Valuation of Non-Marketable Equity Securities

In the past we invested in illiquid equity securities acquired directly from issuers in private transactions. These investments are generally subject to restrictions on resale or otherwise are illiquid and generally have no established trading market. Additionally, our investment in Alacra, our only remaining investment in a privately held company, will not be eligible for sale to the public without registration under the Securities Act of 1933. Because of the type of investments that we made and the nature of our business, our valuation process requires an analysis of various factors.

Investments in non-marketable securities are inherently risky and the one remaining privately held company that we have invested in may fail. Its success (or lack thereof) is dependent upon product development, market acceptance, operational efficiency and other key business success factors. In addition, depending on its future prospects, it may not be able to raise additional funds when needed or it may receive lower valuations, with less favorable investment terms than in previous financings, likely causing our investments to become impaired.

We review all of our investments quarterly for indicators of impairment; however, for non-marketable equity securities, the impairment analysis requires significant judgment to identify events or circumstances that would likely have a material adverse effect on the fair value of the investment. The indicators that we use to identify those events or circumstances includes as relevant, the nature and value of any collateral, the portfolio company’s ability to make payments and its earnings, the markets in which the portfolio company does business, comparison to valuations of publicly traded companies, comparisons to recent sales of comparable companies, the discounted value of the cash flows of the portfolio company and other relevant factors. Because such valuations are inherently uncertain and may be based on estimates, our determinations of fair value may differ materially from the values that would be assessed if a liquid market for these securities existed.

Investments identified as having an indicator of impairment are subject to further analysis to determine if the investment is other than temporarily impaired, in which case we write the investment down to its impaired value. When a portfolio company is not considered viable from a financial or technological point of view, we write down the entire investment since we consider the estimated fair market value to be nominal. If a portfolio company obtains additional funding at a valuation lower than our carrying amount or requires a new round of equity funding to stay in operation and the new funding does not appear imminent, we presume that the investment is other than temporarily impaired, unless specific facts and circumstances indicate otherwise.

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Security investments which are publicly traded on a national securities exchange or over-the-counter market are stated at the last reported sale price on the day of valuation or, if no sale was reported on that date, then the securities are stated at the last quoted bid price. We may determine, if appropriate, to discount the value where there is an impediment to the marketability of the securities held.

Valuation of Intangible Assets

We assess the impairment of intangible assets when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors that we consider in deciding when to perform an impairment review include significant under-performance of a product line in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in our use of the assets. Recoverability of intangible assets that will continue to be used in our operations is measured by comparing the carrying amount of the asset grouping to our estimate of the related total future net cash flows. If an asset grouping’s carrying value is not recoverable through the related cash flows, the asset grouping is considered to be impaired. The impairment is measured by the difference between the asset grouping’s carrying amount and its fair value, based on the best information available, including market prices or discounted cash flow analysis. Impairments of intangible assets are determined for groups of assets related to the lowest level of identifiable independent cash flows. Due to our limited operating history and the early stage of development of some of our intangible assets, we must make subjective judgments in determining the independent cash flows that can be related to specific asset groupings. To date we have not recognized impairments on any of our intangible assets related to the Safety Sponge™ System.

Stock-Based Compensation

We have adopted the provisions of SFAS No. 123(R), Share-Based Payment, effective January 1, 2005 using the modified retrospective application method as provided by SFAS 123(R) and accordingly, financial statement amounts for the prior periods in which the Company granted employee stock options have been restated to reflect the fair value method of expensing prescribed by SFAS 123(R). The fair value of each option grant, nonvested stock award and shares issued under the employee stock purchase plan were estimated on the date of grant using the Black-Scholes option pricing model and various inputs to the model. Expected volatilities were based on historical volatility of our stock. The expected term represents the period of time that grants and awards are expected to be outstanding. The risk-free interest rate approximates the U.S. treasury rate corresponding to the expected term of the option, and dividends were assumed to be zero. These inputs are based on our assumptions, which include complex and subjective variables. Other reasonable assumptions could result in different fair values for our stock-based awards.

