices of claimed infringement of patents based on our existing processes or
products; but, due to the nature of the industry, we may receive such claims in
the future. Likewise, we believe that we may have claims against other
semiconductor companies should certain of our pending patents be favorably
granted. However, there can be no assurance thereof nor any assurance that we
could successfully exploit any potential patent claims against larger
competitors.
We acquired the basic ShBoom technology from nanoTronics Corporation in
return for 10,000,000 shares of our common stock in 1994. We do not believe we
are obligated to pay any royalties on aspects of the ShBoom technology specified
in prior agreements between nanoTronics Corporation and a previous inventor. We
believe that, should there be royalties due to the previous inventor, the
obligation is that of nanoTronics. We have been informed by
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nanoTronics that the inventor has rejected a tender of a part of the
consideration paid by us to nanoTronics. The inventor has proposed that he is
entitled to royalties and the return of the basic ShBoom technology. The
inventor has filed a lawsuit to enforce these claims. The lawsuit is further
discussed in the "Litigation" section of this prospectus. If it is ultimately
determined that the inventor is entitled to royalties, we could be subject to
indemnification claims by nanoTronics of up to $1,250,000 based on our agreement
with nanoTronics.
Based on the asset purchase agreement and plan of reorganization
between Patriot, nanoTronics and Mr. Falk, we were the recipients of a number of
warranties and indemnities. We believe nanoTronics has been or is in the process
of liquidation and due to Mr. Falk's death in July 1995, we may be limited in
our ability to obtain satisfaction should we have any future claims against
nanoTronics or the Falk Family Estate.
We have entered into the following licenses related to the
microprocessor technology:
- Sun Microsystems Inc. In June 1997, we entered into an
agreement with Sun Microsystems, Inc. which enabled us to
develop and distribute products based on Sun's JavaOS
technology. In June 1998, we exercised an option under that
agreement to license from Sun, personalJava, a smaller
platform on which to run Java applications, that did not
include an operating system. We determined that personalJava
was better suited to the markets available to the PSC1000. We
are currently working on porting personalJava to the PSC1000.
- Wind River. In July 1997, we entered into an agreement with
Wind River that provided us with a license for an operating
system, VXWorks, to be used in conjunction with personalJava.
We are currently working on porting VXWorks to the PSC1000.
- Forth Inc. In July 1997, we entered into a license agreement
with Forth Inc. whereby Forth will provide software support
and operating system development tools for the Forth
programming language. Several customers are evaluating the
PSC1000 as a microprocessor using the Forth programming
language.
- VSAC. In December 1998, we entered into a licensing agreement
with Venture System LSI Assist Center under which our core
license is made available for evaluation and review by
qualified Japanese companies. Certain companies attaining
1,000 unit volumes will be required to enter into sub-license
agreements with us.
We have two U.S. patents on our gas plasma antenna technology including
one U.S. patent on antenna technology directly related to our ground penetrating
radar technology. No foreign application has been made. Although plans in this
regard are not definite, our intention is
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to apply for patents only as to selected aspects of our ground penetrating radar
and gas plasma antenna technology in order to reduce the risk of infringement or
duplication by competitors. Considering the rapid advancements in the field of
electronics generally, we believe that our interests will best be served by
treating as trade secrets non-patented components or instrumentation groups used
in some of our technologies. There are a large number of patents owned by others
in the radar and antenna fields generally and in the field of ground penetrating
radar specifically. Accordingly, although we are not aware of any possible
infringement and have not received any notices of claimed infringement, we may
receive such claims in the future.
In 1995, we entered into a fully paid license agreement with
Telenetworks that enables us to use their ISDN software technology. In addition
to the protection afforded us through this ISDN technology license, we have
created our own software and hardware designs and use copyright, trade secret
laws, software security measures and nondisclosure agreements to protect our
proprietary products, technology and software. We have one U.S. patent on our
high-speed data communication technology. Despite our precautions, it may be
possible for unauthorized third parties to copy aspects of, or otherwise obtain
and use, our high-speed data communication technology and software without
authorization. In addition, we cannot be certain that others will not develop
substantially equivalent or superior proprietary technology thereby
substantially reducing the value of our proprietary rights.
In 1993, we licensed the technology related to a family of
communication interface microprocessors to Sipex Corporation. The agreement
provided that Sipex could exclusively use the technology through December 1998
if it paid a $50,000 per year minimum. Subsequent to December 1998 the license
continues on a non-exclusive basis based on the mutual consent of both parties.
Currently, Sipex is continuing to use the technology and paying a royalty fee.
In addition, we entered into a license agreement with Multi-Tech
relating to the ATComm/PRI technology. Multi-Tech paid us an up-front license
fee of $50,000 plus an additional royalty fee of $50 per unit for each unit sold
up to a maximum royalty fee of $25,000 after which time the agreement becomes a
paid up license. Multi-Tech also pays us a support fee of $5,000 per year for
five years through 2001. Currently Multi-Tech is continuing to use the
technology and paying a royalty fee.
There can be no assurance that any patents will issue from pending or
future applications or that any patents that are issued will provide meaningful
protection or other commercial advantages to us. Although we intend to protect
our rights vigorously, there can be no assurance that these measures will be
successful.
We generally require all of our employees and consultants, including
our management, to sign a non-disclosure and invention assignment agreement upon
employment with us.
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MARKETING AND DISTRIBUTION. Our products are marketed through a
combination of a direct sales force and distributors. Approximate sales by
principal geographic area (as a percentage of sales) for fiscal years ended May
31 were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Domestic sales 96% 77%
Foreign sales
North America 1% 13%
Europe 3% 6%
Other -- 4%
Total sales 100% 100%
</TABLE>
All of our operating assets are located within the United States. While
sales to certain geographic areas generally vary from year to year, we do not
expect that changes in the geographic composition of sales will have a material
adverse effect on operations.
DEPENDENCE UPON SINGLE CUSTOMERS. Ten percent (10%) or more of our
consolidated net sales for the fiscal years indicated were derived from
shipments to the following customers:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Intermec $578,000 $473,000
G.E. Capital $478,000 $472,000
Spacenet
Carrier $ -- $212,000
Technology
Advanced $207,000 $ --
Communications
</TABLE>
All of the above sales were for communication products and were shipped
against multiple purchase orders from each customer.
FACILITIES. We have one 10,000 square foot office located at 10989 Via
Frontera, San Diego, California. The facility is leased and is currently held
under an option that will expire in July 1999. We are currently in discussions
with the existing lessor to extend the current lease and
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are looking at other alternative properties of similar size in the San Diego
area. There are a variety of facilities of similar size and cost available
should we decide to relocate our offices. In addition, several of our employees
who are supporting the PSC1000 microprocessor are telecommuting from their homes
in northern California.
EMPLOYEES. We currently have twenty full-time and two part-time
personnel. Eleven full-time persons are employed in research and development,
three full-time persons are engaged in manufacturing and assembly, three
full-time persons are engaged in marketing and three full-time and two part-time
persons are engaged in general and administrative activities. These persons
include Mr. Norris and Mr. Putnam, who only devote a part of their available
time to our affairs. We also engage additional consultants and part-time persons
as needed from time to time.
Our future success depends in significant part upon the continued
service of our key technical and senior management personnel. The competition
for highly qualified personnel is intense, and there can be no assurance that we
will be able to retain our key managerial and technical employees or that we
will be able to attract and retain additional highly qualified technical and
managerial personnel in the future. None of our employees is represented by a
labor union, and we consider our relations with our employees to be good. None
of our employees is covered by key man life insurance policies.
GOVERNMENT REGULATION. To our knowledge, our products are not subject
to governmental regulation by any federal, state or local agencies that would
affect the manufacture, sale or use of our products, other than occupational
health and safety laws and labor laws which are generally applicable to most
companies. We cannot, of course, predict what sort of regulations of this type
may be imposed in the future but do not anticipate any unusual difficulties in
complying with governmental regulations which may be adopted in the future.
Our proposed ground penetrating radar device and antenna technology
uses microwave radio waves. The Federal Communications Commission (FCC)
regulates the use of such radio waves in a product. Since we have limited
manufacturing capabilities, we most likely would license the technology to other
companies for production. The other companies would be required to obtain the
proper FCC approvals for their products. We do not believe that the operation of
the ground penetrating radar prototype on contract analysis projects requires
FCC approval.
We have not incurred costs associated with environmental laws and do
not anticipate such laws will have any significant effect on our future
business.
USE OF PROCEEDS
We expect to sell to Swartz Private Equity, LLC $5,000,000 of common
stock under the investment agreement. Additional amounts may be received if the
warrants to purchase common stock are exercised. In addition, we have already
received $343,000 from the sale of common stock to private investors. This
amount plus funds raised from the issuance of short-term
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<PAGE> 41
loans, $698,000, were used to meet our operating expenses for the months of
November 1998 through June 1999. Net proceeds are determined after deducting all
expenses of the offering (estimated to be $64,000).
We intend, in the following order of priority, to use the net proceeds
from this offering as follows:
<TABLE>
<CAPTION>
<S> <C>
Repayment of short-term loans $ 698,000
Marketing, sales, and commercialization 1,000,000
Expenses for marketing and sales in conjunction with the market
introduction of the microprocessor as a commercial product. Such
expenses include market research studies, marketing collateral
materials, trade show participation, public relations, advertising
expenses and sales and marketing personnel.
Completion of the microprocessor development 1,000,000
Expenses for completion of the development include porting an
operating system and personalJava to the microprocessor and obtaining
tools to make use of the processor more user- friendly.
Working capital and general corporate purposes 2,238,000
----------
Total $4,936,000
==========
</TABLE>
The amount and timing of working capital expenditures may vary
significantly depending upon numerous factors such as:
- The progress of our final development of the microprocessor,
- Revenues generated from existing and anticipated products and
licenses,
- The development of marketing and sales resources,
- Administrative and legal expenses, and ~ Other requirements
not now known or estimable.
We believe that our available cash and existing sources of funding,
together with the proceeds of this offering and interest earned thereon, will be
adequate to maintain our current and planned operations for at least the next 18
months.
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<PAGE> 42
LITIGATION
In October 1998, Patriot was sued in the District Court for Travis
County, Texas by the Fish Family Trust, an assignee of a co-inventor of the
original ShBoom technology. The suit also named as defendants nanoTronics and
Gloria Felcyn as trustee of the Falk Family Trust. The suit sought a judgment
for damages, a rescission of the technology transfer agreement by which
nanoTronics obtained the technology and a restoration of the technology to the
Fish Family Trust. We had the suit removed to the United States District Court
for the Western District of Texas, Austin Division. We requested the Federal
District Court dismiss the suit based on a lack of minimum contacts with Texas
or, in the alternative, to transfer the case to the Southern District of
California. In January 1999, the Federal District Court dismissed the suit for
lack of subject matter and personal jurisdiction.
The Fish Family Trust then refiled the suit in the Superior Court of
San Diego County, California seeking remedies similar to the action dismissed by
the Federal District Court. We have joined with nanoTronics and Gloria Felcyn,
Trustee, and retained joint legal counsel to defend this suit. We have not had
any meaningful settlement discussions. A trial has been scheduled for December,
1999. We and the other defendants intend to vigorously contest the plaintiff's
allegations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Our results of operations have been and may continue to be subject to
significant variations. The results for a particular period may vary due to a
number of factors. These include:
- the overall state of the semiconductor and communications
segments of the economy,
- the development status of and demand for our products,
- economic conditions in our markets,
- the timing of orders,
- the timing of expenditures in anticipation of future sales,
- the mix of products sold by us,
- the introduction of new products,
- product enhancements by us or our competitors, and
- pricing and other competitive conditions.
As described in Note 1 to the Consolidated Financial Statements,
effective December 26, 1996, we acquired 96.9% of the common stock of Metacomp.
The business combination was accounted for as a pooling of interests and,
accordingly, our financial statements have been presented to include the results
of Metacomp as though the business combination occurred as of
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<PAGE> 43
June 1, 1995. In addition, Metacomp changed its fiscal year-end from July 31 to
May 31 to conform to our fiscal year-end. Based on the difference in fiscal
year-ends, results of operations for the two months ended July 31, 1996 were
included in our results of operations for the year ended May 31, 1997.
RESULTS OF OPERATIONS FOR THE YEARS ENDED MAY 31, 1998 AND 1997
Net sales. Total net sales for the fiscal year ended May 31, 1998
increased 3.0% to $1,902,874 from $1,847,421 for the fiscal year ended May 31,
1997. This increase was due primarily to the initial sales of the microprocessor
and the development contracts for the radar/antenna product line.
Cost of sales. Cost of sales as a percentage of net sales increased to
61.2% in fiscal 1998 compared to 54.3% in fiscal 1997. This increase in the cost
of sales percentage was a result of increasing the obsolescence reserve by
$203,000 for component and finished parts inventory related to older products
being phased out. Additional inventory write downs and reserves may be necessary
in future years since additional communication products are nearing the end of
their life cycles. Future sales may not be sufficient to use existing finished
parts inventory (which had built up in previous years in anticipation of larger
orders) and component parts may not be usable in other products. Each period we
review component part and finished goods inventory quantities and estimate the
amount of useable inventory based on historical usage. If the quantities
anticipated to be used are less than the quantities on hand, then we increase
the obsolescence reserve and record additional cost of sales.
Research and development expenses increased 17.5% from $1,367,937 in
fiscal 1997 to $1,607,828 for fiscal 1998. This increase was due primarily to an
increase in licensed software support and update fees.
Selling, general and administrative expenses increased 67.1% from
$2,448,751 in fiscal 1997 to $4,090,937 in fiscal 1998. This increase was due
primarily to:
- the costs of two financings, which financings were in the
total amount of $3,000,000,
- an increase in personnel costs related to our addition of one
marketing executive and one financial officer,
- the compensation costs of $1,995,000 related to the earnout
from escrow of 2,000,000 shares of common stock in 1998 as
compared to compensation cost of $725,000 related to the
earnout of 500,000 shares of common stock in 1997 as discussed
in Note 4 to the Consolidated Financial Statements, and
- an increase in marketing costs related to introducing our
products to the marketplace.
Amortization of purchased ShBoom technology was $612,333 for fiscal 1997.
The technology was totally amortized during fiscal year 1997 and, accordingly,
there was no corresponding expense for fiscal year 1998.
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<PAGE> 44
Other income (expense) was significantly higher for fiscal 1998 as a
result of a recognition of $2,592,446 of non-cash interest related to the
discount on convertible term debentures and valuation of warrants as discussed
in Note 5 to the Consolidated Financial Statements and the interest on these
debentures.
A one-time extraordinary income item of $1,779,457 was recorded in fiscal
1997. Metacomp filed for protection from its creditors in 1991 and entered a
plan of reorganization with the U.S. Bankruptcy Court. The Chapter 11 plan was
completed in July 1996 and resulted in this amount of debt being discharged.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED FEBRUARY 28, 1999 AND 1998
Net sales. Total net sales for the nine months ended February 28, 1999
decreased 2.9% to $1,108,022 from $1,140,711 for the corresponding period of
fiscal 1998. This decrease was due primarily to a reduction in follow on
shipments for our matured communication products several of which are
approaching the end of their life cycles. Development and sales of new
communications products have not achieved a level to replace the maturing
products. Also, we had to reschedule the product delivery on our kiosk
application order of $3,355,000. Although no assurance can be given, the kiosk
order is scheduled to begin shipments in the first fiscal quarter of 2000, June
1 to August 31, 1999, with the balance of shipments to be completed by the end
of fiscal year 2000.
Cost of sales. Cost of sales as a percentage of net sales increased to
61.7% for the nine months ended February 28, 1999 compared to 47.9% for the
corresponding period of the previous fiscal year. This increase is due in part
to lower profit margins on the non-recurring engineering portion of our kiosk
application order compared to profit margins typically associated with our other
product lines. The remainder of the kiosk order is anticipated to put upward
pressure on the cost of sales as a percentage of net sales when shipments of the
product portion of the kiosk order commences.
Research and development expenses increased 25.7% for the nine months
ended February 28, 1999 to $1,634,060 from $1,299,975 for the corresponding
period for the previous fiscal year. This was due to an increase in licensed
software support and update fees for the Java OS and Personal Java application,
increased costs of porting a real time operating system to the PSC1000, and
costs related to the development of the kiosk.
Selling, general and administrative expenses decreased by 32.5% to
$1,770,158 for the nine months ended February 28, 1999 compared to $2,620,908
for the corresponding period of the previous fiscal year. This decrease was due
primarily to a reduction in compensation costs.
Other expense was $335,993 for the nine months ended February 28, 1999
compared to $1,665,725 for the corresponding period for the previous fiscal
year. This decrease was due primarily to the non-cash interest related to
Convertible Term Debentures discussed in Note 5 to the Consolidated Financial
Statements and the interest on those Debentures being significantly
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<PAGE> 45
lower in the current nine month period.
LIQUIDITY AND CAPITAL RESOURCES
At February 28, 1999, working capital was a negative $1,013,056 and cash
and cash equivalents totaled $16,800. We have funded our operations primarily
through the issuance of securities and debt financings. Cash and cash
equivalents decreased $585,656 during the nine months ended February 28, 1999.
The net cash used in operating activities was $1,136,873, additions to property
and equipment were $273,096, and funds generated from debt and equity financings
were $824,313. During the nine months ended February 28, 1999, accounts
receivable decreased $136,220 as a result of a reduction in sales, increased
collection efforts and the sale of receivables to a bank under a factoring
agreement. Prepaid expenses increased $49,198 as a result of maintenance
contracts on software being amortized over the entire year. Accounts payable
increased $900,413 as a result of annual obligations for software maintenance
and a slow down in payments as a result of the cash and cash equivalent
reduction.
Our current cash requirements to sustain our operations for the next
twelve months are estimated to be $1,600,000. We expect that these requirements
will be provided:
Internally by:
- the cash profits related to the $3,355,000 kiosk order, (a
portion of which is anticipated as an advance payment during
our first fiscal quarter of 2000 (June 1 to August 31, 1999),
previous to any product shipments, and
Externally by:
- short-term debt instruments, including a receivable financing
arrangement established with our bank,
- previous to the effective date of the registration of the
underlying stock to be resold under the investment agreement,
private placement debt and/or equity financings, and
- subsequent to the effective date of the registration of the
underlying stock to be resold under the investment agreement,
draws against the equity line of credit.
Since February 28, 1999, we have issued short-term debt financings for
$553,000 and sold equity to two private investors totaling $75,000. These
amounts have enabled us to meet our current needs and will provide funding for
the next 30 to 60 days. If, during the next 60 days, we do not receive the
initial funding for the kiosk order or the initial draw against the investment
agreement, then additional similar debt or equity financings will be necessary
to continue to meet our cash requirements.
