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, 2011.

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. We intend to continue our joint venture with TPL to pursue license agreements with unlicensed users of our technology. We believe that continuing to work through TPL, as compared to pursuing other alternatives, including creating and using our own licensing team for those activities, avoids a competitive devaluation of our principal assets and is a prudent way to achieve the desired results as we seek to obtain fair value from users of our intellectual property.

On October 5, 2009, we announced a reorganization of PDSG and our management. On January 25, 2010, we sold the Iameter assets and during August 2010, we sold the Vigilys business line. As a result of our reorganization and PDSG's continued inability to meet its business plan, we have incurred impairment charges for our intangibles and goodwill in the PDSG segment of our business. On July 28, 2011, PDSG announced new business initiatives including Software as a Service offerings aimed at providing alternative methods to generate new revenues. We continue to fund the day to day operating costs of PDSG. Our merger and acquisition activities have ceased since our October 2009 reorganization.

Cash shortfalls and liquidity issues currently experienced by PDS and continued negative cash flows incurred by PDSG will have an adverse effect on our liquidity. Accordingly, we have and may continue to examine alternatives that could allow for the partnering or divestiture of PDSG. During October 2011, we retained an investment banker to seek a buyer for PDSG although given the operational history of PDSG to date there can be no guarantee that a divestiture will result in the realization of material consideration. With respect to PDS and TPL, we do not have any contractual commitments to fund any cash requirements of these entities.

On January 9, 2012 PDS' cash balance is $314,388. Management's plans for the continued operation of PDS rely on the ability of TPL to obtain license agreements to cover the operational costs of PDS. PDS has experienced a decline in licensing revenues and has experienced an increase in legal costs due to the patent litigation actions currently in progress. In the event that TPL cannot obtain license agreements to cover the operational costs of PDS, we and TPL must decide whether to fund PDS' legal costs on a go forward basis.

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 Phoenix Digital Solutions, LLC ("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 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.

During the six months ended November 30, 2011, our share of loss in PDS exceeds our investment in PDS by $2,017,797. We presently do not have a contractual obligation to fund any cash requirements of PDS and accordingly we have not recorded the excess loss on our consolidated financial statements, which is a change in our policy of accounting for PDS. Under the equity method of accounting, we are to continue to report losses up to our carrying amount of the investment. Once the investment balance is reduced to $0, we are to discontinue applying the equity method until such time that our share of future net income reported by PDS equals our share of net losses not recognized during the period the equity method was suspended.

We review our investment in an affiliated company 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 the investee. If the decline in value is deemed to be other than temporary, we would recognize an impairment loss.

3. Revenue Recognition

Revenue from technology license agreements is recognized at the time a contract is entered into, the license method is determined (paid-in-advance or on-going royalty), and the customer is provided with the licensed technology, if applicable.

PDSG sells software and services to end users primarily through relationships with systems integrators and prime contractors. PDSG recognizes revenue in accordance with authoritative guidance for the software industry. PDSG's revenue is derived primarily from the following sources: (i) software licensing,
(ii) related professional services, and (iii) post contract customer support ("PCS") agreements. PCS agreements typically include software updates, on a when and if available basis, telephone and Internet access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.

PDSG's contracts with customers, including systems integrators and prime contractors, are multiple element arrangements which contain professional services that are considered essential to the functionality of the other elements of the arrangement. PDSG accounts for revenue on these arrangements according to authoritative guidance for contract accounting. Under this guidance, PDSG recognizes revenue based on progress towards contract completion measured by actual hours incurred in relation to the estimate of total expected hours. PDSG measures these revenues by applying the contract-specific estimated percentage of completion to the total contract amount for software and professional services. PDSG routinely updates the estimates of future hours for agreements in process and reports any cumulative effects of such adjustments in current operations. PDSG immediately recognizes any loss expected on these contracts when it is projected that loss is probable.

We allocate PDSG's revenues to all deliverables based on their relative selling price using a specific hierarchy. The hierarchy is as follows: vendor-specific objective evidence ("VSOE"), third-party evidence of selling price ("TPE") or best estimate of selling price ("BESP"). When a sale involves multiple elements, PDSG allocates the entire fee from the arrangement to each respective element based on VSOE of fair value and recognizes revenue when each element's revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately. PDSG has established VSOE for its CDX software licenses and PCS based on historical stand-alone sales to third parties or from the stated renewal rates contained in the customer contracts. PCS is recognized on a straight-line basis over the support period.

PDSG has not yet demonstrated VSOE for the professional services that are rendered in conjunction with its software license sales. In accordance with the hierarchy we would attempt to establish the selling price of professional services using TPE. PDSG's product contains significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained. PDSG is typically not able to obtain TPE for professional services.

