UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2014
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to _______________
Commission File Number 0-22182
PATRIOT SCIENTIFIC CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
84-1070278
(I.R.S. Employer Identification No.)
701 Palomar Airport Road, Suite 170, Carlsbad, California
(Address of principal executive offices)
92011
(Zip Code)
(Registrant’s telephone number, including area code): (760) 547-2700
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ]
(do not check if smaller reporting company) Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
On October 9, 2014, 401,392,948 shares of common stock, par value $0.00001 per share were outstanding.
INDEX
Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed consolidated Balance Sheets as of August 31, 2014 (unaudited) and May 31, 2014 3
Condensed consolidated Statements of Operations for the three months ended August 31, 2014 and August 31, 2013 (unaudited) 4
Condensed consolidated Statements of Cash Flows for the three months ended August 31, 2014 and August 31, 2013 (unaudited) 5
Notes to condensed consolidated Financial Statements (unaudited) 6-20
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 21-29
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 30
ITEM 4. Controls and Procedures 30
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 30
ITEM 1A. Risk Factors 31
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 31
ITEM 3. Defaults Upon Senior Securities 31
ITEM 4. Mine Safety Disclosures 31
ITEM 5. Other Information 31
ITEM 6. Exhibits 31-34
SIGNATURES
2
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Patriot Scientific Corporation
Condensed Consolidated Balance Sheets
August 31, 2014 May 31, 2014
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 4,449,307 $ 4,716,208
Restricted cash and cash equivalents 21,150 21,123
Marketable securities 1,502,182 1,701,647
Prepaid expenses and other current assets 156,782 203,146
Current assets of discontinued operations 11,800 57,477
Total current assets 6,141,221 6,699,601
Property and equipment, net 2,942 2,775
Other assets 3,036 3,036
Investment in affiliated company – 95,981
Total assets $ 6,147,199 $ 6,801,393
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable $ 55,178 $ 224,059
Accrued expenses and other 44,370 62,485
Income tax payable 2,299 3,599
Total current liabilities 101,847 290,143
Cumulative losses in excess of investment in affiliated company 128,055 –
Total liabilities 229,902 290,143
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.00001 par value; 5,000,000 shares authorized: none outstanding – –
Common stock, $0.00001 par value: 600,000,000 shares authorized: 438,242,618 shares issued and 401,392,948 shares outstanding at August 31, 2014 and May 31, 2014 4,382 4,382
Additional paid-in capital 77,400,852 77,400,852
Accumulated deficit (56,862,069 ) (56,268,116 )
Common stock held in treasury, at cost – 36,849,670 shares at August 31, 2014 and May 31, 2014 (14,625,868 ) (14,625,868 )
Total stockholders’ equity 5,917,297 6,511,250
Total liabilities and stockholders’ equity $ 6,147,199 $ 6,801,393
See accompanying notes to unaudited condensed consolidated financial statements.
3
Patriot Scientific Corporation
Condensed Consolidated Statements of Operations
(Unaudited)
Three months ended
August 31, 2014 August 31, 2013
Operating expenses:
Selling, general and administrative $ 372,625 $ 438,654
Total operating expenses 372,625 438,654
Other income (expense):
Interest income 2,248 490
Other income 60 –
Equity in loss of affiliated company (224,036 ) (85,184 )
Total other expense, net (221,728 ) (84,694 )
Loss from continuing operations before income taxes (594,353 ) (523,348 )
Provision for income taxes 2,400 3,900
Loss from continuing operations (596,753 ) (527,248 )
Income from discontinued operations, net 2,800 40,358
Net loss $ (593,953 ) $ (486,890 )
Basic and diluted income (loss) per common share:
Loss from continuing operations $ – $ –
Income from discontinued operations $ – $ –
Net loss $ – $ –
Weighted average number of common shares outstanding – basic and diluted 401,392,948 402,402,775
See accompanying notes to unaudited condensed consolidated financial statements.
4
Patriot Scientific Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Three months ended
August 31, 2014 August 31, 2013
Operating activities:
Net loss $ (593,953 ) $ (486,890 )
Less: Net income from discontinued operations 2,800 40,358
Net loss from continuing operations (596,753 ) (527,248 )
Adjustments to reconcile net loss before discontinued operations to net cash used in operating activities:
Depreciation 535 576
Share-based compensation – 62,418
Accrued interest income added to investments (1,640 ) –
Equity in loss of affiliated company 224,036 85,184
Changes in operating assets and liabilities:
Accounts receivable - affiliated company – (16,862 )
Prepaid expenses and other current assets 46,364 44,098
Accounts payable, accrued expenses and other (186,995 ) (181,381 )
Income tax payable (1,300 ) 2,400
Net cash used in operating activities of continuing operations (515,753 ) (530,815 )
Net cash provided by operating activities of discontinued operations 48,476 10,683
Net cash used in operating activities (467,277 ) (520,132 )
Investing activities:
Proceeds from sales of marketable securities 951,078 –
Purchases of marketable securities (750,000 ) –
Purchase of property and equipment (702 ) –
Distributions from affiliated company – 6,250
Net cash provided by investing activities 200,376 6,250
Net decrease in cash and cash equivalents (266,901 ) (513,882 )
Cash and cash equivalents, beginning of period 4,716,208 7,572,887
Cash and cash equivalents, end of period $ 4,449,307 $ 7,059,005
Supplemental Disclosure of Cash Flow Information:
Cash paid for income taxes $ 3,700 $ 1,500
See accompanying notes to unaudited condensed consolidated financial statements.
