TMCnet News
PATRIOT SCIENTIFIC CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2013. 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, in furtherance of the management and commercialization of the MMP Portfolio. The July 2012 Agreements ("July 2012 Agreements") paved the way for an aggressive litigation strategy subsequently initiated on July 24, 2012 whereby Alliacense filed parallel actions with the ITC and in the U.S. District Court against multiple companies alleged to be infringers of the MMP portfolio. While we continue to believe that the significant investment in legal effort and costs incurred to date at PDS, in addition to this expanded litigation strategy, is necessary for the protection of our interests in the MMP portfolio and its future success, to date it has generated mixed results. During fiscal 2013 and through the date of this filing, we and TPL each contributed $1,097,809 to fund the working capital of PDS. To the extent MMP portfolio license proceeds are insufficient, we expect working capital contributions to PDS to continue 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 to provide for PDS litigation support payments to Alliacense, in the event license revenues received by PDS are insufficient to meet these needs. On April 9, 2014 PDS' cash balance was $1,137,752. Management's plans for the continued operation of PDS rely on the ability of Alliacense to obtain license agreements to cover the operational costs of PDS. Notwithstanding the November 30, 2012 and May 31, 2013 fiscal quarters, where licensing revenues were $4,370,000 and $6,250,000, respectively, PDS has experienced a decline in licensing revenues. In fact, Alliacense has not obtained any license agreements since September 2013 and it is unclear when any additional licensing revenues may be generated. We believe that PDS should take action to ensure that Alliacense is maximizing the value of the MMP Portfolio. However, our and TPL's representatives to the PDS management have not been able to agree on a course of action and no action has been taken with respect to Alliacense's performance at this time. 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 the deadlock on this and other issues. PDS may not be able to take any action with respect to Alliacense's performance, or on other matters, unless and until the independent manageris appointed. On April 4, 2014, we were notified of the resignation of TPL's representative to the PDS management committee, and the concurrent appointment by TPL of its new representative to PDS. While we are hopeful that this may relieve some of the decision deadlock at PDS, the impact of this action has yet to be determined. 23 Further frustrating management's plans for the continued operation of PDS, PDS has been notified by its current patent counsel that they are no longer able to work on a contingency basis. PDS and its current patent counsel are currently discussing alternative, hybrid hourly/contingency fee arrangements. While it is unclear whether PDS will come to an agreement with its current patent litigation counsel, it is reasonably likely that PDS' legal fees will materially increase in the future. Additionally, a significant delay in revising the terms of PDS' engagement of its current patent counsel or in engaging new counsel could result in material delays in the underlying litigation and delays in receiving any judgments resulting therefrom, if any. In any event, 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 with HTC Corporation, and Acer, Inc., in U.S. District Court, and actions with the ITC Investigation No. 337-TA-853. The HTC and Acer U.S. District Court actions have largely concluded except for certain post-trial appeals pending in the HTC matter, and a ruling has now been issued by the ITC affirming its previous Initial Determination. However, as a result of any future litigation including actions against additional defendants in U.S. District Court which are currently stayed 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. 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. If we 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. If we determine that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their fair values at the date that we have the controlling financial interest. 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 February 28, 2014, the gain on the asset sale of PDSG is approximately $45,000. Summarized operating results of discontinued operations for the three and nine months ended February 28, 2014 and 2013 are as follows: Three Months Ended Nine Months Ended February 28, February 28, February 28, February 28, 2014 2013 2014 2013 (Unaudited) (Unaudited) (Unaudited) (Unaudited) Operating loss from discontinued operations $ - $ (761 ) $ - $ (3,222 ) Gain on sale of discontinued operations $ - $ 2,009 $ 40,583 $ 4,694 Income before income taxes $ - $ 1,248 $ 40,583 $ 1,472 Income from discontinued operations $ - $ 1,248 $ 40,583 $ 1,472 PDSG activity for the three and nine months ended February 28, 2014 consists of PDSG royalty revenues. 