Table of Contents

|                                  
|----------------------------------
|UNITED STATES                     
|SECURITIES AND EXCHANGE COMMISSION
|WASHINGTON, D.C.
 20549           
|                                  
|(MARK ONE)                        
|FORM10-K                          

| |                                                                               |                                                                                      
| | ----------------------------------------------------------------------------- | -------------------------------------------------------------------------------------
| | þ                                                                             | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 EXCHANGE ACT OF 1934
| |                                                                               |                                                                                      
| | FOR THE FISCAL YEAR ENDEDDECEMBER 31,
 2009                                  
| |                                                                               |                                                                                      
| | OR                                                                           
| |                                                                              
| | o                                                                             | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
 EXCHANGE ACT OF 1934  
| |                                                                              
| | FOR THE TRANSITION PERIOD FROM__________________ TO__________________________
| | COMMISSION FILE NUMBER: 0-29192                                              
| |                                                                              
| | PURADYN FILTER TECHNOLOGIES INCORPORATED                                     
| | (Name of
 registrant as specified in its charter)                            

|                                                                |                                      
|--------------------------------------------------------------- | -------------------------------------
|DELAWARE                                                        | 14-1708544                           
|(State or
 other jurisdiction of incorporation or organization) | (I.R.S.
 Employer Identification No.)

|                                              |           
|--------------------------------------------- | ----------
|2017 HIGH
 RIDGE ROAD, BOYNTON BEACH, FLORIDA | 33426     
|(Address of principal executive offices)      | (Zip Code)

|                                                   |              
|-------------------------------------------------- | -------------
|REGISTRANTS TELEPHONE NUMBER,INCLUDING AREA CODE: | 561 547
 9499

|                                                      | 
|----------------------------------------------------- | 
|SECURITIES REGISTERED UNDER SECTION 12(b) OF THE ACT: | 

|                     |                                           
|-------------------- | ------------------------------------------
|TITLE
 OF EACH CLASS | NAME
 OF EACH EXCHANGE ON WHICH REGISTERED
|NONE                 | NONE                                      

|                                                    
|----------------------------------------------------
|SECURITIES
 REGISTERED UNDER SECTION12(g) OF THEACT:

|                                       
|---------------------------------------
|COMMON STOCK, PAR VALUE $.001 PER SHARE
|(Title
 of class)                      

|                                                                                                                                                                                                                                                                                                                                                                                                  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Indicate by
 check mark if the registrant is a well-known seasoned issuer, as defined in
 Rule 405 of the Securities Act.                                                                                                                                                                                                                                                                         
|o Yes þ No                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                  
|Indicate by
 check mark if the registrant is not required to file reports pursuant to
 Section 13 or Section 15(d) of the Act.                                                                                                                                                                                                                                                                    
|o Yes þ No                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                  
|Indicate by
 check mark whether the registrant (1) has filed all reports required to be
 filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
 the preceding 12 months (or for such shorter period that the registrant was
 required to file such reports), and (2) has been subject to such filing
 requirements for the past 90 days. Yes þ No o                          
|                                                                                                                                                                                                                                                                                                                                                                                                  
|Indicate by check mark
whether the registrant has submitted electronically and posted on its Corporate
Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). Yes o No o
|                                                                                                                                                                                                                                                                                                                                                                                                  
|Indicate by
 check mark if disclosure of delinquent filers pursuant to Item 405 of
 Regulation S-K is not contained herein, and will not be contained, to the
 best of the registrants knowledge, in definitive proxy or information
 statements incorporated by reference in Part III of this Form 10-K or any
 amendment to this Form 10-K.                                                    
|o                                                                                                                                                                                                                                                                                                                                                                                                 

---



Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company:

|                                                                     |   |                            |  
|-------------------------------------------------------------------- | - | -------------------------- | -
|Large
 accelerated filer                                             | o | Accelerated
 filer         | o
|Non-accelerated
 filer (Do not check if 
 smaller reporting company) | o | Smaller
 reporting company | þ

|                                                                                                                 
|-----------------------------------------------------------------------------------------------------------------
|Indicate by
 check mark whether the registrant is a shell company (as defined in Rule
 12b-2 of the Exchange Act)
|Yes o No þ                                                                                                       

State the aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price
at which the common equity was sold, or the average bid and asked prices of such common equity, as of the last business day
of the registrants most recently completed second fiscal quarter. $5,759,661 on June 30, 2009.

Indicate the number of shares outstanding of each of the registrants
classes of common stock, as of the latest practicable date.
43,947,126 shares of common stock are issued and outstanding as of April 14, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

List hereunder the following documents if incorporated by reference and the Part of the Form 10-K
(e.g., Part I, Part II, etc.) into which the document is incorporated: (1) Any annual report to security holders; (2)
Any proxy or information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933.
The listed documents should be clearly described for indentification purposes (e.g., annual report to security holders for fiscal
year ended December 24, 1980).

None.

2

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TABLE OF CONTENTS

|            |                                                                                                                |          |    | 
|----------- | -------------------------------------------------------------------------------------------------------------- | -------- | -- | 
|            |                                                                                                                | Page No.
|Part I      |                                                                                                                |          |    | 
|Item
 1.    | Business.                                                                                                      |          | 4  | 
|Item
 1A.   | Risk Factors                                                                                                   |          | 12 | 
|Item
 1B.   | Unresolved Staff Comments.                                                                                     |          | 14 | 
|Item
 2.    | Properties.                                                                                                    |          | 14 | 
|Item
 3.    | Legal Proceedings.                                                                                             |          | 14 | 
|Item
 4.    | (Removed and Reserved).                                                                                        |          | 15 | 
|Part II     |                                                                                                                |          |    | 
|Item
 5.    | Market for Registrants Common Equity, Related Stockholder
 Matters and Issuer Purchases of Equity Securities. |          | 15 | 
|Item
 6.    | Selected Financial Data                                                                                        |          | 16 | 
|Item
 7.    | Managements Discussion and Analysis of Financial
 Condition and Results of Operation.                         |          | 16 | 
|Item 7A.    | Quantitative and
 Qualitative Disclosures About Market Risk.                                                   |          | 23 | 
|Item 8.     | Financial
 Statements and Supplementary Data.                                                                  |          | 24 | 
|Item 9.     | Changes In and
 Disagreements With Accountants on Accounting and Financial Disclosure.                         |          | 24 | 
|Item 9A.(T) | Controls and
 Procedures.                                                                                      |          | 24 | 
|Item 9B.    | Other
 Information.                                                                                            |          | 25 | 
|Part
 III   |                                                                                                                |          |    | 
|Item 10.    | Directors,
 Executive Officers and Corporate Governance.                                                       |          | 25 | 
|Item 11.    | Executive
 Compensation.                                                                                       |          | 28 | 
|Item 12.    | Security
 Ownership of Certain Beneficial Owners and Management and Related Stockholder
 Matters.              |          | 33 | 
|Item 13.    | Certain
 Relationships and Related Transactions, and Director Independence.                                    |          | 36 | 
|Item 14.    | Principal
 Accountant Fees and Services.                                                                       |          | 36 | 
|Part
 IV    |                                                                                                                |          |    | 
|Item 15.    | Exhibits,
 Financial Statement Schedules.                                                                      |          | 37 | 

3

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CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING INFORMATION

Certain
statements in this annual report contain or may contain forward-looking
statements that are subject to known and unknown risks, uncertainties and other
factors which may cause actual results, performance or achievements to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. These forward-looking
statements were based on various factors and were derived utilizing numerous
assumptions and other factors that could cause our actual results to differ
materially from those in the forward-looking statements. These factors include,
but are not limited to

| |   |                                                                                                   
| | - | --------------------------------------------------------------------------------------------------
| |  | our history of losses and
 uncertainty that we will be able to continue as a going concern,       
| |  | our ability to generate net
 sales in an amount to pay our operating expenses,                    
| |  | our need for additional
 financing and uncertainties related to our ability to obtain these funds,
| |  | our ability to repay the outstanding
 debt of approximately $5.7 million to one of our Directors, 
| |  | our reliance on sales to a
 limited number of customers,                                          
| |  | our dependence on a limited
 number of distributors,                                              
| |  | our ability to compete,                                                                           
| |  | our ability to protect our
 intellectual property,                                                
| |  | market overhang issues, and                                                                       
| |  | the application of Penny
 Stock Rules to the trading in our stock.                                

Most
of these factors are difficult to predict accurately and are generally beyond
our control. You
should consider the areas of risk described in connection with any
forward-looking statements that may be made herein. Readers are cautioned not
to place undue reliance on these forward-looking statements and readers should
carefully review this annual report in its entirety, including the risks
described in Part I. Item 1A. Risk Factors. Except for our ongoing
obligations to disclose material information under the Federal securities laws,
we undertake no obligation to release publicly any revisions to any
forward-looking statements, to report events or to report the occurrence of
unanticipated events. These forward-looking statements speak only as of the
date of this annual report, and you should not rely on these statements without
also considering the risks and uncertainties associated with these statements
and our business.

OTHER PERTINENT INFORMATION

Our
website is www.puradyn.com. The information which appears on our website
is not part of this report.

When
used in this annual report, the terms Puradyn, the Company, we, our,
and us refers to Puradyn Filter Technologies Incorporated, a Delaware
corporation, and our subsidiary.

PART I

|        |          
|------- | ---------
|ITEM 1. | BUSINESS.

The Company

Puradyn
Filter Technologies Incorporated designs, manufactures, markets and distributes
worldwide the puraDYN®bypass oil filtration system (the Puradyn)
for use with substantially all internal combustion engines and hydraulic
equipment that use lubricating oil. Working in conjunction with an engines
full-flow oil filter, the Puradynsystem
cleans oil by continually removing solid, liquid and gaseous contaminants from
the oil through a sophisticated and unique filtration and evaporation process.
For engine lubricating oil, our filters incorporate an additive package.
Because Puradyn filtered
lubricating oil is kept in a continually clean state, our system has been used effectively to extend
oil-drain intervals and to extend the time between engine overhauls. We are the
exclusive manufacturer of the disposable replacement filter elements (Element)
for the Puradyn.

4

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Products

The
core product, the patented Puradynbypass
oil filtration system, is offered in two families of models, TF and PFT, and
can be attached to almost any engine and hydraulic system. The concept of
bypass filtration is similar to a dialysis machine that filters blood to rid it
of impurities, keeping the oil continually clean. Whenever the engine or
machinery is operating, the Puradynis
extracting from the oil solid particles down to less than one micron (1/39
millionth of an inch), as well as gaseous and liquid contaminants, while
protecting the engine or hydraulic equipment from harmful wear caused by
contaminants in the oil. Additive packages in which chemicals are added to the
filtering media replenish spent additives in the oil, helping to maintain the
oils proper chemical balance and viscosity.