5
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
1. Basis of Presentation and Summary of Significant Accounting Policies
The unaudited condensed consolidated financial statements of Patriot Scientific Corporation (the “Company”, “PTSC”, “Patriot”, “we”, “us” or “our”) presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in our Report on Form 10-K for our fiscal year ended May 31, 2014.
In the opinion of management, the interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the results for the interim period presented. Operating results for the three month period ended August 31, 2014 are not necessarily indicative of the results that may be expected for the year ending May 31, 2015.
Basis of Consolidation
The condensed consolidated balance sheets at August 31, 2014 and May 31, 2014 and condensed consolidated statements of operations for the three months ended August 31, 2014 and 2013 include our accounts and those of our wholly owned subsidiary Patriot Data Solutions Group, Inc. (“PDSG”) which includes Crossflo Systems, Inc. (“Crossflo”), and our inactive subsidiary Plasma Scientific Corporation. All significant intercompany accounts and transactions have been eliminated.
PDSG is being presented as discontinued operations in the condensed consolidated statements of operations for all periods presented. See “Discontinued Operations and Assets Held for Sale” below for additional information.
Liquidity and Management’s Plans
Cash shortfalls currently experienced by Phoenix Digital Solutions, LLC (“PDS”) will have an adverse effect on our liquidity. To date, we have determined that it is in the best interests of the Moore Microprocessor Patent (“MMP”) licensing program that we provide our 50% share of capital to provide for PDS expenses including legal retainers, and litigation related payments in the event license revenues received by PDS are insufficient to meet these needs. We believe it is likely that contributions to PDS to fund working capital will continue to be required.
PDS had been incurring significant third-party costs for expert testimony, depositions and other related litigation costs. We could be required to make capital contributions to PDS for any future litigation related costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.
Our current liquid cash resources as of August 31, 2014, are expected to provide the funds necessary to support our operations through at least the next twelve months. The cash flows from our interest in PDS represent our only significant source of cash generation. In the event of a continued decrease or interruption in MMP portfolio licensing we will incur a significant reduction to our cash position. It is highly unlikely that we would be able to obtain any additional sources of financing to supplement our cash and cash equivalents and short-term investment position of $5,951,489 at August 31, 2014.
6
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Liquidity and Management’s Plans (continued)
On March 20, 2013, Technology Properties Limited, Inc. (“TPL”) filed a petition under Chapter 11 of the United States Bankruptcy Code. We have been appointed to the creditors’ committee and have been closely monitoring the progress in this matter as it relates to our interest in PDS. On July 18, 2014, TPL and the creditors’ committee announced that a term sheet serving as the basis for a Joint Plan of Reorganization (the “Joint Plan”) had been agreed to. On September 3, 2014 and September 17, 2014, respectively, the Joint Plan and Joint Disclosure Statement were filed with the Bankruptcy Court. A competing reorganization plan has also been filed with the Court. In the event we are required to provide funding to PDS that is not reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our consolidated financial statements.
Discontinued Operations and Assets Held for Sale
On February 17, 2012, our board of directors authorized management to sell the assets of PDSG due to the inability of PDSG to meet its business plan and continuing projected negative cash flows. In accordance with authoritative guidance we have classified the assets, operations and cash flows of PDSG as discontinued operations for all periods presented. During March 2012, we entered into an interim agreement with the purchaser of the assets of PDSG which required the purchaser to pay PDSG $93,450 to subsidize the April 2012 expenses of PDSG during the sale transaction negotiations. On April 30, 2012, we negotiated a sale transaction in which we sold substantially all of the assets of PDSG in exchange for a royalty on PDSG revenues for a period of three years. From April 30, 2012 to August 31, 2014, the gain on the asset sale of PDSG is approximately $96,000.
Summarized operating results of discontinued operations for the three months ended August 31, 2014 and 2013 are as follows:
Three Months Ended
August 31, 2014 August 31, 2013
(Unaudited) (Unaudited)
Gain on sale of discontinued operations $ 2,800 $ 40,358
Income before income taxes $ 2,800 $ 40,358
Income from discontinued operations $ 2,800 $ 40,358
PDSG activity for the three months ended August 31, 2014 and 2013 consists of PDSG royalty revenues.
The following table summarizes the carrying amount at August 31, 2014 and May 31, 2014 of the major classes of assets of PDSG classified as discontinued operations:
August 31, 2014 May 31, 2014
(Unaudited)
Current assets:
Other current assets $ 11,800 $ 57,477
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Investments in Marketable Securities
We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date. Our investments in marketable securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities. Available-for-sale marketable securities are stated at fair market value. Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss). We follow the authoritative guidance to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in fair value judged to be other than temporary are determined based on the specific identification method and are reported in other income (expense), net in the condensed consolidated statements of operations.
Investment in Affiliated Company
We have a 50% interest in PDS (see Note 3). We account for our investment using the equity method of accounting since the investment provides us the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee’s Board of Directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the investee and is recognized in the condensed consolidated statements of operations in the caption “Equity in loss of affiliated company” and also is adjusted by contributions to and distributions from PDS.
PDS, as an unconsolidated equity investee, recognizes revenue from technology license agreements at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), performance obligations under the license agreement are satisfied, and the realization of revenue is assured which is generally upon the receipt of the license proceeds. PDS may at times enter into license agreements whereby contingent revenues are recognized as one or more contractual milestones are met.
