The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes thereto contained elsewhere in this Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. All statements regarding future events, our future financial performance and operating results, our business strategy and our financing plans are forward-looking statements. In many cases, you can identify forward-looking statements by terminology, such as "may," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential," or "continue" or the negative of such terms and other comparable terminology. These statements are only predictions. Known and unknown risks, uncertainties and other factors could cause our actual results to differ materially from those projected in any forward-looking statements. In evaluating these statements, you should specifically consider various factors, including, but not limited to, those set forth under "Item 1A. Risk Factors" and elsewhere in this report on Form 10-K.

The following "Overview" section is a brief summary of the significant issues addressed in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"). Investors should read the relevant sections of the MD&A for a complete discussion of the issues summarized below. The entire MD&A should be read in conjunction with Item 6. Selected Financial Data and Item
8. Financial Statements and Supplementary Data appearing elsewhere in this Form 10-K.

Overview

Patient Safety Technologies, Inc. is a Delaware corporation. The Company's operations are conducted through its wholly-owned operating subsidiary, SurgiCount Medical, Inc., a California corporation.

The Company's primary focus is development, manufacturing and distribution of products and services focused primarily in the health care and medical products field, particularly the patient safety markets. SurgiCount's Safety-Sponge System is designed to reduce the number of retained sponges and towels unintentionally left in patients during surgical procedures by allowing faster and more accurate counting of surgical sponges. The SurgiCount Safety-Sponge System is a patented turn-key line of modified surgical sponges, SurgiCounterTM scanners, and software file and database elements integrated to form a comprehensive counting and documentation system. Our business model consists of selling our unique surgical sponge products and selling or renting the scanners and software to hospitals. We use an exclusive supplier to manufacture our sponge products and we sell through a direct sales force for initial hospital conversions and through distributor organizations for the ongoing supply of sponge products to customers.

The Safety-Sponge System works much like a grocery store checkout process: Every surgical sponge and towel is affixed with a unique inseparable two-dimensional data matrix bar code and used with a SurgiCounterTM to scan and record the sponges during the initial and final counts during a surgical procedures. Because each sponge is identified with a unique code, a SurgiCounterTM will not allow the same sponge to be counted more than one time. When counts have been completed at the end of a procedure, the system stores a documented electronic record of all sponges used and removed and can output records to a hospital electronic records system. The Safety-Sponge System is the first FDA 510k approved computer assisted sponge counting system.

Our management considers several variables associated withtheongoing operations of our business, including market demand, product life cycle, manufacturing, inventory levels, head count and expenses related to research and development. We are currently focused on increasing our market penetration, the size and effectiveness of our sales force, marketing activities, research and development efforts, inventory management and our corporate infrastructure.

Results of Operations

Operating Segments

Patient Safety Technologies, Inc. currently conducts business solely through its wholly owned subsidiary, SurgiCount Medical, Inc. During the 2007 period ending August 13, 2007, the company operated a subsidiary called Automotive Services Group, Inc., which was previously reported as a separate operating segment pursuant to Statement of Financial Accounting Standards No. 131. Based on the sale of all assets of this subsidiary in 2007, we now report as one operating segment. The results of the former Automotive Services Group segment are reported as "discontinued operations" within the Consolidated Statements of Operations.

Revenue and Expense Components

The following is a description of the primary components of our revenues and expenses:

Revenues. We derive our revenue primarily from the sale of our SurgiCount sponges and the related hardware. Our revenues are generated by our direct sales force and independent distributors. Our products are typically ordered directly by the hospitals through our distributors who ship and bill directly. We expect that once an institution adopts our system, they will be committed to its use and therefore provide a recurring source of revenues for sales of the safety sponge.

· Surgical Sponge Revenues: Revenues related to the sale of sponges are recognized in accordance with SAB 104. Generally revenues from the sale of sponges are recognized upon shipment, as most sponge sales are sold FOB shipping point. In the event that terms of the sale are FOB customer, revenue is recognized at the time delivery to the customer has been completed.