The
condition of the oil is monitored through use of a simple oil analysis sample taken
in lieu of performing a regularly scheduled oil change. If the sample results,
typically received in five to seven days, show that the condition of the oil
is considered good for continued use, only thePuradynreplacement element is to be changed  there is no need to
change the oil if it is clean.

Consequently,
the Puradynsignificantly reduces
maintenance costs by decreasing oil consumption, engine wear and certain other
types of general maintenance as well as reducing environmental concerns and
costs associated with the storage and disposal of waste oil. These potential
savings are achieved from utilizing the Puradyn,
which generally has a relatively short payback period of, on average, six to 14
months, depending upon the application.

The
Puradynsystem is currently
manufactured in six different sizes suitable for placement on engines or
equipment with oil sump capacities ranging from a minimum of eight to a maximum
of 300 quarts. The later generation PFT model offers the same benefits and
features of the original TF model, with the added enhancements of easier
serviceability and the main component of the system being more
corrosion-resistant.

All
Puradynsystems are compatible
with virtually all standard and synthetic oils on the market and they work with
engines using gasoline, diesel, propane or natural gas. The Puradynsystem cannot be used on engines
that do not have a pressurized lubricating system, and none of the products can
be used on any engines that mix oil with fuel.

We
also manufacture and distribute Elements for the Puradynsystem. Depending upon the application, we generally
recommend that the Element be replaced at the engine manufacturers
recommended/approved periodic oil change interval or as oil analysis dictates.
The type of Element used also depends upon the specific type of engine or
hydraulic application. A customer can change the Element and take the required
oil sample in approximately five to 10 minutes.

By
continually removing contaminants and replacing vital additives through a
patented time-release additive package to keep oil constantly clean, the PuradynElement substantially extends
intervals between oil changes. Elements are interchangeable between
similar-sized models.

The
Company has implemented patented and/or proprietary technology in the filter
Elements that provides several advantages including:

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | An additive
 package in which pellet-encased chemicals are incorporated in the replaceable
 filter element to replenish additives in the oil. This additive package helps
 to maintain the oils chemical balance and viscosity. In 2006, the Company
 re-engineered the additive package to be compatible with new oils designed to
 meet EPA 2007 and in 2010 on-highway exhaust emission standards, and
 be simultaneously backwards-compatible with all older API diesel lubrication
 oil service categories.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | In late
 2009, the Extreme Duty (XD) Element, specifically formulated to meet the
 needs of diesel engine lubricating oils operating in the harsh environments,
 is targeted to receive enhancements to its additive package. The new XD
 filter element, with an increased additive package level, also addresses the
 next level of emissions reduction beginning in 2010.                                                                                                                                     
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | CGP®
 Extended Life Filter Element containing a patent-pending process for chemical
 grafting. This technology improves the attraction and retention of soot and
 other solid contaminants to the packed cotton filter material. CGP technology
 was developed over a three-year period inclusive of laboratory and
 field-testing. Consolidated results from                                                                                                                                                    

5

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|  |                                                                                                                               
|- | ------------------------------------------------------------------------------------------------------------------------------
|  | across the
 country show that test vehicles averaged more than 1,000,000 miles without
 the need for a traditional oil change.
|  |                                                                                                                               
| | Ease of
 maintenance: The filter Element can be replaced in a matter of seconds.                                              

When
the Element is changed, an insignificant amount of make-up oil is added to
replace any oil retained in the used Element or consumed during the normal
engine combustion process. The Companys performance warranties require the
user to change the Puradynfilter
element and take a small sample of the oil for submission to an oil-testing
laboratory at the same intervals that the original equipment manufacturer
(OEM) recommends for an oil change, or as oil analysis dictates. The oil
analysis allows end users to monitor oil quality and, to some degree, engine
condition and provides a trend and timeline for both the Company and end user
should a problem arise.

The
Puradynhas no moving parts and
consequently requires no significant ongoing maintenance. As long as Elements
are changed at the recommended intervals and other standard preventive
maintenance procedures such as changing factory full flow and air filters and
oil analysis are completed, the Company believes the Puradynwill perform as designed.

We
are also distributor for the MotorCheck On-Site Oil Analysis. The analyzer
combines optical emission and infrared oil analysis with optional viscometer
within a desktop-sized enclosure for fast, accurate fluid analysis.

Warranties

The
Puradyncarries a six-month
money-back performance guarantee, and is currently warranted to the original
user to be free of defects in material and workmanship for five years with
unlimited miles/hours, with a one-year limited warranty on the heating element.

For
the Companys performance guarantee and warranties to remain in effect, users
must, among other things, maintain a record of the laboratory oil analysis
results. To date, there have been no significant warranty claims, although
there can be no assurances that such a trend will continue.

The
Company has received letters from numerous OEMs which have all stated that the
installation and use of the Puradyndoes
not void their manufacturer warranties unless an engine failure is attributed
to the Puradyn. Oil analysis is a
standard industry practice endorsed by OEMs and various fleet maintenance
organizations and most engine manufacturers will accept oil analyses as
alternatives to their recommended oil change intervals.

Marketing

The
Company has established an in-house marketing department.

The
Companys products are marketed to numerous industries including marine,
trucking, agricultural, bus, generator, construction, mining, industrial and a
multitude of hydraulic applications, and other users of engines or equipment
that utilize up to 50 weight oil for lubrication. Currently, the Companys
primary focus is on the industrial/construction, generator set, marine, and OEM
segments.

Instead
of traditional media advertising campaigns, the Company is concentrating
instead on direct sales contacts, trade shows, white papers and other methods
of demonstration, such as Internet-based marketing, to promote its products,
generate awareness and stimulate sales.

We
rely on managements ability to determine the existence and extent of available
markets for our product. Company management have considerable sales and
marketing backgrounds and devote a significant portion of their time to
sales-related activities.

One
of our marketing strategies is based on creating customer pull-through, a
sustained level of request for our product on the OEM level from end-users. To
date, customer pull-through has resulted in a limited number of our systems
being factory-installed at individual Kenworth and Freightliner truck
facilities as well as at the John Deere Forestry Division facility in Joensuu,
Finland.

6

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Taking
a long-term approach, management believes that federal government entities and
the U.S. military are markets that can be successfully cultivated, based on the
following:

|  |                                                                                                                                                                                                                                                                                       
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2009 renewal
 of the Companys General Services Administration (GSA) contract,
 GS-30F-0007R.                                                                                                                                                                                         
| | 2008
 contract received from the U.S. Army to supply 70 Puradyn systems to outfit
 the JERRV, part of MRAP (Mine Resistant Ambush Protected) vehicle family.                                                                                                                          
| | 2008
 continuing orders placed by the U.S. Military for installation on new trucks
 supplied by Freightliner LLC for foreign military sales.                                                                                                                                          
| | 2007 National
 Stocking Number (NSN) assigned to a specific Puradyn system kit to be
 installed on the U.S. Armys Mine Protection Vehicle family.                                                                                                                                    
| | 2006 final
 test results from the US Department of Energy, which shows that the systems
 used in evaluation of the benefits and cost analysis of bypass oil
 filtration, have produced an estimated savings of 89% in oil usage and
 purchases when used on heavy-duty diesel engines.

Distribution

Distributors
maintain minimum product inventory levels, maintain a storefront and service
bay(s), and retain access to qualified technicians trained by our technical
personnel in product installation and service. All distributors must pay in a
timely fashion, and with respect to international distributors, the agreements
typically establish the minimum dollar amount of inventory to be purchased as
well as shipping terms.

We
currently have approximately 68 domestic and 38 international active
distributors. However there are additional potential distributors that participate
in other programs; such as Freightliner, Paccar and John Deere. While not all
of these potential distributors actively promote our products, all of these
dealers have access to our product and have the capability to sell our product.

In
February 2008 we entered into a Master Distributorship Agreement
(International) with Filter Solutions Ltd. pursuant to which we appointed that
company as our exclusive master distributor in the U.K., mainland Europe and
Ireland, as well as additional future territories which we may agree upon for
sales made to end users with fleets of vehicles, users of hydraulic
applications for manufacturing processes and distributors who market to
end-users with either fleets of vehicles or users of hydraulic applications for
manufacturing processes. The distributor agreed to minimum purchases of
$900,000 during the first nine months of the term, with successive minimum
purchases increasing 15% annually over the previous 12 month annual rate. The
agreement was for an initial term of five years with an automatic one year
renewal on each anniversary, negotiated for minimum quantities. The agreement
could be terminated by either party upon 30 days written notice, or by us
without notice upon the occurrence of certain events. In February 2009 FSL
terminated the Master Distributorship Agreement due to their financial and
economic concerns. Due to the changes in the economy and the Companys ability
to service customers from the U.S., we expect any additional future financial
impact to be minimal. This was a moderate component contributing to the
Companys decrease in international sales for the year ended 2009, accounting
for approximately 18% of the 70% decline.

The
Company has warehouse distributors located throughout North America and we
previously utilized inventory storage space in the U.K. provided by Filter
Solutions Ltd., a master distributor. Following the termination of this
arrangement in February 2009 they informed the Company that they wanted to
focus their sales efforts only within the United Kingdom, as a standard
Distributor. Until the Company identifies a replacement, sales in Europe will
be administered by Puradyn in the United States. Initially, there could be a
shipping delay for European distributors requiring product, however, we expect
this to be resolved by earlier order placement in anticipation of longer
shipping time. Shipping costs may not be dramatically higher than when the
product was dispensed from our U.K. warehouse, as shipping costs from the U.S.
was typically already included in the prices charged to the distributors. We
believe this was a marginal factor contributing to the decline in international
sales during 2009.

Although
this distributor will continue to maintain minimum inventory levels, as do all
distributors, the bulk of the inventory held in their warehouse is being
returned to the U.S., since customer service and shipments will be administered

7

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from the U.S.
The remaining distributors are located primarily in South America, Europe and
Asia. These distributors purchase product directly from the Company and sell to
their existing or new customers. The Company will accept returns of products
that are defective at the time of sale to the distributor or prove to be
defective during the warranty period. Returns are subject to specific
conditions.