In February 1999, we entered into an agreement for up to $5,000,000 under
an investment agreement. The investment agreement allows us, at our sole
discretion, to put common stock into the hands of Swartz Private Equity, LLC at
a discount from market, ranging from 10% to 20%
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<PAGE> 46
depending on the market price of the common stock. The puts are subject to
common stock trading volume limitations and registration of the securities. We
anticipate the initial put under the investment agreement will take place during
the first quarter of fiscal year 2000, June 1- August 31, 1999. The funds
anticipated from the kiosk order are subject to our customer receiving funds
from the Mexican Department of Tourism and on several occasions product
shipments have been rescheduled pending the receipt of those funds.
We anticipate that we may require additional equipment, fabrication,
components and supplies during the next twelve months to continue development of
our technologies. Product introductions such as those currently underway for
communication products and the PSC1000 may require significant inventory,
product launch, marketing personnel and other expenditures that we can not
currently estimate. Further, if expanded development is commenced or new
generations of microprocessors are accelerated beyond our current plans,
additional expenditures, that we can not currently estimate, may be required. It
is possible therefore, that higher levels of expenditures may be required than
we currently contemplate resulting from changes in development plans or as
required to support new developments or commercialization activities or
otherwise.
Based on the current fiscal year's rate of cash operating expenditures and
current plans, we anticipate a need for additional cash to meet our requirements
for the next twelve months. There can be no assurance that any funds required
during the next twelve months or thereafter can be generated from operations or
that if such required funds are not internally generated that funds will be
available from external sources such as debt or equity financings or other
potential sources. The lack of additional capital could force us to
substantially curtail or cease operations and would, therefore, have a material
adverse effect on our business. Further, there can be no assurance that any such
required funds, if available, will be available on attractive terms or that they
will not have a significantly dilutive effect on our existing shareholders.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information" which supersedes SFAS No. 14
"Financial Reporting for Segments of a Business Enterprise." SFAS No. 131
establishes standards governing the way that public companies report financial
information about operating segments in annual financial statements, and
requires reporting of selected information about operating segments in interim
financial statements issued to the public. It also establishes standards for
disclosure regarding products and services, geographic areas and major
customers. SFAS No. 131 defines operating segments as components of a company
about which separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to allocate
resources and in assessing performance. We have only one operating segment. SFAS
No. 131 is effective for financial statements for periods beginning after
December 15, 1997 and requires comparative information for earlier years to be
restated. We will implement SFAS No. 131 in our May 31, 1999 financial
statements. Results of operations and financial position will be unaffected by
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<PAGE> 47
implementation of the standard. We believe the adoption of this statement will
have no material impact on our financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
market value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. The key criterion for hedge
accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. SFAS No. 133 is
effective for fiscal periods beginning after June 15, 1999. We believe the
adoption of this statement will have no material impact on our financial
statements.
TAX LOSS CARRYFORWARDS
As of May 31, 1998, we had approximately $9,052,000 of tax loss
carryforwards. A valuation allowance has been recorded for the net-deferred tax
asset of $4,258,000 arising primarily from tax loss carryforwards because we
cannot determine that it is more likely than not that the deferred tax asset
will be realized. See also Note 8 to the Consolidated Financial Statements.
YEAR 2000 COMPLIANCE
Many existing computer programs use only two digits to identify a year in
the date field, with the result that data referring to the year 2000 and
subsequent years may be misinterpreted by these programs. If present in the
computer applications of a company or third parties (such as customers,
financial institutions, and suppliers) and not corrected, this problem may cause
computer applications to fail or to create erroneous results and could cause a
disruption in operations and have an adverse effect on a company's business and
results of operations.
We have adopted a formal plan to evaluate our readiness for the Year 2000
and to address any deficiencies. The plan encompasses:
- information technology (IT) systems,
- non-IT systems,
- our products, and
- systems of third parties, including distributors and key
suppliers.
INFORMATION TECHNOLOGY. Our principal computer systems that we use for
financial accounting, manufacturing, inventory control, purchasing, sales
administration, engineering, and other business functions are not Year 2000
compliant. We have identified a replacement system that we expect to purchase,
install, and have fully functional before June 30, 1999. The cost of this new
system will be approximately $30,000.
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NON-IT SYSTEMS. By the end of June 1999, we expect to have completed an
evaluation of telephone systems, manufacturing equipment, facility heating and
cooling systems, and other non-IT systems for Year 2000 readiness and will
promptly take remedial action as necessary.
OUR PRODUCTS. We have completed a series of tests, utilizing industry
standards, of the electronics systems of our products, including those product
lines no longer being manufactured but remaining in use at customer sites. Our
review has determined that the products should continue to operate according to
specifications after December 31, 1999.
KEY VENDORS AND SUPPLIERS. We will initiate a survey of our key vendors
and suppliers to assess their plans for bringing any non-compliant systems into
Year 2000 compliance. This study is expected to be completed by the end of June
1999.
Other than the replacement computer system discussed above, substantially
all of the effort to evaluate our Year 2000 readiness has been made using
internal personnel, and therefore incremental expenses have been less than
$50,000. We have not incurred any material expenses in connection with our
evaluation of non-IT systems and do not expect material expense in the future,
although the evaluation of non-IT systems is not yet complete. We have not
incurred any material expenses to date in connection with the evaluation of our
products and the status of our vendors and suppliers with respect to Year 2000
issues. We do not anticipate material expenses in the future, although the
evaluation of key vendors' and suppliers' Year 2000 readiness is not yet
complete.
Our Year 2000 readiness plan, as well as our consideration of contingency
plans, are ongoing and will continue to evolve as new information becomes
available. At the present time, we believe that it is difficult to identify the
cause of the most reasonably likely worst case Year 2000 scenario. We have not
yet adopted any formal contingency plans and will determine the need for such
plans as part of our ongoing assessment of vendors and suppliers, products, and
internal business systems. Due to the complexity and pervasiveness of the Year
200 issue, and in particular the uncertainty regarding the Year 2000 compliance
programs of third parties, no assurances can be given that the Year 2000 problem
will not have material adverse effects on our business or our results from
operations.
MANAGEMENT
IDENTIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS
Our current directors and executive officers, their ages, positions held
with us and duration as such, are as follows:
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<PAGE> 49
<TABLE>
<CAPTION>
NAME AGE POSITION AND OFFICES DIRECTOR SINCE
- ---- --- -------------------- --------------
<S> <C> <C> <C>
Elwood G. Norris 60 Chairman and Director August 1989
James T. Lunney 44 President, CEO and April 1998
Director
Lowell W. Giffhorn 52 Chief Financial Officer N/A
Donald R. Bernier 56 Director January 1995
Helmut Falk, Jr. 42 Director December 1997
Phillip Morettini 42 Vice President Sales and N/A
Marketing
Frederick G. Thiel 38 Director February 1999
Robert Putnam 40 Secretary N/A
Jayanta K. Maitra 48 Vice President N/A
Engineering
Richard G. Blum 68 Director February 1999
</TABLE>
The terms of all directors will expire at the next annual meeting of our
shareholders, or when their successors are elected and have qualified. Directors
are elected each year, and all directors serve one-year terms. Officers serve at
the pleasure of the board of directors. No family relationship exists among our
management members. Mr. Norris, Mr. Bernier and Mr. Falk were elected to the
board of directors in December 1997. Mr. Lunney was appointed to the board of
directors in April 1998. Mr. Thiel and Mr. Blum were appointed to the board of
directors in February 1999.
BIOGRAPHICAL INFORMATION
ELWOOD G. NORRIS. Mr. Norris has been a director of Patriot since 1989 and
served as Chairman and Chief Executive Officer (CEO) until June 1994. In June
1995 he was again appointed President and CEO until June 1996, when he was
appointed Chairman. Since March 1988, he has been a director of e.Digital, Inc.,
a public company engaged in electronic product development, distribution and
sales. Until October 1995, when he became Chief Technology Officer, he was also
President of e.Digital, and in January 1997 he was appointed interim CEO. Since
August 1980, he has also been a director of American Technology Corporation, a
publicly held consumer electronics company, and served as its President and CEO
until February 1994. Mr. Norris is an inventor with over twenty U.S. patents
primarily in the fields of electrical and acoustical engineering. He invented
the base ground penetrating radar technology and the gas plasma antenna
technology owned by us. Mr. Norris works only part-time for us.
JAMES T. LUNNEY. Mr. Lunney has been the President and CEO of Patriot
since March 1998 and was appointed as a Director in April 1998. From February
1997 to March 1998, he was the President of Signal Processing Systems, a San
Diego manufacturer of signal processing
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technologies. From November 1992 to February 1997, he was the Manager of
Production Programs, Vice President and Business Area Manager for Signal
Processing, which was a division of Scientific Atlanta until August 1996, when
it was acquired by Global Associates Ltd. Previously, Mr. Lunney held various
managerial positions with GE Aerospace, Defense Systems Division and Ordinance
Systems Division. In 1977, he received a B.S. in Electrical Engineering from
Worcester Polytechnic Institute.
ROBERT PUTNAM. Mr. Putnam has been the Secretary and Treasurer of Patriot
since 1989 and was a director from 1989 to April 1998. Since 1988 he has served
as Secretary of e.Digital, Inc. Since 1984 he has been a director of American
Technology Corp., where he served as Secretary/Treasurer from 1984 and as
President and CEO from February 1994 until September 1997. He received a B.A.
degree in Mass Communication/Advertising from Brigham Young University in 1983.
Mr. Putnam works only part-time for us.
JAYANTA K. MAITRA. Mr. Maitra has been Vice President of Engineering of
Metacomp since 1990 and was appointed Vice President of Engineering of Patriot
in January 1997. From 1985 to 1987 he was Manager of Hardware Engineering for
Systech Corporation, a San Diego based hardware and software communications
company. From 1974 to 1985 he held various engineering positions with several
computer related technology companies. He obtained a B.S. in Electrical
Engineering from the Indian Institute of Technology in 1972 and an M.S. in
Electrical Sciences at State University of New York in 1973.
LOWELL W. GIFFHORN. Mr. Giffhorn was the principal in his own financial
management consulting firm from August 1996 until joining Patriot as Chief
Financial Officer (CFO) in May 1997. Since November 1996, Mr. Giffhorn, in
addition to other consulting engagements, performed the duties of Acting CFO for
Patriot. From June 1992 to August 1996 and from September 1987 to June 1990 he
was the CFO of Sym-Tek Systems, Inc. and Vice President of Finance for its
successor, Sym-Tek Inc. Sym-Tek Systems, Inc. was a major supplier of capital
equipment to the semiconductor industry, which filed under Chapter 11 of the
U.S. Bankruptcy Code in May 1994 while Mr. Giffhorn was the CFO. He was
instrumental in selling the assets of Sym-Tek Systems, Inc. to Sym-Tek Inc., a
wholly owned subsidiary of Aetrium Inc. He continued with Sym-Tek Inc. as Vice
President Finance during the transition and concluded the liquidation of Sym-Tek
Systems, Inc. He has over twenty-five years of experience in a variety of
financial positions, including eleven years as Controller for Langley
Corporation, a publicly traded, San Diego, defense contractor. Mr. Giffhorn
obtained a M.B.A. degree from National University in 1975 and he obtained a B.S.
in Accountancy from the University of Illinois in 1969.
DONALD R. BERNIER. Since 1971, Mr. Bernier has been the owner and
President of Compunetics Incorporated, a Troy, Michigan-based electronics firm
of which he the founder. Compunetics engages in contract research and
development, specializing in microelectronics primarily for the automotive
industry.
HELMUT FALK, JR. For the past six years, Dr. Falk has been the Director of
Anesthesia for the Johnson Memorial Hospital in Franklin, Indiana. Dr. Falk
received his D.O. from the College
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<PAGE> 51
of Osteopathic Medicine of the Pacific in 1987 and his B.S. in Biology from the
University of California, Irvine in 1983. Dr. Falk is the son of the late Helmut
Falk, who was the sole shareholder of nanoTronics and the Chairman and CEO of
Patriot until his death in July 1995. Dr. Falk is also an heir to the Helmut
Falk Estate, which is the beneficial owner of our shares held by the Helmut Falk
Family Trust and nanoTronics Corporation.
PHILIP MORETTINI. Mr. Morettini has been the Vice President of Sales and
Marketing of Patriot since July 1997. From September 1995 to April 1997, he was
the President and CEO of Sdept Computer Solutions, a San Diego software company.
From December 1993 to September 1995, he was the principal in his own management
consulting firm; and from March 1990 to September 1993, he held several
positions, including Division Manager, for Horizons Technology, a San Diego
software and services company. Previously, he held various marketing and product
development positions with Spectragraphics and Hewlett-Packard. In 1981 Mr.
Morettini received a M.B.A. degree from the University of Detroit and in 1979 he
obtained a B.S. in Engineering from the University of Illinois.
FREDERICK G. THIEL. Since April 1998, Mr. Thiel has been the President and
CEO of Lantronix, Inc., an Irvine, CA based developer/manufacturer of computer
network enabling devices and systems. From July 1996 to April 1998 he was the
Vice President of Marketing and General Manager for CDM Technology, Inc., an
Irvine, CA based developer of high-end storage controller and intelligent serial
input/output microprocessor technology. From June 1994 to March 1996 he was the
Director of World Wide Marketing for Standar Microsystems Corporation, an
Irvine, CA based network technology developer and manufacturer. Mr. Thiel was
educated in the United States and Europe and studied business administration
while at the Stockholm School of Economics.
RICHARD G. BLUM. Mr. Blum retired as Chairman and President of Kysor
Europe, a wholly owned subsidiary of Kysor Industrial Corporation, in 1991.
Previously Mr. Blum held a variety of executive level positions with ITT Europe
and ADT Europe. He completed his undergraduate work at Oregon State and Linfield
Colleges in 1951 and post graduate work at John Carrol and Canisius Universities
in 1958.
GENERAL CONFLICTS OF INTEREST
Conflicts of interest now exist and will continue to exist between us and
certain of our officers and directors due to the fact that certain officers and
directors have other employment or business interests to which they devote
attention. We have not established policies or procedures for the resolution of
current or potential conflicts of interest between us and our management or
management-affiliated entities. There can be no assurance that members of
management will resolve all conflicts of interest in our favor.
It is conceivable that the respective areas of interest of ours, American
Technology Corp. and e.Digital could overlap or conflict. We believe that,
although each of the three corporations is involved in the electronics industry,
their respective areas of focus, products and technology are
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<PAGE> 52
sufficiently distinct that no conflict in business lines or executive loyalties
will result. Therefore, no steps have been taken to resolve possible conflicts
among us, American Technology Corp., and e.Digital; and any such conflicts,
should they arise, will be addressed at the appropriate time.
INDEMNIFICATION OF OFFICERS, DIRECTORS AND OTHERS
As permitted by Delaware law, our certificate of incorporation provides
that we will indemnify our officers, directors, employees and agents. This
includes indemnification against attorneys' fees and other expenses and
liabilities they incur to defend, settle or satisfy any civil or criminal action
brought against them arising out of their association with or activities on
behalf of us. However, they will not be indemnified if they are adjudged to have
acted with gross negligence or to have engaged in willful misconduct. We may
also bear the expenses of such litigation for any such persons upon their
promise to repay such sums if it is ultimately determined that they are not
entitled to indemnification. Such expenditures could be substantial and may not
be recouped, even if we are so entitled. We have provided for indemnification
for liabilities arising under the Securities Act of 1933 as they may be
permitted to directors, officers or persons controlling us. The SEC has informed
us that such indemnification is against public policy and may be unenforceable.
EXCLUSION OF DIRECTOR LIABILITY
In accordance with Delaware law, our certificate of incorporation excludes
personal liability on the part of our directors to us for monetary damages based
upon any violation of their fiduciary duties as directors, except as to:
- liability for any breach of the duty of loyalty,
- acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law,
- acts in violation of Section 174 of the General Corporation
Law of Delaware, or
- any transaction from which a director receives an improper
personal benefit.
This exclusion of liability does not limit any right which a director may have
to be indemnified and does not affect any director's liability under federal or
applicable state securities laws.
EXECUTIVE COMPENSATION
The following table sets forth information concerning the compensation of
our chief executive officers and each of the other four most highly compensated
executive officers whose salary and bonus exceeded $100,000 for the fiscal years
ended May 31, 1996, 1997 and 1998.
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<PAGE> 53
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Cash Compensation Long-Term Compensation
---------------------------- -----------------------------------
Name and Principal Fiscal Options All Other
Position Year Salary Bonus (# of Shares) Compensation(7)
<S> <C> <C> <C> <C> <C>
James T. Lunney 1998 $ 26,385 Nil 350,000 None
President and CEO(1) shares
Michael A. Carenzo 1998 $164,133 Nil 50,000 None
President and CEO(2) 1997 $138,000 shares None
900,000
shares
Elwood G. Norris 1996 $60,000 Nil 50,000 None
President and CEO(3) shares
Helmut Falk 1996 $9,231 Nil None None
President and CEO(4)
Norman J. Dawson 1998 $114,169 Nil 50,000 None
Vice President and 1997 $128,483 Nil 533,953 $4,241
General Manager(5)
Jayanta K. Maitra 1998 $104,500 Nil 25,000 None
Vice President 1997 $118,700 Nil 535,753 $2,874
Engineering(6)
</TABLE>
- ----------
(1) Mr. Lunney has served as President and CEO since March 23, 1998.
(2) Mr. Carenzo served as President and CEO from June 1, 1996 to March
1998, when Mr. James T. Lunney was appointed President and CEO. Mr.
Carenzo continued to serve on the Board until his resignation in
October, 1998.
(3) Mr. Norris served as CEO from 1989 to June 1994, when Mr. Falk became
Chairman, President and CEO. He was reappointed President and CEO on
June 5, 1995 due to Mr. Falk's illness and served in such capacity
until June 1, 1996, when Mr. Carenzo was appointed President and CEO.
(4) Mr. Falk served as Chairman from June 1994 until his death on July 6,
1995. He also served as President and CEO from June 1994 to June 5,
1995.
(5) Mr. Dawson was appointed Vice President and General Manager on December
26, 1996 as a result of our acquisition of Metacomp. The amounts
disclosed reflect his compensation before and after the acquisition.
Mr. Dawson terminated his relationship with us in October 1998.
(6) Mr. Maitra was appointed Vice President Engineering on December 26,
1996 as a result of our acquisition of Metacomp. The amounts disclosed
reflect his compensation before and after the acquisition.
(7) Represents long-term disability insurance payments made us on behalf of
Mr. Dawson and Mr. Maitra during the fiscal year ended May 31, 1997.
We maintain employee benefits that are generally available to all of
our employees,
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<PAGE> 54
including medical, dental and life insurance benefits and a 401(k) retirement
savings plan. We did not make matching contributions under the 401(k) plan on
behalf of the above named officers during the fiscal year ended May 31, 1998.