At August 31, 2014, our share of loss in PDS exceeds our investment in PDS by $128,055. This amount is recorded as “Cumulative losses in excess of investment in affiliated company” on our condensed consolidated balance sheet at August 31, 2014, due to the intent to fund the working capital requirements of PDS.
At August 31, 2014, our investment in PDS is presented as a liability pursuant to accounting principles generally accepted in the United States of America. In the event our investment in PDS was to reflect an asset balance, we would review our investment in PDS to determine whether events or changes in circumstances indicate that an asset carrying amount may not be recoverable. The primary factors we would consider in our determination are the financial condition, operating performance and near term prospects of the investee. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.
Earnings (Loss) Per Share
Basic earnings per share for continuing and discontinued operations includes no dilution and is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share for continuing and discontinued operations reflect the potential dilution of securities that could share in the earnings of an entity.
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Earnings (Loss) Per Share (continued)
At August 31, 2014 and 2013 potential common shares of 1,335,000 and 1,510,000, respectively, related to our outstanding options were not included in the calculation of diluted loss per share for continuing and discontinued operations as we recorded a loss. Had we reported net income for the three months ended August 31, 2014 and 2013, none and 575,000, respectively, shares of common stock would have been included in the calculation of diluted income per share for continuing and discontinued operations using the treasury stock method.
In connection with our acquisition of Crossflo, which is part of PDSG, we issued escrow shares that are contingent upon certain representations and warranties made by Crossflo at the time of the merger agreement (see Note 6). We exclude these escrow shares from the basic loss per share calculations and include the escrowed shares in the diluted loss per share calculations.
Income Taxes
We follow authoritative guidance in accounting for uncertainties in income taxes. This authoritative guidance prescribes a recognition threshold and measurement requirement for the financial statement recognition of a tax position that has been taken or is expected to be taken on a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Under this guidance we may only recognize tax positions that meet a “more likely than not” threshold.
We follow authoritative guidance to evaluate whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. We are assessing our deferred tax assets under more likely than not scenarios in which they may be realized through future income.
We have determined that it was more likely than not that all of our deferred tax assets will not be realized in the future due to our continuing pre-tax and taxable losses. As a result of this determination we have placed a full valuation allowance against our deferred tax assets.
We follow authoritative guidance to adjust our effective tax rate each quarter to be consistent with the estimated annual effective tax rate. We are also required to record the tax impact of certain discrete items, unusual or infrequently occurring, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, in the interim period in which they occur. In addition, jurisdictions with a projected loss for the year or a year-to-date loss where no tax benefit can be recognized are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings or losses versus annual projections.
Assessment of Contingent Liabilities
We are involved in various legal matters, disputes, and patent infringement claims which arise in the ordinary course of our business. We accrue for any estimated losses at the time when we can make a reliable estimate of such loss and it is probable that it has been incurred. By their very nature, contingencies are difficult to estimate. We continually evaluate information related to all contingencies to determine that the basis on which we have recorded our estimated exposure is appropriate.
9
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Intellectual Property Rights
PDS, our investment in affiliated company, relies on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. There are currently two unexpired U.S. patents issued dating back to 1998 on our microprocessor technology in addition to three European and two Japanese patents. The U.S. patents will expire in 2015 and the European and Japanese patents will expire in 2016. There are also five U.S. patents, six European, and one Japanese patent all of which expired between August 2009 and August 19, 2014. These patents, while expired, may have certain retrospective statutory benefits that will fully diminish six years after the patent expiration date. The patent useful life for purposes of negotiating licenses is finite and these patents are subject to legal challenges, which in combination with the limited life, could adversely impact the stream of revenues. A successful challenge to the ownership of the technology or the proprietary nature of the intellectual property would materially damage business prospects. Any issued patent may be challenged and invalidated.
Recent Accounting Pronouncements
In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-15, "Presentation of Financial Statements – Going Concern." ASU 2014-15 provides guidance in generally accepted accounting principles about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. ASU 2014-15 is effective for annual reporting periods ending after December 15, 2016 and for annual periods and interim periods thereafter (fiscal year 2017 for the Company). Early adoption is permitted. We have not yet determined the potential effects of the adoption of ASU 2014-15 on our condensed consolidated financial statements.
2. Cash, Cash Equivalents, Restricted Cash and Marketable Securities
We consider all highly liquid investments with original maturities of three months or less to be cash equivalents.
Restricted cash and cash equivalents at August 31, 2014 and May 31, 2014 consist of deposits in a savings account required to be held as collateral for our corporate credit card.
At August 31, 2014 and May 31, 2014, our marketable securities in the amount of $1,502,182 and $1,701,647, respectively, consist of the par value plus accrued interest of our time deposits. These marketable securities are classified as available-for-sale and are reported at fair market value.
We follow authoritative guidance to account for our marketable securities as available-for-sale. Under this authoritative guidance we are required to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. We determine fair value based on quoted prices when available or through the use of alternative approaches, such as discounting the expected cash flows using market interest rates commensurate with the credit quality and duration of the investment or valuations by third party professionals. The three levels of inputs that we may use to measure fair value are:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2: Quoted prices in markets that are not active or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; and
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Cash, Cash Equivalents, Restricted Cash and Marketable Securities (continued)
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e. supported by little or no market activity).
