<PAGE> 1
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For quarterly period ended February 28, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _____________ to _______________
Commission File Number 0-22182
PATRIOT SCIENTIFIC CORPORATION
(Exact name of small business issuer as specified in its charter)
Delaware 84-1070278
(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
10989 Via Frontera, San Diego, California 92127
(Address of principal executive offices)
(619) 674-5000
(Issuer's telephone number)
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date:
<TABLE>
<CAPTION>
Common Stock, $.00001 par value 41,063,915
- ------------------------------- -------------------------------
<S> <C>
(Class) (Outstanding at April 14, 1999)
</TABLE>
<PAGE> 2
PATRIOT SCIENTIFIC CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of February 28, 1999 (unaudited)
and May 31, 1998 3
Consolidated Statements of Operations for the nine months and three
months ended February 28, 1999 and 1998 (unaudited) 4
Consolidated Statements of Cash Flows for the nine months ended
February 28, 1999 and 1998 (unaudited) 5
Notes to Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
PART II. OTHER INFORMATION 16
Item 1. Legal Proceedings *
Item 2. Changes in Securities *
Item 3. Defaults upon Senior Securities *
Item 4. Submission of Matters to a Vote of Security Holders *
Item 5. Other Information *
Item 6. Exhibits and Reports on Form 8-K *
SIGNATURES 16
</TABLE>
* No information provided due to inapplicability of the item.
2
<PAGE> 3
PART I- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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
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
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) 20,215,934 18,396,092
Accumulated deficit (20,543,135) (17,239,623)
------------ ------------
(326,790) 1,156,848
------------ ------------
Total Liabilities and Stockholders' Equity $ 1,345,311 $ 2,189,654
============ ============
</TABLE>
See notes to consolidated financial statements.
3
<PAGE> 4
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 726,983 389,043 1,644,658 1,750,908
------------ ------------ ------------ ------------
1,205,554 864,257 3,278,718 3,050,883
------------ ------------ ------------ ------------
Operating loss (1,047,454) (719,996) (2,854,019) (2,456,302)
------------ ------------ ------------ ------------
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) (134,000) (1,000,000) (433,802) (1,624,678)
------------ ------------ ------------ ------------
(146,925) (1,016,366) (449,493) (1,665,725)
------------ ------------ ------------ ------------
Net loss $ (1,194,379) $ (1,736,362) $ (3,303,512) $ (4,122,027)
============ ============ ============ ============
Basic and diluted loss
per common share: $ (0.03) $ (0.06) $ (0.09) $ (0.14)
============ ============ ============ ============
Weighted average number of
common shares outstanding
during the period(Note 1) 36,634,034 31,914,153 34,986,232 29,864,424
============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
4
<PAGE> 5
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 $(3,303,512) $(4,122,027)
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 --
Warrants issued for services -- 10,500
Non-cash compensation expense 350,000 375,000
Non-cash interest expense related to
convertible debentures, common stock
and warrants(Notes 4 and 5) 448,472 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 (1,231,844) (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 466,402 230,283
Proceeds from issuance of convertible notes -- 3,000,000
----------- -----------
Net cash provided by financing activities 919,284 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
5
<PAGE> 6
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 three month and 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, 3,500,000 shares of common stock in escrow as of February 28, 1999
were not considered outstanding for diluted loss per share because the Company
is currently negotiating whether they will be released.
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.
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. 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.
6
<PAGE> 7
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
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
liquidity for the next twelve months is anticipated to be provided by (1) the
cash profits related to the $3,300,000 kiosk order, a portion of which is
anticipated as an advance payment in May 1999, previous to any product
shipments, (2) short-term debt instruments, including a receivable financing
arrangement established with the Company's bank, and (3) additional equity
financings. Since February 28, 1999, the Company has received short-term debt
financings for $110,000. In February 1999, the Company entered into an agreement
for up to $5,000,000 under an equity line of credit. The equity line of credit
allows the Company, at its sole discretion, to put common stock into the hands
of an institutional underwriter at a discount from market, ranging from 10% to
20% depending on the market price of the common stock, subject to common stock
trading volume limitations and registration of the securities. The Company
anticipates the initial put under the equity line of credit will take place
during the first quarter of the fiscal year 2000, June 1 - August 31, 1999.