OPTION GRANTS
The following table sets forth information on grants of stock options
pursuant to our 1996 Stock Option Plan to the officers reflected in the Summary
Compensation Table shown above.
OPTION GRANTS TABLE FOR FISCAL YEAR ENDED MAY 31, 1998
<TABLE>
<CAPTION>
Percent of Total
Number of Options Granted
Option Options to Employees in Exercise
Name Date Granted Fiscal Year Price
- ---- ---- ------- ----------------- --------
<S> <C> <C> <C> <C>
James T. Lunney February 22, 2003 350,000 23.2% $ 0.86
Michael A. Carenzo January 26, 2003 50,000 3.3% $ 0.59
Elwood G. Norris January 26, 2003 50,000 3.3% $ 0.59
Norman J. Dawson January 26, 2003 50,000 3.3% $ 0.59
Jayanta K. Maitra January 26, 2003 25,000 1.7% $ 0.59
</TABLE>
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END VALUES
Shown below is information on exercises of stock options and fiscal
year-end values under our 1996 and 1992 Stock Option Plans to the officers
reflected in the Summary Compensation Table shown above.
<TABLE>
<CAPTION>
Shares Value of Unexercised
Acquired Number of Unexercised In-The-Money Options
on Value Options Held at May 31, 1998 At May 31, 1998
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
<S> <C> <C> <C> <C> <C> <C>
Michael A. Carenzo 40,200 $53,466 525,691 -- $ 8,000 $ --
Norman J. Dawson 54,600 $61,666 50,000 375,000 $ -- $ --
Elwood G. Norris -- -- 100,000 -- $ 8,000 $ --
James T. Lunney -- -- 116,667 233,333 $ -- $ --
Jayanta Maitra -- -- 110,753 375,000 $ 24,379 $ --
</TABLE>
The fair market value of the unexercised in-the-money options at May 31,
1998 was determined by subtracting the option exercise price from the last sale
price as reported on the over the counter bulletin board on May 31, 1998, $.75.
This value was multiplied by the number of shares into which the option was
exercisable. Any options whose exercise price were greater than $.75 were
excluded from the valuation.
We have not awarded stock appreciation rights to any employee of ours. We
have no
52
<PAGE> 55
long-term incentive plans except a $50,000 demonstration bonus payable to Mr.
Norris upon successful demonstration of a prototype ground penetrating radar
device.
Under Mr. Maitra's Employment Contract, the board of directors canceled
75,000 stock options in fiscal year 1998 and 225,000 stock options in fiscal
year 1999 which had previously been granted to him. This change was made as a
consequence of our not meeting certain performance goals. As a result of Mr.
Carenzo's resignation in March, 1998, 337,500 previously granted stock options
were canceled. We have no defined benefit or actuarial plans covering any
person.
COMPENSATION OF DIRECTORS
No direct or indirect remuneration has been paid or is payable by us to
the directors in their capacity as directors other than the granting of stock
options. We expect that, during the next twelve months, we will not pay any
direct or indirect remuneration to any directors of ours in their capacity as
directors other than in the form of stock option grants or the reimbursement of
expenses of attending directors' or committee meetings.
EMPLOYMENT CONTRACTS
JAMES T. LUNNEY. We entered into an employment agreement dated as of
February 23, 1998 and approved by our directors on March 24, 1998, with Mr.
Lunney providing for his employment as President and CEO effective March 23,
1998. The agreement is for a three year term and provides for a base salary of
$130,000 per annum for the first year with an increase in the second year to at
least $140,000 per annum. The base salary may be increased at the discretion of
the board of directors. The agreement provides for a guaranteed bonus of 25% of
the base salary at the end of the first year of its term or on certain changes
in control as defined in the agreement. During subsequent years, Mr. Lunney is
eligible for a bonus equal to 25% of the base salary conditioned on Mr. Lunney
meeting certain objectives established by the board of directors. In addition,
the agreement provides a $600 per month car allowance. We may terminate Mr.
Lunney's employment with or without cause, but termination without cause (other
than disability or death) would result in a lump sum severance payment ranging,
depending on length of service, from six to twelve months salary plus any
prorated earned bonuses. Also, upon a change of control, as defined in the
agreement, Mr. Lunney may elect to terminate employment and obtain a lump sum
severance payment equal to the base salary for the remaining months of the
agreement. We have granted Mr. Lunney options to purchase 350,000 common shares,
116,667 vesting on March 23, 1998 and the balance vesting equally at the end of
twelve and twenty-four months from the date of the agreement, subject to earlier
vesting in the event of a change in our control.
PHILIP MORETTINI. We entered into an employment agreement dated as of July
28, 1997 and approved by our directors on August 18, 1997, with Mr. Morettini
providing for his employment as Vice President of Sales and Marketing. The
agreement is for a three year term providing for a base salary of $110,000 per
annum for the first year and not less than $110,000
53
<PAGE> 56
per annum during the second and third years of the agreement. The base salary
may be increased at the discretion of the board of directors. The agreement
provides for a bonus up to 50% of the annual base consideration for the
applicable year. We may terminate Mr. Morettini's employment with or without
cause, but termination without cause (other than disability or death) would
result in a lump sum severance payment equal to four months of his then current
base salary. If within twelve months of a change in control, as defined in the
agreement, Mr. Morettini's employment is terminated for other than cause or if
Mr. Morettini refuses to accept or voluntarily resigns from a position other
than a qualified position, as that term is defined in the agreement, then he
will receive a lump sum severance payment equal to twelve months of his then
current salary. Under the agreement, we granted Mr. Morettini options to
purchase 300,000 common shares, 30,000 vesting on July 28, 1997 and the balance
vesting one-third per year starting July 28, 1998, subject to certain
performance standards. Options may vest earlier subject to the discretion of the
board of directors.
LOWELL W. GIFFHORN. We entered into an employment agreement dated as of
July 23, 1998 with Mr. Giffhorn providing for his employment as our Chief
Financial Officer. The agreement is for a three year term providing for a base
salary of $110,000 per annum for the first year and not less than $110,000 per
annum during the second and third years of the agreement. The base salary may be
increased at the discretion of the board of directors. The agreement provides
for a bonus up to 50% of the annual base consideration for the applicable year.
We may terminate Mr. Giffhorn's employment with or without cause, but
termination without cause (other than disability or death) would result in a
lump sum severance payment equal to four months of his then current base salary.
If within twelve months of a change in control, as defined in the agreement, Mr.
Giffhorn's employment is terminated for other than cause or if Mr. Giffhorn
refuses to accept or voluntarily resigns from a position other than a qualified
position, as that term is defined in the agreement, he will receive a lump sum
severance payment equal to twelve months of his then current salary.
JAYANTA K. MAITRA. We entered into an employment agreement dated January
1, 1997 with Mr. Maitra providing for his employment as Vice President of
Engineering. The agreement is for a three year term providing for a base salary
of $104,400 per year with an increase in the second and third years as
recommended by the President and Chief Executive Officer and approved by the
board of directors. Mr. Maitra's salary was increased to $120,000 for the second
year. The agreement provides for incentive bonuses in certain instances of up to
50% of the total yearly base compensation. We may terminate Mr. Maitra's
employment with or without cause, but termination without cause (other than
disability or death) during the first year of the agreement would result in a
lump sum severance payment equal to twelve months salary. Under the agreement,
we originally granted Mr. Maitra options to purchase 500,000 common shares,
50,000 vesting on December 26, 1996 and the balance vesting one-third per year
starting December 31, 1997 subject to certain performance standards. As a result
of not meeting the performance standards, the board of directors canceled
300,000 of such options. Options may vest earlier subject to the discretion of
the board of directors.
54
<PAGE> 57
PRINCIPAL SHAREHOLDERS
The following table sets forth, as of June 14, 1999, the stock ownership
of each officer and director of ours, of all officers and directors of ours as a
group, and of each person known by us to be a beneficial owner of 5% or more of
our common stock. Except as otherwise noted, each person listed below is the
sole beneficial owner of the shares and has sole investment and voting power
over such shares. No person listed below has any option, warrant or other right
to acquire additional securities of ours, except as otherwise noted.
<TABLE>
<CAPTION>
Name and Address of Amount & Nature
Title of Class Beneficial Owner of Beneficial Owner Percent of Class
- -------------- ---------------- ------------------- ----------------
<S> <C> <C> <C>
Common Stock par
value $.00001 Gloria Felcyn, CPA 9,092,535 (1) 21.6%
14395 Saratoga Ave.,
Suite 100
Saratoga, CA 95070
Same Helmut Falk Family 6,092,535 (3) 14.5%
Trust
Gloria Felcyn,
Trustee
14395 Saratoga Ave.,
Suite 110
Saratoga, CA 95070
Same Elwood G. Norris 4,252,500 (4) 10.1%
10989 Via Frontera
San Diego, CA 92127
Same nanoTronics 3,000,000 (2) 7.1%
Corporation
Attn: Gloria Felcyn,
CPA
14395 Saratoga Ave.,
Suite 110
Saratoga, CA 95070
Same Jayanta K. Maitra 298,095 (4) *
10989 Via Frontera
San Diego, CA 92127
Same James T. Lunney 233,334 (5) *
10989 Via Frontera
San Diego, CA 92127
Same Donald R. Bernier 125,000 (4) *
10989 Via Frontera
San Diego, CA 92127
Same Philip Morettini 121,000 (4) *
10989 Via Frontera
San Diego, CA 92127
Same
Lowell W. Giffhorn 120,000 (5) *
10989 Via Frontera
San Diego, CA 92127
</TABLE>
55
<PAGE> 58
<TABLE>
<CAPTION>
Name and Address of Amount & Nature
Title of Class Beneficial Owner of Beneficial Owner Percent of Class
- -------------- ---------------- ------------------- ----------------
<S> <C> <C> <C>
Same Robert Putnam 75,000 (4) *
10989 Via Frontera
San Diego, CA 92127
Same Helmut Falk, Jr. 50,000 (5) *
10989 Via Frontera
San Diego, CA 92127
Same Frederick G. Thiel 50,000 (5) *
10989 Via Frontera
San Diego, CA 92127
Same Richard G. Blum 50,000 (5) *
10989 Via Frontera
San Diego, CA 92127
Same All directors & 5,374,929 (6) 12.8%
officers
as a group (10
persons)
</TABLE>
- ----------
* Less than 1%.
(1) As trustee of the Helmut Falk Family Trust and executor of the Helmut Falk
estate, Ms. Felcyn effectively controls the shares described in Notes 2
and 3 below.
(2) These shares have been issued but are subject to an escrow arrangement as
described in "Certain Transactions." The shares were originally issued to
nanoTronics in connection with the ShBoom technology acquisition.
(3) These shares remain from 5,000,000 non-escrowed shares and 2,000,000
shares released from escrow, which were issued to nanoTronics in
connection with the ShBoom technology acquisition. These shares were
subsequently transferred to the Helmut Falk Family Trust.
(4) For Mr. Norris, the amount includes 100,000 shares, for each of Mssrs.
Bernier and Putnam the amount includes 50,000 shares, for Mr. Maitra the
amount includes 110,753 shares, and for Mssrs. Morettini the amount
includes 120,000 shares issuable upon the exercise of immediately
exercisable outstanding stock options granted pursuant to the 1996 and
1992 Stock Option Plans.
(5) Consists entirely of shares issuable upon the exercise of outstanding
stock options.
(6) Includes 4,449,842 shares issued and outstanding and 934,087 shares
issuable upon exercise of stock options.
CERTAIN TRANSACTIONS
There were no transactions, or series of transactions, during fiscal
1997 or 1998, nor are there any currently proposed transactions, or series of
transactions, to which we are a party, in which the amount exceeds $60,000, and
in which to our knowledge any director, executive officer, nominee, five percent
or greater shareholder, or any member of the immediate family of any of the
foregoing persons, have or will have any direct or indirect material interest
other than
56
<PAGE> 59
as described below.
Based on the asset purchase agreement and plan of reorganization dated
June 22, 1994 between Patriot, nanoTronics Corporation and Helmut Falk, we
issued a total of 10,000,000 restricted common shares to nanoTronics, 5,000,000
of which are a contingent payment subject to the terms of an earnout escrow.
These shares were issued in consideration of technology acquired. nanoTronics
was formed in 1991 and acquired certain base technology for a simplified 32-bit
microprocessor integrated on a single chip with merged stack/register
architecture. nanoTronics expended in excess of $1.9 million (unaudited) while
engaged in further development of that technology and produced from the basic
architecture an enhanced microprocessor (ShBoom-architecture microprocessor). In
connection with the acquisition, we also acquired certain fixed assets including
a SunSparc 2 workstation and various terminals, peripheral devices and software.
A majority of the expenditures by nanoTronics consisted of microprocessor and
related software development costs. The result of these efforts was a successful
initial fabrication of the microprocessor in early 1994 demonstrating technical
feasibility of the ShBoom architecture. nanoTronics also expended funds on the
preparation and prosecution of patent applications.
The shares were issued to nanoTronics of which Falk was the sole
shareholder. Although 5,000,000 of the shares issued were subject to the terms
of an earnout escrow, as more fully described below, the shares are issued for
the purpose of dividends and voting. Prior to the transaction, Mr. Falk was an
unaffiliated person with respect to us. At the time of issuance the 10,000,000
common shares represented approximately 36% of our total issued and outstanding
shares.
Although the transaction did not result in a majority change in our board
of directors, or a majority change in our stock ownership, the issuance of new
stock resulted in a large percentage ownership controlled by one entity with the
ability to have significant influence over our future affairs.
Based on the terms of the purchase agreement, 5,000,000 of the common
shares were issued to nanoTronics subject to an earnout escrow arrangement as a
contingent purchase price. The terms of the escrow arrangement, as defined in
the purchase agreement, provides for the earnout from escrow of 500,000 common
shares for each $500,000 of Patriot revenues commencing June 1, 1994 and ending
May 31, 1999. The purchase agreement also provides for full earnout on other
major corporate events including a sale of substantially all our assets, certain
mergers, combinations or consolidations, certain tender offers and upon a
liquidation or dissolution. Any shares not earned by May 31, 1999 would be
canceled. The shares may be sold, assigned or transferred within the escrow
arrangement but would still be subject to the escrow terms. As of May 31, 1999:
- 2,000,000 shares had been released from escrow,
- an additional 2,000,000 shares have been earned and charged to
compensation costs but remain in escrow pending the resolution
of litigation between us, nanoTronics, and
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<PAGE> 60
the Fish Family Trust, and
- 1,000,000 shares will be returned to us since the earnout
expires as of May 31, 1999 and the revenue was not sufficient
to earn this portion of the escrowed shares.
We have granted certain registration and information rights with respect
to the shares issued to nanoTronics, such rights being assignable to Falk and
the Fish Family Trust (such trust having certain rights to become a shareholder
in nanoTronics). We have been advised that nanoTronics has been liquidated with
the 10,000,000 shares in the process of being transferred to the Helmut Falk
Family Trust which is entitled to the same registration rights. We are obligated
to use our best efforts to effect a registration upon written request up to two
times subject to certain limitations. We are also obligated to include the
shares, subject to certain limitations, in any underwriting and in any other
registration filed by us.
During January 1999 through April 1999, we entered into four short-term
notes with Gloria Felcyn, the trustee for the Falk Family Trust, accumulating
$175,000 with maturity dates ranging from July 18, 1999 to August 17, 1999. On
the issuance of each of the first three notes, we released 500,000 shares from
the earnout escrow. We are holding the remaining 2,000,000 shares earned and
subject to the earnout escrow pending resolution of the Fish Family Trust
lawsuit. Upon the resolution of the lawsuit, the remaining shares held in escrow
will either be released to the Falk Family Trust, used either partially or in
their entirety as a means of settling the lawsuit, or be returned to us. The
shares being held in escrow were recorded as additional compensation costs
during the period in which the earnout was satisfied.
We entered into an agreement to exchange technology for stock dated August
8, 1989 with Mr. Norris. Under the agreement, Mr. Norris is entitled to a
royalty equal to two and one-half percent (2.5%) of the gross revenues received
by us directly or indirectly from exploitation of our ground penetrating radar
technology (up to a maximum royalty of $400,000). Mr. Norris was given an
advance royalty payment of $17,000. Mr. Norris also is entitled to a cash bonus
of $50,000 within 45 days after we successfully demonstrate a working prototype
of a ground penetrating radar unit meeting specified performance criteria and a
request for such bonus is made to the board of directors and approved.
TRADING MARKET AND RELATED MATTERS
Our common stock is traded in the over-the-counter market and is quoted on the
NASD OTC Bulletin Board system maintained by the National Association of
Securities Dealers, Inc. Prices reported represent prices between dealers, do
not include markups, markdowns or commissions and do not necessarily represent
actual transactions. The market for our shares has been sporadic and at times
very limited.
The following table sets forth the high and low bid quotations for the
common stock for the nine months ended February 28, 1999 and the fiscal years
ended May 31, 1998 and 1997.
58
<PAGE> 61
<TABLE>
<CAPTION>
HIGH LOW
<S> <C> <C>
Nine Months Ended February 28, 1999
First Quarter $0.77 $0.41
Second Quarter 0.81 0.38
Third Quarter 0.60 0.30
Fiscal Year Ended May 31, 1998
First Quarter $2.31 $1.36
Second Quarter 1.78 1.00
Third Quarter 1.15 0.53
Fourth Quarter 1.36 0.72
Fiscal Year Ended May 31, 1997
First Quarter $3.50 $1.75
Second Quarter 2.44 1.75
Third Quarter 1.83 0.94
Fourth Quarter 1.62 0.94
</TABLE>
We have approximately 254 shareholders of record as of June 14, 1999. At
June 14, 1999 there were 40,861,120 shares of common stock issued and
outstanding. We have never paid a cash dividend on our common stock and do not
expect to pay one in the foreseeable future.
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 60,000,000 shares of common
stock, $.00001 par value per share. At June 14, 1999, a total of 40,861,120
common shares were issued and outstanding. The holders of common stock are
entitled to one vote for each share held. The affirmative vote of a majority of
votes cast at a meeting which commences with a lawful quorum is sufficient for
approval of most matters upon which shareholders may or must vote, including the
questions presented for approval or ratification at the Annual Meeting. However,
removal of a director from office or repeal of the certificate of incorporation
in its entirety require the affirmative vote of a majority of the total voting
power for approval, and certain other matters (such as shareholder amendment of
the bylaws, and amendment, repeal or adoption of any provision inconsistent with
provisions in the certificate of incorporation regarding indemnification of
directors, officers and others, exclusion of director liability, and our
election not to be governed by statutory provisions concerning business
combinations with interested shareholders) require the affirmative vote of
two-thirds of the total voting power for approval. Common shares do not carry
cumulative voting rights, and holders of more than 50% of the common stock have
the power to elect all directors and, as a practical matter, to control the
company. Holders of common stock are not entitled to preemptive rights, and the
common stock may only be redeemed at our election.