Stock-based compensation expense, as determined using the Black-Scholes option pricing model, is recognized on a straight line basis over the service period, net of estimated forfeitures. Forfeiture estimates are based on historical data. To the extent actual results or revised estimates differ from the estimates used, such amounts will be recorded as a cumulative adjustment in the period that estimates are revised.

New Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in an income tax return. FIN 48 was effective for us beginning January 1, 2007. The adoption of FIN 48 did not have a material impact on our financial position, results of operations or cash flows.

 

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Financial Condition, Liquidity and Capital Resources

Our cash and marketable securities were $1,411,000 at March 31, 2007, versus $4,000 at December 31, 2006. Total current liabilities were $6,292,000 at March 31, 2007, versus $5,637,000 at December 31, 2006. Included in current liabilities at December 31, 2006 is a note payable to Winstar Communications, Inc. (“Winstar”), in the amount of $450,000, which was repaid during the three months ended March 31, 2007.

We had a working capital deficit of approximately $4,185,000 at March 31, 2007 and we continue to have recurring losses. In the past we have relied upon private placements of equity and debt securities and we may rely on private placements to fund our capital requirements in the future. We have received a significant amount of funding from Ault Glazer Capital Partners, LLC (formerly AGB Acquisition Fund) (the “Fund”). AG Management is the managing member of the Fund. The managing member of AG Management is The Ault Glazer Group, Inc. (“The AG Group”) (f/k/a Ault Glazer Bodnar & Company, Inc.). The Company’s former Chairman and former Chief Executive Officer, Milton “Todd” Ault, III, is Chairman, Chief Executive Officer and President of The AG Group. At March 31, 2007 the outstanding principal balance of loans that we have entered into with the Fund was $2,576,000. We have begun discussions with the Fund to restructure the terms of these loans. At March 31, 2007 we also had outstanding promissory notes to primarily three additional lenders in the principal amount of $4,104,000.

On January 12, 2006, Steven J. Caspi (“Caspi”) loaned $1,000,000 to ASG. As consideration for the loan, ASG issued Caspi a promissory note in the principal amount of $1,000,000 (the “Caspi Note”) and granted Caspi a mortgage on certain real estate owned by ASG and a security interest on all personal property and fixtures located on such real estate as security for the obligations under the Caspi Note. In addition, we entered into an agreement guaranteeing ASG’s obligations pursuant to the Caspi Note. The Caspi Note initially accrued interest at the rate of 10% per annum, which together with principal, was due to be repaid on July 13, 2006. The Caspi Note was not repaid by the scheduled maturity and to date has not been extended. The Caspi Note is in default and therefore accruing interest at the rate of 18% per annum.

From September 8, 2006 through September 19, 2006, Caspi loaned the Company a total of $1,495,000, all of which is outstanding at March 31, 2007. As consideration for the loan, the Company issued Caspi a Convertible Promissory Note in the principal amount of $1,495,000 (the “Second Caspi Note”). The Second Caspi Note bears interest at the rate of 12% per annum and is due upon the earlier of March 31, 2008 or, the occurrence of an event of default, and is convertible into shares of the Company’s common stock at $1.25 per share. As security for the performance of the Company’s obligations pursuant to the Second Caspi Note, the Company granted Caspi a security interest in certain real property.

On May 1, 2006, Herbert Langsam, a Class II Director of the Company, loaned the Company $500,000. The loan is documented by a $500,000 Secured Promissory Note (the “Langsam Note”). The Langsam Note accrues interest at the rate of 12% per annum and had a maturity date of November 1, 2006. The Langsam Note is in default and classified with current liabilities on the balance sheet. As a result of the default, the interest rate increased to 16% per annum.

On November 13, 2006, Mr. Langsam loaned the Company an additional $100,000. The loan is documented by a $100,000 Secured Promissory Note (the “Second Langsam Note”). The Second Langsam Note accrues interest at the rate of 12% per annum and had a maturity date of May 13, 2007. The Second Langsam Note is in default and classified with current liabilities on the balance sheet. As a result of the default the interest rate increased to 16% per annum.