As
a significant portion of our products are sold to distributors and end users
for use on transportation vehicles, this could unfavorably affect our overall
exposure to credit risk as these customers could be affected by potential
economic or other conditions.

There
can be no assurance that such distributors will be successful in introducing
the Puradyn in their territories
as they will face obstacles similar to those the Company and its other
distributors have encountered in introducing an innovative technology in their
territories.

Sales

Direct
Sales

The
Company directly and/or with the assistance of its manufacturers
representatives, distributors or other agents, markets its products directly to
OEMs, other distributors and national accounts. Typically larger customers, and
some smaller customers, require an evaluation period to operate the system on
their equipment. While set for a specific period of time, usually ranging from
three to 12 months, evaluations are often influenced by a number of variables
including equipment downtime or servicing which may extend the evaluation
period. Consequently, the sales period can be relatively long. We believe this
evaluation period will continue to be shortened as the Companys products gain
wider acceptance and support from well-known end users and OEMs.

Currently,
our products are being evaluated (in various stages of progress) by numerous
potential end users and existing customers including, among others:

| |   |                                   
| | - | ----------------------------------
| |  | A major
 engine OEM               
| |  | A major
 transmission OEM         
| |  | A road
 materials handling Company
| |  | Two leading
 food companies       
| |  | The U.S.
 Military                
| |  | Two major
 long-haul carriers     

In
December 2009 we were awarded a renewal of a five-year contract on the
Vehicular Multiple Award Schedule, New Technologies with a six-month option
predicated upon sales. This enables us to offer our Puradynsystem to all federal, state and local government agencies.
The new schedule allows easy access to our products without the usual lengthy
bid process to all federal agencies that purchase vehicles, including
construction equipment, medium and heavy trucks, waste disposal vehicles,
aerial lift vehicles and fire trucks. The contract period is for five years
from the date of the award.

We
are dependent upon sales to a limited number of customers. During 2009 and 2008
two customers together accounted for approximately 33% and 34%, respectively,
of the Companys consolidated net sales. These two customers individually
accounted for greater than 10% each of net sales, or approximately $904,000 and approximately $622,000, respectively in 2008 and 2009.

In
2008, sales to one of our largest international distributors, located in
Southeast Asia, represented 18% of our consolidated net sales. In 2002, after
extensive testing, one of the worlds largest manufacturers of medium-size
power generators purchased over $350,000 of product during that year. This
customer accounted for 16% of our 2008 consolidated net sales and less than 1%
of our 2009 consolidated net sales.

At
December 31, 2009 there were four customers, whose trade receivable balances
equaled or exceeded 5% of total receivables, representing approximately 22%,
19%, 13%, and 12% of total accounts receivable. The loss of business from one
or a combination of the Companys significant customers could adversely affect
its operations.

The
Companys sales are made on credit terms, which vary depending on the nature of
the sale. The Company

8

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Table of Contents

believes it
has established sufficient reserves to accurately reflect the amount or
likelihood of product returns or credits and uncollectible receivables. However,
there can be no assurance that actual returns and uncollectible receivables
will not exceed the Companys recorded reserves.

International
Sales

The
Company, directly and/or with the assistance of commission-based manufacturers
representatives, has established primarily non-exclusive distributors and sales
representation in various countries, including Denmark, Germany, South Africa,
Nigeria, United Kingdom, Thailand, Colombia, and others. The ultimate success
of these and other distributors depends upon, among other things, their
abilities to successfully introduce and sell the product in their territories
including obtaining local evaluations, establishing distribution and other
factors similar to those faced by the Company in the United States. Total
international sales amounted to approximately 24% and 55% of consolidated net
sales in 2009 and 2008, respectively.

Manufacturing and Production

The
Company purchases component parts for its Puradynsystems and manufactures its entire line of filter Elements. The
component parts are assembled, packed and shipped from our facility in Boynton
Beach, Florida.

We
currently source (i.e., purchase each raw material and component part from a
specific vendor) substantially all of our raw materials and component parts
from various vendors in the United States. Substantially all the tools and dies
used by certain of our vendors are owned by the Company. We have researched
alternative sources of supply and do not anticipate that the loss of any single
supplier would have a material long-term adverse effect on our business,
operations or financial condition.

Since
January 2004, we have maintained ISO 9001:2000 certification from the
International Organization for Standardization. ISO 9001:2000 is a series of
internationally accepted, multi-part quality management systems for
industry-wide standardization applied to manufacturing and service
organizations. Management believes this certification will reinforce
recognition of its tangible commitment to quality control from OEMs and other
potential large customers. In December 2009, the Company again completed its
recertification audit to retain 9001:2000 certification.

Competition

Our
primary competitors are Premo Lubrication Technologies, Inc., OilGuard, Amsoil
Inc., and Oil Purification Systems, Inc. Competitive bypass oil filters
produced by other companies in varying degrees address the issues of solid or
liquid contaminant filtration through centrifugal design, media filtration or
evaporation. However, Puradyn believes that it designs and manufactures the
only bypass oil filtration system that incorporates all of the following
features which we believe provides us with a competitive advantage:

| |   |                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Filtering
 solid contaminants to below one micron, including enhanced soot retention
 through the use of a patent-pending process for chemical grafting;
| |  | Effectively
 removing harmful gaseous and liquid contaminants through a heated evaporation
 chamber;                                                    
| |  | Replenishing
 the base additives; and                                                                                                                   
| |  | Maintain
 proper oil viscosity                                                                                                                          

In
addition, the Puradyn system was
the only bypass oil filtration system designated by the California EPA as a
Pollution Prevention technology during the tenure of its program, which has
since been discontinued. The certificate states in part, The Puradyn®
system has been shown to be an effective means of extending engine oil change
intervals without adversely affecting engine wear or performance.

Tests
performed by a leading independent testing facility demonstrated that the Puradynsystem surpassed the capacity,
efficiency and overall performance of its leading competitors. Using our
standard filter with additives, the Puradyn
system tested 92.05% efficient under the SAE HS806-95 (modified) standards for
filter capacity and contaminant removal. Efficiency reflects the ability to
remove particles and other chemicals from the oil. While efficiency is not
necessarily a standard of comparison to other products, it does demonstrate the
filtering capability of thePuradynunit.

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The proper
use of our products reduces the need for maintenance services, replacement
parts, original oil sales and waste oil disposal.

Intellectual Property

The
Company owns patents for the Puradyn
system; filter Elements, oil flow meter, and two patents for technology, which
include a manifold type full-flow filter/bypass filtration unit (side-by-side)
in the U.S. and certain other countries. The expiration dates of these patents
range from May 2014 to October 2016. The following table provides information
on our current U.S. patents.

|           |  |                                                                          |  |                   | 
|---------- |  | ------------------------------------------------------------------------ |  | ----------------- | 
|Patent No. |  | Description                                                              |  | Date Issued       | 
|5,630,912  |  | oil reclamation device with evaporator base and head mounted
filter      |  | May 20, 1997      | 
|5,591,330  |  | oil filter containing a soluble thermoplastic additive material
 therein |  | July 7, 1997      | 
|5,639,965  |  | oil reclamation system flow meter                                        |  | July 17, 1997     | 
|5,718,258  |  | releasing additives into engine oil                                      |  | February 17, 1998 | 
|6,139,715  |  | oil reclamation device with vaporization chamber                         |  | October 31, 2000  | 

We
believe that the patented technology is especially important on engines built
since the enactment of the Clean Air Act of 1992, which requires tighter
specifications for diesel engines. We have also applied for and received patents
on these technologies in a number of foreign counties.

During
2009 and 2008, we applied for the following patents:

|  |                                                                                                                                                                                                                                                                                          
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A new patent
 for micro-fine filtration. This patent incorporates technology that includes
 a means to remove liquid and gaseous contaminants within a closed system
 where the Companys legacy evaporation chamber may be counter-indicated due
 to physical or regulatory limitations.
| | A new patent
 for a technologically advanced engine-mounted full-flow filter/micro-fine
 bypass filter system with smart sensor capability not available from any
 other competitive device.                                                                                             

There
can be no assurance that such patents will withstand competitive threats to
their patentability or, in the case of the redesigned Puradyn, be developed into commercially
viable products.

We
have registered the product trademark Puradyn
in the United States and other countries where the Purifiner trademark was registered, and have registered the
product trademarks CGP and Keep It Clean!in the United States.

We
have also obtained the rights to the domain name www.puradyn.com as well as the
domain names puradyn.asia, puradyn.org, puradyn.us, puradyn.info and
puradyn.biz. As with telephone numbers, we do not have and cannot acquire any
property rights in an Internet address. We do not expect to lose the ability to
use these Internet addresses; however, there can be no assurance in this
regard.

Governmental Influence

Our
products typically do not require any governmental approvals. As part of the
certification process under the California Environmental Protection Agencys
Department of Toxic Substances in July 1994 and subsequent re-certifications in
July 1998 and August 2003, the Company obtained an Executive Order issued by
the State of California Air Resources Board stating that the Puradyn does not reduce the effectiveness
of applicable vehicle pollution control systems, and may be installed on all
2002 and older model vehicles with pressure oil systems. While this
certification is no longer in use by the California EPA, the Puradyn
remains the only technology of its kind to be designated as a Pollution
Prevention technology.

2007
emissions standards represented landmark regulations affecting engines using
catalytic converters and

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particulate traps in
addition to that using exhaust gas recirculation (EGR). Due to these
after-treatment devices and their sensitivity to ash content, the oil industry
developed entirely new additive formulations removing any additives that
produced ash as a byproduct. In order to be compatible with the new oil
formulation, we developed an entirely new additive package for 2007. In
addition, this new additive package is backwards-compatible in that it is also
compatible with the pre-2007 oils. Both lab and field tests of the newer
additive package have demonstrated excellent results and a next-generation
additive package has been formulated to meet more stringent 2010 regulations.

As
more engine manufacturers move to newer methods, including EGR, the oil is
being subjected to more extreme conditions increasing the need for finer
filtration of contaminants such as soot; reduction of water and gaseous
contaminants, and constant replenishment of oil additives to combat oxidation
and acid.

We
believe that engine and truck manufacturers can capitalize on our enhanced
technology to remove soot from their oil to maintain their extended drain
intervals by operating on constantly clean oil.

The
conservation of energy, oil, and natural resources has become an important part
of the 2010 national energy and environment agenda. We believe the new
administrations agenda, which in part, makes the commitment to conserve more
oil over the next ten years than the U.S. currently imports from Middle East
and Venezuela combined, could result in a mandate of federal fleets to use
bypass filtration technology as a means to immediately conserve resources while
alternative means of energy and environmental conservation are researched.