A special meeting of shareholders may be called by or at the request
of:
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<PAGE> 62
- the Chairman of the Board,
- the President or any two directors, and
- persons owning in the aggregate not less than 20% of the
issued and outstanding common shares entitled to vote in
elections for directors.
After the satisfaction of requirements with respect to preferential dividends,
if any, holders of common stock are entitled to receive, pro rata, dividends
when and as declared by the board of directors out of funds legally available
therefor. Upon our liquidation, dissolution or winding-up, after distribution in
full of the preferential amount, if any, to be distributed to holders of the
preferred stock, holders of common stock are entitled to share ratably in our
assets legally available for distribution to our shareholders.
Our board of directors is authorized to issue 5,000,000 shares of
undesignated preferred stock, $.00001 par value, without any further action by
the stockholders. The board of directors may also divide any and all shares of
preferred stock into series and fix and determine the relative rights and
preferences of the preferred stock, such as the designation of series and the
number of shares constituting such series, dividend rights, redemption and
sinking fund provisions, liquidation and dissolution preferences, conversion or
exchange rights and voting rights, if any. Issuance of preferred stock by the
board of directors will result in such shares having dividend and/or liquidation
preferences senior to the rights of the holders of common stock and could dilute
the voting rights of the holders of common stock. There are currently no shares
of preferred stock issued and outstanding.
We have not paid any cash dividends to date, and no cash dividends will be
declared or paid on the common shares in the foreseeable future. Payment of
dividends is solely at the discretion of our board of directors.
Interwest Transfer Company, Inc., 1981 East 4800 South, Suite 100, Salt
Lake City, Utah 84117, acts as our transfer agent and registrar for our common
stock. Their telephone number is (801) 272-9294.
LEGAL MATTERS
Luce, Forward, Hamilton & Scripps LLP, 600 West Broadway Street, Suite
2600, San Diego, California 92101 will pass on the validity of the common stock
offered by us. Luce, Forward, Hamilton & Scripps LLP owns 279,326 shares of our
common stock, which it received in consideration of services rendered. These
shares are offered as part of this prospectus.
EXPERTS
The financial statements and schedules included in this Prospectus have
been audited by BDO Seidman, LLP, independent certified public accountants, to
the extent and for the periods set forth in their reports appearing elsewhere
herein, and are included herein in reliance upon such reports given upon the
authority of said firm as experts in auditing and accounting.
60
<PAGE> 63
Harlan & Boettger, LLP, independent certified public accountants for the
fiscal year ended July 31, 1996, have audited the financial statements of
Metacomp, Inc.. Their report appears elsewhere herein and in the registration
statement. We are including and relying upon such report based on the authority
of said firm as experts in accounting and auditing.
61
<PAGE> 64
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Reports of Independent Certified Public Accountants...................... F-2-F-3
Consolidated Balance Sheet as of May 31, 1998............................ F-4
Consolidated Statements of Operations for the Years Ended
May 31, 1998 and 1997.............................................. F-5
Consolidated Statements of Stockholders' Equity for the Years
Ended May 31, 1998 and 1997........................................ F-6
Consolidated Statements of Cash Flows for the Years ended
May 31, 1998 and 1997.............................................. F-7
Summary of Accounting Policies........................................... F-8-F-12
Notes to Consolidated Financial Statements............................... F-13 -F-25
Consolidated Balance Sheets as of February 28, 1999 (unaudited)
and May 31, 1998 ............................................... F-26
Consolidated Statements of Operations for the nine months and three
months ended February 28, 1999 and 1998 (unaudited) ............ F-27
Consolidated Statements of Cash Flows for the nine months ended
February 28, 1999 and 1998 (unaudited) ......................... F-28
Notes to Consolidated Financial Statements ............................. F-29- F-35
</TABLE>
F-1
<PAGE> 65
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
Patriot Scientific Corporation
San Diego, California
We have audited the accompanying consolidated balance sheet of Patriot
Scientific Corporation as of May 31, 1998 and the related statements of
operations, stockholders' equity and cash flows for each of the years in the two
year period ended May 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. The consolidated
financial statements give retroactive effect to the merger of Patriot Scientific
Corporation and Metacomp, Inc., which has been accounted for as a pooling of
interests as described in Note 1 to the consolidated financial statements. As
discussed in Note 1 to the consolidated financial statements, we did not audit
the financial statements of Metacomp, Inc., the Company's majority owned
subsidiary for its fiscal year ended July 31, 1996, of which total revenues of
$239,501 are included in the consolidated financial statements for the year
ended May 31, 1997. In addition, we did not audit the extraordinary item of
$1,741,700 as discussed in Notes 1 and 11 to the consolidated financial
statements. Those statements were audited by other auditors whose report has
been furnished to us, and our opinion, insofar as it relates to the amounts
incurred for Metacomp, Inc. for the year ended May 31, 1997 is based solely on
the report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above, present fairly, in all
material respects, the financial position of Patriot Scientific Corporation as
of May 31, 1998, and the results of their operations and their cash flows for
each of the years in the two year period ended May 31, 1998 in conformity with
generally accepted accounting principles.
As discussed in Note 15, the accompanying financial statements have been
restated to reflect the effect of a change in the accounting treatment for
escrowed shares of common stock.
/s/ BDO Seidman, LLP
Denver, Colorado
July 17, 1998, except for notes 4 and 15 which are as of June 15, 1999
F-2
<PAGE> 66
(Harlan & Boettger Certified Public Accountants Letterhead)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of METACOMP, INC.:
We have audited the balance sheet of METACOMP, Inc. a California Corporation, as
of July 31, 1996, and the related statements of operations, changes in
shareholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of July 31,
1996, and the results of its operations and its cash flows for the year then
ended in conformity with generally accepted accounting principles.
/s/ Harlan & Boettger
San Diego, California
December 17, 1996
F-3
<PAGE> 67
PATRIOT SCIENTIFIC CORPORATION
Consolidated Balance Sheet
<TABLE>
<CAPTION>
May 31, 1998
- ---------------------------------------------------------------------------------------------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 602,456
Accounts receivable, net of allowance
of $5,000 for uncollectible accounts 593,542
Inventories (Note 2) 230,417
Prepaid expenses 109,365
- ---------------------------------------------------------------------------------------------
Total current assets 1,535,780
Property and equipment, net (Note 3) 453,211
Other assets:
Patents and trademarks, net 196,942
Other 3,721
- ---------------------------------------------------------------------------------------------
Total other assets 200,663
- ---------------------------------------------------------------------------------------------
$ 2,189,654
=============================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 391,184
Accrued liabilities 131,088
Current portion-capital lease obligations (Note 10) 2,179
- ---------------------------------------------------------------------------------------------
Total current liabilities 524,451
- ---------------------------------------------------------------------------------------------
Long-term liabilities:
Capital lease obligations (Note 10) 1,355
5% Convertible term debentures (Note 5) 507,000
- ---------------------------------------------------------------------------------------------
Total liabilities 1,032,806
- ---------------------------------------------------------------------------------------------
Commitments and contingencies (Note 10)
Stockholders' equity (Notes 6, 9 and 11):
Preferred stock, $.00001 par value; 5,000,000 shares
authorized: none outstanding --
Common Stock, $.00001 par value; 40,000,000 shares
authorized: issued and outstanding 37,880,776 379
Additional paid-in capital 20,741,092
Accumulated deficit (19,584,623)
- ---------------------------------------------------------------------------------------------
Total stockholders' equity 1,156,848
- ---------------------------------------------------------------------------------------------
$ 2,189,654
=============================================================================================
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
F-4
<PAGE> 68
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
(SEE NOTE 1)
Years Ended May 31, 1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Net sales (Note 12) $ 1,902,874 $ 1,847,421
Cost of sales:
Product costs 960,688 893,445
Inventory obsolescence 203,000 110,000
- ----------------------------------------------------------------------------------------
Cost of sales 1,163,688 1,003,445
- ----------------------------------------------------------------------------------------
Gross profit 739,186 843,976
Operating expenses:
Research and development 1,607,828 1,367,937
Selling, general and
administrative 4,090,937 2,448,751
Amortization -- 612,333
- ----------------------------------------------------------------------------------------
5,698,765 4,429,021
- ----------------------------------------------------------------------------------------
Operating loss (4,959,579) (3,585,045)
- ----------------------------------------------------------------------------------------
Other income (expenses):
Interest income 61,610 39,302
Interest expense (24,370) (30,491)
Non-cash interest expense
related to convertible
notes (Note 5) (2,592,446) (392,015)
- ----------------------------------------------------------------------------------------
(2,555,206) (383,204)
- ----------------------------------------------------------------------------------------
Net loss before extraordinary
item (7,514,785) (3,968,249)
Extraordinary income (Note 11) -- 1,779,457
- ----------------------------------------------------------------------------------------
Net loss $ (7,514,785) $ (2,188,792)
========================================================================================
Basic and diluted income (loss) per
common share (Note 7):
Before extraordinary item $ (0.24) $ (0.15)
Extraordinary income -- 0.07
- ----------------------------------------------------------------------------------------
Basic and diluted (loss)
per common share $ (0.24) $ (0.08)
========================================================================================
Weighted average number of
common shares outstanding
during the period (Note 7) 31,016,956 27,250,755
========================================================================================
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
F-5
<PAGE> 69
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (See Note 1)
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Years Ended May 31, 1998 and 1997
Common Stock Additional Total
------------------------------- Paid-in Accumulated Stockholders'
Shares Amount Capital Deficit Equity
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, June 1, 1996 30,985,257 $ 310 $ 10,151,024 $ (8,139,346) $ 2,011,988
Exercise of warrants at $1.58
per share 154,883 2 239,499 -- 239,501
Common stock issued for services
at $1.28 per share 22,600 -- 28,927 -- 28,927
Exercise of stock options at $.18 to
$.625 per share 380,486 4 165,857 -- 165,861
Non-cash interest expense related to
convertible notes recorded to
additional paid-in capital (Note 6) -- -- 375,000 -- 375,000
Non-cash compensation expense (Note 6) -- -- 291,180 -- 291,180
Common stock earned under an escrow
agreement for purchased technology
at $1.44 per share (Note 4) -- -- 725,000 725,000
Conversion of 6% Convertible
Subordinated Notes plus interest
at $.85 to $1.27 per share (Note 6) 1,525,103 15 1,517,000 -- 1,517,015
Adjustment for Metacomp Inc.
pooling of interests from year-
end change (Note 1) -- -- - (1,741,700) (1,741,700)
Net loss -- -- - (2,188,792) (2,188,792)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 1997 33,068,329 331 13,493,487 (12,069,838) 1,423,980
==================================================================================================================================
Common stock earned under an escrow
agreement for purchased technology
at $.75-$1.41 per share (Note 4) -- -- 1,995,000 1,995,000
Exercise of stock options at $.18 to
$.875 per share 478,854 5 247,802 247,807
Non-cash interest expense related to
convertible notes recorded to additional
paid-in capital (Note 5) -- -- 2,018,111 2,018,111
Unamortized debt issuance costs
related to convertible notes -- -- (114,100) (114,100)
Conversion of 5% Convertible
term debentures plus interest
at $.50 to $1.09 per share (Note 5) 4,333,593 43 2,523,292 2,523,335
Value of warrants issued (Note 6) -- -- 577,500 577,500
Net loss -- -- - (7,514,785) (7,514,785)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, May 31, 1998 37,880,776 $ 379 $ 20,741,092 $ (19,584,623) $ 1,156,848
==================================================================================================================================
</TABLE>
See accompanying summary of accounting policies and notes to
consolidated financial statements.
F-6
<PAGE> 70
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Years Ended May 31, 1998 1997
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $(7,514,785) $(2,188,792)
Adjustments to reconcile net loss
to cash used in operating activities:
Adjustment for Metacomp Inc. pooling of
interests from year-end change (Note 1) -- (1,741,700)
Amortization and depreciation 341,072 836,692
Provision for doubtful accounts 41,761 5,000
Provision for inventory obsolescence 203,000 110,000
Common stock and warrants issued for services 33,500 28,927
Non -cash interest expense related to
convertible notes 2,096,446 392,015
Non-cash interest expense related to warrants 496,000 --
Amortization of debt issuance costs 140,000 45,000
Non -cash compensation expense 1,995,000 1,016,180
Changes in:
Accounts receivable (375,183) (65,719)
Inventories 96,116 (28,377)
Prepaid and other assets 7,940 (23,163)
Accounts payable and accrued expenses 16,053 (74,231)
- ---------------------------------------------------------------------------------------------
Net cash used in operating activities (2,423,080) (1,688,168)
- ---------------------------------------------------------------------------------------------
INVESTING ACTIVITIES -
Purchase of property, equipment and patents (417,225) (238,447)
FINANCING ACTIVITIES:
Principal payments on notes payable and
long-term debt (2,721) (320,016)
Proceeds from issuance of common stock
and exercise of common stock warrants
and options 247,807 405,362
Proceeds from issuance of convertible notes 3,000,000 1,500,000
Payments for debenture costs (280,000) (45,000)
- ---------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,965,086 1,540,346
- ---------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 124,781 (386,269)
CASH AND CASH EQUIVALENTS, beginning of year 477,675 863,944
- ---------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, end of year $ 602,456 $ 477,675
==============================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Convertible notes and accrued interest
exchanged for common stock $ 2,409,236 $ 1,500,000
Cash payments for interest 383 30,491
- ---------------------------------------------------------------------------------------------
</TABLE>
See accompanying summary of accounting policies and notes
to consolidated financial statements.
F-7
<PAGE> 71
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Patriot Scientific Corporation (the "Company") is engaged in the development,
marketing, and sale of patented microprocessor technology and high-performance
high-speed data communication products. The Company also owns and is developing
innovative radar and antenna technology.
BASIS OF PRESENTATION AND CONSOLIDATION
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and include the accounts of the
Company, its majority owned subsidiaries, Metacomp, Inc. ("Metacomp") and Plasma
Scientific Corporation. All material intercompany transactions and balances have
been eliminated in consolidation.
As described in Note 1, effective December 26, 1996, the Company acquired 96.9%
of the common stock of Metacomp. The business combination was accounted for as a
pooling of interests and, accordingly, the Company's financial statements have
been presented to include the results of Metacomp as though the business
combination occurred as of June 1, 1995. The minority interest is not shown
separately in the Consolidated Financial Statements as it is not material.
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
The Company's financial instruments that are exposed to concentrations of credit
risk consist primarily of cash and cash equivalents and accounts receivable.
The Company's cash equivalents are placed in high quality money market accounts
with major financial institutions and high grade short-term commercial paper.
The investment policy limits the Company's exposure to concentrations of credit
risk. Money market accounts are federally insured; however, commercial paper is
not insured. The Company has not experienced any losses in such accounts.
Concentrations of credit risk with respect to accounts receivable are limited
due to the wide variety of customers and markets which comprise the Company's
customer base, as well as their dispersion across many different geographic
areas. The Company routinely assesses the financial strength of its customers
and, as a consequence, believes that its accounts receivable credit risk
exposure is limited. Generally, the Company does not require collateral or other
security to support customer receivables. As of May 31, 1998, the Company had
approximately 35% and 27% in accounts receivable from two customers.
The carrying amounts of financial instruments including cash and cash
equivalents, accounts receivable, accounts payable, accrued expenses, capital
leases and convertible debt approximated fair value because of the immediate or
short-term maturity of these instruments.
F-8
<PAGE> 72
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
Inventories consist of raw materials, work in process and finished goods and are
valued at the weighted average cost method, which approximates cost on a
first-in, first-out basis, not in excess of market value.
PROPERTY, EQUIPMENT AND DEPRECIATION
Property and equipment are stated at cost. Depreciation is computed over the
estimated useful life of three to five years using the straight line method. The
Company follows the provisions of the Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to
be Disposed Of." Long-lived assets and certain identifiable intangibles to be
held and used by the Company are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The Company continuously evaluates the recoverability of its
long-lived assets based on estimated future cash flows from and the estimated
liquidation value of such long-lived assets, and provides for impairment if such
undiscounted cash flows are insufficient to recover the carrying amount of the
long-lived asset.
PURCHASED TECHNOLOGY
In accordance with the provisions of FASB Interpretation No. 4, "Applicability
of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase
Method", purchased semiconductor microprocessor technology that is determined to
have alternative future uses is capitalized at cost. Effective June 1, 1994, the
Company began amortizing such technology using the straight-line method over its
estimated useful life of three years (See Note 4). As of May 31, 1998, the
purchased technology was fully amortized.
Purchased technology is assessed periodically for impairment. The amount of
impairment, if any, is charged to operations. The Company recovers its
investments in purchased technology based upon net cash flows from future sales
and license agreements.
PATENTS AND TRADEMARKS
Patents and trademarks are carried at cost less accumulated amortization and are
amortized over their estimated useful lives of four years. The carrying value of
patents and trademarks is periodically reviewed and impairments, if any, are
recognized when the expected future benefit to be derived from individual
intangible assets is less than its carrying value determined based on the
provisions of SFAS No. 121 as discussed above.
REVENUE RECOGNITION
Revenue is recognized upon the shipment of product to the customer. Licensing
and royalty income is recognized when earned.
F-9
<PAGE> 73
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
INCOME TAXES
The Company accounts for income taxes under SFAS No. 109. Temporary differences
are differences between the tax basis of assets and liabilities and their
reported amounts in the financial statements that will result in taxable or
deductible amounts in future years.
NET LOSS PER SHARE
At May 31, 1998, the Company implemented SFAS No. 128, "Earnings Per Share."
SFAS No. 128 provides for the calculation of "Basic" and "Diluted" earnings per
share. Basic earnings per share includes no dilution and is computed by dividing
income available to common stockholders by the weighted average number of common
shares outstanding for the period. Diluted earnings per share reflects the
potential dilution of securities that could share in the earnings of an entity,
similar to fully diluted earnings per share. All prior earnings per share data
has been restated to reflect the requirements of SFAS No.128. The adoption of
SFAS No. 128 had no effect on the Company's previously reported earnings per
share.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
During the quarter ended May 31, 1998, based upon information then available,
the Company revised its estimates regarding the recovery of certain inventories.
As a result, the Company increased existing reserves for obsolescence by
approximately $203,000.
STOCK OPTIONS
The Company applies Accounting Principles Board ("APB") Opinion 25, "Accounting
for Stock Issued to Employees," and related Interpretations in accounting for
all stock option plans. Under APB Opinion 25, compensation cost has been
recognized for stock options granted to employees when the option price is less
than the market price of the underlying common stock on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net income as if compensation cost for
the Company's stock option plans had been determined in accordance with the fair
value based method prescribed in SFAS No. 123. To provide the required pro forma
information, the Company estimates the fair value of each stock option at the
grant date by using the Black-Scholes option-pricing model.
