<PAGE> 1
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended August 31, 2000
---------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _____________ to _______________
Commission File Number 0-22182
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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
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(Address of principal executive offices)
(858) 674-5000
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Common Stock, $.00001 par value 52,425,948
------------------------------- ----------
(Class) (Outstanding at October 2, 2000)
Transitional Small Business Disclosure Format (check one): YES [ ] NO [X]
<PAGE> 2
PATRIOT SCIENTIFIC CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as of August 31, 2000 (unaudited)
and May 31, 2000 3
Consolidated Statements of Operations for the three months ended
August 31, 2000 and 1999 (unaudited) 4
Consolidated Statements of Cash Flows for the three months ended
August 31, 2000 and 1999 (unaudited) 5
Notes to Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10-15
PART II. OTHER INFORMATION 15
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 15
SIGNATURES 15
</TABLE>
* No information provided due to inapplicability of the item.
2
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PART I- FINANCIAL INFORMATION
Item 1. Financial Statements
PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
August 31, May 31,
2000 2000
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 677,625 $ 2,100,242
Accounts receivable, net of allowance
of $5,000 for uncollectible accounts 107,144 61,152
Note receivable (Note 7) 80,000 --
Inventories (Note 3) 217,672 71,164
Prepaid expenses 155,863 60,048
------------ ------------
Total current assets 1,238,304 2,292,606
Property and equipment, net 295,369 289,880
Patents and trademarks, net 134,322 150,662
------------ ------------
$ 1,667,995 $ 2,733,148
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 174,739 $ 393,150
Accrued liabilities 105,519 130,116
------------ ------------
Total current liabilities 280,258 523,266
Commitment (Note 8)
Stockholders' equity (Note 6):
Preferred stock, $.00001 par value; 5,000,000 shares
authorized: none outstanding -- --
Common stock, $.00001 par value; 100,000,000 shares
authorized; issued and outstanding 51,367,281 and 51,126,675 514 511
Additional paid-in capital 33,623,550 33,559,158
Accumulated deficit (32,236,327) (31,349,787)
------------ ------------
Total stockholders' equity 1,387,737 2,209,882
------------ ------------
$ 1,667,995 $ 2,733,148
============ ============
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
3
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Patriot Scientific Corporation
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
August 31, August 31,
2000 1999
<S> <C> <C>
Net sales $ 119,101 $ 199,024
Cost of sales 134,206 126,610
------------ ------------
Gross profit (loss) (15,105) 72,414
Operating expenses:
Research and development 554,862 433,400
Selling, general and
administrative 330,445 345,714
------------ ------------
885,307 779,114
------------ ------------
Operating loss (900,412) (706,700)
------------ ------------
Other income (expenses):
Gain on sale of technology -- 250,000
Interest income 14,619 98
Interest expense (747) (26,355)
Non-cash interest expense
related to notes payable
(Note 4) -- (265,821)
------------ ------------
13,872 (42,078)
------------ ------------
Net loss $ (886,540) $ (748,778)
============ ============
Basic and diluted loss
per common share $ (0.02) $ (0.02)
============ ============
Weighted average number of
common shares outstanding
during the period (Note 1) 51,260,601 39,575,872
============ ============
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
4
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PATRIOT SCIENTIFIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
August 31, 2000 August 31, 1999
<S> <C> <C>
Increase (Decrease) in Cash and Cash Equivalents
Operating activities:
Net loss $ (886,540) $ (748,778)
Adjustments to reconcile net loss
to cash used in operating activities:
Amortization and depreciation 57,133 90,077
Non-cash interest expense related to
notes payable (Note 4) -- 265,821
Gain on sale of technology -- (250,000)
Changes in:
Accounts receivable (45,992) (112,863)
Inventories (146,508) 7,602
Prepaid and other assets (95,815) 27,387
Accounts payable and accrued expenses (243,008) 188,468
--------------- ---------------
Net cash used in operating activities (1,360,730) (532,286)
--------------- ---------------
Investing activities:
Note receivable (Note 7) (80,000) --
Purchase of property and equipment (46,282) (31,667)
Proceeds from sale of technology -- 250,000
--------------- ---------------
Net cash provided by (used in) investing activities (126,282) 218,333
--------------- ---------------
Financing activities:
Proceeds from issuance of short term notes payable -- 205,000