24 PDSG activity for the three and nine months ended February 28, 2013 consists of operating expenses for legal, insurance, taxes and bank fees offset by PDSG royalty revenues. The following table summarizes the carrying amount at February 28, 2014 and May 31, 2013 of the major classes of assets of PDSG classified as discontinued operations: February 28, 2014 May 31, 2013 (Unaudited) Current assets: Other current assets $ 15,000 $ 40,682 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. 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. 25 3. Share-Based Compensation Share-based compensation expense recognized during the period is based on the grant date fair value of the portion of share-based payment awards ultimately expected to vest during the period. As share-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeiture rates are based on historical forfeiture experience and estimated future employee forfeitures. 4. 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. 5. 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. Results of Operations Comparison of the Three Months Ended February 28, 2014 and Three Months Ended February 28, 2013. Three months ended February 28, 2014 February 28, 2013 Selling, general and administrative $ 379,004 $ 345,111 Selling, general and administrative expenses increased from approximately $345,000 for the three months ended February 28, 2013 to approximately $379,000 for the three months ended February 28, 2014. The increase consisted primarily of approximately $27,000 in legal fees. 26 Three months ended February 28, 2014 February 28, 2013 Other income (expense): Interest income $ 2,458 $ 4,995 Other income - 26,250 Equity in loss of affiliated company (29,889 ) (601,929 ) Total other expense, net $ (27,431 ) $ (570,684 ) Our other expense, (net) for the three months ended February 28, 2014 and 2013 included equity in the loss of PDS of approximately $(30,000) and $(602,000), respectively. Our investment in PDS is accounted for in accordance with the equity method of accounting for investments. The reduction in the equity loss in the current quarter is attributable to the cessation of significant litigation related activity not covered by contingent cost agreements, coupled with the absence of licensing revenues for the period. Three months ended February 28, February 28, 2014 2013Loss from continuing operations before income taxes $ (406,435 ) $ (915,795 ) Loss from continuing operations before income taxes decreased from approximately $(916,000) for the three months ended February 28, 2013 to approximately $(406,000) for the three months ended February 28, 2014 due to the change in equity in earnings of PDS. Benefit for income taxes During the three months ended February 28, 2014 and 2013, we recorded a benefit for income taxes related to federal and California taxes of approximately $(10,400) and $(2,800), respectively. Net loss Our net loss for the three months ended February 28, 2014 and 2013, was $(396,010) and $(911,721) respectively. Comparison of the Nine Months Ended February 28, 2014 and Nine Months Ended February 28, 2013. Nine months ended February 28, 2014 February 28, 2013Selling, general and administrative $ 1,191,149 $ 975,344 Selling, general and administrative expenses increased from approximately $975,000 for the nine months ended February 28, 2013 to approximately $1,191,000 for the nine months ended February 28, 2014. The increase consisted primarily of approximately $153,000 in legal fees and approximately $62,000 in stock based compensation expense. Nine months ended February 28, 2014 February 28, 2013 Other income (expense): Interest income $ 3,623 $ 13,165 Other income - 217,618 Realized recovery (loss) on marketable securities (347 ) 55,873 Equity in earnings of affiliated company 356,930 75,666 Total other income, net $ 360,206 $ 362,322 27 Our other income for the nine months ended February 28, 2014 and 2013 included equity in the earnings of PDS of approximately $357,000 and $76,000, respectively. Our investment in PDS is accounted for in accordance with the equity method of accounting for investments. The change in the earnings of PDS is due to the decrease in legal expenses and payments to Alliacense during the current period as compared to the prior period. Included in realized recovery on marketable securities for the nine months ended February 28, 2013 is approximately $56,000 of recovery on the $600,879 realized loss on sale of marketable securities relating to our auction rate securities recognized during the fiscal year ended May 31, 2011. Through February 2013 we have received proceeds totaling $403,325 relating to the recovery of our fiscal 2011 realized loss. Also included in interest and other income for the nine months ended February 28, 2013 is the one time receipt of proceeds associated with the settlement of certain litigation unrelated to our patent portfolio. Nine months ended February 28, February 28, 2014 2013Loss from continuing operations before income taxes $ (830,943 ) $ (613,022 ) Loss from continuing operations before income taxes increased from approximately $(613,000) for