F-10
<PAGE> 74
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
STATEMENT OF CASH FLOWS
For purposes of the statement of cash flows, the Company considers all highly
liquid investments purchased with an original maturity of three months or less
to be cash equivalents.
RECENT ACCOUNTING PRONOUNCEMENTS
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income" and SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 130 establishes standards for reporting and display of comprehensive income,
its components and accumulated balances. Comprehensive income is defined to
include all changes in equity except those resulting from investments by owner
and distributions to owners. Among other disclosures, SFAS No. 130 requires that
all items that are required to be recognized under current accounting standards
as components of comprehensive income be reported in a financial statement that
displays with the same prominence as other financial statements. SFAS No. 131
supersedes SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes standards on the way that public companies
report financial information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial statements issued to the public. It also
establishes standards for disclosure regarding products and services, geographic
areas and major customers. SFAS No. 131 defines operating segments as components
of a company about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance.
SFAS 130 and 131 are effective for financial statements for periods beginning
after December 15, 1997 and require comparative information for earlier years to
be restated. Because of the recent issuance of the standards, management has
been unable to fully evaluate the impact, if any, the standards may have on
future financial statement disclosures. Results of operations and financial
position, however, will be unaffected by implementation of these standards.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits" which standardizes the disclosure
requirements for pensions and other postretirement benefits and requires
additional information on changes in the benefit obligations and fair values of
plan assets that will facilitate financial analysis. SFAS No. 132 is effective
for years beginning after December 15, 1997 and requires comparative information
for earlier years to be restated, unless such information is not readily
available. Management believes the adoption of this statement will have no
material impact on the Company's financial statements.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
market value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. The key criterion for hedge
accounting is that the hedging
F-11
<PAGE> 75
PATRIOT SCIENTIFIC CORPORATION
SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
relationship must be highly effective in achieving offsetting changes in fair
value or cash flows. SFAS No. 133 is effective for fiscal periods beginning
after June 15, 1999. Management believes the adoption of this statement will
have no material impact on the Company's financial statements.
RECLASSIFICATIONS
Certain items included in the 1997 financial statements have been reclassified
to conform to the current year presentation.
F-12
<PAGE> 76
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ACQUISITION OF METACOMP, INC. COMMON STOCK
On December 26, 1996, the Company acquired 96.9% of the common stock of Metacomp
in exchange for 1,272,068 shares of the Company's common stock. Metacomp
designs, manufactures, and sells high-performance high-speed data communication
products. The business combination was accounted for as a pooling of interests.
Accordingly, the Company's financial statements were restated to include the
results of Metacomp for all periods presented. Metacomp's fiscal year-end was
changed from July 31 to May 31 to conform to the Company's fiscal year-end.
Based on the difference in fiscal year-ends, results of operations for the two
months ended July 31, 1996 were included in the consolidated statements of
operations for both years ended May 31, 1997 and 1996. For the two months ended
July 31, 1996, Metacomp recorded total revenues of $239,501, a net loss before
extraordinary item of $37,759, extraordinary income of $1,779,457 and net income
after extraordinary item of $1,741,700. The accompanying consolidated statements
of stockholders' equity and cash flows for the year ended May 31, 1997, have
also been adjusted to eliminate the net income after extraordinary item. The
extraordinary income was the primary source of income for these two months.
Separate net sales, net income and related per share amounts of the merged
entities through the date of the business combination are presented in the
following table. In addition, the table includes unaudited pro forma net income
and net income per share amounts as of the date of the business combination
which reflect the elimination of the nonrecurring merger costs and expenses.
<TABLE>
<CAPTION>
1997
- --------------------------------------------------------------
<S> <C>
Net sales
Patriot $ 19,362
Metacomp 874,377
- --------------------------------------------------------------
Total $ 893,739
- --------------------------------------------------------------
Net income (loss)
Patriot $(1,202,485)
Metacomp before extraordinary income 40,706
Metacomp extraordinary income 1,779,457
- --------------------------------------------------------------
Pro forma net income 617,678
Merger costs and expenses (30,000)
Interest income (6,000)
Interest expense 15,625
- --------------------------------------------------------------
Net income, as reported $ 597,303
- --------------------------------------------------------------
Basic income per common share
As reported $ 0.02
Pro forma $ 0.02
</TABLE>
Merger costs and expenses consisted of legal and accounting fees.
F-13
<PAGE> 77
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. INVENTORIES Inventories at May 31, 1998 consisted of the following:
<TABLE>
<CAPTION>
----------------------------------------------------
<S> <C>
Component parts $ 418,502
Work in process 60,136
Finished goods 116,779
------------
595,417
Reserve for obsolescence (365,000)
------------
$ 230,417
----------------------------------------------------
</TABLE>
3. PROPERTY AND Property and equipment consisted of the following at May 31,
EQUIPMENT 1998:
<TABLE>
<CAPTION>
----------------------------------------------------------
<S> <C>
Computer equipment and software $1,101,418
Furniture and fixtures 286,732
Laboratory equipment 197,534
----------------------------------------------------------
1,585,684
Less accumulated depreciation and amortization 1,132,473
----------------------------------------------------------
Net property and equipment $ 453,211
----------------------------------------------------------
</TABLE>
Depreciation expense was approximately $281,130 and
$184,055 for the years ended May 31, 1998 and 1997.
At May 31, 1998, property and equipment includes certain
equipment under capital lease agreements with an
original cost of $36,427 and accumulated depreciation of
$28,084.
4. PURCHASED TECHNOLOGY
SEMICONDUCTOR MICROPROCESSOR TECHNOLOGY
Effective May 31, 1994, the Company acquired certain proprietary semiconductor
microprocessor technology (the "ShBoom Technology") and related computer
software from a corporation in exchange for 10,000,000 restricted shares of the
Company's common stock (5,000,000 of which were originally placed in escrow
subject to an earnout arrangement as discussed below).
F-14
<PAGE> 78
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The cost of this technology of $1,875,000 was based upon the estimated current
fair market value of the 5,000,000 non-contingent shares of the Company's common
stock issued under this agreement and was amortized over its estimated useful
life of three years. The remaining 5,000,000 shares issued for this technology
were subject to an earnout escrow arrangement. As such, when the escrowed shares
are earned, they are charged to compensation costs. The terms of the escrow
arrangement provide for an earnout formula of 500,000 shares for each $500,000
of revenues earned by the Company during the period from June 1, 1994 through
May 31, 1999. Additionally, this agreement also provides for the full earnout of
these shares if during the earnout period there is (i) any sale of the assets of
the Company, (ii) a business combination with another entity where the Company
is not the surviving entity, (iii) at least 75% of the Company's stock is
tendered to another organization, or (iv) a liquidation or dissolution of the
Company. Any of the contingent shares not earned by May 31, 1999 would be
returned to the Company and canceled.
During the years ended May 31, 1997 and 1998, 500,000 shares and 2,000,000
shares, respectively, were earned as a result of the arrangement and $725,000
and $1,995,000, respectively, were charged to compensation costs. The 500,000
shares that were earned during the year ended May 31, 1997 were released during
the current year. At May 31, 1998, 4,500,000 shares remain in escrow of which
2,000,000 shares have been earned and charged to compensation cost but remain in
escrow pending the outcome of a lawsuit between the Company, nanoTronics and the
Fish Family Trust as discussed in Note 14 to the Consolidated Financial
Statements. Upon the resolution of the lawsuit, the remaining shares held in
escrow will either be released to the Falk Family Trust, used either partially
or in their entirety as a means of settling the lawsuit, or be returned to the
Company. At May 31, 1998, the 2,500,000 shares that have not met the earnout
arrangement have been excluded from the calculation of basic or diluted earnings
per share.
RADAR TECHNOLOGY
Effective August 8, 1989, the Company acquired certain proprietary ground
penetrating radar ("GPR") technology from a current director of the Company,
primarily in exchange for 5,000,000 shares of the Company's common stock. Such
shares were subject to an escrow agreement and were releaseable to the director
under various specified conditions including the Company's subsequent merger or
business combination with any third party.
As a result of the Company's acquisition of the ShBoom, these 5,000,000 shares
were released to the director and the escrow agreement was terminated. Effective
May 31, 1994, additional costs totaling $1,875,000 of this previously purchased
GPR technology was recorded as compensation costs due to the release of the
5,000,000 shares. Such cost was based upon the estimated current fair market
value of the Company's common stock.
Additionally, under the terms of the agreement to acquire the GPR technology,
the director is to be paid a royalty equal to 2.5% of all gross revenues
received from the GPR technology, up to a
F-15
<PAGE> 79
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
maximum of $400,000. The director also is to receive a $50,000 bonus upon the
successful demonstration of a working prototype of the technology meeting
specified performance criteria. As of May 31, 1998, no amounts were due under
this agreement; however, an advance of $17,000 against the royalty was paid at
the inception of the agreement.
5. 5% CONVERTIBLE TERM DEBENTURES
In June 1997, the Company issued to a limited number of investors for cash an
aggregate of $2,000,000 of unsecured 5% Convertible Term Debentures due June 2,
1999 ("Debentures") and Stock Purchase Warrants ("Warrants") with a right to
purchase an aggregate 611,733 shares of common stock, par value $.00001 per
share, at an exercise price of $1.69125. In November 1997, the Company issued to
the same investors for cash an aggregate of $1,000,000 of Debentures due June 2,
1999 and Warrants with a right to purchase an aggregate 305,867 shares of common
stock, par value $.00001 per share, at an exercise price of $1.50. The principal
and interest amount of each Debenture may, at the election of the holder, be
converted in whole or in part and from time to time into fully paid and
nonassessable shares of common stock, $.00001 par value, of the Company, at a
price which is the lower of (i) $1.1646 per share or (ii) depending on the
number of days the Debentures have been held after June 2, 1997, from 75% to 91%
of the average of the closing bid prices for the common stock for the ten
consecutive trading days ending on the trading day immediately preceding such
conversion date. If the Debentures have not been converted into common shares of
the Company by June 2, 1999, under certain conditions, the Debentures will
automatically be converted into shares of the common stock of the Company. As of
May 31, 1998, $2,445,000 of the Debentures and $78,335 of the accrued interest
thereon had been converted into 4,333,593 common shares of the Company.
Convertible debt instruments which are convertible at a discount to market are
accounted for by treating such discount as additional interest expense. The
Company computed the amount of the discount based on the difference between the
conversion price and fair value of the underlying common stock on the dates the
Debentures were issued. The Company recorded $2,018,111 of additional paid-in
capital for the discount related to the embedded interest in the Debentures
during fiscal 1998. The same amount, $2,018,111, was expensed for fiscal 1998
and is included under the caption "Non-cash interest expense related to
convertible notes" in the accompanying Consolidated Statements of Operations.
The warrants to purchase 917,600 shares of common stock were valued at $544,000.
Such amount was originally recorded as a reduction of the carrying amount of the
Debentures with an offset to Paid-In Capital. The discount is amortized as
additional interest expense over the term of the Debentures. In the fourth
quarter of fiscal 1998, $496,000 had been recorded as interest expense. The
balance of $48,000 is reflected as a reduction of the Debenture balance of
$555,000.
F-16
<PAGE> 80
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. STOCKHOLDERS' EQUITY
PRIVATE OFFERINGS AND WARRANTS
During fiscal 1997, a total of 154,883 shares of the Company's common stock were
issued upon the exercise of outstanding warrants which had been issued in fiscal
1996. The net proceeds from the exercise were $239,501.
During fiscal 1997, the Company issued for cash an aggregate of $1,500,000 of
unsecured 6% Convertible Subordinated Promissory Notes due September 30, 1998
("Notes"). The principal and interest amount of each Note could at the election
of the noteholder be converted one or more times into fully paid and
nonassessable shares of common stock, $.00001 par value, ("Shares") of the
Company, at a price which was the lower of (i) $2.00 per share or (ii) 80% of
the average of the five days market price prior to conversion but not less than
$0.80 per share. As of May 31, 1997, all Notes plus accrued interest had been
converted into 1,525,103 shares of common stock of the Company.
Convertible debt instruments which are convertible at a discount to market
should be accounted for by treating such discount as additional interest
expense. The Company computed the amount of the discount based on the difference
between the conversion price and fair value of the underlying common stock on
the date the Notes were issued. In 1997, the Company recorded $375,000 of
additional paid-in capital for the discount related to the embedded interest in
the Notes. This same amount was expensed during fiscal 1997 under the caption
"Non-cash interest expense related to convertible notes" in the accompanying
Consolidated Statements of Operations.
During fiscal 1998, the Company issued warrants to purchase 1,147,600 common
shares of stock with exercise prices ranging from $1.25 to $7.50 per share. All
warrants were outstanding at May 31, 1998. Included in this amount are warrants
to purchase 917,600 common shares related to the Debentures discussed in Note 5
to the consolidated financial statements. The Company valued warrants issued in
fiscal 1998 at $577,500.
1992 INCENTIVE STOCK OPTION PLAN ("ISO")
The Company has an ISO Plan, expiring May 20, 2002, reserving for issuance
750,000 shares of the Company's common stock. The ISO Plan provides for grants
to either full or part time employees, at the discretion of the board of
directors, options to purchase common stock of the Company at a price not less
than the fair market value of the shares on the date of grant. In the case of a
significant stockholder, the option price of the share is not less than 110
percent of the
F-17
<PAGE> 81
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
fair market value of the share on the date of grant. Any options granted under
the ISO Plan must be exercised within ten years of the date they were granted
(five years in the case of a significant stockholder).
1992 NON-STATUTORY STOCK OPTION PLAN("NSO")
The Company has an NSO Plan, expiring May 20, 2002, reserving for issuance
750,000 shares of the Company's common stock. The NSO Plan provides for grants
to either full or part time employees, at the discretion of the board of
directors, options to purchase common stock of the Company at a price not less
than the fair market value of the shares on the date of grant. Any options
granted under the NSO Plan must be exercised within ten years of the date they
were granted.
1995 EMPLOYEE STOCK COMPENSATION PLAN ("ESC")
Effective October 1995, the Company adopted the ESC Plan, expiring September 30,
1998, reserving for issuance 250,000 shares of the Company's common stock. The
ESC Plan provides for compensation awards of the Company's common stock to
employees (as defined), at the discretion of the board of directors. During
fiscal 1997, the Company issued 22,600 shares of common stock under the Plan
recording compensation costs of $28,927 for awards valued at an estimated fair
market value of $1.28 per share. During fiscal 1998, no shares were issued under
this plan. As of May 31, 1998, 32,400 shares remain available for granting under
this plan.
1996 STOCK OPTION PLAN
Effective March 1996, the Company adopted the 1996 Stock Option Plan, which was
amended by the Stockholders in December 1997, expiring March 24, 2006, reserving
for issuance 4,000,000 shares of the Company's common stock. The 1996 Stock
Option Plan provides for grants to either full or part time employees, at the
discretion of the board of directors, options to purchase common stock of the
Company at a price not less than the fair market value on the date of grant for
incentive stock options or not less than 85% of the fair market value on the
date of grant for non-qualified stock options. In the case of a significant
stockholder, the option price of the share is not less than 110 percent of the
fair market value of the shares on the date of grant. Any option granted under
the 1996 Stock Option Plan must be exercised within ten years of the date they
are granted (five years in the case of a significant stockholder). During the
fiscal year ended May 31, 1997, the Company issued options to purchase 1,713,000
shares of stock under the non-qualified provisions of the plan at an exercise
price of 85% of the fair market value on the date of grant and recorded
corresponding non-cash compensation in the amount of $291,180. During the fiscal
year ended May 31, 1998, the Company issued options to purchase 1,511,000 shares
of stock at market value.
F-18
<PAGE> 82
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the Company to
provide pro forma information regarding net loss and net loss per share as if
compensation costs for the Company's stock option plans and other stock awards
had been determined in accordance with the fair value based method prescribed in
SFAS No. 123. The Company estimates the fair value of each stock award at the
grant date by using the Black-Scholes option-pricing model with the following
weighted-average assumptions used respectively: dividend yield of zero percent
for all years; expected volatility of 50 percent; risk-free interest rates of
5.6 to 6.1 percent; and expected lives of 3 to 5 years.
Under the accounting provisions for SFAS No. 123, the Company's net loss per
share would have been increased by the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------------
<S> <C> <C>
As reported
Net loss before extraordinary item $ (7,514,785) $ (3,968,249)
Extraordinary item -- 1,779,457
------------- -------------
Net loss $ (7,514,785) $ (2,188,792)
============= =============
Pro forma
Net loss before extraordinary item $ (8,451,147) $ (4,460,409)
Extraordinary item -- 1,779,457
------------- -------------
Net loss $ (8,451,147) $ (2,680,952)
============= =============
As reported per share
Basic loss before extraordinary item $ (0.24) $ (0.15)
Extraordinary item -- 0.07
------------- -------------
Basic loss $ (0.24) $ (0.08)
============= =============
Pro forma per share
Basic loss before extraordinary item $ (0.27) $ (0.16)
Extraordinary item -- 0.06
Basic loss $ (0.27) $ (0.10)
============= =============
</TABLE>
During the initial phase-in period of SFAS 123, the effect on pro forma results
are not likely to be representative of the effects on pro forma results in
future years since options vest over several years and additional awards could
be made each year.
F-19
<PAGE> 83
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
A summary of the status of the Company's stock option plans and warrants as of
May 31, 1998 and 1997 and changes during the years ending on those dates is
presented below:
<TABLE>
<CAPTION>
1998 1997
------------------------ --------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding, beginning of year 4,123,331 $ 1.24 3,077,775 $ 1.08
Granted 2,658,600 1.39 1,940,000 1.36
Cancelled (1,059,407) 1.11 (362,375) 2.01
Exercised (478,854) 0.52 (532,069) 0.76
- ------------------------------------------------------------------------------------------------------
Outstanding, end of year 5,243,670 $ 1.26 4,123,331 $ 1.24
- ------------------------------------------------------------------------------------------------------
Exercisable, end of year 3,430,836 $ 1.32 1,526,332 $ 0.85
- ------------------------------------------------------------------------------------------------------
Weighted average fair value of options
and warrants granted during the year $ 0.61 $ 0.68
- ------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes information about stock options and warrants
outstanding at May 31, 1998:
<TABLE>
<CAPTION>
Outstanding Exercisable
------------------------------------- ------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.18 - 0.37 519,379 2.48 $ 0.32 511,379 $ 0.32
0.50 - 0.59 545,000 4.18 0.57 425,000 0.57
0.80 - 1.17 2,024,691 4.11 1.16 765,691 0.81
1.25 - 1.76 1,594,600 3.68 1.52 1,237,100 1.56
2.28 - 2.50 460,000 1.50 2.31 391,666 2.31
5.00 - 7.50 100,000 0.93 6.25 100,000 6.25
- -----------------------------------------------------------------------------------
$ 0.18 - 7.50 5,243,670 4.23 $ 1.26 3,430,836 $ 1.32
- -----------------------------------------------------------------------------------
</TABLE>
F-20
<PAGE> 84
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. EARNINGS (LOSS) PER SHARE
In February 1997, SFAS No. 128, "Earnings per Share," was issued, which required
the Company to change the method used to calculate earnings per share. Under
SFAS No. 128, basic earnings (loss) per share is calculated as income (loss)
available to common stockholders divided by the weighted average number of
common shares outstanding. Diluted earnings (loss) per share is calculated as
net income (loss) divided by the diluted weighted average number of common
shares. The diluted weighted average number of common shares is calculated using
the treasury stock method for common stock issuable pursuant to outstanding
stock options, common stock warrants, and debt convertible into common stock.