The following tables detail the fair value measurements within the fair value hierarchy of our cash, cash equivalents and investments in marketable securities:
Fair Value Measurements at August 31, 2014 (Unaudited) Using
Quoted Prices Significant
in Active Other Significant
Fair Value at Markets for Observable Unobservable
August 31, Identical Assets Inputs Inputs
2014 (Level 1) (Level 2) (Level 3)
Cash and cash equivalents:
Cash $ 72,035 $ 72,035 $ – $ –
Money market funds 3,426,046 3,426,046 – –
Certificates of deposit 951,226 951,226 – –
Restricted cash and cash equivalents 21,150 21,150 – –
Marketable securities:
Short-term:
Certificates of deposit 1,502,182 – 1,502,182 –
Total $ 5,972,639 $ 4,470,457 $ 1,502,182 $ –
Fair Value Measurements at May 31, 2014 Using
Quoted Prices Significant
in Active Other Significant
Fair Value at Markets for Observable Unobservable
May 31, Identical Assets Inputs Inputs
2014 (Level 1) (Level 2) (Level 3)
Cash and cash equivalents:
Cash $ 340,555 $ 340,555 $ – $ –
Money market funds 4,375,653 4,375,653 – –
Restricted cash and cash equivalents 21,123 21,123 – –
Marketable securities:
Short-term:
Certificates of deposit 1,701,647 – 1,701,647 –
Total $ 6,438,978 $ 4,737,331 $ 1,701,647 $ –
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Cash, Cash Equivalents, Restricted Cash and Marketable Securities (continued)
We purchase certificates of deposit with varying maturity dates greater than three months. The following table summarizes the maturities, gross unrealized gains or losses and fair value of the certificates of deposit as of August 31, 2014:
August 31, 2014
(Unaudited)
Cost Gross Unrealized Gains/(Losses) Fair
Value
Maturity
Due in three months or less $ 951,226 $ – $ 951,226
Due in one year or less $ 1,502,182 $ – $ 1,502,182
The following table summarizes the maturities, gross unrealized gains or losses and fair value of the certificates of deposit as of May 31, 2014:
May 31, 2014
Cost Gross Unrealized Gains/(Losses) Fair
Value
Maturity
Due in one year or less $ 1,701,647 $ – $ 1,701,647
3. Investment in Affiliated Company
On June 7, 2005, we entered into a Master Agreement (the “Master Agreement”) with TPL, and Charles H. Moore (“Moore”), the co-inventor of the technology which is the subject of the MMP Portfolio of microprocessor patents, pursuant to which the parties resolved all legal disputes between them. Pursuant to the Master Agreement, we and TPL entered into the Limited Liability Company Operating Agreement of PDS (the “LLC Agreement”) into which we and Moore contributed our rights to certain of our technologies.
We and TPL each own 50% of the membership interests of PDS, and each member has the right to appoint one member of the three member management committee. The two appointees are required to select a mutually acceptable third member of the management committee. There has not been a third management committee member since May 2010; however we have initiated arbitration seeking the appointment of a third member (see Note 6). Pursuant to the LLC Agreement, we and TPL initially agreed to establish a working capital fund for PDS of $4,000,000, of which our contribution was $2,000,000. The working capital fund was increased to a maximum of $8,000,000 as license revenues are achieved. We and TPL are obligated to fund future working capital requirements at the discretion of the management committee of PDS in order to maintain working capital of not more than $8,000,000. If the management committee determines that additional capital is required, neither we nor TPL are required to contribute more than $2,000,000 in any fiscal year. Since there is currently not a third member of the management committee, working capital contributions made to PDS require the approval of both management committee members. Distributable cash and allocation of profits and losses will be allocated to the members in the priority defined in the LLC Agreement.
Previously PDS reimbursed TPL for payment of all legal and third-party expert fees and other related third-party costs and expenses. Presently the majority of third-party costs are paid directly by PDS. During the three months ended August 31, 2014 and 2013, PDS expensed $401,943 and $973,531, respectively, pursuant to the Commercialization and Program agreements. These expenses are recorded in the accompanying PDS statements of operations presented below net of $0 and $309,892, respectively, of legal fee reversals previously expensed and recorded as accounts payable to TPL during the three months ended August, 2014 and 2013 as the statute of limitations had expired.
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Investment in Affiliated Company (continued)
On July 11, 2012, we entered into the Program Agreement with PDS, TPL, and Alliacense, and an Agreement (the “TPL Agreement”) with TPL. Pursuant to the Program Agreement, PDS engaged Alliacense to negotiate MMP portfolio licenses and to pursue claims against violators of the MMP portfolio on behalf of PDS, TPL, and the Company. The Program Agreement continues through the useful life of the MMP portfolio patents. Pursuant to the TPL Agreement, we and TPL agreed to certain allocations of obligations in connection with the engagement of Alliacense. On July 24, 2014, the Program Agreement was amended with PDS and Alliacense entering into the Amended Alliacense Services and Novation Agreement (the “Novation Agreement”). Pursuant to the Novation Agreement certain performance goals and incentives were established for Alliacense that may impact the continuity of their services. The Novation Agreement also provides for the addition of a second licensing company, which was engaged on October 10, 2014, to complement the MMP licensing commercialization.
On July 17, 2012, we entered into an Agreement with PDS, TPL and Alliacense whereby we agreed to certain additional allocations of obligations relating to the Program Agreement.