the nine months ended February 28, 2013 to approximately $(831,000) for the nine months ended February 28, 2014 due to the change in equity in earnings of PDS. Provision (benefit) for income taxes During the nine months ended February 28, 2014 we recorded a provision for income taxes related to federal and California taxes of approximately $25,000. During the nine months ended February 28, 2013 we recorded a benefit for income taxes related to federal and California taxes of approximately $(100). Net loss Our net loss for the nine months ended February 28, 2014 and 2013, was $(815,648) and $(611,437) respectively. Results of Discontinued Operations Comparison of the Three Months Ended February 28, 2014 and Three Months Ended February 28, 2013. Three months ended February 28, 2014 February 28, 2013Selling, general and administrative $ - $ 761 Selling, general and administrative expenses decreased approximately $800 for the three months ended February 28, 2013 due to the sale of substantially all of the assets of PDSG in April 2012. Three months ended February 28, 2014 February 28, 2013 Other income: Interest and other income $ - $ 2,009 Total other income $ - $ 2,009 Interest and other income for the three months ended February 28, 2013 of approximately $2,000 consists of royalties earned for the period. 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. Income from discontinued operations, net We recorded net income from discontinued operations of $0 and $1,248 for the three months ended February 28, 2014 and 2013, respectively. 28 Comparison of the Nine Months Ended February 28, 2014 and Nine Months Ended February 28, 2013. Nine months ended February 28, 2014 February 28, 2013Selling, general and administrative $ - $ 3,222 Selling, general and administrative expenses decreased approximately $3,000 for the nine months ended February 28, 2013 due to the sale of substantially all of the assets of PDSG in April 2012. Nine months ended February 28, 2014 February 28, 2013 Other income: Interest and other income $ 40,583 $ 4,694 Total other income $ 40,583 $ 4,694 Interest and other income of approximately $40,600 and $4,700 for the nine months ended February 28, 2014 and 2013, respectively, consists of royalties earned for the period. 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. Income from discontinued operations, net We recorded net income from discontinued operations of $40,583 and $1,472 for the nine months ended February 28, 2014 and 2013, respectively. Liquidity and Capital Resources Liquidity Our cash and cash equivalents and short-term investment balances decreased from approximately $7,767,000 as of May 31, 2013 to approximately $6,863,000 as of February 28 2014. We also have restricted cash balances amounting to approximately $21,000 as of May 31, 2013 and February 28, 2014. Total current assets decreased from approximately $8,040,000 as of May 31, 2013 to approximately $7,038,000 as of February 28, 2014. Total current liabilities amounted to approximately $278,000 and approximately $92,000 as of May 31, 2013 and February 28, 2014, respectively. The change in our working capital position as of February 28, 2014 as compared with May 31, 2013 results primarily from payment of our operating expenses. Cash shortfalls currently experienced by PDS will have an adverse effect on our liquidity. During the fiscal year ended May 31, 2013 and through the date of this filing we and TPL each contributed $1,097,809 in additional capital to fund the operations of PDS. To date we have determined that it is in the best interests of the MMP licensing program that we provide our 50% share of capital to provide for PDS expenses including legal retainers and litigation related payments, as well as licensing and litigation support payments to Alliacense, 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 February 28, 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 $6,862,527 at February 28, 2014. 29 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. In the event that we provide funding to PDS that is not reciprocated by TPL, which would result in our having a larger ownership percentage in PDS, we will have a controlling financial interest in PDS, in which case, we will consolidate PDS in our consolidated financial statements. If we determine that it is appropriate to consolidate PDS, we would measure the assets, liabilities and noncontrolling interests of PDS at their fair values at the date that we have the controlling financial interest. Cash Flows From Operating Activities Cash used in operating activities of continuing operations was approximately $1,263,000 and $686,000 for the nine months ended February 28, 2014 and 2013, respectively. The principal components of the current period amount were net loss from continuing operations of approximately $856,000, the earnings of affiliated company of approximately $357,000 and changes in accounts payable and accrued expenses of approximately $207,000. These decreases were primarily offset by changes in prepaid expenses and other current assets of approximately $137,000, share-based