Common stock options of 880,989 and 1,438,980 and debt convertible into
1,748,134 and 160,118 common shares of stock were not included in diluted
earnings (loss) per share in 1998 or 1997, respectively, as the effect was
antidilutive due to the Company recording losses in each of those years.
In addition, 2,500,000 shares of common stock in escrow that had not met the
earnout arrangement as of May 31, 1998 were not considered outstanding for
diluted earnings (loss) per share. See Note 4 to the Consolidated Financial
Statements.
Options and warrants to purchase 2,989,604 shares of common stock at exercise
prices from $0.80 to $7.50 per share were outstanding at May 31, 1998 but were
not included in the computation of diluted earnings (loss) per share because the
exercise prices were greater than the average market price of the common shares.
Options and warrants to purchase 822,750 shares of common stock at exercise
prices from $1.37 to $2.30 per share were outstanding at May 31, 1997 but were
not included in the computation of diluted earnings (loss) per share because the
exercise prices were greater than the average market price of the common shares.
8. INCOME TAXES As of May 31, 1998, the net deferred tax asset
recorded and its approximate tax effect consisted of the
following:
<TABLE>
<CAPTION>
----------------------------------------------------------------
<S> <C>
Net operating loss carryforwards $ 3,078,000
Purchased technology 565,000
Depreciation and amortization 279,000
Warrants valuation 180,000
Other, net 156,000
----------------------------------------------------------------
4,258,000
Valuation allowance 4,258,000
----------------------------------------------------------------
Net deferred tax asset $ --
================================================================
</TABLE>
F-21
<PAGE> 85
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of May 31, 1998, a valuation allowance equal to the net deferred tax asset
recognized has been recorded, as Management has not determined that it is more
likely than not that the deferred tax asset will be realized. No current tax
provision was recorded for fiscal 1998 and 1997 due to reported losses.
At May 31, 1998, the Company has net operating loss carryforwards of
approximately $9,052,000 that expire through 2013 and are subject to certain
limitations under the Internal Revenue Code of 1986, as amended.
9. PROFIT-SHARING PLAN
Effective July 1, 1993, the Company adopted a savings and profit-sharing plan
that allows participants to make contributions by salary reduction pursuant to
Section 401(k) of the Internal Revenue Code. At the Company's discretion, the
Company may match contributions at 20% of the employee's contribution up to 6%
of the employee's salary. The Company contributions are vested 20% per year
beginning with the first year of service. The Company's contributions to the
plan were $642 in fiscal 1997. The Company made no matching contribution in
fiscal 1998.
10. COMMITMENT AND CAPITAL The Company, through its subsidiary,
LEASE OBLIGATIONS Metacomp, entered into an eight year
operating lease for its office
and manufacturing facilities located in
San Diego, California.
The Company also leases a copier,
computers, and test equipment at interest
rates between (4-18%). Future minimum lease
payments required under the operating and
capital leases are as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------
Operating Capital Leases
<S> <C> <C> <C>
1999 $ 96,940 $ 2,387
2000 16,190 1,393
----------------------------------------------------------------
Total minimum lease payments 113,130 3,780
Less amount representing interest - 246
---------------------------------------------------------------
Present value of net minimum
lease payments 113,130 3,534
Less current portion - 1,355
----------------------------------------------------------------
Total $ 113,130 $ 2,179
================================================================
</TABLE>
Rent expense for fiscal 1998 and 1997 was $85,120 and
$80,371,respectively.
F-22
<PAGE> 86
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. EXTRAORDINARY INCOME
The extraordinary income is a gain from the discharge of debt as a result of the
completion of Metacomp's plan of reorganization under Chapter 11 of the U.S.
Bankruptcy Code as of July 1996.
In 1990, Metacomp filed a Chapter 11 bankruptcy petition. In 1991, the
Bankruptcy Court confirmed Metacomp's plan of reorganization which provided for
60 monthly payments to creditors with minimum payments averaging $23,400 per
month or larger depending on operating results. As of July 1996, the unsecured
creditors were paid approximately 13% of their approved claims and the balance
was discharged. One secured creditor was scheduled to be paid in full as part of
the plan of reorganization. As of July 31, 1996, this secured creditor had a
remaining balance of $312,306. The Company paid to this secured creditor a
remaining balance of $252,306 plus accrued interest in conjunction with the
business combination with Metacomp.
12. SALES INFORMATION
EXPORT SALES
During the fiscal year ended May 31, 1998, the Company's foreign sales were less
than 10% of total sales. During the fiscal year ended May 31, 1997, the
Company's sales by geographic area consisted of the following:
<TABLE>
<S> <C>
Domestic sales $1,428,000
Foreign sales:
Canada 244,000
Other 175,000
----------
Total foreign sales 419,000
----------
Total net product sales $1,847,000
==========
</TABLE>
The Company has no foreign assets.
F-23
<PAGE> 87
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SALES TO MAJOR CUSTOMERS
The Company had sales in excess of 10% to the following customers:
<TABLE>
<CAPTION>
1998 1997
---- ----
Customer Sales Percent Sales Percent
-------- ----- ------- ----- -------
<S> <C> <C> <C> <C>
A $578,000 30.3% $473,000 25.6%
B $478,000 25.1% $472,000 25.5%
C -- -- $212,000 11.5%
D $207,000 10.9% -- --
</TABLE>
13. FOURTH QUARTER ADJUSTMENTS
The Company recorded in the fourth quarter certain adjustments relative to
non-cash interest expense related to convertible debt and associated debenture
costs and a write-down of inventory due to obsolescence amounting to an
aggregate of $2,100,000 which are discussed in Notes 5 and 6 to the Consolidated
Financial Statements. Of the aggregate amount, $1,000,000 and $1,100,000 related
to the third and fourth quarters, respectively. The Company plans to file an
amended Form 10-QSB for the quarter ended February 28, 1998.
14. SUBSEQUENT EVENT
In June 1998, the Company, the seller of the ShBoom technology and the
co-inventor entered into a nonbinding agreement in principle to settle the
dispute in consideration of mutual releases and the Company assigning patents on
the ShBoom technology back to the co-inventor in exchange for the co-inventor
granting a fully-paid, worldwide, subliceneable license to use the ShBoom
technology patents exclusive in the Company's existing and future fields of use.
In addition, nanoTronics agreed to release any obligation of the Company to
deliver a number of shares of the Company's stock pursuant to the original
acquisition agreement as discussed in Note 4 to the Consolidated Financial
Statements. Any stock not delivered will be retired. Settlement documentation
has been exchanged between the parties, although disputes remain concerning
terms contained within the documents. The Company is unable at this time to
determine whether such disputes will be resolved. The Company's Consolidated
Financial Statements do not include any adjustments that might result from the
outcome of this uncertainty.
15. RESTATEMENT OF 1998 FINANCIAL STATEMENTS
During the years ended May 31,1998 and 1997, shares of common stock were
earned under the terms of the escrow arrangement as discussed in Note 4 to the
Consolidated Financial
F-24
<PAGE> 88
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Statements. Previously, compensation expense was recognized upon the release of
shares from escrow rather than when such shares were earned. The market value of
the shares at the release date was previously recorded as compensation expense
in the year ended May 31, 1998. The market value of the shares at the date that
such shares were earned should have been recorded as compensation expense in the
fiscal years ended May 31, 1998 and 1997. Accordingly, the Company restated its
1998 and 1997 Consolidated Financial Statements. As a result of this
restatement, the 1998 and 1997 net loss before extraordinary item and net loss
were each increased by $1,620,000 and $725,000, respectively, and basic and
diluted loss per share were each decreased by $0.04 and $0.03 per share,
respectively.
F-25
<PAGE> 89
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
February 28, May 31,
1999 1998
(Unaudited)
<S> <C> <C>
Current Assets
Cash and cash equivalents $ 16,800 $ 602,456
Accounts receivable 250,322 593,542
Inventories (Note 3) 187,384 230,417
Prepaid expenses and other 204,539 109,365
------------ ------------
Total current assets 659,045 1,535,780
Property and equipment - net 531,579 453,211
Patents, trademarks, net 150,966 196,942
Other 3,721 3,721
============ ============
Total Assets $ 1,345,311 $ 2,189,654
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities
Short-term notes payable $ 247,500 $ --
Accounts payable 1,238,156 391,184
Accrued liabilities 184,529 131,088
Current portion - capital lease obligations 1,916 2,179
------------ ------------
Total current liabilities 1,672,101 524,451
Long-term Liabilities
Capital lease obligations -- 1,355
5% Convertible Term Debentures (Note 5) -- 507,000
------------ ------------
Total Liabilities 1,672,101 1,032,806
Stockholders' Equity (Deficit)
Preferred stock $.00001 par value; authorized
5,000,000 shares; none outstanding -- --
Common stock $.00001 par value; authorized
60,000,000 shares; 41,063,915 and 37,880,776
shares issued and outstanding (Note 4) 411 379
Additional paid-in capital (Note 4) 22,572,934 20,741,092
Accumulated deficit (22,900,135) (19,584,623)
------------ ------------
(326,790) 1,156,848
============ ============
Total Liabilities and Stockholders' Equity (Deficit) $ 1,345,311 $ 2,189,654
============ ============
</TABLE>
See notes to consolidated financial statements.
F-26
<PAGE> 90
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
February 28, February 28,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net sales $ 271,525 $ 253,691 $ 1,108,022 $ 1,140,711
Cost of sales 113,425 109,430 683,323 546,130
------------ ------------ ------------ ------------
Gross profit 158,100 144,261 424,699 594,581
Operating expenses:
Research and development 478,571 475,214 1,634,060 1,299,975
Selling, general and
administrative 407,483 389,043 1,770,158 2,620,908
------------ ------------ ------------ ------------
886,054 864,257 3,404,218 3,920,883
------------ ------------ ------------ ------------
Operating loss (727,954) (719,996) (2,979,519) (3,326,302)
------------ ------------ ------------ ------------
Other income (expenses):
Interest income 45 16,197 3,764 51,313
Interest expense (12,970) (32,563) (19,455) (92,360)
Non-cash interest expense
(Notes 4 and 5) (20,500) (1,000,000) (320,302) (1,624,678)
------------ ------------ ------------ ------------
(33,425) (1,016,366) (335,993) (1,665,725)
------------ ------------ ------------ ------------
Net loss $ (761,379) $ (1,736,362) $ (3,315,512) $ (4,992,027)
============ ============ ============ ============
Basic and diluted loss
per common share: $ (0.02) $ (0.06) $ (0.09) $ (0.17)
============ ============ ============ ============
Weighted average number of
common shares outstanding
during the period (Note 1) 39,134,034 31,432,995 37,485,732 29,974,221
============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
F-27
<PAGE> 91
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended February 28,
1999 1998
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES:
Net loss $(3,315,512) $(4,992,027)
Adjustments to reconcile net loss
to cash used in operating activities:
Amortization and depreciation 194,728 225,031
Amortization of debt issuance costs 48,000 --
Common stock and warrants issued
for services 94,971 10,500
Non-cash compensation expense 445,000 1,245,000
Non-cash interest expense related to
convertible debentures, common stock
and warrants (Notes 4 and 5) 365,472 1,624,678
Changes in:
Accounts receivable 136,220 (133,687)
Inventories 43,033 1,206
Prepaid and other assets (49,198) (212,406)
Accounts payable and accrued expenses 900,413 8,295
----------- -----------
Net cash used in operating activities (1,136,873) (2,223,410)
----------- -----------
INVESTING ACTIVITIES:
Purchase of property and equipment (273,096) (285,701)
FINANCING ACTIVITIES:
Proceeds from the issuance of notes payable 247,500 --
Proceeds from sale of accounts receivable 207,000 --
Principal payments on notes payable and
long-term debt (1,618) (2,203)
Proceeds from issuance of common stock
and exercise of common stock warrants
and options 371,431 230,283
Proceeds from issuance of convertible notes -- 3,000,000
----------- -----------
Net cash provided by financing activities 824,313 3,228,080
----------- -----------
Net increase (decrease) in cash (585,656) 718,969
Cash and cash equivalents at
beginning of period 602,456 477,675
----------- -----------
Cash and cash equivalents at
end of period $ 16,800 $ 1,196,644
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Convertible debentures and accrued interest
exchanged for common stock $ 575,642 $ 1,498,566
=========== ===========
Cash payments for interest $ 19,455 $ 43,794
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-28
<PAGE> 92
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The consolidated financial statements of Patriot Scientific Corporation ("the
Company") presented herein have been prepared pursuant to the rules of the
Securities and Exchange Commission for quarterly reports on Form 10-QSB and do
not include all of the information and footnotes required by generally accepted
accounting principles. These statements should be read in conjunction with the
Company's audited financial statements and notes thereto for the year ended May
31, 1998.
In the opinion of management, the interim financial statements reflect all
adjustments of a normal recurring nature necessary for a fair statement of the
results for interim periods. Operating results for the nine month periods are
not necessarily indicative of the results that may be expected for the year.
LOSS PER SHARE
During the year ended May 31, 1998, the Company implemented Standard of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." Under
SFAS No. 128, basic loss per share is calculated as loss available to common
stockholders divided by the weighted average number of common shares
outstanding. Diluted loss per share is calculated as net loss divided by the
diluted weighted average number of common shares. The diluted weighted average
number of common shares is calculated using the treasury stock method for common
stock issuable pursuant to outstanding stock options, common stock warrants, and
debt convertible into common stock. Common stock options and warrants of 115,078
and 367,789 for the three months and 157,315 and 999,674 for the nine months and
debt convertible into none and 2,707,522 common shares of stock for the three
months and 330,726 and 2,351,774 common shares of stock for the nine months were
not included in diluted loss per share for the periods ended February 28, 1999
or 1998, respectively, as the effect was antidilutive due to the Company
recording losses in each of those periods.
In addition, 1,500,000 shares of common stock in escrow as of February 28, 1999
were not considered outstanding for diluted loss per share because these shares
are subject to an earnout agreement which has not yet been met.
Options and warrants to purchase 3,474,291 shares of common stock at exercise
prices from $0.45 to $2.30 per share were outstanding at February 28, 1999 but
were not included in the computation of diluted loss per share because the
exercise prices were greater than the average market price of the common shares.
Options and warrants to purchase 4,426,791 shares of common stock at exercise
prices from $0.80 to $7.50 per share were outstanding at February 28, 1998 but
were not included in the computation of diluted loss per share because the
exercise prices were greater than the average market price of the common shares.
F-29
<PAGE> 93
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
SALE OF ACCOUNTS RECEIVABLE
The Company has adopted SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" ("SFAS 125"). SFAS 125
provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings. A factoring line
established by the Company with a bank qualifies for a sale of assets since (1)
the Company has transferred all of its right, title and interest in the selected
accounts receivable invoices to the bank, (2) the bank may pledge, sell or
transfer the selected accounts receivable invoices, and (3) the Company has no
effective control over the selected accounts receivable invoices since it may
not redeem the invoices sold previous to maturity. Under SFAS 125, after a
transfer of financial assets, an entity recognizes the financial and servicing
assets it controls and the liabilities it has incurred, derecognizes financial
assets when control has been surrendered, and derecognizes liabilities when
extinguished. The Company sold approximately $259,000 of its accounts receivable
to a bank under a factoring agreement for approximately $207,000. Pursuant to
the provisions of SFAS 125, the Company reflected the transaction as a sale of
assets and established an accounts receivable from the bank for the retained
amount less the costs of the transaction and less any anticipated future loss in
the value of the retained asset.
MANAGEMENT'S PLAN
At February 28, 1999, working capital was a negative $1,013,056 and cash
and cash equivalents totaled $16,800. The Company has funded its operations
primarily through the issuance of securities and debt financings. The Company's
current cash requirements to sustain its operations for the next twelve months
are estimated to be $1,600,000. The Company's management expects that these
requirements will be provided:
Internally by:
- the cash profits related to the $3,355,000 kiosk order, a
portion of which is anticipated as an advance payment during its
first fiscal quarter of 2000 (June 1 to August 31, 1999),
previous to any product shipments, and
Externally by:
- short-term debt instruments, including a receivable financing
arrangement established with the Company's bank,
- private placement debt and/or equity financings, and
- the investment agreement.
F-30
<PAGE> 94
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Since February 28, 1999, the Company has issued short-term debt financings for
$553,000 and sold equity to two private investors totaling $75,000. In February
1999, the Company entered into an agreement for up to $5,000,000 under an
investment agreement as discussed in Note 6.
The investment agreement allows the Company, at its sole discretion, to put
common stock into the hands of Swartz Private Equity, LLC at a discount from
market, ranging from 10% to 20% depending on the market price of the common
stock. The puts are subject to common stock trading volume limitations and
registration of the securities. The Company anticipates the initial put under
the investment agreement will take place during the first quarter of fiscal year
2000, June 1 to August 31, 1999.
With the exception of the financings discussed above, there can be no assurance
that any funds required during the next twelve months or thereafter can be
generated from operations or that if such required funds are not internally
generated that funds will be available from external sources such as debt or
equity financings or other potential sources. The funds anticipated from the
kiosk order are subject to the Company's customer receiving funds from the
Mexican Department of Tourism and on several occasions product shipments have
been rescheduled pending the receipt of those funds. The lack of additional
capital could force the Company to substantially curtail or cease operations and
would, therefore, have a material adverse effect on the Company's business.
Further, there can be no assurance that any such required funds, if available,
will be available on attractive terms or that they will not have a significantly
dilutive effect on existing shareholders of the Company.
2. NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information" which
supersedes SFAS No. 14 "Financial Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes standards on the way that public companies
report financial information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial statements issued to the public. It also
establishes standards for disclosure regarding products and services, geographic
areas and major customers. SFAS No. 131 defines operating segments as components
of a company about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. SFAS 131 is effective for
financial statements for periods beginning after December 15, 1997 and requires
comparative information for earlier years to be restated. The Company will
implement SFAS No. 131 in its May 31, 1999 financial statements. Results of
operations and financial position will be unaffected by implementation of the
standard. Management believes the adoption of this statement will have no
material impact on the Company's financial statements.