Pursuant to the Program Agreement, PDS had committed to Alliacense a quarterly amount of $500,000 which represented the licensing services fees due Alliacense, subject to a contingency arrangement which provided for a percentage on future revenues, for its efforts to secure licensing agreements on behalf of PDS. During fiscal 2014, PDS discontinued these payments which were formally eliminated by terms of the Novation Agreement. These payments had replaced the quarterly amounts previously paid to TPL pursuant to the Commercialization Agreement. During the three months ended August 31, 2013, PDS expensed $481,353 pursuant to this commitment. This expense is recorded in the accompanying PDS statement of operations presented below.
Pursuant to the Program Agreement PDS had committed to pay Alliacense litigation support fees relating to Alliacense’s special work and effort regarding internal costs related to MMP maintenance and litigation support including support in the U.S. District Court and the complaints filed on behalf of TPL, PDS and us with the U.S. International Trade Commission (“ITC”) on July 24, 2012. During the three months ended August 31, 2014 and 2013, PDS reversed $(24,59
in connection with the Novation Agreement, and expensed $122,578, respectively, pursuant to this commitment. Future litigation support payments to Alliacense relating to the ITC litigation had been subject to a contingency arrangement which provided for a percentage of future recoveries in these actions. The Novation Agreement eliminated the Program Agreement’s litigation support activity by Alliacense. These amounts are recorded in the accompanying PDS statements of operations presented below.
During the fiscal year ended May 31, 2014 and the three months ended August 31, 2014, PDS paid Alliacense $300,000 and $323,000, respectively, pursuant to the terms of the Novation Agreement (see Note 6).
During January 2013, TPL and Moore settled their litigation. Terms of the settlement include the payment by PDS to Moore of a consulting fee of $250,000 for four years or until the completion of all outstanding MMP litigation, whichever comes first. Per terms of the agreement, PDS paid Moore $150,000 on the settlement date and paid Moore $16,667 per month from August 2013 through January 2014 and will pay $20,833 per month beginning February 2014 through January 2017. During the three months ended August 31, 2014 and 2013, PDS expensed $62,499 and $16,667, respectively, pursuant to this commitment. These expenses are recorded in the accompanying PDS statements of operations presented below.
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Investment in Affiliated Company (continued)
Based on our analysis of current authoritative accounting guidance with respect to our investment in PDS, we continue to account for our investment in PDS under the equity method of accounting, and accordingly have recorded our share of PDS’s net loss during the three months ended August 31, 2014 and 2013 of $224,036 and $85,184, respectively, as a decrease in our investment. We received distributions of $6,250 from PDS during the three months ended August 31, 2013 and we have recorded these distributions as a decrease in our investment.
At August 31, 2014, our share of loss in PDS exceeds our investment in PDS by $128,055. This amount is recorded as “Cumulative losses in excess of investment in affiliated company” on our condensed consolidated balance sheet at August 31, 2014.
We have recorded our share of PDS’s net loss for the three months ended August 31, 2014 and 2013 as “Equity in loss of affiliated company” in the accompanying condensed consolidated statements of operations.
During the three months ended August 31, 2014 and 2013, PDS entered into licensing agreements with third parties, pursuant to which PDS received aggregate proceeds of $0 and $1,490,000, respectively.
At August 31, 2014, PDS had accounts payable balances of approximately $574,000, and $92,000 to TPL and PTSC, respectively.
PDS’s balance sheets at August 31, 2014 and May 31, 2014 and statements of operations for the three months ended August 31, 2014 and 2013 are as follows:
Balance Sheets
Assets:
August 31, 2014 May 31, 2014
(Unaudited) (Audited)
Cash $ 414,407 $ 1,063,536
Prepaid expenses 142,949 247,776
Total assets $ 557,356 $ 1,311,312
Liabilities and Members’ Equity (Deficit):
August 31, 2014 May 31, 2014
(Unaudited) (Audited)
Payables $ 813,467 $ 1,107,560
Income tax payable – 11,790
Members’ equity (deficit) (256,111 ) 191,962
Total liabilities and members’ equity $ 557,356 $ 1,311,312
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Investment in Affiliated Company (continued)
Statements of Operations
Three Months Ended
August 31,
2014 2013
(Unaudited) (Unaudited)
Revenues $ – $ 1,490,000
Expenses 448,072 1,660,369
Operating loss (448,072 ) (170,369 )
Net loss $ (448,072 ) $ (170,369 )
PDS Related Party Balances And Transactions
Balances with related parties as of August 31, 2014 and May 31, 2014 are summarized as follows:
August 31, 2014 May 31, 2014
(Unaudited)
Liabilities:
Related party payables and accrued expenses (TPL) (1) $ 574,123 $ 666,412
Related party payables (PTSC) 92,050 92,050
Related party payables (Alliacense) – 24,598
Settlement fee payable (Alliacense) – 323,000
Total liabilities $ 666,173 $ 1,106,060
(1) Pursuant to the terms of the Commercialization Agreement, PDS reimbursed TPL for the payment of all legal and third party expert fees and other related third party costs and expenses upon TPL’s submission of documentation supporting that payment by them had occurred.
Transactions with related parties for the three months ended August 31, 2014 and 2013 are as follows:
August 31, 2014 August 31, 2013
(Unaudited) (Unaudited)
Expenses paid or accrued (TPL) $ 401,943 $ 973,531
Expenses paid (reversed) or accrued (Alliacense) $ (24,598 ) $ 603,931
Significant Contractual Legal Relationship
PTSC, through its unconsolidated affiliate, PDS has incurred litigation related costs from an unrelated law firm and legal subcontractors with respect to substantial legal services for the commercialization of the MMP portfolio of microprocessor patents.