Also, 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.
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 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.
130, "Reporting Comprehensive Income" which 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 owners and distributions to owners. Among other
disclosures, SFAS 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 130 has been adopted and there was no effect on
the financial statements.
Also, in June 1997, the 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.
7
<PAGE> 8
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> <C>
Balance June 1, 1998 37,880,776 $18,396,471
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 -- 350,000
Exercise of warrants 555,000 200,000
Non-cash interest expense related to convertible notes
and warrants recorded to additional paid-in capital -- 427,830
----------- -----------
Balance February 28, 1999 41,063,915 $20,216,345
=========== ===========
</TABLE>
A total of 5,000,000 shares of the Company's outstanding common stock was issued
as a contingent cost of the Company's acquisition of its ShBoom technology in
1994. During the three months and nine months ended February 28, 1999, 1,000,000
shares were released from escrow. The value of the released shares, $350,000,
was reflected as general and administrative expense during the current fiscal
period. As of February 28, 1999, a total of 1,500,000 shares have been released
from escrow and 3,500,000 shares remain in escrow of which 2,000,000 shares may
have been earned but remain in escrow pending the resolution of litigation which
has been filed against the Company and nanoTronics, the seller of the ShBoom
technology, by one of the co-inventors of the technology. See Note 6 for
additional discussion. Any of the escrowed shares not released prior to May 31,
1999 are to be returned to the Company and canceled. The 3,500,000 shares are
excluded from the calculation of basic and diluted weighted
8
<PAGE> 9
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
average number of common shares outstanding for the computation of loss per
share until the shares are released or the dispute is settled.
During the current fiscal quarter, 859,761 shares of common stock were issued at
a discount to a group of investors in exchange for cash or services. Common
stock which is issued at a discount to market is accounted for by treating such
discount as additional interest expense. The Company computed the amount of the
additional interest based on the difference between the price paid and the
closing price of the common stock on the dates the common stock was issued. The
Company recorded $113,500 of additional paid-in capital for the discount related
to the embedded interest in the common stock. This same amount has been expensed
during the three months and nine months ended February 28, 1999 and included
under the caption "Non-cash interest 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. 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 $192,500 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
9
<PAGE> 10
PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
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 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. 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 obtained its rights to the basic ShBoom technology in 1994 pursuant
to an Assets Purchase Agreement and Plan of Reorganization between the Company,
nanoTronics Corporation and Helmut Falk. The basic ShBoom technology was
purchased by nanoTronics from the Fish Family Trust in 1991 pursuant to a Stock
Purchase and Technology Transfer Agreement.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE
COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING,
"FUTURE PERFORMANCE AND RISK FACTORS." SEE ALSO THE COMPANY'S ANNUAL REPORT ON
FORM 10-KSB FOR THE YEAR ENDED MAY 31, 1998.
The Company's results of operations have and may continue to be subject to
significant quarterly variation. The results for a particular quarter may vary
due to a number of factors, including the overall state of the microprocessor
and communications segments of the economy, the development status and demand
for the Company's products, economic conditions in the Company's markets, the
timing of orders, the timing of expenditures in anticipation of future sales,
the mix of products sold by the Company, the introduction of new products and
product enhancements by the Company or its competitors and pricing and other
competitive conditions.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED FEBRUARY 28, 1999 AND 1998
Net sales. Total net sales for the third quarter of fiscal 1999 increased 7.0%
to $271,525 from $253,691 for the third quarter of fiscal 1998. This increase
was due primarily to a new licensing agreement for the Company's PSC1000
microprocessor for $80,000 coupled with a reduction in follow on shipments for
the Company's 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.
Cost of sales. Cost of sales as a percentage of net sales decreased to 41.8% for
the third quarter of fiscal 1999 compared to 43.1% for the corresponding quarter
of the previous fiscal year. This decrease is due to the licensing agreement for
the PSC1000, which does not have associated costs, favorably impacting the cost
of sales percentage.