compensation of approximately $62,000 and income taxes payable of approximately $21,000. The principal components of the prior period are the prior period net loss from continuing operations, changes in accounts payable and accrued expenses, earnings of affiliated company offset by changes in prepaid expenses and accounts receivable from affiliated company. Cash provided by operating activities of discontinued operations was approximately $66,000 and $16,000 for the nine months ended February 28, 2014 and 2013, respectively. Cash provided by discontinued operations activities relates to royalty revenue received during the period. Cash Flows From Investing Activities Cash used in investing activities for the nine months ended February 28, 2014 was approximately $431,000. Cash provided by investing activities for the nine months ended February 28, 2013 was approximately $907,000. Cash activities for the current period were primarily attributable to purchases and sales of marketable securities and distributions from PDS. Cash activities for the prior period were attributable to purchases and sales of marketable securities and contributions to and distributions from PDS. Cash Flows From Financing Activities Cash used in financing activities for the nine months ended February 28, 2014 and 2013 was approximately $84,000 and $57,000, respectively. Cash activities for the current and prior periods were attributable to purchases of commonstock for treasury. Capital Resources Our current liquid cash resources as of February 28, 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 primary 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 $6,862,527 at February 28, 2014. 30 Recent Accounting Pronouncements During the nine months ended February 28, 2014, there were no recent issuances of accounting pronouncements as compared to those described in our Annual Report on Form 10-K for the fiscal year ended May 31, 2013, that are of significance, or have potential material significance to us. Risk Factors We urge you to carefully consider the following discussion of risks as well as other information regarding our common stock. We believe the following to be our most significant risk factors as of the date this report is being filed. The risks and uncertainties described below are not the only ones we face. Please refer to our risk factors contained in our Form 10-K for the year ended May 31, 2013 for additional risk factors. We May Be Required To Fund Our Joint Venture's Legal Costs. On March 20, 2013 TPL filed a petition under Chapter 11 of the United States Bankruptcy Code. While TPL's petition does not at present affect the licensing agreement between PDS and Alliacense, PDS has incurred significant legal costs in matters before the U.S. District Court, and the actions with the ITC Investigation No. 337-TA-853, one or both of which have certain aspects which are ongoing. If PDS does not receive sufficient licensing revenues to pay these expenses, we may be required to pay these expenses. In the event the cost of legal actions exceeds our ability to fund these efforts, our options for additional sources of financing may be limited. The Impact Of TPL's Bankruptcy On PDS And The Future Success Of The Licensing Program Is Uncertain. While TPL's bankruptcy petition does not appear to affect the licensing agreement between PDS and Alliacense, the consequences of an approved plan of reorganization under Chapter 11, the appointment of a Chapter 11 trustee, or the conversion to a Chapter 7 proceeding may have consequences to PDS and the licensing program which are uncertain and potentially adverse. For example, a trustee may approve the sale of TPL's interest in PDS to be sold to an unknown third party. It is unclear how that may affect the operation of PDS or the licensing program, but it may be adverse. We Have Reported Licensing Income In Prior Fiscal Years Which May Not Be Indicative Of Our Future Income. We have entered into license agreements through our joint venture with TPL and have reported income from the joint venture for the fiscal years 2006 to 2011 and 2013. The joint venture has recorded losses for the three and nine months ended February 28, 2014, and recorded no license revenues for the quarter then ended. Because of the uncertain nature of the negotiations that lead to license revenues, pending litigation with companies which we allege have infringed on our patent portfolio, the possibility of legislative action regarding patent rights, and the possible effect of new judicial interpretations of patent laws, we may not receive revenues from such agreements in the future consistent with amounts received in the past, and we may not receive future revenues from license agreements at all. We Are Dependent Upon A Joint Venture In Which Our Role Is Of A Passive Nature For Substantially All Of Our Income. In June 2005, we entered into a joint venture with TPL, which as a result of agreements entered into in June 2005 and July 2012, TPL and its affiliate Alliacense are responsible for the licensing and enforcement of our microprocessor patent portfolio. This joint venture has been the source of substantially all of our income since June 2005. Therefore, in light of the absence of significant revenue from other sources, we should be regarded as entirely dependent on the success or failure of the licensing and prosecution efforts of TPL and Alliacense on behalf of the joint venture, and the ability of TPL and Alliacense to obtain capital when necessary to fund their operations. 