Pursuant to the terms of Security Agreements dated May 1, 2006 and November 13, 2006, the Company granted the Herbert Langsam Revocable Trust a security interest in all of the Company’s assets as collateral for the satisfaction and performance of the Company’s obligations under the terms of the Langsam Note and the Second Langsam Note.

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On November 3, 2006, we entered into a convertible promissory note in the principal amount of $400,000 with Charles J. Kalina, III (the “Kalina Note”). The Kalina Note bears interest at the rate of 12% per annum, is due to be paid on January 31, 2008, and is convertible into shares of the Company’s common stock at $1.25 per share.

In August 2006, we entered into subscription agreements with two unaffiliated accredited investors, pursuant to which we sold 200,000 shares of the Company’s common stock, $0.33 par value per share, at a price of $1.25 per share. We received gross proceeds of approximately $250,000 from the sale of our common stock to the accredited investors. Pursuant to the subscription agreement, we granted the accredited investors piggy back registration rights to register the resale of the shares of common stock.

Between November 30, 2006 and December 15, 2006, the Company entered into a subscription agreement and sold an aggregate of 238,000 shares of its Common Stock and warrants to purchase an aggregate of up to 119,000 shares of its Common Stock in a private placement transaction to certain unaffiliated accredited investors. The warrants are exercisable for a period of three years, have an exercise price equal to $2.00, and 50% of the warrants are callable upon the occurrence of any one of a number of specified events when, after any such specified occurrence, the average closing price of the Company’s common stock during any period of five consecutive trading days exceeds $4.00 per share. Pursuant to the subscription agreement, we granted the accredited investors piggy back registration rights to register the resale of the shares of common stock. We received aggregate gross proceeds of $298,000.

On January 29, 2007, the Company entered into a subscription agreement and sold an aggregate of 800,000 shares of its Common Stock and warrants to purchase an aggregate of up to 300,000 shares of its Common Stock in a private placement transaction to A Plus, an accredited investor. The warrants are exercisable for a period of five years, have an exercise price equal to $2.00, and 50% of the warrants are callable upon the occurrence of any one of a number of specified events when, after any such specified occurrence, the average closing price of the Company’s common stock during any period of five consecutive trading days exceeds $4.00 per share. The Company received gross proceeds of $500,000 in cash and will receive $500,000 in product over the course of the next twelve (12) months. We used the net proceeds from the private placement transaction primarily for general corporate purposes and repayment of existing liabilities. Pursuant to the subscription agreement, we granted the accredited investors piggy back registration rights to register the resale of the shares of common stock.

On January 29, 2007, the Company entered into a subscription agreement with several unaffiliated accredited investors in a private placement exempt from the registration requirements of the Securities Act. The Company issued and sold to these accredited investors an aggregate of 104,000 shares of its common stock and warrants to purchase an additional 52,000 shares of its common stock. The warrants are exercisable for a period of five years, have an exercise price equal to $2.00, and 50% of the warrants are callable upon the occurrence of any one of a number of specified events when, after any such specified occurrence, the average closing price of the Company’s common stock during any period of five consecutive trading days exceeds $4.00 per share. These issuances resulted in aggregate gross proceeds to the Company of $130,000. We used the net proceeds from the private placement transaction primarily for general corporate purposes . Pursuant to the subscription agreement, we granted the accredited investors piggy back registration rights to register the resale of the shares of common stock.