Research and development expenses remained substantially the same at $478,571
for the third fiscal quarter of 1999 compared to $475,214 for the third fiscal
quarter of 1998.
Selling, general and administrative expenses increased by 86.9% from $389,043
for the third quarter of fiscal 1998 to $726,983 for the third quarter of fiscal
1999. This increase was due primarily to the recording of $350,000 in costs
related to the release from escrow of 1,000,000 shares of common stock to the
seller of the ShBoom technology during the third quarter of fiscal 1999. When
and if the additional 3,500,000 escrowed shares are released, selling, general
and administrative expenses could be impacted significantly.
Other income (expense) was significantly lower for the third quarter of fiscal
1999 compared to the corresponding period of the previous fiscal year primarily
as a result of higher non-cash interest expense recognized in 1998 as discussed
in Notes 4 and 5 to the consolidated financial statements.
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 rescheduling the product delivery on the
Company's $3,300,000 kiosk application order coupled with a reduction in follow
on shipments for the Company's 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. Although no assurance can be given, the kiosk order is scheduled to
begin shipments in May 1999 with the completion of shipments scheduled for
fiscal year 2000.
11
<PAGE> 12
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 the Company's $3,300,000
kiosk application order compared to profit margins typically associated with the
Company's 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 6.1% to $1,644,658 for
the nine months ended February 28, 1999 compared to $1,750,908 for the
corresponding period of the previous fiscal year. This decrease was due
primarily to a reduction in compensation expenses.
Other income (expense) was $449,493 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 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. The Company has funded its 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 $1,024,844, additions to property
and equipment were $273,096, and funds generated from debt and equity financings
were $712,284. During the nine months ended February 28, 1999, accounts
receivable decreased $343,220 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.
The Company's liquidity for the next twelve months is anticipated to be provided
by (1) the cash profits related to the $3,300,000 million kiosk order, a portion
of which is anticipated as an advance payment in May 1999, previous to any
product shipments, (2) short-term debt instruments, including a receivable
financing arrangement established with the Company's bank, and (3) additional
equity financings. Since February 28, 1999, the Company has received short-term
debt financings for $110,000. In February 1999, the Company entered into an
agreement for up to $5,000,000 under an equity line of credit. The equity line
of credit allows the Company, at its sole discretion, to put common stock into
the hands of an institutional underwriter at a discount from market, ranging
from 10% to 20% depending on the market price of the common stock, subject to
common stock trading volume limitations and registration of the securities. The
Company anticipates the initial put under the equity line of credit will take
place during the first quarter of the fiscal year 2000, June 1 - August 31,
1999. Also, 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.
The Company anticipates that it may require additional equipment, fabrication,
components and supplies during the next twelve months to continue development of
the Company's 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 not
presently estimable by management. Further, if expanded development is commenced
or new generations of microprocessors are accelerated beyond current plans,
additional expenditures, not currently estimable by management, may be required.
It is possible therefore, that higher levels of expenditures may be required
than currently contemplated by management resulting from changes in development
plans or as required to support new developments or commercialization activities
or otherwise.
12
<PAGE> 13
Based on the current fiscal year's rate of cash operating expenditures and
current plans, management anticipates additional cash 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 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.
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 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.
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.
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 the 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 the company's business and results
of operations.
The Company adopted a formal plan to evaluate its readiness for the Year 2000
and address any deficiencies. The plan encompasses 1) information technology
(IT) systems, 2) non-IT systems, 3) Company products, and 4) systems of third
parties, including distributors and key suppliers.
INFORMATION TECHNOLOGY: The Company's principal computer systems that it
uses for financial accounting, manufacturing, inventory control, purchasing,
sales administration, engineering, and other business functions have been
determined to not be Year 2000 compliant. The Company has identified a
replacement system that it will purchase, install, and have fully functional
before June 30, 1999. The cost of this new system will be approximately $30,000.
13
<PAGE> 14
NON-IT SYSTEMS: By the end of the second quarter of 1999, the Company
expects 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.