31 We Are Involved In Multiple Disputes With Our Joint Venture Partner. We are involved in multiple disputes with our joint venture partner TPL and its affiliate Alliacense, including objections over amounts invoiced by Alliacense to the joint venture and approval of reimbursements to us of amounts we incurred on the joint venture's behalf. Since there currently are only two appointed managers of the joint venture, a deadlock exists on these and other issues that are unlikely to be resolved quickly. If the deadlock continues, the joint venture may not be able to take actions when appropriate or necessary. We have initiated a formal arbitration proceeding seeking the appointment of an independent manager to the management committee of the joint venture (see Note 6 to the condensed consolidated financial statements). We have concluded that a delay or failure to resolve the issues with TPL and Alliacense and to obtain the appointment of an independent manager may have a negative impact on the licensing program and PDS' business. Our Joint Venture Is At Risk For Going Concern And An Inability To Meet Certain Obligations. PDS, our joint venture with TPL, which received a going concern opinion in its May 31, 2013, 2012 and 2011 financial statements, has experienced significant declines in revenues while at the same time incurring significant legal costs associated with litigation with companies which we allege have infringed on our patent portfolio. Terms of the July 2012 licensing agreement with Alliacense will require TPL and us to fund PDS in the event PDS does not generate enough licensing revenue to cover the licensing and litigation support fees of Alliacense. PDS' licensing revenues have declined over recent years to a point where PDS' ability to make future payments is in substantial doubt unless licensing revenues substantially increase in the near term. In the event that PDS does not have the funds to pay one or more of the aforementioned costs, we and TPL must decide whether to contribute additional capital to PDS to fund such payments and due to TPL's bankruptcy filing, we may be required to pay these expenses without any contribution from TPL. Our Microprocessor Patents Are In The Process Of Expiring. We have three unexpired U.S. patents, one of which will expire on August 19, 2014 and two of which will expire in 2015, and three European and two Japanese patents expiring in 2016. We also have four U.S. patents, six European, and one Japanese patent all of which expired between August 2009 and February 2014. While expired patents may have certain retrospective statutory benefits, their value as assets for licensing and cash generation is significantly diminished. A Successful Challenge To Our Intellectual Property Rights Could Have A Significant And Adverse Effect On Us. We Have Had Mixed Results In Our Litigation Efforts To Date. A successful challenge to our ownership of our technology or the proprietary nature of our intellectual property could materially damage our business prospects. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. With respect to our core technologies, we currently have three unexpired U.S., three European and two Japanese patents issued. Any issued patent may be challenged and invalidated. Any claims allowed from existing patents may not be of sufficient scope or strength to provide significant protection. Our competitors may also be able to design around our patents. Vigorous protection and pursuit of intellectual property rights or positions characterize the fiercely competitive semiconductor industry, which has resulted in significant and often protracted and expensive litigation. Therefore, our competitors and others may assert that our technologies infringe on their patents or proprietary rights. Persons we believe are infringing our patents are likely to vigorously defend their actions and assert that our patents are invalid. Problems with patents or other rights could result in significant costs, and limit future license revenue. If infringement claims against us are deemed valid or if our infringement claims are successfully opposed, we may not be able to obtain appropriate licenses on acceptable terms or at all. Litigation could be costly and time-consuming but may be necessary to protect our future patent and/or technology license positions or to defend against infringement claims. From time to time parties have petitioned the USPTO to re-examine certain of our patents. An adverse decision in litigation or in the re-examination process could have a very significant and adverse effect onour business. 