Employees

At
April 14, 2010, the Company had 21 full-time employees, including our executive
officers.

None
of the employees are covered by collective bargaining agreements, and we
believe our relationships with our employees to be good.

History of our Company

The
patents issued on the oil filtration system that, after further development,
has evolved into the current Puradyn bypass oil filtration system, were
issued in the early 1980s. The owners of these patents attempted to market and
sell the original system under various other trade names, but were not
successful. In 1987, T/F Systems, Inc., a Delaware corporation, of which
Messrs. Richard C. Ford and Willard H. Taylor (deceased) were equal
stockholders, obtained certain limited distribution rights to the Puradyn
bypass oil filtration system, previously known as the Purifiner in several
states from Refineco Manufacturing Company, Inc. Mr. Ford served as an
executive officer and director of our company from inception to October 2006.
In 1988, T/F Systems, Inc. obtained an option to acquire the exclusive
manufacturing and marketing rights to the Purifiner in the event Refineco
Manufacturing Company, Inc., and subsequently, Purifiner Distribution
Corporation of Chicago, Illinois, were unable to meet their commitments to
supply Purifiners to T/F Systems, Inc. As a result of a default, and a failure
of the manufacturer to meet this supply commitment, T/F Systems, Inc. obtained
the worldwide manufacturing and marketing rights to the Purifiner in 1990.

In
February 1988, we were incorporated in Delaware under the name Econology
Systems, Inc. On October 16, 1990, the name was changed to T/F Purifiner,
Inc. We were inactive until 1991, when we obtained the distribution and
marketing rights to the Purifiner by virtue of an assignment from T/F Systems,
Inc. However, T/F System, Inc.s ownership of the rights to the Purifiner were
contested in court by other third parties who were also manufacturing and
marketing a device similar to the Purifiner and using the Purifiner trademark.
Eventually, the court ruled in favor of T/F Systems, Inc. with respect to its
manufacturing and marketing rights, and in May 1993 all appeals by the other
parties were exhausted. During the period of this litigation, we continued to
market the Purifiner, but success was limited due to various factors including
the pending litigation and the actions by these other parties in the
marketplace.

Prior
to December 31, 1995, we were the exclusive distributor and T/F Systems, Inc.
was the exclusive manufacturer of the Purifiner. On December 31, 1995, in
exchange for any claims we had in the delay damage award, we purchased all
operating assets and assumed all operating liabilities of T/F Systems, Inc.
except for any benefits and/or liabilities related to a delay damage judgment
awarded in December 1994 against the other parties discussed above, and
liabilities related to certain stockholder advances made to T/F Systems, Inc.
by Messrs. Ford and Taylor.

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On
February 4, 1998, the company filed a Certificate of Amendment to its
Certificate of Incorporation, which changed its name from T/F Purifiner, Inc.
to Puradyn Filter Technologies Incorporated.

|         |               
|-------- | --------------
|ITEM 1A. | RISK
 FACTORS.

An investment in our common
stock involves a significant degree of risk. You should not invest in our
common stock unless you can afford to lose your entire investment. You should
consider carefully the following risk factors and other information in this
annual report before deciding to invest in our common stock. If any of
the following risks and uncertainties develop into actual events, our business,
financial condition or results of operations could be materially adversely
affected and you could lose your entire investment in our company.

WE HAVE A HISTORY OF LOSSES AND OUR INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM HAS SUBSTANTIAL DOUBTS ABOUT OUR ABILITY TO
CONTINUE AS A GOING CONCERN.

We have
incurred substantial operating and net losses, as well as negative operating
cash flows, since our inception through December 31, 2009. For the years ended
December 31, 2009 and 2008, we reported net losses of $2,070,598 and
$2,644,547. At December 31, 2009, we had an accumulated deficit of
approximately $50.5 million. These recurring operating losses, liabilities
exceeding assets and the reliance on cash inflows from an institutional
investor and current stockholder have led our independent registered public
accounting firm to include a statement in its audit report relating to our
audited consolidated financial statements for the years ended December 31, 2009
and 2008 expressing substantial doubt about our ability to continue as a going
concern. Our ability to continue as a going concern is dependent upon our
ability to obtain the necessary financing to meet our obligations and repay our
liabilities when they become due and to generate profitable operations in the
future. We have no firm commitments from any third party to provide this
financing and we cannot assure you we will be successful in raising working
capital as needed. There are no assurances that we will have sufficient funds
to execute our business plan, pay our obligations as they become due or
generate positive operating results and it is possible that we will be required
to cease some or all of our operations if we are not successful in raising
capital as needed. In that event, you could lose your entire investment in our
company.

OUR NET SALES ARE NOT SUFFICIENT TO FUND OUR
OPERATING EXPENSES AND OUR SALES HAVE REMAINED RELATIVELY FLAT OVER THE PAST
SEVERAL YEARS. THERE ARE NO ASSURANCES WE WILL BE ABLE TO INCREASE OUR SALES,
IN THE NEAR FUTURE, TO A LEVEL WHICH WILL FUND OUR OPERATING EXPENSES.

We used cash
in operations of approximately $1.1 million and approximately $2.3 million in
2009 and 2008, respectively. Our net sales declined approximately 13% for 2009
from 2008. Our operating expenses decreased approximately 28% in 2009 from
2008.. Our net sales have never been sufficient to fund our operating expenses.
During 2009 and in to 2010 we continue to implement cost reductions in an
effort to improve margins, including securing alternative suppliers for raw
materials and manufacturing and we anticipate these cost reductions will impact
our results of operations during the balance of 2010 and beyond. Unfortunately,
due to the down turn in the economy and the resultant sales decline, the impact
of these actions has thus far been minimal. As long as our cash flow from
operations remains insufficient to fund our operations, we will continue
depleting our cash and other financial resources. Our failure to achieve
profitable operations in future periods will adversely affect our ability to
continue as a going concern. In this event, you could lose all of your
investment in our company.

WE NEED ADDITIONAL FINANCING WHICH WE MAY NOT
BE ABLE TO OBTAIN ON ACCEPTABLE TERMS. IF WE CANNOT RAISE ADDITIONAL CAPITAL AS
NEEDED, OUR ABILITY TO EXECUTE OUR GROWTH STRATEGY AND FUND OUR ONGOING
OPERATIONS WILL BE IN JEOPARDY.

Historically,
our operations have been financed primarily through a credit line from our
Chairman, as well as the issuance of equity and short-term loans. Our future
capital requirements, however, depend on a number of factors, including our
ability to internally grow our revenues, manage our business and control our
expenses. At December 31, 2009, we had working capital deficit of $198,476 as
compared to working capital of $244,621 at December 31, 2008. We need to raise
additional capital to fund our ongoing operations, pay our existing obligations
and for future growth of our company. We do not have any commitments for
additional capital and we cannot assure you that any additional capital will be
available to us in the future upon terms acceptable to us. Given our history of
losses, debt levels and general uncertainties of the capital markets,

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we face a
number of challenges in our ability to raise capital. If we do not raise funds
as needed, our ability to provide for current working capital needs, pay our
obligations as they become due, grow our company, and continue our existing
business and operations is in jeopardy. In this event, you could lose all of
your investment in our company.

WE OWE ONE OF OUR DIRECTORS APPROXIMATELY $5.7 MILLION WHICH
IS DUE BY DECEMBER 31, 2011.

Since March
2002, one of our Directors has been providing funding to us for working capital on an
unsecured basis. At December 31, 2009, we owed him approximately $5.7 million.
As extended, this loan is due on December 31, 2011 or (i) at such time as we
have raised an additional $7 million over the $3.5 million raised in prior
offerings, or (ii) at such time as we are operating within sufficient cash flow
parameters to sustain operations, or (iii) until a disposition of our company,
such as an acquisition or merger, occurs. We do not have sufficient funds to pay
this loan when it becomes due and there are no assurances our CEO will extend
the due date. While the loan is unsecured, this obligation makes it more
difficult for us to secure the additional financing we need to fund our
operations.

WE RELY ON SALES TO A LIMITED NUMBER OF CUSTOMERS AND THERE
ARE NO ASSURANCES THAT THESE CUSTOMERS WILL CONTINUE TO PURCHASE PRODUCTS FROM
US.

We are
dependent upon sales to a limited number of customers. During 2009 two
customers individually accounted for approximately 22% and approximately 11%
(for a total of approximately 33%) of our net sales. During 2008 two customers
together accounted for approximately 34% of our net sales. We do not have
contracts with our customers and the loss of sales from one or more of these customers
could materially impact our results of operations in future periods.

WE ARE DEPENDENT ON A LIMITED NUMBER OF SUPPLIERS. WHILE WE
HAVE IDENTIFIED ALTERNATIVE SOURCES FOR VARIOUS MATERIALS WE USE, A TEMPORARY
DISRUPTION IN OUR ABILITY TO PROCURE NECESSARY MATERIALS AND PARTS COULD
ADVERSELY IMPACT OUR NET SALES IN FUTURE PERIODS.

A substantial portion of the
component parts to our products are manufactured by various suppliers for
assembly by us. We believe the relationships with our suppliers are satisfactory
and that alternative suppliers are available if relationships falter or
existing suppliers should become unable to keep up with our requirements.
However, there can be no assurance that our current or future suppliers will be
able to meet our requirements on commercially reasonable terms or within
scheduled delivery times. An interruption of our arrangements with suppliers
could cause a delay in the production of our products for timely delivery to
distributors and customers which could result in a loss of sales revenue in
future periods.

WE FACE COMPETITION FROM A NUMBER OF COMPANIES AND THERE ARE
NO ASSURANCES WE CAN EFFECTIVELY COMPETE IN OUR SECTOR.

There are a number of
companies which sell bypass oil filtration systems. Most of our competitors have
more capital, greater brand recognition, larger customer bases and
significantly greater financial, technical and marketing resources than we do.
These competitors may also engage in more extensive development of their
technologies, adopt more aggressive pricing policies and establish more
comprehensive marketing and advertising campaigns than we can. While we believe
that our product is superior in performance to our competitors products, there
are no assurances our belief is correct. For these and other reasons, our
competitors products may achieve greater acceptance in the marketplace than
our own, limiting our ability to gain market share and customer loyalty and to
generate sufficient revenues to achieve a profitable level of operations.

IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY OUR
ABILITY TO CONDUCT OUR BUSINESS AS IT IS PRESENTLY CONDUCTED IS IN JEOPARDY.

Our success is heavily
dependent on our proprietary technology and we rely on a combination of
contractual rights, patents, trade secrets, trademarks and non-disclosure
agreements to establish and protect our proprietary rights. There can be no
assurances that the steps we take to protect our proprietary rights will be
adequate to prevent misappropriation of the technology or independent
development by others of products with features based upon, or otherwise
similar to, our products. In addition, although we believe that any new
technology currently in development or patent pending has been independently
developed and does not infringe on the proprietary rights of others, there can
be no assurance that we are correct or that third parties will not assert
infringement claims against us in the future. If instituted, there can be no
assurances we will have

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adequate resources to defend a patent infringement or other proprietary
rights infringement action. If we are unable to adequately protect our
proprietary rights or if other products should be developed which are
substantially similar to ours, our ability to continue our operations as they
are presently conducted could be in jeopardy and we could be forced to cease
operations.

THE EXERCISE OF OUTSTANDING WARRANTS AND
OPTIONS WILL BE DILUTIVE TO OUR EXISTING STOCKHOLDERS.

At December
31, 2009, we had 43,370,935 shares of our common stock issued and outstanding
and the following securities, which are exercisable into shares of our common
stock, were outstanding:

| |   |                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 4,426,025 shares of our common stock issuable upon the exercise of
 warrants with exercise prices ranging from $0.50 to $2.00 per share; and    
| |   |                                                                                                                                                 
| |  | 1,910,975 shares of our common stock issuable upon the exercise of
 options with exercise prices ranging from $.14 per share to $9.25 per share.

The
issuance of these shares will be dilutive to our existing stockholders.

BECAUSE OUR STOCK CURRENTLY TRADES BELOW
$5.00 PER SHARE, AND IS QUOTED ON THE OTC BULLETIN BOARD, OUR STOCK IS
CONSIDERED A PENNY STOCK WHICH CAN ADVERSELY AFFECT ITS LIQUIDITY.

As the
trading price of our common stock is less than $5.00 per share, our common
stock is considered a penny stock, and trading in our common stock is subject
to the requirements of Rule 15g-9 under the Securities Exchange Act of 1934.
Under this rule, broker/dealers who recommend low-priced securities to persons
other than established customers and accredited investors must satisfy special
sales practice requirements. The broker/dealer must make an individualized
written suitability determination for the purchaser and receive the purchasers
written consent prior to the transaction.

Securities
and Exchange Commission regulations also require additional disclosure in
connection with any trades involving a penny stock, including the delivery,
prior to any penny stock transaction, of a disclosure schedule explaining the
penny stock market and its associated risks. These requirements severely limit
the liquidity of our common stock in the secondary market because few brokers or
dealers are likely to undertake these compliance activities. Purchasers of our
common stock may find it difficult to resell the shares in the secondary
market.

|         |                            
|-------- | ---------------------------
|ITEM 1B. | UNRESOLVED
 STAFF COMMENTS.

Not
applicable to a smaller reporting company.

|        |            
|------- | -----------
|ITEM 2. | PROPERTIES.

We lease
approximately 25,500 square feet of office and warehouse space in Boynton
Beach, Florida from an unrelated third party which serves as our principal
executive offices. Under the term of the five year lease which expires on July
31, 2013. Due to a negotiated rent reduction we pay rent of approximately
$157,000 per year, with a 19% increase in 2010 and will increase 3% annually
during the term of the lease.

|        |                   
|------- | ------------------
|ITEM 3. | LEGAL PROCEEDINGS.

On July 7, 2009 the Company filed a lawsuit
in the Circuit Court in 15th Judicial District in and for Palm Beach County,
Florida, styled Puradyn Filter Technologies, Inc. versus Richard C. Ford case
number 502009CA023128XXXXMB. In this action against Mr. Ford, our former Chief
Executive Officer, the Company is alleging non-payment of three promissory
notes totaling $756,250 with interest at a rate of 5.63% per annum since July
25, 2001, the execution date of the notes. As of November 13, 2009 interest on
all three notes amounts to $353,796, for an aggregate amount owing of
$1,110,046. At the time of the execution of these promissory notes, Mr. Ford
was Chief Executive Officer of the Company and drafter of these

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instruments. The Company is seeking payment
of the promissory notes and accrued interest. On August 7, 2009, Mr. Ford
responded by filing a Motion to Disqualify the Companys legal counsel, Gary E.
Susser and request a staying action until such time as the Company obtains new
legal counsel. As of November 13, 2009, the hearing for this motion has not
been scheduled in court. On September 16, 2009 a hearing on Order to Show Cause
occurred. On October 26, 2009 a ruling was issued, denying the Companys
request for custody of the collateral. On November 5, 2009 Richard Ford filed a
motion to stay proceeding pending payment of documentary stamps and amendment
of the complaint and relief from prior orders relating to production of
information pertaining to the sale of stock. On November 5, 2009, the Company
filed a Motion for Rehearing on Plaintiffs Request for Possession to obtain
custody of the collateral. This was heard on November 12, 2009, and the Company
is awaiting a ruling.

On July 13, 2009, Richard C. Ford filed a
demand for Arbitration, Case No. 32 145 00573 09 with the American Arbitration
Association, Commercial Tribunal, claiming that his contract was terminated
without cause and commissions earned were unpaid. This case evolves from the
contract between the Company and R.C.Ford and Associates, dated January 1, 2009,
which was terminated on July 2, 2009. On August 25, 2009, the Company filed a
Denial of Claim, stating that all monies due were paid and contract was
terminated. On October 28, 2009 a preliminary hearing was held. On November 9,
2009, the Company filed Respondents Factual Bases for Affirmative Defenses. A
final Arbitration Hearing was scheduled on April 21, 2010. On November 11,
2009, Richard C. Ford withdrew his demand for arbitration.

|        |                        
|------- | -----------------------
|ITEM 4. | (REMOVED AND RESERVED).

None.

PART II

|        |                                                                                                               
|------- | --------------------------------------------------------------------------------------------------------------
|ITEM 5. | STOCKHOLDER MARKET FOR REGISTRANTS COMMON
 EQUITY, RELATED MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Our
common stock is quoted on the OTCBB under the symbol PFTI. The reported high
and low sales prices for the common stock as reported on the OTCBB are shown
below for the periods indicated. The quotations reflect inter-dealer prices,
without retail mark-up, markdown or commission, and may not represent actual
transactions.

|                                       |  |      |      |     |   |      | 
|-------------------------------------- |  | ---- | ---- | --- | - | ---- | 
|                                       |  | High |      | Low |  
|Fiscal 2008                            |  |      |      |     |   |      | 
|First quarter ended March 31, 2008     |  | $    | 0.40 |     | $ | 0.30 | 
|Second quarter ended June 30, 2008     |  | $    | 0.31 |     | $ | 0.25 | 
|Third quarter ended September 30, 2008 |  | $    | 0.40 |     | $ | 0.20 | 
|Fourth quarter ended December 31, 2008 |  | $    | 0.19 |     | $ | 0.13 | 
|                                       |  |      |      |     |   |      | 
|Fiscal 2009                            |  |      |      |     |   |      | 
|                                       |  |      |      |     |   |      | 
|First quarter ended March 31, 2009     |  | $    | 0.41 |     | $ | 0.14 | 
|Second quarter ended June 30, 2009     |  | $    | 0.33 |     | $ | 0.14 | 
|Third quarter ended September 30, 2009 |  | $    | 0.47 |     | $ | 0.22 | 
|Fourth quarter ended December 31, 2009 |  | $    | 0.41 |     | $ | 0.14 | 
|                                       |  |      |      |     |   |      | 

On
April 9, 2010, the last sale price of our common stock as reported on the
OTCBB was $0.17. As of April 14, 2010, there were approximately 312 record
owners of our common stock. The transfer agent for the Companys common
stock is Florida Atlantic Stock Transfer, Inc., 7130 Nob Hill Road, Tamarac,
Florida 33321.

Dividend Policy

The Company
has never declared or paid cash dividends on its common stock. Under Delaware
law, we may declare and pay dividends on our capital stock either out of our
surplus, as defined in the relevant Delaware statutes, or if there is no

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such surplus, out of our net profits for the fiscal year in which the
dividend is declared and/or the preceding fiscal year. If, however, the capital
of our company, computed in accordance with the relevant Delaware statutes, has
been diminished by depreciation in the value of our property, or by losses, or
otherwise, to an amount less than the aggregate amount of the capital
represented by the issued and outstanding stock of all classes having a
preference upon the distribution of assets, we are prohibited from declaring
and paying out of such net profits and dividends upon any shares of our capital
stock until the deficiency in the amount of capital represented by the issued
and outstanding stock of all classes having a preference upon the distribution
of assets shall have been repaired.

The Company
presently intends to retain future earnings, if any, to finance the expansion
of its business and does not anticipate any cash dividends will be paid in the
foreseeable future. The future dividend policy will depend on our earnings,
capital requirements, expansion plans, financial condition and other relevant
factors.

Recent Sales
of Unregistered Securities

On December 28, 2009, the Company received
proceeds of $100,000 from an investor for the sale of 555,556 shares of common
stock at a price of $.18 per share and as part of the offering, awarded 55,556
warrants to purchase common stock at a price of $.50, which expire December 24,
2014. The purchaser was an accredited investor and the transaction was exempt
from registration under the Securities Act of 1933 in reliance on an exemption
provided by Section 4(2) of that act. We did not pay any commissions or
finders fees and we are using the proceeds for general working capital.

|        |                         
|------- | ------------------------
|ITEM 6. | SELECTED FINANCIAL DATA.

Not
applicable to a smaller reporting company.

|        |                                                                                       
|------- | --------------------------------------------------------------------------------------
|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF
 FINANCIAL CONDITION AND RESULTS OF OPERATION.

General

Sales of
the Companys products, the puraDYN® bypass oil filtration
system and replaceable filter elements will depend principally upon end user
demand for such products and acceptance of the Companys products by OEMs. The
oil filtration industry has historically been competitive and, as is typically
the case with innovative products, the ultimate level of demand for the
Companys products is subject to a high degree of uncertainty. Developing
market acceptance for the Companys existing and proposed products will require
substantial marketing and sales efforts and the expenditure of a significant
amount of funds to inform customers of the perceived benefits and cost
advantages of its products. As a result of our limited resources, to date we
have not had adequate funds available to undertake these necessary marketing
efforts.