Proceeds from sale of accounts receivable -- 95,193
Principal payments on notes payable and
long-term debt -- (573)
Proceeds from exercise of common stock
warrants and options 64,395 7,400
--------------- ---------------
Net cash provided by financing activities 64,395 307,020
--------------- ---------------
Net decrease in cash and cash equivalents (1,422,617) (6,933)
Cash and cash equivalents, beginning of period 2,100,242 35,813
--------------- ---------------
Cash and cash equivalents, end of period $ 677,625 $ 28,880
--------------- ---------------
Supplemental Disclosure of Cash Flow Information:
Notes payable and accrued interest exchanged
for common stock $ -- $ 116,182
Cash payments for interest $ 747 $ 1,403
Unamortized debt discount $ -- $ 225,355
--------------- ---------------
</TABLE>
See accompanying summary of accounting policies and notes to consolidated
financial statements.
5
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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, 2000.
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 period are
not necessarily indicative of the results that may be expected for the year.
LOSS PER SHARE
The Company follows 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 and
common stock warrants. Common stock options and warrants of 6,854,399 and
6,877,476 for the three months ended August 31, 2000 and 1999, respectively,
were not included in diluted loss per share for the periods as the effect was
antidilutive due to the Company recording losses in each of those periods.
SALE OF ACCOUNTS RECEIVABLE
The Company follows SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities". SFAS No. 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 enables the Company to sell selected accounts
receivable invoices to the bank with full recourse against the Company. These
transactions qualify for a sale of assets since (1) the Company has transferred
all of its right, title and interest in the selected accounts receivable
invoices to the bank, (2) the bank may pledge, sell or transfer the selected
accounts receivable invoices, and (3) the Company has no effective control over
the selected accounts receivable invoices since it may not redeem the invoices
sold previous to the invoices being greater than 90 days past due. Under SFAS
No.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. During the first three months of
fiscal 2000, the Company sold approximately $119,000 of its accounts receivable
to a bank under a factoring agreement for approximately $95,000. Pursuant to the
provisions of SFAS No. 125, the Company reflected the transactions as sales of
assets and established an accounts receivable from the bank for the retained
amount less the costs of the transaction and less any anticipated future loss in
the value of the retained asset. The retained amount was equal to 20% of the
total accounts receivable invoice sold to the bank less 1% of the total invoice
as an administrative fee and 1.75% per month of the total outstanding accounts
receivable invoices as a finance fee. The estimated future loss reserve for each
receivable included in the estimated value of the retained asset was based on
the payment history of the accounts receivable customer. As of August 31, 2000,
there were no balances outstanding under the factoring line.
RECLASSIFICATIONS
Certain items in the 1999 Financial Statements have been reclassified to conform
to the current presentation.
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PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("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 all fiscal quarters of all fiscal periods beginning after June 15,
2000. The Company believes the adoption of this statement will have no material
impact on its financial statements.
In March 2000, the FASB issued FASB Interpretation No. 44, Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25. The Company adopted the Interpretation on July 1, 2000. The
Interpretation requires that stock options that have been modified to reduce the
exercise price be accounted for as variable. The Company has repriced stock
options on October 5, 1999 and in accordance with generally accepted accounting
principles accounted for the repriced stock options as fixed. As a result of
adopting the Interpretation, the Company is required to apply variable
accounting to these options and if the market price of the Company's stock
increases subsequent to July 1, 2000 it will recognize additional compensation
expense that it otherwise would not have incurred. As of August 31, 2000, there
was no additional compensation expense recorded because the market price of the
Company's common stock was lower than the price at July 1, 2000. However, the
ultimate impact cannot be determined as it is dependent on the change in the
market price of the stock from July 1, 2000 until the stock options are
exercised, forfeited or expire unexercised.