· Hardware, Software and Maintenance Agreement Revenues: For the hardware and software elements, revenues are recognized on delivery, considered to be at the time of shipment where terms are FOB shipping point, and upon receipt by the customer when terms of the sale are FOB destination. As the software included in the scanner is not incidental to the product being sold, the sale of the software falls within the scope of SOP 97-2. The scanner is considered to be a software-related element, as defined in SOP 97-2, since the software is essential to the functionality of the scanner, and the maintenance agreement, which provides for product support including unspecified product upgrades and enhancements developed by the Company during the period covered by the agreement is considered to be post-contract customer support ("PCS") as defined in SOP 97-2. These items are considered to be separate deliverables within a multiple-element arrangement, and accordingly, the total price of this arrangement is allocated to each respective deliverable, and recognized as revenue as each element is delivered. Delivery with respect to the initial one-year maintenance agreement is considered to occur on a monthly basis over the term of the one year period, and revenues related to this element are recognized on a pro-rata basis during this period.

Cost of revenues. Cost of revenues consist of direct product costs billed from our contract manufacturers.

Research and development. Research and development expense consists of costs associated with the design, development, testing and enhancement of our products. Research and development costs also include salaries and related employee benefits, research-related overhead expenses and fees paid to external service providers.

Sales and marketing. Our sales and marketing expense consists primarily of salaries and related employee benefits, sales commissions and support cost, professional service fees, travel, education, trade show and marketing costs.

General and administrative. Our general and administrative expense consists primarily of salaries and related employee benefits, professional service fees, legal costs and expenses related to being a public entity.

Other income (expense). Total other income (expense) includes interest income, interest expense, change in fair value of warrant liability, realized gain
(loss) on assets held for sale and unrealized loss on assets held for sale.

Income tax (benefit) provision. The income tax (benefit) expense for 2008 and 2007 consisted primarily of incomes taxes and the tax effect of changes in deferred tax liabilities associated with goodwill.

Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007

Revenues. Revenues increased $1.7 million, or 155%, to $2.8 million for fiscal year ended December 31, 2008 from $1.1 million for the fiscal year ended December 31, 2007. Revenues for the twelve months ended December 31, 2008 consisted of sales from the Safety-Sponge of $2.4 million and sales from hardware and related supplies of $357 thousand, respectively. Revenues for the twelve months ended December 31, 2007 consisted of sales from the Safety-Sponge of $873 thousand and sales from hardware and related supplies of $216 thousand, respectively. Although hardware sales are not considered a recurring item, we expect that once an institution adopts our system, they will be committed to its use and therefore provide a recurring source of revenues from the sales of the safety sponge.

We attribute a significant amount of the increase in sales generated by our Safety-SpongeTM System to increased product awareness and demand. We have had several major institutions adopt the Safety-SpongeTM System and expect this trend to continue. The Safety-SpongeTM System is currently being evaluated by a large number of medical institutions, the adoption by any one of which would have a material impact on our revenues. We expect that each of the smaller sized medical institutions which adopt the Safety-SpongeTM System will produce approximately $100 thousand in annual revenue whereas each of the larger institutions could produce annual recurring revenues of $400 thousand or more.

Cost of revenue.Cost of revenues increased $1.1 million, or 152% to $1.8 million for the fiscal year ended December 31, 2008 compared to $716 thousand for fiscal year ended December 31, 2007. This reflects an increase in sales of our Safety-Sponge TM System and an inventory write down for obsolete inventory returned from a distributor of $87 thousand.

Research and development.Research and development costs were $271 thousand and $133 thousand, for the fiscal years ended December 31, 2008 and 2007, respectively. The increase is primarily due to an increase in software development costs associated with our system hardware.

Sales and marketing.We had sales and marketing expenses of $2.5 million and $1.8 million for the fiscal years ended December 31, 2008 and 2007, respectively. The increase is primarily due to the addition of sales and clinical representatives in the field and the associated salary, commission, benefits and travel expenses.