When we are unable to establish selling prices using VSOE or TPE, we use BESP. The objective of BESP is to determine the price at which PDSG would transact a sale if professional services were sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for highly customized offerings which is the case with PDSG's professional services deliverable.

4. Research and Development

Research and development costs are expensed as incurred and primarily include payroll and related benefit costs and contractor fees.

5. 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.

6. 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.

During the fiscal 2011, we determined that is was not more likely than not that all of our deferred tax assets will 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.

7. 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 November 30, 2011 and Three Months Ended
November 30, 2010.

Consolidated:
                                                               Three months ended
                                              November 30, 2011                  November 30, 2010
                                          Dollars        % of Revenue        Dollars        % of Revenue
Revenue:
 License and service revenue            $    47,587             100.0%     $    72,775             100.0%
Cost of sales:
License and service revenue                  12,313              25.9%           5,000               6.9%
Amortization of purchased intangibles             -                  -          68,889              94.7%
Total cost of sales                          12,313              25.9%          73,889                  -
 Gross profit (loss)                    $    35,274              74.1%     $    (1,114 )                -

PDSG

Revenue consisting of software licenses and associated services relating to PDSG's CDX product decreased from approximately $73,000 for the three months ended November 30, 2010 to approximately $48,000 for the three months ended November 30, 2011. The decrease was primarily due to the level of activity and progress towards completion rendered on one time contracts that vary in size and scope depending upon the requirements of the customer. Cost of sales includes the direct time of PDSG employees on each project. Included in cost of sales is approximately $68,900 of amortization expense on purchased intangible assets for the three months ended November 30, 2010. Profit margin excluding amortization decreased for the three months ended November 30, 2011 as compared to the three months ended November 30, 2010 due to a greater portion of service revenue generated in the current period as compared to the prior period. During fiscal 2011, we wrote off PDSG's remaining balance of purchased intangible assets.

Consolidated:
                                       Three months ended
                            November 30, 2011       November 30, 2010
Research and development   $           150,757     $           157,545

PDSG

Research and development costs consist of PDSG's payroll and related expenses for software engineers. The primary decreases in research and development costs for the three months ended November 30, 2011 as compared to November 30, 2010 were approximately $2,500 in outside contractor costs due to completion of CDX4 and approximately $4,000 in salaries and related costs due to management's restructuring plan implemented in October of 2009. For the three months ended November 30, 2011 and 2010, approximately $500 and $500, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.

Consolidated:
                                                  Three months ended
                                       November 30, 2011       November 30, 2010
Selling, general and administrative   $           665,813     $           940,399



Segment Results:
                                                  Three months ended
                                       November 30, 2011       November 30, 2010
PDSG:
Selling, general and administrative   $           214,436     $           265,597
PTSC:
Selling, general and administrative   $           451,377     $           674,802

PDSG

Selling, general and administrative expenses decreased from approximately $266,000 for the three months ended November 30, 2010 to approximately $214,000 for the three months ended November 30, 2011, due to management's restructuring plan to reduce expenses. Decreases consisted primarily of approximately $45,000 in salaries and related expenses and approximately $13,000 in rent expenses due to the sublease of Suite 102. For the three months ended November 30, 2011 and 2010, approximately $4,500 and $4,500, respectively, of share-based compensation was recorded in connection with vesting of employee stock options.

PTSC

Selling, general and administrative expenses decreased from approximately $675,000 for the three months ended November 30, 2010 to approximately $451,000 for the three months ended November 30, 2011. The decrease consisted primarily of approximately $68,000 in legal fees, approximately $58,000 in consulting fees due to the termination of the services of Attain, and approximately $44,000 in board of directors' fees due to fewer directors serving on our board during the current year period. For the three months ended November 30, 2010, approximately $3,000 of share-based compensation was recorded in connection with vesting of employee stock options.

Consolidated

Selling, general and administrative expenses decreased from approximately $940,000 for the three months ended November 30, 2010 to approximately $666,000 for the three months ended November 30, 2011 primarily due to continued cost reductions implemented by management.

Consolidated:
                                 Three months ended
                         November 30,         November 30,
                             2011                 2010
Impairment of goodwill   $           -       $      642,981

PDSG

Management's plan of restructuring on October 5, 2009 and the continuing inability of PDSG to meet its business plan were indicators of potential impairment on our goodwill. Accordingly, at November 30, 2010, management determined that goodwill was impaired by approximately $643,000.

Consolidated:
                        Three months ended
                  November 30,      November 30,
                      2011               2010
Operating loss   $     (781,296 )   $  (1,742,039 )

Segment Results:
                        Three months ended
                  November 30,      November 30,
                      2011               2010
PDSG:
Operating loss   $     (329,919 )   $  (1,067,237 )
PTSC:
Operating loss   $     (451,377 )   $    (674,802 )

PDSG

Operating loss decreased from approximately $1,067,000 for the three months ended November 30, 2010 to approximately $330,000 for the three months ended November 30, 2011 primarily due to the lack of goodwill impairment in the current fiscal year and decreases in operating expenses as management continued to implement cost reductions.