In December 1999, the Securities and Exchange Commission (the "SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements" which provides additional guidance in applying generally accepted
accounting principles to revenue recognition in financial statements. SAB 101 is
effective as of the fourth quarter of fiscal year ending May 31, 2001. The
Company believes the adoption of this bulletin will have no material impact on
its financial statements.
In March 2000, the FASB issued Emerging Issues Task Force Issue No 00-2,
"Accounting for Web Site Development Costs" ("EITF 00-2"), which is effective
for all such costs incurred for fiscal quarters beginning after June 30, 2000.
This Issue establishes accounting and reporting standards for costs incurred to
develop a web site based on the nature of each cost. Currently, as the Company
has no web site development costs, the adoption of EITF 00-2 would have no
impact on the Company's financial condition or results of operations. To the
extent the Company begins to enter into such transactions in the future, the
Company will adopt the Issue's disclosure requirements in the quarterly and
annual financial statements for the year ending May 31, 2001.
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 August 31, 2000 and May 31, 2000, consist of the following:
<TABLE>
<CAPTION>
August 31, 2000 May 31, 2000
<S> <C> <C>
Component parts $ 344,698 $ 332,271
Work in process 59,761 38,213
Finished goods 152,213 39,680
--------------- ---------------
556,672 410,164
Reserve for obsolescence (339,000) (339,000)
--------------- ---------------
$ 217,672 $ 71,164
=============== ===============
</TABLE>
7
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PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. NOTES PAYABLE
As of August 31, 1999, the Company had short term notes payable aggregating
$803,000 with a group of individual investors, one of which was a major
shareholder in the Company. Of this amount, $205,000 was issued during the first
fiscal quarter of 2000. The notes typically had four month maturity dates and
accrued interest at the rate of 10%. These notes were paid in full during the
balance of fiscal 2000.
In addition to the interest on the notes, warrants exercisable for three years,
for an aggregate of 3,178,122 common shares of the Company were issued to
investors at exercise prices ranging from $.25 to $.50 which was equal to the
market price of the common stock on the date of the issuances. During the three
months ended August 31, 1999, warrants to purchase 538,342 common shares of the
Company were issued related to the $205,000 short term notes placed during the
three months and warrants to purchase 961,318 common shares of the Company were
issued to the individual investors to extend the due dates of their short term
notes. These warrants were valued using the Black-Scholes model and the value of
$596,176 was reflected as a discount to the debt and was amortized over the life
of the debt. In the first three months of fiscal 2000, $265,821 of the debt
discount was amortized and reflected as non-cash interest expense.
5. INVESTMENT AGREEMENT
In May 2000, the Company entered into an investment agreement with Swartz
Private Equity LLC ("Swartz"). The investment agreement entitles the Company, at
the Company's option, to issue and sell its common stock for up to an aggregate
of $30 million from time to time during a three-year period through June 23,
2003, 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 that can be sold to
Swartz within a 30 day time period based on the trading volume of the stock,
among others. Swartz can purchase the common stock from the Company at a
discount ranging from 7% to 10% 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 as
determined during the pricing period, subject to further semi-annual price
adjustments if the price of the common stock goes down. The Company had
previously entered into a similar investment agreement with Swartz.
The registration statement went effective on June 23, 2000. Subsequent to the
end of the quarter, in September, 2000 the Company received proceeds of $683,167
from the sale of 1,000,000 shares of common stock as a result of the initial
put. Per the terms of the investment agreement, the Company issued a five year
warrant for 150,000 shares of common stock exercisable initially at a price of
$0.9625 related to the initial put.