General and administration.General and administrative costs were $5.2 million and $3.7 million for the fiscal years ended December 31, 2008 and 2007, respectively. The decrease is due to a decrease in stock based compensation relating to stock option forfeitures that were recorded during the twelve months ended December 31, 2008. This decrease was partially off-set by an increase in legal fees, salaries and officers severance.

Total other income (expense), net.Other income and expenses increased to income of $2.2 million from an expense of $1.7 million for the fiscal years ended December 31, 2008 and 2007, respectively. This increase was mainly due to a decrease in the fair market value of our warrant derivative liability resulting in a gain of $2.6 million and a decrease in interest expense of $1.2 million, partially off-set by a realized loss of $91 thousand on assets held for sale.

Interest expense. We had interest expense of 333thousand and $1.5 million for the fiscal years ended December 31, 2008 and 2007, respectively. The decrease in interest expense for the fiscal year ended December 31, 2008 when compared to December 31, 2007 is primarily attributable to the non-cash interest charges incurred in fiscal year 2007 as a result of the debt discount amortization associated with our short-term debt financings. These charges resulted from the issuance of debt that either had conversion prices on the date of issuance that were below the fair market value of the underlying common stock or required the issuance of warrants to purchase shares of our common stock, which required us to record an expense based on the estimated fair value of the warrants. We recorded $167 thousand and $1.1 million in non-cash interest charges for the fiscal years ended December 31, 2008 and 2007, respectively.

Realized gains (losses) on investments, net. We recorded a realized loss on investments of $91 thousand and a realized gain of $22 thousand for the fiscal years ended December 31, 2008 and 2007, respectively. The realized loss for fiscal year 2008 was the result of a sale of approximately 0.61 acres of undeveloped land in Springfield, Tennessee. The realized losses in fiscal year 2007 were a result of the sale of certain non-operating assets for a gain of $22 thousand.

Unrealized loss on assets held for sale, net.We recorded unrealized losses on assets held for sale of zero and $25 thousand for fiscal years ended December 31, 2008 and 2007, respectively. During the year ended December 31, 2007, we recognized unrealized loss due to a write-down to fair value of approximately 8.5 acres of undeveloped land in Heber Springs, Arkansas. In March 2008, the Company completed the sale of this real property for net proceeds of $226 thousand.

Loss from discontinued operations. During the fiscal year ended December 31, 2007, we recorded a loss from our discontinued car wash segment of $166 thousand. Consistent with our decision to focus our business exclusively on the patient safety medical products field, we completed the divestiture of ASG in August 2007. We did not incur a loss from discontinued operations for the fiscal year ended December 31, 2008.

Income tax (benefit) provision.We recorded a tax benefit of $439thousand for fiscal year ended December 31, 2008 compared to a tax expense of $31 thousand for fiscal year ended December 31, 2007. As of December 31, 2008 we had net operating loss carryforward of approximately $29 million to offset future taxable income for federal income tax purposes. The utilization of the loss carryforwards to reduce any future income taxes will depend on our ability to generate sufficient taxable income prior to the expiration of the net operating loss carryforwards. The carryforward begin expiring in 2016.

Financial Condition, Liquidity and Capital Resources

Our principal sources of cash have included the issuance of equity and debt securities. Principal uses of cash have included cash used in operations, capital expenditures and working capital. We expect that our principal uses of cash in the future will be for operations, working capital, capital expenditures and research and development. We expect that, as our revenues grow, our sales and marketing and research and development expenses will continue to grow and, as a result, we will need to generate significant net revenues to achieve profitability. We do not believe that our current cash and cash equivalents, will be enough to fund our projected operating requirements. In order to ensure the continued viability of the Company, additional financing must be obtained and profitable operations must be achieved in order to repay the existing short-term and long-term debt and to provide a sufficient source of operating capital. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of equity or debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Any additional financing may not be available in amounts or on terms acceptable to us, or at all. If we are unable to obtain this additional financing, we may berequired to reduce the scope of our planned product development and marketing efforts.