Currently
no bypass oil filtration system has captured a substantial share of the
estimated recurring $15 billion potential market, based upon figures supplied
by The Rhein Report, a diesel engine industry consulting, publishing and market
research company. We believe we are in a unique position to capitalize on the
growing acceptance of bypass oil filtration given that our product and our
Company are positioned as, including, but not limited to:

| |   |                                                                                                                                                                                                                                                                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A competitively priced, value-added product based on an advanced,
 patented technology;                                                                                                                                                                                                                                                                                    
| |  | An alternative solution to the rising costs and national concerns
 over dependence on foreign oil ; and                                                                                                                                                                                                                                                                    
| |  | Providing an operational maintenance solution to end users in
 conjunction with existing and reasonably foreseeable federal environmental
 legislation such as new regulation affecting diesel engines and diesel fuels,
 mandating cleaner diesel engines which first went into effect January 1,
 2007. Additional and more stringent legislation is anticipated in 2010.

We focus
our sales strategy on individual sales and distribution efforts as well as on
the development of a nationwide distribution network that will not only sell
but also install and support our product. We currently have approximately 106
active distributors in the U.S. and internationally. The number of distributors
will frequently change as we add new distributors as well as when OEMs come
onboard with their distribution network.

We continue
to focus our sales and marketing efforts to target industries more open to
innovative methods to reduce

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oil maintenance operating costs. These industries were searching for
new and progressive ways to maintain their equipment, including bypass oil
filtration. This strategy includes focus on:

| |   |                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The expansion of existing strategic relationships we have with John
 Deere, Avis, and others;                                                                                                               
| |  | Continued development and expansion of our distribution network with
 distributors who are trained by us and stock inventory in order to establish
 a sales- and service-oriented nationwide infrastructure;
| |  | Continuing to target existing and new industrial/construction
 equipment fleets and major diesel engine and generator set OEMs;                                                                             
| |  | Creating customer pull-through, a sustained level of request for
 our product on the OEM level; and                                                                                                       
| |  | Converting customer evaluations into sales, both immediate and long
 term.                                                                                                                                  

While this
is a long-term and ongoing commitment, we believe we have achieved a limited
amount of industry acceptance based on recent accomplishments:

| |   |                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In 2009, repeat orders received from the Foreign Military Sales
 program, the government-to-government method for selling U.S. defense
 equipment, services and training, to supply the Puradyn systems for the
 line haul fleet.                                                      
|
| |  | The November 2009 announcement that Puradyn has established yet
 another relationship in the oil and gas services industry and received a
 purchase order for approximately 200 Puradyn systems for delivery that month.                                                               
|
| |  | The May 2009 announcement that a major oil drilling company,
 operating land drilling and offshore rigs in over 30 countries, has started a
 program to outfit its drilling platforms with the Puradyn system. Worldwide
 equipment fleet of over 2,700 has been targeted for retrofit.
|
| |  | The March 2009 announcement that the Company has entered into an
 exclusive sales representative agreement for the country of Nigeria and
 adjacent waters, effectively opening a new market for the Puradyn
 system.                                                                  
|
| |  | The September 2008 announcement that Avis Budget Group will be
 installing the Puradyn system asstandard equipment on its fleet of 300+
 heavy duty buses. Avis is the first in the car rental industry to use bypass
 oil filtration.                                                 
|
| |  | In August 2008, we announced that John Deere Forestry Division is
 factory-installing Puradyn systems in Joensuu, Finland on
 equipment to be utilized in Russia and other countries where high sulfur fuel
 is used.                                                                  

We believe
that the renewed interest shown in the technology of bypass oil filtration as
an economic alternative to significantly rising oil prices, dependence upon
foreign oil, with the added benefit of being environmentally beneficial, will
timely and favorably position the Company as a manufacturer of a cost efficient
green product.

We
believe that industry acceptance resulting in sales will continue to grow in
2010; however, there can be no assurance that any of our sales efforts or
strategic relationships will meet managements expectations or result in actual
revenues. Even with the above announcements, business revenue in 2009 was below
management expectations, which we believe is attributable to the sluggish
economic environment.

The
Companys sales effort not only involves educating the potential customer on
the benefits of our product, but also allowing the end-user to test and
evaluate the Puradyn system on its fleet equipment. While set for a
specific period of time, typically ranging from three to 12 months, evaluations
are often influenced by a number of variables including equipment applications
downtime or servicing, which may extend the evaluation period. Consequently,
the sales cycle can be relatively long.

We believe
international sales are especially well suited to our product given that
environmental controls are not as regulated in countries outside North America.
Certain applications representing a higher return on investment are more
prevalent in use outside of North America and end-users consequently are more
receptive to the total maintenance package, including the use of oil analysis,
which the Puradyn
system requires to verify oil condition. In 2008, total international sales
accounted for 55% of the Companys consolidated net sales. However, we believe that the
substantial decline in international sales

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to approximately 24% of our total net revenues in 2009 is attributable
to the recession impacting the economy since 2009.

Optimizing
our limited resources will be key to accomplishing our goals. We will need to remain
focused on working with OEMs, continue developing the independent distributors
we have onboard and maintain growth within the major accounts using our system.
To accomplish these tasks, we will need to add appropriate sales and marketing
support to be sure our distributors and customers are served. In early 2010, an
additional sales person was added to the sales department. At this time, we
anticipate the need for at least one additional salesperson and one sale
support person. We have recently added an application engineer and will need a
product engineer as we grow our OEM account list. A second application engineer
and product engineer will be needed as we add our third OEM. The expansion into
the OEM area, is rewarding in that it requires exceptionally strong customer service, yet provides a steady flow of
material requirements for our manufacturing plant. Additionally, OEM business allows us a slower turnover and training of
manufacturing personnel, a stronger supply chain with steady production, economics
of scale and the ability to better utilize our overhead with higher average
material turn rates.

We continue
to address our liquidity and working capital issues as we continue to seek to
raise additional capital from institutional and private investors and current
stockholders. Historically, we have faced difficulties in raising adequate
capital and we anticipate that those efforts will continue given the
uncertainties facing the capital markets in the U.S. We also continue to
implement cost reductions in an effort to improve margins, including securing
alternative suppliers for raw materials and manufacturing and we anticipate
these costs reductions will impact our results of operations during the balance
of 2010 and beyond. We also continue to review cost of material increases, some
of which are passed through to our customers as product price increases
beginning in January in each of the past few years. These price increases were
generally limited to market conditions,
but, exclusive of 2010, we expect to continue to be applied each January and
are in the range of 3% to 7%. As a result of the declining economy, in January 2010, we elected not
to implement a yearly price increase. As of the date of this report, we have not implemented one for 2010, however,
we may revisit this issue if the economy continues to improve and raw material costs increase.

Going
Concern

Our
financial statements have been prepared on the basis that we will operate as a
going concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. We have incurred net losses each
year since inception and have relied on the sale of our stock from time to time
and loans from third parties and from related parties to fund our operations. These
recurring operating losses, liabilities exceeding assets and the reliance on
cash inflows from an institutional investor and current stockholder have led
our independent registered public accounting firm Webb & Company P.A. to
include a statement in its audit report relating to our audited consolidated
financial statements for the years ended December 31, 2009 and 2008 expressing
substantial doubt about our ability to continue as a going concern. Our ability
to continue as a going concern is dependent upon our ability to obtain the
necessary financing to meet our obligations and repay our liabilities when they
become due and to generate profitable operations in the future. We plan to
continue to provide for our capital requirements through the sale of equity
securities, however, we have no firm commitments from any third party to
provide this financing and we cannot assure you we will be successful in
raising working capital as needed. There are no assurances that we will have
sufficient funds to execute our business plan, pay our obligations as they
become due or generate positive operating results.

Critical Accounting Policies and Estimates

The
Companys discussion and analysis of its financial condition and results of
operations are based upon the Companys consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure
of contingent assets and liabilities. On an on-going basis, the Company
evaluates its estimates, including those related to product returns, bad debts,
inventories, financing operations, warranty obligations and contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under
different assumptions or conditions.

The Company
believes the following critical accounting policies affect its more significant
judgments and estimates used in the preparation of its consolidated financial
statements.

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Allowance for Doubtful Accounts

The Company
maintains allowances for doubtful accounts for estimated losses resulting from
the inability of its customers to make required payments. If the financial
conditions of the Companys customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required. The Company provides for potential uncollectible accounts receivable
based on customer specific identification and historical collection experience.
If market conditions decline, actual collection experience may not meet expectations
and may result in decreased cash flows and increased bad debt expense.

The policy
for determining past due status is based on the contractual payment terms of
each customer, which is generally net 30 or net 60 days. Once collection efforts
by the Company and its collection agency are exhausted, the determination for
charging off uncollectible receivables is made.

Estimation of Product Warranty Cost

The Company
provides for the estimated cost of product warranties at the time revenue is
recognized. While the Company engages in product quality programs and
processes, including actively monitoring and evaluating the quality of its
component suppliers, the Companys warranty obligation is affected by product
failure rates, material usage and service delivery costs incurred in correcting
a product failure. Should actual product failure rates, material usage or
service delivery costs differ from the Companys estimates, revisions to the
estimated warranty liability would be required.

Estimation of Inventory Obsolescence

The Company
provides for estimated inventory obsolescence or unmarketable inventory in
amounts equal to the difference between the cost of inventory and the estimated
market value based upon assumptions about future demand and market conditions.
If actual market conditions are less favorable than those projected by
management, additional inventory write-downs may be required.

Impairment of Long-Lived Assets

The
Company periodically evaluates the recoverability of the carrying amount of its
long-lived assets under the guidelines of FASB ASC 360, Property, Plant, and Equipment. Factors
that the Company considers in making this evaluation include estimating the undiscounted
net cash flows estimated to result from the assets over their remaining useful
life. Should the Companys estimates of
these factors change, the Companys results of operations and financial
condition could be adversely impacted.

Revenue Recognition

Revenue is
recognized when earned. The Companys revenue recognition policies are in
compliance with the provisions issued in FASB ASC 605, Revenue Recognition. Revenue from product
sales to customers, distributors and resellers is recorded when products that
do not require further services or installation by the Company are shipped,
when there are no uncertainties surrounding customer acceptance and for which
collectibility is reasonably assured. The Company provides for sales returns
based on an historical analysis of returns. The estimate is updated for current
return activity and the provision is adjusted accordingly. Should actual
returns exceed managements estimates, the provision may require further
adjustment and accordingly, net sales may decrease.