6. STOCKHOLDERS' EQUITY
The following table summarizes equity transactions during the three months ended
August 31, 2000:
<TABLE>
<CAPTION>
Common
Shares Dollars
<S> <C> <C>
Balance June 1, 2000 51,126,675 $33,559,669
Exercise of common stock warrants 240,606 64,395
----------- -----------
Balance August 31, 2000 51,367,281 $33,624,064
=========== ===========
</TABLE>
At August 31, 2000, the Company had 262,500 options outstanding pursuant to its
1992 ISO Stock Option Plan exercisable at a range of $0.32 to $1.325 per share
expiring beginning in 2001 through 2005. The Company had 135,753 options
outstanding pursuant to its 1992 NSO Stock Option Plan exercisable at a range of
$0.18 to $1.325 per share expiring beginning in 2001 through 2005. The Company
also had 1,940,571 options outstanding pursuant to its 1996 Stock Option Plan
exercisable at a range of $0.32 to $1.41 per share expiring beginning in 2001
through 2005.
8
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PATRIOT SCIENTIFIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Some of the options outstanding under these plans are not presently exercisable
and are subject to meeting vesting criteria.
At August 31, 2000, the Company had warrants outstanding exercisable into
4,515,575 common shares at exercise prices ranging from $0.25 to $1.12 per share
expiring beginning in 2002 through 2005. During fiscal year 2000, the Company
issued 1,052,219 warrants to purchase common stock which are subject to
repricings at the six month anniversary of the issuance of the warrant. At each
anniversary date the warrants will be repriced to the lesser of the initial
exercise price or 110% of the lowest closing bid price of the Company's common
stock for the five trading days ending on such six month anniversary date of the
date of issuance. As of August 31, 2000 none of the warrants have been repriced.
7. NOTE RECEIVABLE
In June 2000, the Company entered into a three-year, $80,000 Secured Promissory
Note Receivable with an individual who was, at the time of the issuance of the
note, an executive officer of the Company. On September 25, 2000, he requested
and was relieved of his duties as an executive officer and director of the
Company. The note bears interest at the rate of 6% per annum with interest
payments due semi-annually and the principal due at the maturity of the note.
The individual pledged 100,000 shares of the Company's common stock that he held
on the date of issuance as security for this note.
8. COMMITMENT
In July 2000, the Company entered into a purchase agreement whereby it plans to
purchase a two-story, 12,760 square foot building which is under construction
and anticipated to be completed and ready for occupancy in the second calendar
quarter of 2001. The agreement is subject to the Company completing its due
diligence and obtaining satisfactory financing on the completed building. The
cost of the completed project is anticipated to be approximately $2,200,000 and
the Company anticipates that, initially, it would rent out to third parties
approximately one-half of the total space.
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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, 2000.
The Company's 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 its products,
- economic conditions in its 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,
- product enhancements by the Company or its competitors, and
- pricing and other competitive conditions.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED AUGUST 31, 2000 AND AUGUST 31,
1999
Net sales. Total net sales for the first fiscal quarter ended August 31,
2000 decreased 40.2% to $119,101 from $199,024 for the corresponding period of
the previous fiscal year. This decrease was due to a reduction in follow-on
shipments for the Company's matured communication products, several that are
approaching the end of their life cycles, coupled with a reduction in license
fee income. Development and sales of new communications products have not
achieved a level to replace the maturing products. The Company anticipates this
trend in communication product revenue to continue since many of the
communication products are approaching the end of their life cycles and its
efforts are being focused on the microprocessor product line. Microprocessor
sales increased slightly to $13,095 compared to $6,345 for the same period of
the previous year. This increase is the result of the revenues from initial
shipments of evaluation kits containing the latest version of the 0.35 micron
chip.