Our cash and cash equivalents balance was $296 thousand as of December 31, 2008 compared to $405 thousand at December 31, 2007. Total current liabilities were $6.8 million and $3.1 million for the fiscal years ended December 31, 2008 and 2007, respectively. As of December 31, 2008 we had a working capital deficit of approximately $5.7 million. Since we continue to have recurring losses, we have relied upon private placements of equity and debt securities. Our existing cash and cash equivalents balance are not expected to meet our anticipated funding requirements during the next twelve months.

2008 Private Placements

During the period May 20, 2008 to August 29, 2008, we sold to accredited investors in our private placements, as reflected below, $5.1 million in equity securities.

Between May 20, 2008 and June 19, 2008, the Company entered into a securities purchase 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 investors an aggregate of 2.1 million shares of its common stock and warrants to purchase an additional 1.2 million shares of its common stock.

Between August 1, 2008 and August 29, 2008, the Company entered into securities purchase agreements with several accredited investors, in a private placement exempt from the registration requirements of the Securities Act. The Company issued and sold to these investors an aggregate of 2.0 million shares of its common stock and warrants to purchase an additional 1.3 million shares of its common stock.

2007 Private Placements

During 2007 we sold to accredited investors in our private placements, as reflected below, $5.3 million in equity securities.

Between January 29, 2007 and June 8, 2007, we entered into various subscription agreements with accredited investors in private placements exempt from the registration requirements of the Securities Act. We issued and sold to these accredited investors an aggregate of 3.0 million shares of our common stock and warrants to purchase an additional 1.4 million shares of our common stock.

On October 17, 2007, we entered into a securities purchase agreement with Francis Capital Management, LLC, an accredited investor, in a private placement exempt from the registration requirements of the Securities Act. We issued and sold to Francis Capital an aggregate of 1.3 million shares of our common stock and warrants to purchase an additional 763 thousand shares of our common stock. The warrants are exercisable for a period of five years at an exercise price equal to $1.40 per share. These issuances resulted in aggregate gross proceeds to us of $1.5 million in cash and the extinguishment of $90 thousand in existing debt.

Promissory Notes

In addition to our private placements, we have also received funding from Ault Glazer Capital Partners, LLC (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"). 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 December 31, 2008 the outstanding principal balance of the loan that we entered into with the Fund was $1.4 million.

At September 30, 2008 we had additional outstanding promissory notes in the aggregate principal amount of $1.2 million. Between February 28, 2008 and March 20, 2008, Catalysis Offshore, Ltd. and Catalysis Partners, LLC (collectively "Catalysis"), which are parties related to one another, loaned us an aggregate of $500 thousand. As consideration for the loans, we issued Catalysis promissory notes in the aggregate principal amount of $500 thousand (the "Catalysis Notes"). The Catalysis Notes accrue interest at the rate of 8% per annum and has maturity dates of October 31, 2008. The other outstanding promissory notes were entered into during 2006.

During the period from June 29, 2007 to August 13, 2007, Automotive Services Group sold all the assets held by ASG thereby completing the liquidation of Automotive Services Group. We received net proceeds, after expenses of the sales, of $3.2 million which resulted in a gain of $10 thousand. The majority of the proceeds from the sales were used to repay existing debt.

Operating activities

We used net cash of $4.6 million in operating activities for the year ended December 31, 2008. During this period net cash used in operating activities primarily consisted of a net loss of $4.4 million including a $2.6 million non-cash, unrealized gain on our warrant derivative liability caused by the decrease in the value of our common stock ,an increase of $200 thousand in inventory to support implementations scheduled for the first quarter, an increase of $314 thousand in accounts receivable, a decrease of $7 thousand in prepaids and other assets, offset by a $766 thousand increase in accounts payable and accrued liabilities, $1.7 million in stock based compensation and $461 thousand in non-cash costs including amortization, depreciation and deferred income taxes.

We used net cash of $3.8 million in operating activities for the year ended December 31, 2007. During this period net cash used in operating activities primarily consisted of a net loss of $7.0 million, a decrease in accounts payable of $587 thousand offset by a decrease in prepaid expenses of $474 thousand, and increase of accrued liabilities of $320thousand and non-cash costs including $1.1 million in stock based compensation, $1.1 million in amortization of debt discount and $557 thousand in non-cash costs including amortization and depreciation and deferred income taxes.