Accounts payable balances due this law firm and legal subcontractors as of August 31, 2014 and May 31, 2014 were $147,293 and $92,289, respectively.
15
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Investment in Affiliated Company (continued)
Transactions with this law firm and legal subcontractors for the three months ended August 31, 2014 and 2013 were as follows:
August 31, 2014 August 31, 2013
(Unaudited) (Unaudited)
Legal costs $ 401,943 $ 1,123,916
Contractual Commitments
In January 2013, PDS entered into a contractual commitment with a related party to provide consulting services at a cost of $250,000 per year for a duration of four years or the completion of all outstanding MMP litigation, whichever comes first.
For the three months ended August 31, 2014 and 2013, PDS expensed $62,499 and $16,667, respectively, related to this agreement.
We review our investment in PDS to determine whether events or changes in circumstances indicate that the carrying amount may not be recoverable. The primary factors we consider in our determination are the financial condition, operating performance and near term prospects of PDS. If a decline in value is deemed to be other than temporary, we would recognize an impairment loss.
4. Income Taxes
We have determined that it was more likely than not that all of our deferred tax assets will not be realized in the future due to our continuing pre-tax and taxable losses. As a result of this determination we have placed a full valuation allowance against our deferred tax assets. There have been no changes to our determination during the current fiscal year.
5. Stockholders’ Equity
Equity Transactions
The following table summarizes equity transactions during the three months ended August 31, 2014:
Common Stock Additional Paid-in Accumulated Treasury
Shares Amounts Capital Deficit Stock
Balance June 1, 2014 401,392,948 $ 4,382 $ 77,400,852 $ (56,268,116 ) $ (14,625,868 )
Net loss – – – (593,953 ) –
Balance August 31, 2014 401,392,948 $ 4,382 $ 77,400,852 $ (56,862,069 ) $ (14,625,868 )
Stock Option Activity
As of August 31, 2014, we had 1,335,000 fully vested options outstanding pursuant to our 2006 Stock Option Plan exercisable at a range of $0.10 to $0.12 per share expiring through 2018.
16
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Stockholders’ Equity (continued)
Share-based Compensation
Summary of Assumptions and Activity
The fair value of share-based awards to employees and directors is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the pricing term of the grant effective as of the date of the grant. The expected volatility is based on the historical volatilities of our common stock. These factors could change in the future, affecting the determination of share-based compensation expense in future periods.
Three Months Ended
August 31,
2014
(Unaudited)
Three Months Ended
August 31,
2013
(Unaudited)
Expected term * years 5 years
Expected volatility * % 88 %
Risk-free interest rate * % 1.05 %
* No stock options were granted during this period.
A summary of option activity as of August 31, 2014 and changes during the three months then ended, is presented below:
Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Term (Years) Aggregate Intrinsic Value
Options outstanding at June 1, 2014 1,335,000 $ 0.11
Options granted – $ –
Options exercised – $ –
Options forfeited/expired – $ –
Options outstanding at August 31, 2014 1,335,000 $ 0.11 2.47 $ –
Options vested and expected to vest at August 31, 2014 1,335,000 $ 0.11 2.47 $ –
Options exercisable at August 31, 2014 1,335,000 $ 0.11 2.47 $ –
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Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Stockholders’ Equity (continued)
There were no options granted or exercised during the three months ended August 31, 2014.
The aggregate intrinsic value represents the differences in market price at the close of the quarter ($0.06 per share on August 31, 2014) and the exercise price of outstanding, in-the-money options (those options with exercise prices below $0.06 per share) on August 31, 2014.
The following table summarizes our employee share-based compensation for the three months ended August 31, 2014 and 2013, which was recorded in selling, general and administrative expense as follows:
Three Months Ended Three Months Ended
August 31, 2014 August 31, 2013
(Unaudited) (Unaudited)
Selling, general and administrative expense $ – $ 62,418
6. Commitments and Contingencies
Litigation
Patent Litigation
On February 8, 2008, we, TPL and Alliacense Ltd. were named as defendants in separate lawsuits filed in the United States District Court for the Northern District of California by HTC Corporation, and Acer, Inc., and affiliated entities of each of them. (Those cases were deemed related and are referred to herein as the “N.D. Cal. Case”). HTC and Acer sought declaratory relief that their products did not infringe enforceable claims of the '336 patent. We alleged counterclaims for patent infringement of the '336 and '890 patents as to certain of their products.
The Court issued a first claim construction ruling in the N.D. Cal. Case on June 12, 2012, which preserved our ability to proceed on our infringement claims against Acer and HTC. Thereafter, Chief District Judge James Ware retired and the N.D. Cal. Case was reassigned to Magistrate Judge Paul S. Grewal, who held a supplemental claim construction hearing on November 30, 2012. Judge Grewal then issued a supplemental claim construction ruling on December 5, 2012, which preserved our ability to proceed with our infringement claims. On September 6, 2013 Acer entered into an MMP portfolio license agreement that also provided for the dismissal of all claims in the N.D. Cal Case, as well as the filing of a joint motion to terminate Acer as a respondent in the ITC 853 Investigation (described more fully below). On September 19, 2013 the ‘890 patent was dropped from the N.D. Cal Case pursuant to stipulation by all parties. A jury trial was held in the N.D. Cal. Case against HTC, beginning on September 23, 2013. On October 3, 2013, the jury returned a verdict in favor of us and TPL, finding that HTC had infringed the ‘336 patent with damages of $958,560. HTC has appealed the jury verdict and we have filed cross appeals regarding the period available for infringement damages related to the ‘890 patent. The parties participated in magistrate-supervised settlement activity and continue to engage in settlement discussions. However, we cannot opine regarding whether HTC will ultimately enter into a license on the MMP portfolio.