Recent Accounting Pronouncements

In June
2009, the FASB issued ASC 860 Accounting for Transfers of Financial Assets
(SFAS 166). FASB ASC 860 improves the relevance, representational
faithfulness, and comparability of the information that a reporting entity
provides in its financial statements about a transfer of financial assets; the
effects of a transfer on its financial position, financial performance, and
cash flows; and a transferors continuing involvement, if any, in transferred
financial assets. FASB ASC 860 is effective as of the beginning of each
reporting entitys first annual reporting period that begins after November 15,
2009, for interim periods within that first annual reporting period and for
interim and annual reporting periods thereafter. The Company is evaluating the
impact the adoption of FASB ASC 860 will have on its financial statements.

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In June
2009, the FASB issued FASB ASC 810 Consolidations. FASB ASC 810 is effective
as of the beginning of each reporting entitys first annual reporting period
that begins after November 15, 2009, for interim periods within that first
annual reporting period, and for interim and annual reporting periods
thereafter. The Company is evaluating the impact the adoption of FASB ASC 810
will have on its financial statements.

In June
2009, the FASB issued FASB ASC 105 GAAP. The FASB Accounting Standards Codification
(Codification) will be the single source of authoritative nongovernmental
U.S. generally accepted accounting principles. Rules and interpretive releases
of the SEC under authority of federal securities laws are also sources of
authoritative GAAP for SEC registrants. FASB ASC 105 is effective for interim
and annual periods ending after September 15, 2009. All existing accounting
standards are superseded as described in FASB ASC 105. All other accounting
literature not included in the Codification is nonauthoritative. The Company
has updated references accordingly and it has no affect on its financial
position or results of operation.

In October
2009, the FASB issued Accounting Standards Update (ASU) Number 2009-13,
Revenue Recognition (ASC 605) Multiple-Deliverable Revenue Arrangements a
consensus of the FASB Emerging Issues Task Force. This ASU establishes a new
selling price hierarchy to use when allocating the sales price of a multiple
element arrangement between delivered and undelivered elements. This ASU is
generally expected to result in revenue recognition for more delivered elements
than under current rules and is required to be adopted prospectively for new or
materially modified agreements as of January 1, 2011. The Company is evaluating
the impact of this ASU, but does not expect adoption to have a material impact
on its financial statements.

In
January 2010, the Financial Accounting Standards Board (FASB) issued
amendments to the accounting guidance on noncontrolling interests in consolidated
financial statements. This accounting guidance clarifies that the scope of the
decrease in ownership provisions of the original guidance applies to (1) a
subsidiary or group of assets that is a business, (2) a subsidiary that is
a business and is transferred to an equity method investee or joint venture and
(3) an exchange of a group of assets that constitutes a business for a
noncontrolling interest in an entity (including an equity method investee or
joint venture). This accounting guidance also clarifies that the decrease in
ownership provisions of the original guidance does not apply to sales of in
substance real estate, even if they involve businesses. The accounting guidance
expands the disclosures about the deconsolidation of a subsidiary or
derecognition of a group of assets. For entities that have previously adopted
the accounting guidance on noncontrolling interests in consolidated financial
statements, this accounting guidance is effective beginning in the first annual
or interim reporting period ending on or after December 15, 2009 and
should be applied retrospectively to the first period in which the original
guidance was adopted. The adoption and retrospective application of this
accounting guidance did not have a material impact on our financial statements.

Impact of inflation and foreign
currency translation gains and losses

Inflation
has not had a significant impact on our operations. However, any significant
decrease in the price for oil or labor, environmental compliance costs, and
engine replacement costs could adversely impact the end users cost/benefit
analysis as to the use of our products.

The
financial statements of our U.K. subsidiary have been translated into U.S.
dollars in accordance with FASB ASC 830, Foreign
Currency Matters. All balance sheet accounts have been translated
using the exchange rate in effect at the balance sheet date. Income statement
amounts have been translated using an appropriately weighted average exchange
rate for the year. The translation gains and losses resulting from the changes
in exchange rates during the year ended December 31, 2009 as well as 2008 have
been reported in accumulated other comprehensive income, except for gains and
losses resulting from the translation of intercompany receivables and payables,
which are included in earnings for the period. During the years ending December
31, 2009 and 2008, we recorded a foreign currency exchange rate gain of
approximately $121,000 and a loss of approximately $535,000, respectively,
which is included in selling and administrative expenses in the consolidated
statements of operations for each period which appear elsewhere herein. The
exchange rate of the British pound to the U.S. dollar fluctuated from 1.4479 on
December 31, 2008 to 1.5928 on December 31, 2009 as compared to 1.9973 on
December 31, 2007 to 1.4479 on December 31, 2008.

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Results of Operations

Year Ended December 31, 2009 (2009) as
Compared to Year Ended December 31, 2008 (2008)

The
following table sets forth (amounts in thousands) the Companys operating
information for 2009 and 2008:

|                               |  |                |        |      |   |                       |   |   |        |  
|------------------------------ |  | -------------- | ------ | ---- | - | --------------------- | - | - | ------ | -
|                               |  | (in thousands) |       
|                               |  | 2009           |        | 2008 |   | Increase 
 (Decrease) |  
|Net sales                      |  | $              | 1,911  |      | $ | 2,696                 |   | $ | (785   | )
|Operating
 costs and expenses: |  |                |        |      |   |                       |   |   |        |  
|Cost of products sold          |  |                | 1,766  |      |   | 2,456                 |   |   | (690   | )
|Salaries and wages             |  |                | 1,001  |      |   | 1,014                 |   |   | (12    | )
|Selling and administrative     |  |                | 881    |      |   | 1,559                 |   |   | (678   | )
|                               |  |                | 3,648  |      |   | 5,029                 |   |   | (1,381 | )
|                               |  |                |        |      |   |                       |   |   |        |  
|Loss from operations           |  |                | (1,737 | )    |   | (2,333                | ) |   | (596   | )
|                               |  |                |        |      |   |                       |   |   |        |  
|Other income (expense):        |  |                |        |      |   |                       |   |   |        |  
|Interest income                |  |                | (176   | )    |   | 2                     |   |   | 178    |  
|Interest expense               |  |                | (157   | )    |   | (313                  | ) |   | (156   | )
|Total other expense            |  |                | (333   | )    |   | (311                  | ) |   | 22     |  
|                               |  |                |        |      |   |                       |   |   |        |  
|Net loss                       |  | $              | (2,071 | )    | $ | (2,644                | ) | $ | 573    |  
|                               |  |                |        |      |   |                       |   |   |        |  
|(in thousands)                 | 
|                               |  | 2009           |        | 2008 |   | Change                |  
|Gross
 sales                   |  | $              | 1,936  |      | $ | 2,686                 |   | $ | (750   | )
|Sales
 returns and allowances  |  |                | (25    | )    |   | 10                    |   |   | (35    | )
|Net
 Sales                     |  |                | 1,911  |      |   | 2,696                 |   |   | (785   | )
|US domestic sales              |  |                | 1,451  |      |   | 1,220                 |   |   | 231    |  
|US international sales         |  |                | 388    |      |   | 753                   |   |   | (365   | )
|UK sales                       |  |                | 72     |      |   | 723                   |   |   | (651   | )
|Net Sales                      |  | $              | 1,911  |      | $ | 2,696                 |   | $ | (785   | )

Net
Sales Net sales
decreased by approximately 29%, for 2009 from 2008. Domestic sales generated
from the U.S. operations increased approximately $231,000, or approximately
19%, in 2009 as compared to 2008, while the US international sales decreased
approximately $365,000, or approximately 48%, in 2009 as compared to 2008. This
decrease is due almost entirely from the decline in sales from a single customer,
which has been significantly affected by the global economy. Their requirement
for our product still exists due to the use of fuels, which effect the oil
replacement intervals, thus should produce similar sales as in the past once
the economic conditions improve, although there can be no assurances.

The
UK subsidiarys sales decreased by approximately $651,000, or 90%, from
approximately $723,000 in 2008 to approximately $72,000 in 2009. This decrease
is directly attributable to the relocation of the UK office in July, 2008 and
its closing thereafter in March 2009.

Sales to
two customers individually accounted for approximately 22% and 11% (for a total
33%) and 18% and 16% (for a total of 34%) of net sales for 2009 and 2008, respectively.

The
mix of product sold continues to change as unit sales revenues have decreased
to approximately 38% of net sales for 2009, as compared to approximately 50%
for 2008. We believe this is attributable to the economic environment, whereby
the consumer is purchasing replacement filters only as needed and delaying the
more expensive capital additions of new units.

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Cost
of Sales Cost of sales decreased by approximately 28%
in 2009 from 2008. Cost of products sold, as a percentage of sales, increased
from approximately 91% for 2008 to approximately 92% for 2009. The majority of
the decrease in our overall cost of sales is attributable to the 29% decline in
net sales. There were also decreases attributable to reductions in warranty
expense, direct and indirect factory wages and freight out expenses of
approximately $174,000, $66,000, $32,000, and $62,000 respectively. These
decreases were offset by increases in inventory allowance and scrap expense of
approximately $60,000 and $33,000 respectively.

Salaries
and WagesSalaries
and wages decreased approximately 1% for 2009 as compared to 2008. This
decrease is the result of a decrease in salaries and wages of approximately
$21,000 related to the UK office, as the office was closed during 2008. This
decrease was partially offset by additional salaries and wages expenses
incurred in the US office, due to classification of employee and contractor
status. We expect this expense will increase slightly as additional sales and engineer
personnel are hired.

Selling
and Administrative Expenses Selling and administrative expenses decreased by approximately 43% in
2009 from 2008. The majority of the decrease was attributable to an exchange rate gain in 2009 of approximately $121,000 as compared
to a loss in 2008 of approximately $535,000, which resulted in an overall decrease. There was also an increase in
stock based compensation and testing and research expenses of approximately
$133,000 and $23,000, respectively. These increases were partially offset by
decreases UK office expenses, professional fees, patent and marketing expenses
approximately $64,000, $54,000, $29,000 and $25,000, respectively. We expect
these expenses to overall remain unchanged, with the exception of increases in
testing and research and sales and marketing expenses,

Interest
IncomeInterest income decreased approximately
$178,000 in 2009 from 2008. This decrease is attributable to a reserve
established against shareholder loan interest due that was previously accrued
on a principal balance of $756,250 at 5.63% beginning July 25, 2001. This
relates to three promissory notes
totaling $756,250 due from our former Chief Executive Officer, Richard C. Ford,
for which the Company is presently in litigation for collection thereof.