COMPANY PRODUCTS: The Company has completed a series of tests, utilizing
industry standards, of the electronics systems of its products, including those
product lines no longer being manufactured but remaining in use at customer
sites, and has determined that the products should continue to operate according
to specification after December 31, 1999.
KEY VENDORS AND SUPPLIERS: The Company will initiate a survey of its key
vendors and suppliers to assess their plans for bringing any non-compliant
systems into Year 2000 compliance. Such 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 the Company's Year 2000 readiness has been made using
internal personnel, and therefore incremental expenses have been less than
$50,000. The Company has not incurred any material expenses in connection with
its evaluation of non-IT systems, and does not expect material expense in the
future, although the evaluation of non-IT systems is not yet complete. The
Company has not incurred any material expenses to date in connection with the
evaluation of its products and the status of its vendors and suppliers with
respect to Year 2000 issues, and does not anticipate material expenses in the
future, although the evaluation of key vendors' and suppliers' Year 2000
readiness is not yet complete.
Efforts on the Company's Year 2000 readiness plan, as well as its consideration
of contingency plans, are ongoing and will continue to evolve as new information
becomes available. At this stage of the process, the Company believes that it is
difficult to identify the cause of the most reasonably likely worst case Year
2000 scenario. The Company has not yet adopted any formal contingency plans, and
will determine the need for such plans as part of its ongoing assessment of
vendors and suppliers, products, and internal business systems. Due to the
complexity and pervasiveness of the Year 2000 issue, and in particular the
uncertainty regarding the Year 2000 compliance programs of third parties, no
assurances can be given that there will not be material adverse effects on the
Company's business or its results from operations.
FUTURE PERFORMANCE AND RISK FACTORS
THIS REPORT CONTAINS A NUMBER OF FORWARD-LOOKING STATEMENTS WHICH REFLECTS THE
COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE.
THE COMPANY'S FUTURE BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION ARE
SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE SUMMARIZED BELOW.
READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS
CONTAINED HEREIN, WHICH SPEAK ONLY AS OF THE DATE HEREOF. THE COMPANY UNDERTAKES
NO OBLIGATION TO PUBLICLY REVISE THESE FORWARD-LOOKING STATEMENTS, TO REFLECT
EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE OF THIS REPORT.
Since the business combination with Metacomp, effective December, 1996, the
Company has segregated its operations into microprocessor, communication, and
radar/antenna segments. However, synergistic technical and other resources can
and will be deployed across all three segments.
Product revenues have been primarily from the communication segment. The
communication products are specifically designed to fill both the high speed
data as well as the video conferencing requirements of the Internet.
The microprocessor continues to be the Company's primary development focus. The
Company has completed development of a 0.35 micron version of the PSC1000 which
has resulted in increased processing speed and performance. In addition, the
Company is running the Sun Microsystems's Java OS on the PSC1000. The PSC1000
executes Java very efficiently, and is the price/performance leader in the Java
processor marketplace. This
14
<PAGE> 15
enhancement is expected to increase potential market opportunities in areas such
as TV set top boxes, smart phones, PDAs, network computers, and other Internet
related products.
The Company's primary focus for the radar and antenna technology segment
continues to be to pursue various government agencies and commercial entities to
fund additional development efforts and to establish business partnerships that
will enable the Company to commercialize this technology. The Company recently
completed the first phase of a development contract and has submitted a proposal
for additional funding to the Navy to continue development of the gas antenna.
The Company is focusing its sales efforts on original equipment manufacturers,
system integrators, and Internet service providers for both the microprocessor
and communication segments. In addition, the Company anticipates using the
microprocessor in existing and future products developed in all three product
segments.