32 We are parties to multiple lawsuits regarding the MMP Portfolio and have had mixed results in our litigation efforts to date. See footnote 6 to our condensed consolidated financial statements and Part II, Item 1. "Legal Proceedings" in this quarterly report on Form 10-Q for more information. In the event that one or more of these lawsuits regarding the MMP Portfolio are not resolved in our favor, such outcome (or lack of an outcome) could weaken the MMP Portfolio which would have a negative affect on PDS's ability to procure future license revenues and, therefore, adversely affect PDS's and our cash flows. We Are Dependent On A Single Law Firm To Defend And Enforce Our Intellectual Property Rights. A single law firm has been engaged to defend and enforce our intellectual property rights on a contingency fee basis. We have been notified by that law firm that it is no longer able to work on a contingency basis. We are currently discussing alternative, hybrid hourly/contingency fee arrangements with that law firm. Any significant interruption in their services, or the loss of their services for any reason, would have a material adverse effect on our ability to defend and prosecute such lawsuits and, therefore, have a material adverse effect on our business, financial condition and result of operations. The law firm's services could be disrupted for a variety of reasons, and any disruption would have a material adverse effect on our business. Our inability to engage the services of a new law firm in a timely manner could have a substantial negative effect on our business. A Change In Our Relationship With PDS Could Change The Way We Account For Our Interest In The Future. For our investment in PDS accounted for under the equity method, we record as part of other income or expense our share of the increase or decrease in the equity of this company in which we have invested. It is possible that, in the future, our relationships and/or our interests in or with this equity method investee could change. Such potential future changes could result in consolidation of such entity which could result in changes in our reported results. If A Large Number Of Our Shares Are Sold All At Once Or In Blocks, The Market Price Of Our Shares Would Most Likely Decline. Most of our shareholders are not restricted in the price at which they can sell their shares. Shares sold at a price below the current market price at which our Common Stock is trading may cause the market price of our Common Stock to decline. The Market For Our Stock Is Subject To Rules Relating To Low-Priced Stock ("Penny Stock") Which May Limit Our Ability To Raise Capital. Our Common Stock is currently listed for trading in the OTCQB operated by OTC Markets, Inc. and is subject to the "penny stock rules" adopted pursuant to Section 15(g) of the Exchange Act. In general, the penny stock rules apply to non-NASDAQ or non-national stock exchange companies whose common stock trades at less than $5.00 per share or which have tangible net worth of less than $5,000,000 ($2,000,000 if the company has been operating for three or more years). Such rules require, among other things, that brokers who trade "penny stock" on behalf of persons other than "established customers" complete certain documentation, make suitability inquiries of investors and provide investors with certain information concerning trading in the security, including a risk disclosure document, quote information, broker's commission information and rights and remedies available to investors in penny stocks. Many brokers have decided not to trade "penny stock" because of the requirements of the penny stock rules, and as a result, the number of broker-dealers willing to act as market makers in such securities is limited. The "penny stock rules," therefore, may have an adverse impact on the market for our Common Stock and may affect our ability to raise additional capital if we decide to do so. 33 Our Share Price Could Decline As A Result Of Short Sales. When an investor sells stock that he does not own, it is known as a short sale. The seller, anticipating that the price of the stock will go down, intends to buy stock to cover his sale at a later date. If the price of the stock goes down, the seller will profit to the extent of the difference between the price at which he originally sold it less his later purchase price. Short sales enable the seller to profit in a down market. Short sales could place significant downward pressure on the price of our Common Stock. Penny stocks which do not trade on an exchange, such as our Common Stock, are particularly susceptible to short sales. Our Future Success Depends In Significant Part Upon The Continued Services Of Our Key Senior Management. Our future success depends in significant part upon the continued services of our key personnel. The competition for highly qualified personnel is intense, and we may not be able to retain our key employees or attract and retain additional highly qualified personnel in the future. None of our employees are represented by a labor union, and we consider our relations with our employees to be good. None of our employees are covered by key man life insurance policies. |