F-31
<PAGE> 95
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
market value. Gains or losses resulting from changes in the values of those
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. The key criterion for hedge
accounting is that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows. SFAS No. 133 is
effective for fiscal periods beginning after June 15, 1999. Management believes
the adoption of this statement will have no material impact on the Company's
financial statements.
3. INVENTORIES
Inventories are stated at cost (determined primarily by the weighted average
cost method which approximates cost on a first-in, first-out basis) not in
excess of market value.
Inventories at February 28, 1999 and May 31, 1998, consist of the following:
<TABLE>
<CAPTION>
February 28, 1999 May 31, 1998
<S> <C> <C>
Component parts $ 389,938 $ 418,502
Work in process 73,988 60,136
Finished goods 88,458 116,779
--------- ---------
552,384 595,417
Reserve for obsolescence (365,000) (365,000)
--------- ---------
$ 187,384 $ 230,417
========= =========
</TABLE>
4. STOCKHOLDERS' EQUITY
The following table summarizes equity transactions during the nine months ended
February 28, 1999:
<TABLE>
<CAPTION>
Common
Shares Amounts
------ -------
<S> <C> <C>
Balance June 1, 1998 37,880,776 $20,741,471
Issuance of stock and exercise of stock options 892,387 266,402
Stock issued for conversion of debentures and related
accrued interest 1,735,752 575,642
Stock released from escrow for purchased technology -- 445,000
Exercise of warrants 555,000 200,000
Non-cash interest expense related to convertible notes
and warrants recorded to additional paid-in capital -- 344,830
----------- -----------
Balance February 28, 1999 41,063,915 $22,573,345
=========== ===========
</TABLE>
F-32
<PAGE> 96
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
A total of 5,000,000 shares of the Company's outstanding common stock were
placed in escrow as a contingent cost of the Company's acquisition of its ShBoom
technology in 1994. As such, when the escrowed shares are earned, they are
charged to compensation costs. The terms of the escrow arrangement provide for
an earnout formula of 500,000 shares for each $500,000 of revenues earned by the
Company during the period from June 1, 1994 through May 31, 1999. Additionally,
this agreement also provides for the full earnout of these shares if during the
earnout period there is (i) any sale of the assets of the Company, (ii) a
business combination with another entity where the Company is not the surviving
entity, (iii) at least 75% of the Company's stock is tendered to another
organization, and (iv) a liquidation or dissolution of the Company. Any of the
contingent shares not earned by May 31, 1999 would be returned to the Company
and canceled.
During the nine months ended February 28, 1999 and 1998, 1,000,000 shares
and 1,000,000 shares, respectively, were earned as a result of the arrangement
and $445,000 and $1,245,000, respectively, were charged to compensation costs.
The 1,000,000 shares that were earned during the nine months ended February 28,
1999 were released during the current period. At February 28, 1999, 3,500,000
shares remain in escrow of which 2,000,000 shares have been earned and charged
to compensation costs but remain in escrow pending the outcome of a lawsuit
between the Company, nanoTronics and the Fish Family Trust as discussed in Note
7 to the Consolidated Financial Statements. Upon the resolution of the lawsuit,
the remaining shares held in escrow will either be released to the Falk Family
Trust, used either partially or in their entirety as a means of settling the
lawsuit, or be returned to the Company. At February 28, 1999, the 1,500,000
shares that have not met the earnout arrangement have been excluded from the
calculation of basic or diluted earnings per share.
During the current fiscal quarter, in exchange for services, 279,326 shares of
common stock were issued to the Company's attorneys. The fair value (as
determined by the quoted market price) of the common stock in excess of the
liability, $30,500, has been accounted for as additional general and
administrative expense.
At February 28, 1999, the Company had 165,000 options outstanding pursuant to
its 1992 ISO Stock Option Plan exercisable at prices ranging from $0.50 to $2.30
per share expiring beginning 2000 through 2001. The Company had 511,753 options
outstanding pursuant to its 1992 NSO Stock Option Plan exercisable at prices
ranging from $0.18 to $2.30 per share expiring beginning 1999 through 2002. The
Company also had 3,296,691 options outstanding pursuant to its 1996 Stock Option
Plan exercisable at $0.39 to $2.30 per share expiring beginning in 1999 through
2003. Some of the options outstanding under these plans are not presently
exercisable and are subject to meeting vesting criteria.
As of October 1, 1995, the Board of Directors adopted the 1995 Employee Stock
Compensation Plan providing for the issuance of up to 250,000 common shares to
Employees, as defined.
F-33
<PAGE> 97
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Executive officers and directors were not eligible under the Plan. Through
September 30, 1998, the Company had issued 217,600 common shares pursuant to the
plan. The plan expired on September 30, 1998 with no additional common shares
being issued.
At February 28, 1999, the Company had warrants outstanding to purchase 641,171
common shares at exercise prices ranging from $0.35 to $1.69 per share expiring
beginning in 2000 through 2003. During the three months and nine months ended
February 28, 1999, the Company issued warrants to a group of investors who had
loaned the Company in the aggregate $147,500 under short-term notes payable. The
Company has included $20,500 and $29,000 for the three months and the nine
months ended February 28, 1999, respectively, related to the value of these
warrants in "non-cash interest expense".
5. 5% CONVERTIBLE TERM DEBENTURES
In June 1997, the Company issued to a limited number of investors for cash an
aggregate of $2,000,000 of unsecured 5% Convertible Term Debentures due June 2,
1999 ("Debentures") and Stock Purchase Warrants ("Warrants") with a right to
purchase an aggregate 611,733 shares of common stock, par value $.00001 per
share, at an exercise price of $1.69125. In September 1998, the exercise price
for related warrants to purchase 370,000 shares of common stock was reduced from
$1.69125 to $0.36. In November 1997, the Company issued to the same investors
for cash an aggregate of $1,000,000 of Debentures due June 2, 1999 and Warrants
with a right to purchase an aggregate 305,867 shares of common stock, par value
$.00001 per share, at an exercise price of $1.50. In September 1998, the
exercise price for related warrants to purchase 185,000 shares of common stock
was reduced from $1.50 to $0.36. The additional warrants value, due to the
reduction in the exercise price, of $142,500 was reflected as additional
interest expense in the second fiscal quarter of 1999.
The principal and interest amount of each Debenture could, at the election of
the holder, be converted in whole or in part and from time to time into fully
paid and nonassessable shares of common stock, $.00001 par value, of the
Company, at a price which was the lower of (i) $1.1646 per share or (ii)
depending on the number of days the Debentures had been held after the funding
date, from 75% to 91% of the average of the closing bid prices for the common
stock for the ten consecutive trading days ending on the trading day immediately
preceding such conversion date.
As of February 28, 1999, the Debentures had been fully converted into 6,069,345
common shares of the Company. In addition, as of February 28, 1999, the
investors had exercised warrants to purchase 555,000 common shares of the
Company.
Convertible debt instruments which are convertible at a discount to market were
accounted for by treating such discount as additional interest expense. The
Company computed the amount of the
F-34
<PAGE> 98
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
discount based on the difference between the conversion price and fair value of
the underlying common stock on the dates the Debentures were issued. The Company
recorded $2,160,941 of additional paid-in capital for the discount related to
the embedded interest in the Debentures. Of this amount, $142,830 has been
expensed during the nine months ended February 28, 1999 under the caption
"Non-cash interest expense."
6. INVESTMENT AGREEMENT
In February 1999, the Company entered into an investment agreement with Swartz
Private Equity, LLC. The investment agreement entitles the Company, at the
Company's option, to issue and sell its common stock for up to an aggregate of
$5 million from time to time during a three-year period through February 24,
2002, subject to certain conditions including (1) an effective registration
statement must be on file with the SEC registering the resale of the common
shares, and (2) a limitation on the number of common shares which can be sold to
Swartz within a 30 day time period based on the trading volume of the stock,
among others. Swartz may purchase the common stock from the Company at a
discount ranging from 10% to 20% depending on the price of the common stock. In
addition to the common stock purchased, Swartz will receive warrants to purchase
an additional 15% of the common stock equal to 110% of the market price on the
last day of the purchasing period, subject to further semi-annual adjustment if
the price of the common stock goes down.
7. CONTINGENCY
In October 1998, the Company was sued in the District Court for Travis County,
Texas by the Fish Family Trust, a co-inventor of the original ShBoom technology.
The suit also named as defendants nanoTronics and Gloria Felcyn on behalf of the
Falk Trust. The suit sought a judgment for damages, a rescission of the
Technology Transfer Agreement and a restoration of the technology to the
co-inventor. The Company had the suit removed to the United States District
Court for the Western District of Texas, Austin Division, and requested the
Federal District Court to dismiss the suit based on lack of minimum contacts
with Texas or, in the alternative, to transfer the case to the Southern District
of California. In January 1999, the Federal District Court dismissed the suit
for lack of subject matter and personal jurisdiction. The Fish Family Trust then
refiled the suit in the Superior Court of San Diego County, California seeking
remedies similar to the Federal District Court dismissed action. In March 1999,
the Company joined with nanoTronics and Gloria Felcyn and filed its response and
cross-complaint against the Fish Family Trust. The Company and the other
defendants intend to vigorously contest the plaintiff's allegations. Management
does not believe, at this stage of the case, that it is possible to estimate the
outcome of the litigation.
F-35
<PAGE> 99
Until the completion of the resale of the common stock included in this
prospectus, all dealers that effect transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to the dealers' obligation to deliver a prospectus when
acting as underwriters and with respect to their unsold allotments or
subscriptions.
Table of Contents
<TABLE>
<S> <C>
Prospectus Summary ................................................... 5
Risk Factors ......................................................... 7
Plan of Distribution ................................................. 12
Selling Shareholders ................................................. 13
The Company .......................................................... 18
Use of Proceeds ...................................................... 38
Litigation ........................................................... 40
Management's Discussion and Analysis of Financial Condition
and Results of Operations ......................................... 40
Management ........................................................... 46
Principal Shareholders ............................................... 55
Certain Transactions ................................................. 56
Trading Market and Related Matters ................................... 58
Description of Securities ............................................ 59
Legal Matters ........................................................ 60
Experts .............................................................. 60
Index to Financial Statements ........................................ F-1
</TABLE>
The Resale of
15,598,770 Shares
of
Common Stock
Offered by
Selling Shareholders
PATRIOT SCIENTIFIC
CORPORATION
PROSPECTUS
June 21, 1999
<PAGE> 100
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
Pursuant to the Company's Certificate of Incorporation, and as permitted
by Section 145 of the General Corporation Law of Delaware, the Company may
indemnify its directors and officers under certain circumstances against
reasonable expenses (including court costs and attorney's fees), judgments,
penalties, fines, and amounts paid in settlement actually and reasonably
incurred in connection with any action, suit or proceeding, whether civil,
criminal, administrative or investigative, to which any of them is a party by
reason of his being a director, officer, employee, or agent of the Company if it
is determined that he acted in accordance with the applicable standard of
conduct set forth in such statutory provisions. Thus, the indemnification
provisions will protect officers and directors from liability only if the
officer or director meets the applicable standard of conduct and the Company has
the financial ability to honor the indemnity.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Expenses payable in connection with the registration and distribution of
the securities being registered hereunder, all of which will be borne by the
Registrant, are as follows:
<TABLE>
<S> <C>
Registration Fee - Securities and Exchange Commission ........ $ 2,000
Printing and Engraving ....................................... 1,000*
Legal Fees and Expenses ...................................... 40,000*
Accounting Fees .............................................. 20,000*
Blue Sky Fees and Expenses ................................... 1,000*
-------
Total .................................................. $64,000*
=======
</TABLE>
- ---------
* Estimated
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
The following sets forth certain information with respect to all common
stock, $.00001 par value, of the Registrant sold by it within the three-year
period preceding the date of this Registration Statement:
(a) The Registrant offered and sold the following described securities,
either for cash or in consideration of services rendered as indicated below,
without registration under the Securities Act of 1933, as amended; and exemption
for such sales from registration under the Act is claimed in reliance upon the
exemption provided by Section 4(2) thereof on the basis that such offers and
sales were transactions not involving any public offering. Appropriate
precautions against transfer have been taken, including the placing of a
restrictive legend on all certificates evidencing such securities. All such
sales were effected without the aid of underwriters, and no sales commissions
were paid.
<TABLE>
<CAPTION>
Number of Common Aggregate Purchase Purchase Price Per
Name Date of Sale Shares Price Share
---- ------------ ------ ----- -----
<S> <C> <C> <C> <C>
Sea, Ltd. May 29, 1996 500,000(1) $ 250,000 $.50 Cash
Robert Crawford December 4, 1998 100,000 25,000 .25 Cash
December 16, 1998 100,000 23,000 .23 Cash
April 26, 1999 200,000 35,000 .175 Cash
April 28, 1999 100,000 20,000 .20 Cash
</TABLE>
i
<PAGE> 101
<TABLE>
<CAPTION>
Number of Common Aggregate Purchase Purchase Price Per
Name Date of Sale Shares Price Share
---- ------------ ------ ----- -----
<S> <C> <C> <C> <C>
James C. and
Josephine M. Zolin December 29, 1998 130,435 30,000 .23 Cash
January 29, 1999 50,000 17,500 .35 Cash
Wayne Opperman January 29, 1999 50,000 17,500 .35 Cash
Clifford E. Koerner February 1, 1999 100,000 35,000 .35 Cash
Richard D. Daniels February 1, 1999 50,000 17,500 .35 Cash
Luce, Forward, Hamilton
and Scripps, LLP February 11, 1999 279,326 94,971 .34 Services
William G. Crawford April 28, 1999 100,000 20,000 .20 Cash
Castle Creek Technology
Partners, LLC June 14, 1999 397,205 116,183 .292 Note
Conversion
</TABLE>
(1) This reflects exercise of warrants granted as a portion of a unit sold
at $.50 per unit, each consisting of one share of common stock and one
warrant to purchase an additional share of common stock at a price of
$.50 per share.
(b) On February 29, 1996, the Registrant offered and sold for cash an
aggregate of 253,166 shares of common stock at a price of $1.58 per share to a
limited number of investors (all but one of whom already were shareholders of
the Registrant), as well as warrants to purchase an additional 253,166 common
shares at a price of $1.58 per share. During May 1996, such warrants were
exercised resulting in the issuance of 126,583 common shares, and in August 1996
the remaining warrants were exercised. Also in August of 1996, 25,000 warrants
granted with a manufacturing agreement were exercised at a price of $1.58 per
share.
(c) In November 1996, the Company issued 431,297 shares of common stock at
$1.04 per share, in December 1996, the Company issued 933,622 shares at $0.85 to
$1.08 per share; and in February 1997, the Company issued 160,184 shares at
$1.27 per share. All of such issuances resulted from the conversion of 6%
convertible subordinated notes and accrued interest thereon aggregating
$1,517,015. These securities were offered and sold without registration under
the Securities Act of 1933, as amended, and exemption for such sales from
registration under the Act is claimed in reliance upon the exemption provided by
Rule 903 of Regulation S thereunder on the basis that such offers and sales were
made in offshore transactions to persons who were not "U.S. Persons" as defined
in Rule 902 of Regulation S. Appropriate precautions were taken against transfer
into the United States or to any "U.S. Person" during the applicable restricted
period, including the placing of a restrictive legend on all certificates
issued. All such sales were effected without the aid of underwriters, and no
sales commissions were paid.
(d) On January 8, 1997, the Company issued 1,272,068 common shares to 56
persons in connection with the acquisition of Metacomp, Inc. pursuant to an
Exchange Offer and Letter of Transmittal dated December 4, 1996. The effective
date of the acquisition was December 26, 1996. The closing price of the common
shares on December 26, 1996 was $1.375 per share, resulting in aggregate
consideration of $1,749,094. These common shares were issued without
registration under the Securities Act of 1933, as amended, pursuant to the
exemption provided by Regulation D on the ground that such transactions did not
involve any public offering. Appropriate precautions against transfer have been
taken, including the placing of a restrictive legend on all certificates
evidencing such securities. Such shares were issued without the aid of
underwriters, and no sales commissions were paid.
ii
<PAGE> 102
(e) During the period of November 1997 through September 1998, the Company
issued 6,069,345 common shares to two investors pursuant to 5% convertible
debentures aggregating $3,000,000 and the accrued interest thereon. The per
share price for the conversions ranged from $.395 to $1.202. In addition to the
principal, $98,977 of interest was converted into common shares. In September
and October 1998, one of the investors exercised a warrant to purchase 555,000
shares of the Company's common stock at an exercise price of $.36036 per share.
The securities were registered for resale on Forms S-3 which became effective in
September and November 1997.
ITEM 27. EXHIBITS.
The Exhibits to this Registration Statement are listed in the Exhibit
Index commencing at page EX-1 hereof.
ITEM 28. UNDERTAKINGS.
The undersigned Registrant hereby undertakes the following:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement:
(i) to include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) to reflect in the prospectus any facts or events arising after
the effective date of this Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information in this Registration
Statement; and
(iii) to include any material information with respect to the plan
of distribution not previously disclosed in this registration, or any material
change to such information in the Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment to
this Registration Statement any of the securities being registered which remain
unsold at the termination of this offering.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling the
Registrant pursuant to the General Corporation Law of Delaware, the Certificate
of Incorporation, or otherwise, the Registrant has been advised that, in the
opinion of the Securities and Exchange Commission, such indemnification is
against public policy as expressed in such Act, and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or person controlling the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or person controlling the Registrant in connection with any
securities being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in such Act and will be governed by the final
adjudication of such issue.
iii
<PAGE> 103
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all the
requirements for filing on Form SB-2 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of San Diego, State of California, on the date below.
DATED: June 21, 1999 PATRIOT SCIENTIFIC CORPORATION
By: /s/ LOWELL W. GIFFHORN
-------------------------------------
Lowell W. Giffhorn
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/S/ JAMES T. LUNNEY President, Director, June 21, 1999
- ----------------------------- Chief Executive Officer
James T. Lunney
/S/ LOWELL W. GIFFHORN Chief Financial Officer, June 21, 1999
- ----------------------------- Principal Financial
Lowell W. Giffhorn Officer and Principal
Accounting Officer
/S/ ELWOOD G. NORRIS Chairman and Director June 21, 1999
- ----------------------------
Elwood G. Norris
/S/ HELMUT FALK, JR. Director June 21, 1999
- ----------------------------
Helmut Falk, Jr.
/S/ DONALD BERNIER Director June 21, 1999
- ----------------------------
Donald Bernier
/S/ RICHARD G. BLUM Director June 21, 1999
- ----------------------------
Richard G. Blum
/S/ FREDERICK G. THIEL Director June 21, 1999
- ----------------------------
Frederick G. Thiel
</TABLE>
iv
<PAGE> 104
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM SB-2
Registration Statement
Under The Securities Act of 1933
EXHIBITS
PATRIOT SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
EX-1
<PAGE> 105
EXHIBIT INDEX
PATRIOT SCIENTIFIC CORPORATION
The following exhibits are included as part of this registration
statement, except those exhibits marked (1), which have previously been filed
with the Securities and Exchange Commission and are incorporated by reference to
another registration statement, report or document. References to the "Company"
in this Exhibit Index mean PATRIOT SCIENTIFIC CORPORATION, a Delaware
corporation.