Investing activities

We used net cash of $33thousand in investing activities for the year ended December 31, 2008 primarily on $282 thousand for the purchase of property and equipment used to expand our operations offset by $315 thousand received on the sale of our real estate holdings.

We generated net cash of $3.0 million provided by investing activities during the year ended December 31, 2007 primarily from the sale of our assets from our automotive group and undeveloped land in Alabama for $3.2 million and the proceeds from selling one-third of our investment in Alacra Series F Preferred stock for $333 thousand. This was partially offset by capitalized costs of $561 thousand related to the purchase of property and equipment including the ongoing development of purchased software related to our Safety-SpongeSystem.

Financing activities

Cash provided by financing activities during the year ended December 31, 2008 of $4.4 million, resulted primarily from net proceeds from the issuance of common stock and warrants of $4.6 million and $650 thousand in notes payable, offset by repayments of notes payable of $722 thousand and preferred dividends of $77 thousand.

Cash provided by financing activities during the year ended December 31, 2007, of $1.2 million resulted primarily from net proceeds from the issuance of common stock and warrants of $4.5 million offset by the repayment of the notes payable in the amount of $3.4 million.

Investments

Our investment portfolio, which is valued at $667 thousand, is reflected below.
At December 31, 2008, our investment portfolio includes our investment in Alacra
Corporation, our only remaining investment security. At December 31, 2007, our
investment portfolio also consisted of certain real property located in Arkansas
and Tennessee.

 (in thousands)              December 31,      December 31,
                                 2008              2007
Alacra Corporation           $         667     $         667
Investments in Real Estate               -               406
                             $         667     $       1,073

Alacra Corporation

At December 31, 2008, we had an investment in Alacra Corporation ("Alacra"), valued at $667 thousand, which represents 8.4% and 8.2% of our total assets, at December 31, 2008 and 2007, respectively. On April 20, 2000, we purchased $1.0 million worth of Alacra Series F Convertible Preferred Stock. We have the right, subject to Alacra having the available cash, to have the preferred stock redeemed by Alacra over a period of three years for face value plus accrued dividends beginning on December 31, 2006. Pursuant to this right, in December 2006 we informed management of Alacra that we were exercising our right to put back one-third of our preferred stock. Alacra completed the initial redemption of one-third of our preferred stock in December 2007. We received proceeds of $333 thousand, which accounted for the entire amount of the decrease in value of our Alacra investment. In December 2007, we continue to exercise our right to put back our remaining preferred stock to Alacra. In December 2008 Alacra informed the Company that their Board of Directors had authorized the preferred stock redemption for the second one-third of our preferred stock and that they expected the redemption to occur in the second or third quarter of 2009.As there is no readily determinable fair value for the shares of Alacra's Series F Convertible Preferred Stock we account for the investment under the cost method.

Real Estate Investments

At December 31, 2007, we had two real estate investments, valued in the aggregate at $406 thousand. The real estate investments, consisting of approximately 8.5 acres of undeveloped land in Heber Springs, Arkansas and 0.61 acres of undeveloped land in Springfield, Tennessee. During 2008, we completed the sale of the undeveloped land net proceeds of approximately$315 thousand, which resulted in a realized loss of $91 thousand.

Off-Balance Sheet arrangements

As of December 31, 2008, other than our office lease and employment agreements with key executive officers, we had no commitments other than the liabilities reflected in our consolidated financial statements. We are not a party to off-balance sheet arrangements and are not a party to any transaction with persons or activities that derive benefits, except as disclosed herein, from their non-independent relationships with the Company.

Critical accounting policies and estimates

The below discussion and analysis of our financial condition and results of operations is based upon the accompanying financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management's most difficult, complex, or subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Our most critical accounting policy relates to the valuation of our investments in non-marketable equity securities, valuation of our intangible assets and stock based compensation.

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 . . .