Between March 7, 2007 and April 5, 2007, the Company entered into a subscription agreement with several accredited investors in a private placement exempt from the registration requirements of the Securities Act. The Company issued and sold to these accredited investors an aggregate of 2,000,000 shares of its common stock and warrants to purchase an additional 1,000,000 shares of its common stock. The warrants are exercisable for a period of five years, have an exercise price equal to $2.00, and 50% of the warrants are callable upon the occurrence of any one of a number of specified events when, after any such specified occurrence, the average closing price of the Company’s common stock during any period of five consecutive trading days exceeds $4.00 per share. These issuances resulted in aggregate gross proceeds to the Company of $2,500,000. We are required to use our reasonable best efforts to cause the registration statement to become effective within 120 days after the Closing Date, April 5, 2007. If the registration statement has not been filed on or prior to the 120th day after the Closing Date, we will issue, as liquidated damages, to the purchasers of the 2,000,000 shares of our Common Stock and the warrants to purchase 1,000,000 shares of our Common Stock warrants with a term of five years and an exercise price of $2.00 per share to purchase shares of our Common Stock equal to 2.5% of the number of shares of Common Stock purchased by the purchasers. We intend to use the net proceeds from this private placement transaction primarily for general corporate purposes and repayment of existing liabilities.

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On April 4, 2007, ASG entered into an agreement for the sale of real property located in Tuscaloosa, Alabama for $965,000 and on April 26, 2007, ASG entered into a binding term sheet to sell its express car wash and a parcel of real property, both located in Birmingham, Alabama, to Charles H. Dellaccio and Darrell Grimsley for $2.25 milllion. Mr. Grimsley is the Chairman of the Board and Chief Executive Officer of Automotive Services Group. There can be no guarantee that the execution of these contracts will result in the consummation of the transactions. However, to the extent we are successful in consummating these transactions then we would expect to receive proceeds from the transactions in July 2007. If all the properties are sold, we will receive gross proceeds of approximately $3.2 Million. By selling these assets we will be better positioned to aggressively pursue the market for surgical sponges in the United States and Europe, which we believe represents a market opportunity equal to or in excess of $650 million in annual sales.

Management is currently seeking additional financing and believes that it will be successful. However, in the event management is not successful in obtaining additional financing, existing cash resources, together with proceeds from investments and anticipated revenues from operations, may not be adequate to fund our operations for the twelve months subsequent to March 31, 2007. However, ultimately long-term liquidity is dependent on our ability to attain future profitable operations. We intend to undertake additional debt or equity financings to better enable us to grow and meet future operating and capital requirements.

As of March 31, 2007, other than our office lease and employment agreements with key executive officers, we had no commitments not reflected in our consolidated financial statements.

Cash increased by $1,407,000 to $1,411,000 during the three months ended March 31, 2007, compared to a decrease of $22,000 during the three months ended March 31, 2006.

 

Operating activities used $971,000 of cash during the three months ended March 31, 2007, compared to providing $7,000 during the three months ended March 31, 2006.

 

Operating activities for the three months ended March 31, 2007, exclusive of changes in operating assets and liabilities, used $860,000 of cash, as the Company's net cash used in operating activities of $971,000 included non-cash charges for depreciation and amortization of $113,000, debt discount of $169,000 and stock based compensation of $312,000. For the three months ended March 31, 2006, operating activities, exclusive of changes in operating assets and liabilities, used $1,024,000 of cash, as the Company's net cash used in operating activities of $7,000 included non-cash charges for depreciation and amortization of $90,000, debt discount of $75,000, realized losses of $136,000, unrealized gains of $77,000 and stock based compensation of $2,354,000

Changes in operating assets and liabilities used cash of $111,000 during the three months ended March 31, 2007, principally due to decreases in the level of accounts payable and accrued liabilities which were partially offset by a decrease in prepaid expenses. During the three months ended March 31, 2006, changes in operating assets and liabilities provided cash of $1,031,000, principally due to net proceeds received from marketable securities, and decreases in our receivables from investments which were partially offset by decreases in the level of accounts payable and accrued liabilities and amounts due to our broker. The amount due to our broker was directly attributable to purchases of marketable investment securities that were purchased on margin or to securities that were margined subsequent to their purchase. During the three months ended March 31, 2006 we invested our cash balances in the public equity and debt markets in an attempt to maximize the short-term return on such assets. The amount due to our broker varied throughout the year depending upon the aggregate amount of marketable investment securities held by us and the level of borrowing against our available-for-sale securities. The actual amount of marketable investment securities held was influenced by several factors, including but not limited to, our expectations of potential returns available from what we considered to be mispriced securities as well as the cash needs of our operating activities. During times when we were heavily invested in marketable investment securities our liquidity position was significantly reduced. We no longer make a practice of investing in marketable investment securities.