PTSC

Operating loss decreased from approximately $675,000 for the three months ended
November 30, 2010 to approximately $451,000 for the three months ended November
30, 2011 due to decreases in operating expenses for legal, consulting and board
fees.

Consolidated:
                                                  Three months ended
                                            November 30,       November 30,
                                                2011               2010
 Other income (expense):
Interest and other income                  $        5,682     $          791
Interest expense                                        -             (4,213 )
Equity in loss of affiliated company             (227,268 )         (316,136 )
       Total other income (expense), net   $     (221,586 )   $     (319,558 )



Segment Results:
                                    Three months ended
                            November 30,          November 30,
                                2011                   2010
PDSG:
Other income (expense):
Interest and other income   $           -         $         509

                                              Three months ended
                                        November 30,       November 30,
                                            2011               2010
PTSC:
Other income (expense):
Interest and other income              $        5,682     $          282
Interest expense                                    -             (4,213 )
Equity in loss of affiliated company         (227,268 )         (316,136 )
Total other income (expense), net      $     (221,586 )   $     (320,067 )

Consolidated

Our other income and expenses for the three months ended November 30, 2011 and
2010 included equity in the loss of PDS of approximately $227,000 and $316,000,
respectively. Our investment in PDS is accounted for in accordance with the
equity method of accounting for investments, accordingly we will only record
income to the extent PDS eliminates accumulated losses and after basis in our
investment is zero we will only record losses to the extent that we advance or
contribute funds to PDS.

Consolidated:
                                 Three months ended
                           November 30,      November 30,
                                2011              2010
Loss before income taxes   $  (1,002,882 )   $  (2,061,597 )



Segment Results:
                                  Three months ended
                            November 30,      November 30,
                                2011              2010
PDSG:
Loss before income taxes   $     (329,919 )   $  (1,066,728 )
PTSC:
Loss before income taxes   $     (672,963 )   $    (994,869 )

PDSG

Loss before income taxes decreased from approximately $1,067,000 for the three months ended November 30, 2010 to approximately $330,000 for the three months ended November 30, 2011 primarily due to the lack of goodwill impairment in the current fiscal year and decreases in operating expenses as management continued to implement cost reduction measures.

PTSC

Loss before income taxes decreased from approximately $995,000 for the three months ended November 30, 2010 to approximately $673,000 for the three months ended November 30, 2011 primarily due to our inability to recognize our losses from PDS during the three months ended November 30, 2011 as our losses have exceeded the cost basis of our investment.

Provision (benefit) for income taxes

During the three months ended November 30, 2011, we recorded a provision for income taxes related to California taxes of $1,600.

During the three months ended November 30, 2010, we recorded a benefit for income taxes of approximately $562,000 related to federal and California taxes.

Net loss

We recorded a net loss for the three months ended November 30, 2011 and 2010 of $1,004,482 and $1,499,530, respectively.

Comparison of the Six Months Ended November 30, 2011 and Six Months Ended
November 30, 2010.

Consolidated:
                                                               Six months ended
                                              November 30, 2011                 November 30, 2010
                                          Dollars       % of Revenue        Dollars       % of Revenue
Revenue:
 License and service revenue            $   182,150             100.0 %   $   166,830             100.0 %
Cost of sales:
License and service revenue                  45,397              24.9 %        28,415              17.0 %
Amortization of purchased intangibles             -                 -         137,778              82.6 %
Total cost of sales                          45,397              24.9 %       166,193              99.6 %
 Gross profit                           $   136,753              75.1 %   $       637               0.4 %

PDSG

Revenue consisting of software licenses and associated services relating to PDSG's CDX product increased from approximately $167,000 for the six months ended November 30, 2010 to approximately $182,000 for the six months ended November 30, 2011. The increase was primarily due to the level of activity and progress towards completion rendered on one time contracts that vary in size and scope depending upon the requirements of the customer. Cost of sales includes the direct time of PDSG employees on each project. Profit margin excluding amortization decreased for the six months ended November 30, 2011 as compared to the six months ended November 30, 2010 due to a greater portion of service revenue generated in the current period as compared to the prior period. Included in cost of sales is approximately $138,000 of amortization expense on purchased intangible assets for the six months ended November 30, 2010. During fiscal 2011, we wrote off PDSG's remaining balance of purchased intangible assets.

Consolidated:
                                   Six months ended
                            November 30,       November 30,
                                2011               2010
Research and development   $      320,952     $      388,029

PDSG

Research and development costs consist of PDSG's payroll and related expenses for software engineers. The primary decreases in research and development costs for the six months ended November 30, 2011 as compared to November 30, 2010 were . . .