18
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Commitments and Contingencies (continued)
On July 24, 2012 complaints were filed on behalf of us, TPL, and PDS against Acer, Inc., Amazon.com, Inc., Barnes & Noble, Inc., Garmin, Ltd., HTC Corporation, Huawei Technologies Co., Ltd., Kyocera Corporation, LG Electronics, Nintendo Co., Ltd., Novatel Wireless, Inc., Samsung Electronics Co., Ltd., Sierra Wireless, Ltd. and ZTE Corporation with the U.S. International Trade Commission (“ITC”) (ITC Investigation No. 337-TA-853, or the “853 Investigation”) alleging infringement of the ‘336 patent. We also filed new parallel proceedings in the U.S. District Court for the Northern District of California alleging infringement of the US 5,440,749 patent (the “‘749 patent”), and the ‘890 and ‘336 patents against Amazon.com Inc., Barnes & Noble Inc., Garmin Ltd., Huawei Technologies Co. Ltd., Kyocera Corporation, LG Electronics, Nintendo Co. Ltd., Novatel Wireless Inc., Samsung Electronics Co. Ltd., Sierra Wireless Inc., and ZTE Corporation. We subsequently reached a settlement with Sierra Wireless, Inc. Trial proceedings before the ITC began on June 3, 2013 and concluded the following week. Settlements were subsequently reached with Kyocera Corporation, Amazon.com, Inc., and Acer, Inc. An Initial Determination (“ID”) was rendered on September 6, 2013 finding that none of the remaining Respondents had infringed the ‘336 patent. We filed a petition for review of the ID with the full ITC on September 23, 2013. On February 20, 2014, the ITC provided notice affirming the September 6, 2013 ID. We have chosen not to file an appeal of the ITC decision to the United States Court of Appeals for the Federal Circuit. All of the district court actions against the new parties (i.e., all respondents other than Acer and HTC) that have not previously settled and which had been stayed pending resolution of the 853 Investigation are proceeding.
Licensing Fee Disputes
PDS and Alliacense had been involved in multiple disputes regarding amounts asserted by Alliacense as owed by PDS. The disputed amounts included sums for past services and advances. On July 24, 2014, PDS and Alliacense entered into the Novation Agreement, which included provisions for resolving all of the claims in dispute for $623,000. Of that amount, $300,000 was paid by PDS to Alliacense in November 2013, with the balance paid by PDS to Alliacense in two payments of $161,500 each on June 20, 2014 and July 25, 2014.
PDS Management Committee Arbitration
In January 2014, our representative to the PDS management committee filed with the American Arbitration Association (“AAA”) a demand for arbitration pursuant to the terms of the LLC Agreement. The demand seeks the appointment of a third member, referred to as the independent manager member, to the PDS management committee. The AAA appointed an arbitrator who had determined that the parties in action need to be amended to reflect the PDS owners as opposed to its managers. As a result the Bankruptcy Court lifted its stay allowing TPL to be made a party to the arbitration process. The arbitrator will be responsible for selecting the independent manager from a listing of candidates supplied by TPL and PTSC.
401(k) Plan
Patriot has a retirement plan that complies with Section 401(k) of the Internal Revenue Code. All employees are eligible to participate in the plan. Patriot matches 100% of elective deferrals subject to a maximum of 4% of the participant’s eligible earnings. Patriot’s participants vest 33% per year over a three year period in their matching contributions. Patriot’s matching contributions during the three months ended August 31, 2014 and 2013 were $3,750 and $3,754, respectively.
19
Patriot Scientific Corporation
Notes to Unaudited Condensed Consolidated Financial Statements
Commitments and Contingencies (continued)
Guarantees and Indemnities
We have made certain guarantees and indemnities, under which we may be required to make payments to a guaranteed or indemnified party. We indemnify our directors, officers, employees and agents to the maximum extent permitted under the laws of the State of Delaware. In connection with our facility lease, we have indemnified our lessor for certain claims arising from the use of the facility. The duration of the guarantees and indemnities varies, and in many cases is indefinite. These guarantees and indemnities do not provide for any limitation of the maximum potential future payments we could be obligated to make. Historically, we have not been obligated to make any payments for these obligations and no liabilities have been recorded for these guarantees and indemnities in the accompanying condensed consolidated balance sheets.
Escrow Shares
On August 31, 2009 we gave notice to the former shareholders of Crossflo and Union Bank of California (the “Escrow Agent”) under Section 2.5 of the Agreement and Plan of Merger between us and Crossflo (the “Agreement”), outlining damages incurred by us in conjunction with the acquisition of Crossflo, and seeking the return of 2,844,630 shares of our common stock held by the Escrow Agent. Subsequently, former shareholders of Crossflo representing a majority of the escrowed shares responded in protest to our claim, delaying the release of the escrowed shares until a formal resolution is reached. In the event we fail to prevail in our claim against the escrowed shares, we may be obligated to deposit into escrow approximately $256,000 of cash consideration due to the decline in our average stock price over the one year escrow period, calculated in accordance with the Section 2.5 of the Agreement. We have evaluated the potential for loss regarding our claim and believe that it is probable that the resolution of this issue will not result in a material obligation to the Company, although there is no assurance of this. Accordingly, we have not recorded a liability for this matter.