The Company has experienced in the past and may experience in the future many of
the problems, delays and expenses encountered by any business in the early
stages of development, some of which are beyond the Company's control. The
Company has a limited operating history, has incurred significant cumulated
losses, has only recently commenced marketing and sales of its products and has
not achieved a profitable level of operations. There can be no assurance of
future profitability. The Company may require additional funds in the future for
operations or to exploit its technologies. There can be no assurance that any
funds required during the next twelve months or thereafter can be generated from
operations or that such required funds will be available from the aforementioned
or other potential sources. The lack of additional capital could force the
Company to substantially curtail or cease operations and could 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. The Company's technologies are in various
stages of development. The Company's communication products have been developed
to the point of production of marketable product and the PSC1000 is in the first
stages of production. There can be no assurance that any of the technologies in
development can be completed to commercial exploitation due to the inherent
risks of new technology development, limitations on financing, competition,
obsolescence, loss of key technical personnel and other factors. The Company's
development projects are high risk in nature, where unanticipated technical
obstacles can arise at any time and result in lengthy and costly delays or
result in determination that further development is unfeasible. There can be no
assurance that the technologies, if completed, will achieve market acceptance
sufficient to sustain the Company or achieve profitable operations.
The Company relies primarily on patents to protect its intellectual property
rights. There can be no assurance that patents held by the Company will not be
challenged and invalidated, that patents will issue from any of the Company's
pending applications or that any claims allowed from existing or pending patents
will be sufficient in scope or strength or be issued in all countries where the
Company's products can be sold to provide meaningful protection or commercial
advantage to the Company. Competitors may also be able to design around the
Company's patents.
The Company acquired its ShBoom technology pursuant to a chain of agreements,
and there is uncertainty regarding royalty payments, if any, and indemnification
from prior parties. The Company does not believe it is obligated to pay any
royalties on aspects of the ShBoom technology specified in prior agreements
between nanoTronics Corporation and previous inventors. The Company believes,
should there be royalties due to previous inventors, that the obligation is that
of nanoTronics. The Company could become subject to unindemnified claims
relating to any failure by nanoTronics to pay such royalties, if due. Also the
Company could become liable for up to $1,250,000 to nanoTronics under certain
indemnification provisions. The Company has recently been named as a defendant
in a law suit filed by one of the previous inventors. The Company is unable at
this time to determine the eventual outcome of this suit. The Company's
Consolidated Financial Statements do not include any adjustments that might
result from the outcome of this uncertainty.
The Company's common shares are traded on the OTC Bulletin Board, are thinly
traded and are subject to special regulations imposed on "penny stocks." The
Company's shares may experience significant price and volume volatility,
increasing the risk of ownership to investors.
15
<PAGE> 16
PART II. OTHER INFORMATION
None
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PATRIOT SCIENTIFIC CORPORATION
Date: April 21, 1999 By: /s/ LOWELL W. GIFFHORN
-------------------------------------
Chief Financial Officer
(Principal Financial and
Accounting Officer and duly
authorized to sign on behalf
of the Registrant)
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM UNAUDITED
INTERIM STATEMENTS FOR THE SIX MONTHS ENDED FEBRUARY 28, 1999 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH QUARTERLY REPORT ON FORM 10-QSB FOR THE
QUARTERLY PERIOD ENDED FEBRUARY 28, 1999.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> MAY-31-1999
<PERIOD-START> JUN-01-1998
<PERIOD-END> FEB-28-1999
<CASH> 16,800
<SECURITIES> 0
<RECEIVABLES> 250,322
<ALLOWANCES> 0
<INVENTORY> 187,384
<CURRENT-ASSETS> 659,045
<PP&E> 1,858,780
<DEPRECIATION> 1,327,201
<TOTAL-ASSETS> 1,345,311
<CURRENT-LIABILITIES> 1,672,101
<BONDS> 0
0
0
<COMMON> 411
<OTHER-SE> 20,215,934
<TOTAL-LIABILITY-AND-EQUITY> 1,345,311
<SALES> 1,108,022
<TOTAL-REVENUES> 1,108,022
<CGS> 683,323
<TOTAL-COSTS> 683,323
<OTHER-EXPENSES> 3,278,718
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 453,257
<INCOME-PRETAX> (3,303,512)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,303,512)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,303,512)
<EPS-PRIMARY> (.09)
<EPS-DILUTED> (.09)
</TABLE>