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The principal factor in the $79,000 of cash used in investing activities during the three months ended March 31, 2007 was the capitalized costs of $73,000 related to the ongoing development of software related to our Safety-Sponge^TM System. The principal factor in the $2,082,000 of cash used in investing activities during the three months ended March 31, 2006 was the purchase of land of $1,697,000 and capitalized construction costs of $317,000 related to the construction of our first automated car wash site by our subsidiary, ASG.

Cash provided by financing activities during the three months ended March 31, 2007, of $2,457,000 resulted primarily from net proceeds from the issuance of common stock and warrants of $2,897,000 offset by the repayment of the Winstar Note in the amount of $450,000. Cash provided by financing activities for the three months ended March 31, 2006, of $2,054,000 resulted from the net proceeds from notes payable.

Investments

Our financial condition is partially dependent on the success of our existing investments. On March 29, 2006 our Board of Directors directed us to liquidate all of our investments and other assets that do not relate to the patient safety medical products business. Some of our investments are subject to restrictions on resale under federal securities laws and otherwise are illiquid, which will make it difficult to dispose of the securities quickly. Since we will be forced liquidate some or all of the investments on an accelerated timeline, the proceeds of such liquidation may be significantly less than the value at which we acquired the investments. The following is a discussion of our most significant investments at March 31, 2007.

A summary of our investment portfolio, which is valued at $1,442,000 and represents 11.06% of our total assets, is reflected below. Excluding our real estate investments, our investment portfolio represents 7.75% of our total assets. The investment portfolio is classified as long-term investments.  

 

		March 31, 2007
Alacra Corporation		$	1,000,000
Digicorp			10,969
Real Estate			430,564
		$	1,441,533

 

Item 3. Defaults Upon Senior Securities.

On January 12, 2006 ASG entered into a secured promissory note with Steven J. Caspi in the principal amount of $1,000,000 (the “Caspi Note”). The Caspi Note was due to be repaid on July 13, 2006.

On February 8, 2006, ASG entered into a secured promissory note with Ault Glazer Capital Partners, LLC (the “Fund”), a related party, in the principal amount of $687,000 (the “ASG Note”). The ASG Note was due to be repaid on September 15, 2006.

From March 7, 2006 through October 16, 2006, the Fund loaned the Company a total of $524,000, of which $130,000 was repaid. The outstanding balance at March 31, 2007 is $394,000. The loans were advanced to the Company pursuant to a Revolving Line of Credit Agreement (the “Revolving Line of Credit”) entered into with the Fund on March 7, 2006. Each advance under the Revolving Line of Credit is evidenced by a secured promissory note and a security agreement. The secured promissory notes issued pursuant to the Revolving Line of Credit required repayment within 60 days from issuance and are currently in default.

On May 1, 2006, the Company entered into a secured promissory note with Herbert Langsam, a Class II Director of the Company, in the principal amount of $500,000 (the “Langsam Note”). The Langsam Note was due to be repaid on November 1, 2006.

On November 13, 2006, the Company entered into secured promissory note with Mr. Langsam in the principal amount of $100,000 (the “Second Langsam Note”). The Second Langsam Note was due to be repaid on May 13, 2007.

The Company is in the process of restructuring the debt that is owed to the Fund and Messrs. Steven J. Caspi and Herbert Langsam.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

Item 5. Other Information.

None.

Item 6. Exhibits.

Exhibit Number		Description
31.1*		Certification of Chief Executive and Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a)
32.1*		Certification of Chief Executive and Financial Officer required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code

 

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* Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PATIENT SAFETY TECHNOLOGIES, INC.
Date: May 21, 2007	By:	/s/ William B. Horne
		William B. Horne
		Chief Executive and Chief Financial Officer and Principal Accounting Officer

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