Cost of sales. Cost of sales as a percentage of net sales increased to
112.7% in the first fiscal quarter ended August 31, 2000 compared to 63.6% for
the corresponding period of the previous fiscal year. This significant increase
was due in part to the costs of the new evaluation kits which are now being
provided to potential customers. Some of these kits are provided at no cost to
the customer. Also, as a result of the decreased activity in the communications
product revenue, the fixed manufacturing overhead was allocated to a smaller
revenue base which contributed to the increase in the cost of sales as a
percentage of net sales percentage.
Research and development expenses increased 28.0% from $433,400 for the
first fiscal quarter ended August 31, 1999 to $554,862 for the first fiscal
quarter ended August 31, 2000. This increase was due primarily to a ramp up in
personnel and consulting services to introduce a new soft core version of the
microprocessor technology.
Selling, general and administrative expenses decreased 4.4% to $330,445
for the first fiscal quarter ended August 31, 2000 compared to $345,714 for the
first fiscal quarter ended August 31, 1999. This decrease was primarily due to a
reduction in the costs related to financings partially offset by an increase in
consulting costs due to the creation of a new executive position for business
development during the first quarter ended August 31, 2000.
Other income (expense) increased significantly for the first fiscal
quarter ended August 31, 2000, $13,872, compared to ($42,078) for the
corresponding period of the previous fiscal year. This increase in income
resulted primarily from the recognition in the first fiscal quarter ended August
31, 1999 of $265,821 of non-cash interest related to the amortization of the
debt discount, as discussed in Note 4 to the consolidated financial statements,
offset
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<PAGE> 11
by the gain on sale of the gas plasma antenna technology of $250,000. Also
interest expense on short-term notes payable was $26,355 for the corresponding
period of the previous fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
At August 31, 2000, the Company had working capital of $958,046 and
cash and cash equivalents of $677,625. The Company has historically funded its
operations primarily through the issuance of securities and debt financings.
Cash and cash equivalents decreased $1,422,617 during the first fiscal quarter
ended August 31, 2000 due to net cash used in operations of $1,360,730,
additions to property and equipment of $46,282 and the issuance of a note
receivable of $80,000 to an officer of the Company offset by funds generated
from the exercise of warrants to purchase common stock of the Company of
$64,395. The net cash used in operations is primarily a result in a reduction of
accounts payable of $218,411, related to a settlement of a major software
vendor, an increase in inventory of $146,508 which was a result of receiving the
next generation microprocessor and related evaluation kits, and an increase in
accounts receivable of $45,992.
The Company estimates its current cash requirements to sustain its
operations for the next twelve months through August 2001 to be $4 million. The
Company expects that these requirements will be provided by the current working
capital of $958,046, the $30 million equity line of credit, as discussed below,
the exercise of outstanding stock options and warrants, and anticipated
increased microprocessor and license revenue. In addition, the Company has a
$500,000 factoring agreement with its bank.
The Company anticipates that it may require additional equipment,
fabrication, components and supplies during the next twelve months to continue
development of its technologies. Product introductions such as those currently
underway for the PSC1000 may require significant inventory, product launch,
marketing personnel and other expenditures that can not be currently estimated.
Further, if expanded development is commenced or new generations of
microprocessors are accelerated beyond their current plans, additional
expenditures that the Company can not currently estimate, may be required. In
July 2000, the Company entered into a purchase agreement whereby it plans to
purchase a two-story, 12,760 square foot building which is under construction
and anticipated to be completed and ready for occupancy in the second calendar
quarter of 2001. The cost of the completed project is anticipated to be
approximately $2,200,000 and the Company anticipates that, initially, it would
rent out to third parties approximately one-half of the total space. It is
anticipated that the new facility will be paid for partially by encumbering the
property with a mortgage. It is possible therefore, that higher levels of
expenditures may be required than the Company currently contemplates resulting
from changes in development plans or as required to support new developments or
commercialization activities or otherwise. The Company anticipates that, if
needed, the equity line of credit and revenues from the sale of the
microprocessor and licenses of the microprocessor technology will generate the
additional resources necessary to accelerate the marketing and production
activity.