7. Subsequent Events
We have evaluated subsequent events after the balance sheet date and based on our evaluation, management has determined that no subsequent events have occurred that would require recognition in the accompanying condensed consolidated financial statements or disclosure in the notes thereto other than as disclosed in the accompanying notes.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
THE FOLLOWING DISCUSSION AND THE REST OF THIS QUARTERLY REPORT ON FORM 10-Q INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS". SEE ALSO OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MAY 31, 2014.
Overview
In June 2005, we entered into a series of agreements with TPL and others to facilitate the pursuit of unlicensed users of our intellectual property. In October 2011 we settled litigation with TPL that was initiated by us over matters related to the management of the MMP portfolio. In July 2012 we entered into additional agreements with TPL, PDS and the TPL affiliate, Alliacense, including the Licensing Program Services Agreement (the “Program Agreement”) in furtherance of the management and commercialization of the MMP portfolio. On July 24, 2014, the Program Agreement was amended with PDS and Alliacense entering into the Amended Alliacense Services and Novation Agreement (the “Novation Agreement”). The July 2012 and 2014 agreements facilitate an aggressive licensing and litigation strategy which currently includes actions in the U.S. District Court against multiple companies alleged to be infringers of the MMP portfolio. We continue to believe that the significant investment in legal effort and costs incurred to date at PDS is necessary for the protection of our interests in the MMP portfolio and its future success, although to date it has generated mixed results.
To the extent MMP portfolio license proceeds are insufficient, we expect working capital contributions may need to be made for PDS in the future. Cash shortfalls currently experienced by PDS will have an adverse effect on our liquidity. To date, we have determined that it is in the best interests of the MMP licensing program that we contribute our 50% share of additional capital to PDS in the event license revenues received by PDS are insufficient.
On October 9, 2014 PDS’s cash balance was $393,037. Management’s plans for the continued operation of PDS rely on the ability of PDS to obtain license agreements to cover its operational costs. PDS has experienced a decline in licensing revenues and has not obtained significant license revenues since September 2013 and it is unclear when any additional licensing revenues may be generated.
The Novation Agreement, which amended the Program Agreement, provides for the utilization of a second licensing agent, which was engaged on October 10, 2014, in order to complement the MMP licensing commercialization, and increase the opportunity for the successful licensing of the MMP portfolio.
In January 2014, our representative to the PDS management committee filed with the American Arbitration Association (“AAA”) a demand for arbitration seeking the appointment of a third member, referred to as the independent manager member, to the PDS management committee in an effort to eliminate potential deadlock on issues important to PDS. PDS may not be able to take any action with respect to Alliacense’s performance, or on other disputed matters, unless and until the independent manager is appointed.
Management expects to continue to incur significant legal expenses for the continued operation of PDS. PDS has been incurring significant third-party costs for expert testimony, depositions and other related legal costs pursuant to litigation in U.S. District Court and actions with the ITC Investigation No. 337-TA-853 although the ITC matters have now concluded. We could be required to make capital contributions to PDS for any future litigation related costs in the event that PDS does not receive sufficient licensing revenues to pay these expenses.
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On March 20, 2013, TPL filed a petition under Chapter 11 of the United States Bankruptcy Code. We have been appointed to the creditors’ committee and have been closely monitoring the progress in this matter as it relates to our interest in PDS. On July 18, 2014, TPL and the creditors’ committee announced that a term sheet serving as the basis for a Joint Plan of Reorganization (the “Plan”) had been agreed to. On September 3 and September 17, 2014, respectively, the Joint Plan and Joint Disclosure Statement were filed with the Bankruptcy Court. A competing reorganization plan has also been filed with the Court. In the event we are required to provide funding to PDS that is not reciprocated by TPL, our ownership percentage in PDS will increase and we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our consolidated financial statements.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and judgments that significantly affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates, and such differences could affect the results of operations reported in future periods. We believe the following critical accounting policies affect our most significant estimates and judgments used in the preparation of our consolidated financial statements.
1. Investments in Marketable Securities
We determine the appropriate classification of our investments at the time of purchase and reevaluate such designation at each balance sheet date. Our investments in marketable securities have been classified and accounted for as available-for-sale based on management’s investment intentions relating to these securities. Available-for-sale marketable securities are stated at fair market value. Unrealized gains and losses, net of deferred taxes, are recorded as a component of other comprehensive income (loss). We follow the authoritative guidance to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in fair value judged to be other than temporary are determined based on the specific identification method and are reported in other income (expense), net in the condensed consolidated statements of operations.
2. Investment in Affiliated Company
We have a 50% interest in PDS. We account for our investment using the equity method of accounting since the investment provides us the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if we have an ownership interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee’s Board of Directors, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment, originally recorded at cost, is adjusted to recognize our share of net earnings or losses of the investee and is recognized in the consolidated statements of operations in the caption “Equity in earnings (loss) of affiliated company” and also is adjusted by contributions to and distributions from PDS.
PDS, as an unconsolidated equity investee, recognizes revenue from technology license agreements at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), performance obligations under the license agreement are satisfied, and the realization of revenue is assured which is generally upon the receipt of the license proceeds. PDS may at times enter into license agreements whereby contingent revenues are recognized as one or more contractual milestones are met.
At August 31, 2014, our share of loss in PDS exceeds our investment in PDS by $128,055. This amount is recorded as “Cumulative losses in excess of investment in affiliated company” on our condensed consolidated balance sheet at August 31, 2014, due to the intent to fund the working capital requireme
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