<TABLE>
<CAPTION>
Exhibit No. Document No.
- ---------- -------- --
<S> <C> <C>
2.0 PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR
SUCCESSION.
2.1 Agreement to Exchange Technology for Stock in Patriot Scientific (1)
Corporation, incorporated by reference to Exhibit 2.1 to Form 8-K
dated August 10, 1989
2.2 Assets Purchase Agreement and Plan of Reorganization dated June 22, (1)
1994, among the Company, nanoTronics Corporation and Helmut Falk,
incorporated by reference to Exhibit 10.4 to Form 8-K dated July 6,
1994
2.2.1 Amendment to Development Agreement dated April 23, 1996 between the (1)
Company and Sierra Systems, incorporated by reference to Exhibit
2.2.1 to Pre-Effective Amendment No. 1 to Registration Statement on
Form SB-2 dated April 29, 1996
2.3 Form of Exchange Offer dated December 4, 1996 between the Company (1)
and certain shareholders of Metacomp, Inc. incorporated by reference
to Exhibit 2.3 to Form 8-K dated January 9, 1997
2.4 Letter of Transmittal to Accompany Shares of Common Stock of (1)
Metacomp, Inc. Tendered Pursuant to the Exchange Offer Dated
December 4, 1996 incorporated by reference to Exhibit 2.4 to Form
8-K dated January 9, 1997
3.0 ARTICLES AND BYLAWS.
3.1 Original Articles of Incorporation of the Company's predecessor, (1)
Patriot Financial Corporation, incorporated by reference to Exhibit
3.1 to registration statement on Form S-18, file no. 33-23143-FW
3.2 Articles of Amendment of Patriot Financial Corporation, as filed (1)
with the Colorado Secretary of State on July 21, 1988, incorporated
by reference to Exhibit 3.2 to registration statement on Form S-18,
File No. 33-23143-FW
3.3 Certificate of Incorporation of the Company, as filed with the (1)
Delaware Secretary of State on March 24, 1992, incorporated by
reference to Exhibit 3.3 to Form 8-K dated May 12, 1992
3.3.1 Certificate of Amendment to the Certificate of Incorporation of the (1)
Company, as filed with the Delaware Secretary of State on April 18,
1995, incorporated by reference to Exhibit 3.3.1 to Form 10-KSB for
the fiscal year ended May 31, 1995
</TABLE>
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<TABLE>
<CAPTION>
Exhibit No. Document No.
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<S> <C> <C>
3.3.2 Certificate of Amendment to the Certificate of Incorporation of the (1)
Company, as filed with the Delaware Secretary of State on June
19,1997, incorporated by reference to Exhibit 3.3.2 to Form 10-KSB
for the fiscal year ended May 31, 1997
3.4 Articles and Certificate of Merger of Patriot Financial Corporation (1)
into the Company dated May 1, 1992, with Agreement and Plan of
Merger attached thereto as Exhibit A, incorporated by reference to
Exhibit 3.4 to Form 8-K dated May 12, 1992
3.5 Certificate of Merger issued by the Delaware Secretary of State on (1)
May 8, 1992, incorporated by reference to Exhibit 3.5 to Form 8-K
dated May 12, 1992
3.6 Certificate of Merger issued by the Colorado Secretary of State on (1)
May 12, 1992, incorporated by reference to Exhibit 3.6 to Form 8-K
dated May 12, 1992
3.7 Bylaws of the Company, incorporated by reference to Exhibit 3.7 to (1)
Form 8-K dated May 12, 1992
4.0 INSTRUMENTS ESTABLISHING RIGHTS OF SECURITY HOLDERS.
4.1 Specimen common stock certificate, incorporated by reference to (1)
Exhibit 4.1 Form 8-K dated May 12, 1992
4.2 Form of Stock Purchase Warrant (Labway Corporation) dated February (1)
29, 1996, exercisable to purchase 253,166 common shares at $1.58 per
share until August 31, 1996, granted to investors in connection with
an offering of securities made in reliance upon Regulation S,
incorporated by reference to Exhibit 4.2 to Form 10-QSB for fiscal
quarter ended 2/29/96
4.3 Form of 6% Convertible Subordinated Promissory Note due September (1)
30, 1998 aggregating $1,500,000 to six investors incorporated by
reference to Exhibit 4.3 to Form 10-QSB for fiscal quarter ended
August 31, 1996
4.4 Form of 5% Convertible Term Debenture (CC Investments, LDC) due June (1)
2, 1999 aggregating $2,000,000 to two investors incorporated by
reference to Exhibit 4.4 to Form 8-K dated June 16, 1997
4.5 Form of Stock Purchase Warrant (CC Investments, LDC) dated June 2, (1)
1997 exercisable to purchase an aggregate of 400,000 common shares
at $1.69125 per share until June 2, 2002, granted to two investors
in connection with the offering of securities in Exhibit 4.4
incorporated by reference to Exhibit 4.5 to Form 8-K dated June 16,
1997
4.6 Registration Rights Agreement dated June 2, 1997 by and among the (1)
Company and CC Investments, LDC and the Matthew Fund, N.V. related
to the registration of the common stock related to Exhibits 4.4 and
4.5 incorporated by reference to Exhibit 4.6 to Form 8-K dated June
16, 1997
</TABLE>
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<TABLE>
<CAPTION>
Exhibit No. Document No.
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<S> <C> <C>
4.7 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, (1)
L.P.) dated June 2, 1997 exercisable to purchase an aggregate of
211,733 common shares at $1.69125 per share until June 2, 2002,
granted to a group of investors in connection with the offering of
securities in Exhibit 4.4 incorporated by reference to Exhibit 4.7
to Form 8-K dated June 16, 1997
4.8 Registration Rights Agreement dated June 2, 1997 by and among the (1)
Company and Swartz Investments, LLC related to the registration of
the common stock related to Exhibit 4.7 incorporated by reference to
Exhibit 4.8 to Form 8-K dated June 16, 1997
4.9 Form of 5% Convertible Term Debenture (CC Investments, LDC) due June (1)
2, 1999 aggregating $1,000,000 to two investors incorporated by
reference to Exhibit 4.9 to Form 10-KSB for the fiscal year ended
May 31, 1998
4.10 Form of Stock Purchase Warrant (CC Investments, LDC) dated November (1)
24, 1997 exercisable to purchase an aggregate of 200,000 common
shares at $1.50 per share until June 2, 2002, granted to two
investors in connection with the offering of securities described in
Exhibit 4.9 incorporated by reference to Exhibit 4.10 to Form 10-KSB
for the year ended May 31, 1998
4.11 Form of Warrant to Purchase Common Stock (Swartz Family Partnership, (1)
L.P.) dated November 24, 1997 exercisable to purchase an aggregate
of 105,867 common shares at $1.50 per share until June 2, 2002,
granted to a group of investors in connection with the offering of
securities described in Exhibit 4.9 incorporated by reference to
Exhibit 4.11 to Form 10-KSB for the year ended May 31, 1998
4.12 Form of Warrant to Purchase Common Stock (Investor Communications (1)
Group, Inc.) dated June 16, 1997 exercisable to purchase an
aggregate of 130,000 common shares at prices ranging from $2.50 to
$7.50 per share until June 15, 1999 incorporated by reference to
Exhibit 4.12 to Form 10-KSB for the year ended May 31, 1998
4.13 Warrant to Purchase Common Stock issued to Spellcaster (1)
Telecommunications, Inc. dated April 28, 1998 exercisable to
purchase an aggregate of 100,000 common shares at $1.25 per share
until April 28, 2000 incorporated by reference to Exhibit 4.13 to
Form 10-KSB for the year ended May 31, 1998
4.14 Investment agreement dated February 24, 1999 by and between the (1)
Company and Swartz Private Equity, LLC for a maximum aggregate
amount of $5,000,000 incorporated by reference to Exhibit 4.14 to
Form 10-QSB/A for the fiscal quarter ended November 30, 1998
4.15 Registration Rights Agreement dated February 24, 1999 by and between (1)
the Company and Swartz Private Equity, LLC related to the
registration of the common stock related to Exhibit 4.14
incorporated by reference to Exhibit 4.15 to Form 10-QSB/A for the
fiscal quarter ended November 30, 1998
</TABLE>
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<TABLE>
<CAPTION>
Exhibit No. Document No.
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<S> <C> <C>
4.16 Form of Warrant to Purchase Common Stock (Swartz Private Equity, (1)
LLC) dated February 24, 1999 exercisable to purchase commn shares in
connection with the offering of securities in Exhibit 4.14
incorporated by reference to Exhibit 4.16 to Form 10-QSB/A for the
fiscal quarter ended November 30, 1998
5.0 OPINION RE LEGALITY.
5.1 Legal opinion of Luce, Forward, Hamilton & Scripps LLP, attorneys at (2)
law
10.0 MATERIAL CONTRACTS.
10.1 1992 Incentive Stock Option Plan of the Company, incorporated by (1)
reference to Exhibit 10.1 to Form 8-K dated May 12, 1992
10.1.1 Amendment to 1992 Incentive Stock Option Plan dated January 11, (1)
1995, incorporated by reference to Exhibit 10.1.1 to Form S-8 dated
July 17, 1996
10.2 1992 Non-Statutory Stock Option Plan of the Company, incorporated by (1)
reference to Exhibit 10.2 to Form 8-K dated May 12, 1992
10.2.1 Amendment to 1992 Non-Statutory Stock Option Plan dated January 11, (1)
1995 incorporated by reference to Exhibit 10.2.1 to Form 10-KSB for
fiscal year ended May 31, 1996
10.3 Lease Agreement between the Company's subsidiary Metacomp, Inc. and (1)
Clar-O-Wood Partnership, a California limited partnership dated
April 11, 1991 as amended November 11, 1992 and November 2, 1995
incorporated by reference to Exhibit 10.3 to Form 10-KSB for fiscal
year ended May 31, 1997
10.4 Stock Purchase Agreement dated November 29 and 30, 1995, between the (1)
Company and SEA, Ltd., incorporated by reference to Exhibit 10.4 to
Form 8-K dated December 11, 1995
10.4.1 Letter Amendment to Stock Purchase Agreement dated February 21, (1)
1996, between the Company and SEA, Ltd., incorporated by reference
to Exhibit 10.4.1 to Form 10-QSB for fiscal quarter ended 2/29/96
10.5 1995 Employee Stock Compensation Plan of the Company, incorporated (1)
by reference to Exhibit 10.5 to Form 10-QSB for fiscal quarter ended
11/30/95
10.6 Letter Stock and Warrant Agreement dated January 10, 1996 between (1)
the Company and Robert E. Crawford, Jr., incorporated by reference
to Exhibit 10.6 to Form 10-QSB for fiscal quarter ended February 29,
1996
10.7 Non-Exclusive Manufacturing and Line of Credit Agreement dated (1)
February 28, 1996, between the Company and Labway Corporation,
incorporated by reference to Exhibit 10.7 to Form 10-QSB for fiscal
quarter ended February 29, 1996
10.8 Distribution and Representation Agreement dated February 28, 1996, (1)
between the Company and Innoware, Inc., incorporated by reference to
Exhibit 10.8 to Form 10-QSB for fiscal quarter ended February 29,
1996
</TABLE>
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<TABLE>
<CAPTION>
Exhibit No. Document No.
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<S> <C> <C>
10.9 Employment Agreement dated November 20, 1995 between the Company and (1)
Elwood G. Norris, incorporated by reference to Exhibit 10.9 to
Registration Statement on Form SB-2 dated March 18, 1996
10.9.1 First Amendment to Employment Agreement dated May 17, 1996 between (1)
the Company and Elwood G. Norris, incorporated by reference to
Exhibit 10.9.1 to Pre-Effective Amendment No. 2 to Registration
Statement on Form SB-2 dated May 23, 1996
10.10 Employment Agreement dated November 20, 1995 between the Company and (1)
Robert Putnam, incorporated by reference to Exhibit 10.10 to
Registration Statement on Form SB-2 dated March 18, 1996
10.11 Sales Contractual Agreement dated March 19, 1996 between the Company (1)
and Evolve Software, Inc., incorporated by reference to Exhibit
10.11 to Pre-Effective Amendment No. 1 to Registration Statement on
Form SB-2 dated April 29, 1996
10.11.1 Two Year Stock Purchase Warrant dated March 19, 1996 Granted to (1)
Evolve Software, Inc. Providing for the Purchase of up to 50,000
Common Shares at $2.85, incorporated by reference to Exhibit 10.11.1
to Pre-Effective Amendment No. 1 to Registration Statement on Form
SB-2 dated April 29, 1996
10.12 Employment Agreement dated as of May 8, 1996 between the Company and (1)
Michael A. Carenzo, including Schedule A - Stock Option Agreement,
incorporated by reference to Exhibit 10.12 to Pre-Effective
Amendment No. 2 to Registration Statement on Form SB-2 dated May 23,
1996
10.13 1996 Stock Option Plan of the Company dated March 25, 1996 and (1)
approved by the Shareholders on May 17, 1996, incorporated by
reference to Exhibit 10.13 to Pre-Effective Amendment No. 2 to
Registration Statement on Form SB-2 dated May 23, 1996
10.14 Sales Contractual Agreement dated June 20, 1996 between the Company (1)
and Compunetics Incorporated incorporated by reference to Exhibit
10.14 to Form 10-KSB for fiscal year ended May 31, 1996
10.15 Sales Contractual Agreement dated July 31, 1996 between the Company (1)
and Premier Technical Sales, Inc. incorporated by reference to
Exhibit 10.15 to Form 10-KSB for fiscal year ended May 31, 1996
10.16 Employment Agreement dated January 1, 1997 between the Company and (1)
Norman J. Dawson incorporated by reference to Exhibit 10.16 to Form
10-KSB for fiscal year ended May 31, 1997
10.17 Employment Agreement dated January 1, 1997 between the Company and (1)
Jayanta K. Maitra incorporated by reference to Exhibit 10.17 to Form
10-KSB for fiscal year ended May 31, 1997
10.18 Technology License and Distribution Agreement dated June 23, 1997 (1)
between the Company and Sun Microsystems, Inc. incorporated by
reference to Exhibit 10.18 to Form 10-KSB for the fiscal year ended
May 31, 1997
</TABLE>
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<CAPTION>
Exhibit No. Document No.
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10.19 Employment Agreement dated March 23, 1998 between the Company and (1)
James T. Lunney incorporated by reference to Exhibit 10.19 to
Form 10-KSB for the fiscal year ended May 31, 1998
10.20 Employment Agreement dated July 28, 1997 between the Company and (1)
Phillip Morettini incorporated by reference to Exhibit 10.20 to Form
10-KSB for the fiscal year ended May 31, 1998
10.21 Employment Agreement dated July 23, 1997 between the Company and (1)
Lowell W. Giffhorn incorporated by reference to Exhibit 10.21 to
Form 10-KSB for the fiscal year ended May 31, 1998
23.0 CONSENTS OF EXPERTS AND COUNSEL.
23.1 Consent of BDO Seidman, LLP (2)
23.2 Consent of Luce, Forward, Hamilton & Scripps LLP, attorneys at law (2)
(included in Exhibit 5.1)
23.3 Consent of Harlan & Boettger, LLP, Certified Public Accountants (2)
99.0 ADDITIONAL EXHIBITS.
99.1 Form of ISO Plan Option (Gaspar) dated May 29, 1992, incorporated by (1)
reference to Exhibit 28.2 to registration statement on Form SB-2,
file no. 33-57858
99.2 Form of NSO Plan Option (Berlin) dated May 29, 1992, incorporated by (1)
reference to Exhibit 28.3 to registration statement on Form SB-2,
file no. 33-57858
99.3 Form of Incentive Stock Option Agreement to the Company's 1996 Stock (1)
Option Plan (individual agreements differ as to number of shares,
dates, prices and vesting), incorporated by reference to
Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2
dated May 23, 1996
99.4 Form of NonQualified Stock Option Agreement to the Company's 1996 (1)
Stock Option Plan (individual agreement differ as to number of
shares, date, prices and vesting), incorporated by reference to
Pre-Effective Amendment No. 2 to Registration Statement on Form SB-2
dated May 23, 1996
99.5 Press Release of the Company dated November 4, 1996 incorporated by (1)
reference to Exhibit 99.5 to Form 8-K dated January 9, 1997
</TABLE>
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(1) Previously filed in indicated registration statement or report.
(2) Exhibit filed herewith this Registration Statement on Form SB-2.
EX-7
<PAGE> 1
EXHIBIT 5.1
(Luce, Forward, Hamilton & Scripps, LLP Letterhead)
June 21, 1999
Patriot Scientific Corporation
10989 Via Frontera
San Diego, California 92127
Re: Registration Statement on Form SB-2
Ladies and Gentlemen:
We are counsel for Patriot Scientific Corporation, a Delaware corporation
("Patriot"), in connection with the preparation of a Registration Statement on
Form SB-2 of which this opinion is a part, to be filed with the Securities and
Exchange Commission (the "Commission"), for the sale by certain selling
shareholders (the "Selling Shareholders") of 15,598,770 shares of Patriot's
common stock (the "Common Stock").
In connection with rendering our opinion as set forth below, we have reviewed
and examined originals or copies of such corporate records and other documents
and have satisfied ourselves as to such other matters as we have deemed
necessary to enable us to express our opinion hereinafter set forth.
Based upon the foregoing, it is our opinion that:
The shares of Common Stock being registered for the account of the Selling
Shareholders have been validly issued, and are fully paid and non-assessable.
We hereby consent to the filing of this opinion as an Exhibit to the
Registration Statement and to the reference to this firm under the caption
"Legal Matters" in the Prospectus included in the Registration Statement.
Very truly yours,
/s/ LUCE, FORWARD, HAMILTON & SCRIPPS LLP
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Patriot Scientific Corporation
San Diego, California
We hereby consent to the use in the Prospectus constituting a part of this
Registration Statement of our report dated July 17, 1998, except for notes 4 and
15, which are as of June 15, 1999, relating to the consolidated financial
statements of Patriot Scientific Corporation, which is contained in that
Prospectus.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
/s/ BDO Seidman, LLP
Denver, Colorado
June 21, 1999
<PAGE> 1
EXHIBIT 23.3
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Patriot Scientific Corporation
San Diego, California
We hereby consent to the use in the Prospectus constituting a part of this
Registration Statement of our report dated December 17, 1996 relating to the
financial statements of Metacomp, Inc., which is contained in that Prospectus.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
/s/ HARLAN & BOETTGER, LLP
San Diego, California
June 21, 1999