$30 MILLION EQUITY LINE OF CREDIT
Overview. On May 2, 2000, the Company entered into an investment
agreement with Swartz Private Equity, LLC. The investment agreement entitles it
to issue and sell its common stock for up to an aggregate of $30 million from
time to time during a three-year period starting June 23, 2000, the effective
date of the registration statement. This is also referred to as a put right.
Subsequent to the end of the quarter, in September, 2000 the Company received
proceeds of $683,167 from the sale of 1,000,000 shares of common stock as a
result of the initial put.
Put Rights. In order to invoke a put right, the Company 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, the Company must give at least ten but not more than
twenty business days advance notice to Swartz of the date on which it intends to
exercise a particular put right and it must indicate the number of shares of
common stock it intends to sell to Swartz. At its option, the Company may also
designate a maximum dollar amount of common stock (not to exceed $3 million)
which it 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 the Company invoked the put right and ends on and includes the
day which is twenty business days after the date it invoked the put right.
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<PAGE> 12
Swartz will pay the Company a percentage of the market price for each
share of common stock under the put. If the market price is less than $2.00 per
share, the percentage will be 90%; and if the market price is $2.00 or greater,
the percentage will be 93%. Market price is defined as the lowest closing bid
price for the common stock during the applicable pricing period which consists
of two consecutive ten business day periods following the date notice of the put
was provided to Swartz. However, the market price may not be less than the
designated minimum per share price, if any, that the Company indicated in its
notice.
Warrants. Within five business days after the end of each pricing
period, the Company is 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 closing bid price on the put date
for the applicable put. 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.
Limitations and Conditions Precedent to the Company's Put Rights.
Swartz is not required to acquire and pay for any common shares with respect to
any particular put for which:
- The Company has announced or implemented a stock split or
combination of its common stock;
- The Company has paid a common stock dividend;
- The Company has made a distribution of its common stock or of all
or any portion of its assets between the put notice date and the
date the particular put closes; or
- The Company has 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 its 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. The Company must cancel a particular put
between the date of the advance put notice and the last day of the pricing
period if:
- the Company discovers 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, the Company will be required to issue common shares
equal to the lesser of:
- 20% of the daily reported trading volume of its common stock during the
pricing periods up to the applicable put cancellation date;
- the number of shares of common stock put to Swartz which when multiplied by
the applicable put share price equals the designated maximum dollar amount
for the put; or
- 9.9% of the total amount of its common stock that would be outstanding upon
completion of the put.
Shareholder Approval. The Company may currently issue more than 20% of
its outstanding shares. If the Company becomes listed on the Nasdaq Small Cap
Market or Nasdaq National Market, then the Company must get shareholder approval
to issue more than 20% of its outstanding shares. Since the Company is currently
a bulletin board company, it does not need shareholder approval.
Termination of Investment Agreement. The Company may also terminate
its 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 the Company has
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, the Company is prohibited from certain
transactions. These include the issuance of any debt or equity
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securities in a private transaction which are convertible or exercisable into
shares of common stock at a price based on the trading price of the common stock
at any time after the initial issuance of such securities or with a fixed
conversion or exercise price subject to adjustment. The Company is 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 the Company in any private
transaction which closes on or prior to six months after the termination of the
investment agreement.
Swartz's Right of Indemnification. The Company is obligated to
indemnify Swartz (including their stockholders, officers, directors, employees
and agents) from all liability and losses resulting from any misrepresentations
or breaches the Company made in connection with the investment agreement, its
registration rights agreement, other related agreements, or the registration
statement.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 all fiscal quarters of all fiscal periods beginning after June 15,
2000. Management of the Company believes the adoption of this statement will
have no material impact on its financial statements.
In March 2000, the FASB issued FASB Interpretation No. 44, Accounting
for Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25. The Company adopted the Interpretation on July 1, 2000. The
Interpretation requires that stock options that have been modified to reduce the
exercise price be accounted for as variable. The Company has repriced stock
options on October 5, 1999 and in accordance with generally accepted accounting
principles accounted for the repriced stock options as fixed. As a result of
adopting the Interpretation, the Company is required to apply variable
accounting to these options and if the market price of the Company's stock
increases subsequent to July 1, 2000 it will recognize additional compensation
expense that it otherwise would not have incurred. As of August 31, 2000, there
was no additional compensation expense recorded because the market price of the
Company's common stock was lower than the price at July 1, 2000. However, the
ultimate impact cannot be determined as it is dependent on the change in the
market price of the stock from July 1, 2000 until the stock options are
exercised, forfeited or expire unexercised.
In December 1999, the Securities and Exchange Commission (the "SEC")
issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements" which provides additional guidance in applying generally
accepted accounting principles to revenue recognition in financial statements.
SAB 101 is effective as of the fourth quarter of fiscal year ending May 31,
2001. Management of the Company believes the adoption of this bulletin will have
no material impact on its financial statements.
In March 2000, the FASB issued Emerging Issues Task Force Issue No 00-2,
"Accounting for Web Site Development Costs" ("EITF 00-2"), which is effective
for all such costs incurred for fiscal quarters beginning after June 30, 2000.
This Issue establishes accounting and reporting standards for costs incurred to
develop a web site based on the nature of each cost. Currently, as the Company
has no web site development costs, the adoption of EITF 00-2 would have no
impact on the Company's financial condition or results of operations. To the
extent the Company begins to enter into such transactions in the future, the
Company will adopt the Issue's disclosure requirements in the quarterly and
annual financial statements for the year ending May 31, 2001.
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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 product lines.
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, microprocessors and initial
license fees related to the microprocessor application. The Company runs the
technology on a 0.35-micron microprocessor, which is in current production.
The Company has ported the VxWorks operating system and the Sun Microsystems
personalJava virtual machine to the microprocessor. Although the Company
anticipates the microprocessor to be its main product line, it currently
accounts for only 11% of its 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. The Company has decided to concentrate its efforts
on the PSC1000 microprocessor and has suspended its efforts to introduce new
communication products to the market. Although the communications product
line accounted for approximately 89% of its revenue, the Company anticipates
that the microprocessor will be its main product line in the future.
- Radar and antenna. The Company sold the gas plasma antenna technology in
August 1999. Its radar technology has not generated any revenue and the
Company has suspended further development of this technology in order to
concentrate its resources on the PSC1000 microprocessor.
Due to its small size and staffing overlaps among the technologies,
certain personnel work on both the microprocessor and communication technologies
from time to time.
During at least the last three years, the Company has focused the
majority of its efforts on the PSC1000 and high-speed data communications
technologies. The PSC1000 technology and its initial microprocessors, the
PSC1000 family, are targeted for the embedded controller and Java language
processor marketplaces.
In reviewing its communication technology markets, the Company
determined that it could not effectively compete in the ISDN (which stands for
integrated services digital network, a high-speed method of transmitting data
over the Internet) market. However, the Company continues to sell matured
communication products to a select number of customers who have requirements for
older generation products. The Company will continue to serve this sector of the
market as long as doing so is cost beneficial and is not disruptive to its major
product line, the PSC1000.
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 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 in the future can be generated from operations or that such
required funds will be available from 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
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attractive terms or that they will not have a significantly dilutive effect on
the Company's existing shareholders. The Company's technologies are in various
stages of development. 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'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.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - NONE
(b) Reports on Form 8-K
A Report on Form 8-K was filed on September 28, 2000 related to a change
in the Chairman of the Board of Directors, Chief Executive Officer and President
of the Company effective September 25, 2000.
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: October 3, 2000 By: /s/ LOWELL W. GIFFHORN
----------------------------------
Chief Financial Officer
(Principal Financial and
Accounting Officer and duly
authorized to sign on behalf
of the Registrant)
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