Interest
Expense Interest expense decreased by approximately
50% in 2009 from 2008, as a result of a decrease in the interest rate
outstanding balance of the stockholder notes payable. The Company pays interest
monthly on the notes payable to stockholder to our CEO at prime rate less .5%,
with rates reset as often as the Federal Reserve changes interest rates, which
was a weighted average of 2.45% for 2009, as compared to an average of 4.53%
for 2008.

Liquidity and Capital Resources

Liquidity
is the ability of a company to generate adequate amounts of cash to meet its
needs for cash. As of December 31, 2009, we had cash and cash equivalents of
approximately $140,000 as compared to cash and cash equivalents of
approximately $117,000 at December 31, 2008.At
December 31 2009, we had negative working capital of approximately $198,000 and
our current ratio (current assets to current liabilities) was .86 to 1. At
December 31, 2008 we had working capital of approximately $244,000 and our
current ratio was 1.16 to 1. The decrease in working capital and current ratio
is primarily attributable to decreases in inventory, accounts payable, accounts
receivables and prepaid expenses of approximately $405,000, $129,000, $72,000
and $69,000 respectively, as well as an increase in inventory allowance of
approximately $81,000.

We have
incurred net losses each year since inception and at December 31, 2009 we had
an accumulated deficit of $50,540,355. Our net sales are not sufficient to fund
our operating expenses. Historically, we have relied on the sales of our stock
from time to time and loans from third parties and from related parties to fund
our operations. During 2008, we raised a total of $1.820 million in capital
from an institutional investor and current stockholders and during 2009 we
raised a net additional $1.983 million. In addition, as of December 31, 2009,
we owe our CEO $5.7 million for funds he has advanced to us from time to time
for working capital. Interest expense on this loan was approximately $148,000
for the year ended December 31, 2009.

We
do not currently have any commitments for capital expenditures. Currently,
without additional equity investments, we expect our operating cash flows will
suffice through July 2010. While we anticipate cash flows from 2010
sales activity, additional cash will still be needed to support operations,
meet our working capital needs and satisfy our obligations as they become due.
In addition, as set forth above, we owe our CEO $5.7 million which is due on
December 31, 2011 or (i) at such time as we have raised an additional $7
million over the $3.5 million raised in prior offerings, or (ii) at such time
as we are operating within sufficient cash flow parameters to sustain
operations, or (iii) until a disposition of our

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company,
such as an acquisition or merger, occurs. We do not have sufficient funds to
pay this loan when it becomes due and there are no assurances our CEO will
extend the due date. We continue to address liquidity concerns because of
inadequate revenue growth. As a result, cash flow from operations is
insufficient to cover our liquidity needs for the immediate future. We have
implemented measures to preserve our ability to operate, including
organizational changes, a reduction and/or deferral of salaries, reduction in
personnel and renegotiating creditor and collection arrangements. If budgeted
sales levels are not achieved and/or significant unanticipated expenditures
occur, or if we are not able to raise additional investment capital, we may
have to modify our business plan, reduce or discontinue some of our operations
or seek a buyer for part of its assets to continue as a going concern through
2010. There can be no assurance that we will be able to raise additional
capital or that sales will increase to the level required to generate
profitable operations to provide positive cash flow from operations. In that
event, it is possible that stockholders could lose their entire investment in
our company.

Operating activities

Net cash used in operating activities during 2009 was approximately
$1,136,000, as compared to $2,313,000 for 2008. This was primarily the result
from the net loss of approximately $2,071,000 and $2,645,000 for 2009 and 2008,
respectively. During 2009, the effect of the net loss on working capital is
offset by a decrease in inventories, accounts payables and deferred
compensation of approximately $405,000, $129,000 and $119,000 respectively.
During 2008, the effect of the net loss on working capital is offset by
decreases in accounts payables and receivables, inventory of approximately
$289,000, $149,000 and $95,000, respectively, as well as an increase in
stock-based compensation expense and accrued liabilities of approximately
$137,000 and $94,000 respectively,

Investing activities

Net cash used in investing activities during 2009 was approximately
$49,000, as compared to approximately $24,000 for 2008. The majority of the
2009 investments related to computer and software acquisitions, whereas, the
majority of the 2008 investments related to tooling expenditures.

Financing activities

Net
cash provided by financing activities was approximately $1,324,000 for 2009, as
compared to approximately $1,937,000 for 2008. During 2009 approximately
$1,983,000 was received from private stock transactions issued for cash, as
compared to $1,820,000 for 2008. During 2009 approximately $356,000 was
received from a shareholder credit line, as compared to approximately $118,000
which was received in 2008. Approximately $1,013,000 was used to pay down the
credit line. This loan is a line of credit made available to us by a member of our Board of Directors. Approximately $1,000,000 of the stock proceeds were
received during the third quarter of 2009, as compared to the majority of 2008
proceeds being received during the first six months, The majority of reductions
in stockholder loan occurred in August 2009, as proceeds were received from
stock transactions, and were paid to the credit facility for future borrowing
capacity.

Impact of Inflation

Inflation
has not had a significant impact on the Companys operations. However, any
significant decrease in the price for oil or labor, environmental compliance
costs, and engine replacement costs could adversely impact the Companys end
users cost/benefit analysis as to the use of the Companys products.

Off Balance Sheet Arrangements

None.

|         |                                                           
|-------- | ----------------------------------------------------------
|ITEM 7A. | QUANTATIVE
 AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not
applicable to smaller reporting companies.

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|        |                                              
|------- | ---------------------------------------------
|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY
 DATA.

Our
financial statements are contained later in this report beginning on page F-1.

|        |                                                                                       
|------- | --------------------------------------------------------------------------------------
|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH
 ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

|            |                         
|----------- | ------------------------
|ITEM 9A(T). | CONTROLS AND PROCEDURES.

Disclosure Controls
and Procedures

Our Chief
Executive Officer and Chief Financial Officer are responsible for establishing
and maintaining disclosure controls and procedures for us. Disclosure controls
and procedures are controls and procedures designed to reasonably assure that
information required to be disclosed in our reports filed under the Securities
Exchange Act of 1934, such as this report, is recorded, processed, summarized
and reported within the time periods prescribed by SEC rules and regulations,
and to reasonably assure that such information is accumulated and communicated
to our management, including our Chief Executive Officer and Chief Financial
Officer, to allow timely decisions regarding required disclosure.

Our
management does not expect that our disclosure controls or our internal
controls will prevent all error and fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. In addition, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within a company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or
more people or by management override of the control. The design of any systems
of controls also is based in part upon certain assumptions about the likelihood
of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of these
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.

As required
by Rule 13a-15 under the Securities Exchange Act of 1934, as of December 31,
2009, the end of the period covered by this report, our management concluded
its evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures. As of the evaluation date, our Chief
Executive Officer and our Chief Financial Officer concluded that there is a material weakness in
internal control in managements ability to override policies and procedures and therefore disclosure controls and procedures that are not effective in providing reasonable
assurance that information required to be disclosed in our reports under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods prescribed by SEC rules and regulations, and that such
information is accumulated and communicated to our management to allow timely
decisions regarding required disclosure.

Managements Report
on Internal Control over Financial Reporting

Our
management, including our Chief Executive Officer and Chief Financial Officer,
are responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) under the Securities Exchange
Act of 1934. Our management assessed the effectiveness of our internal control
over financial reporting as of December 31, 2009. In making its assessment of
internal control over financial reporting, management used the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) in Internal ControlIntegrated
Framework.

A material weakness is a deficiency, or combination of deficiencies,
in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Companys annual or interim
financial statements will not be prevented or detected on a timely basis. In its assessment of the effectiveness of internal control over financial reporting as of December 31, 2009,
the Company determined that there were control deficiencies that constituted material weaknesses, as described below.

Management has had the ability to override standard processes and policies.

Management does not believe that this control deficiency has had a material
effect on the financial reporting as of December 31, 2009 and will be evaluating processes to reduce this deficiency.

This annual
report does not include an attestation report of our independent registered
public accounting firm regarding internal control over financial reporting. Our
managements report was not subject to attestation by our independent
registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us
to provide only managements report in this annual report.

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Changes in Internal Controls Over
Financial Reporting

There have
been no changes in our internal control over financial reporting during our
fourth fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.

|         |                   
|-------- | ------------------
|ITEM 9B. | OTHER INFORMATION.

None.

PART
III

|         |                                                         
|-------- | --------------------------------------------------------
|ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
 GOVERNANCE.

Directors and Executive Officers

The
following individuals serve as our executive officers and members of our Board
of Directors:

| |                           |  |  |     |  |  |                                                                      
| | ------------------------- |  |  | --- |  |  | ---------------------------------------------------------------------
| | Name                      |  |  | Age |  |  | Positions                                                            
| | Joseph V. Vittoria        |  |  | 74  |  |  | Chairman of the Board of
 Directors and Chief Executive Officer      
| | Kevin G. Kroger           |  |  | 58  |  |  | President, Chief Operating
 Officer and Director                     
| | John S. Caldwell (2)      |  |  | 65  |  |  | Director                                                             
| | Forrest D. Hayes (1), (2) |  |  | 77  |  |  | Director                                                             
| | Dominick Telesco          |  |  | 80  |  |  | Director                                                             
| | Charles W. Walton (1)     |  |  | 77  |  |  | Director                                                             
| | Alan J. Sandler           |  |  | 71  |  |  | Vice President, Chief
 Administrative Officer and Corporate Secretary
| | Cindy Lea Gimler          |  |  | 43  |  |  | Chief Financial Officer                                              

|    |                               
|--- | ------------------------------
|(1) | Audit
 Committee member       
|(2) | Compensation
 Committee member

Joseph
V. Vittoria was appointed to the Puradyn Board of
Directors as Chairman on February 8, 2000 and to the office of Chief Executive
Officer on October 24, 2006. Mr. Vittoria was Chairman and Chief Executive
Officer of Travel Services International, Inc. where he served since 1998. From
1987 to 1997, Mr. Vittoria served as Chairman and Chief Executive Officer of
Avis, Inc., and was its President and Chief Operating Officer from 1982 to
1987. Mr. Vittoria also serves as Chairman of the Board of Great Wolf Resort;
as a member of the board of Vectrix Corporation, world leader in zero emissions
two-wheel vehicles, and as a member of the board of City Car Services, Inc.

Kevin
G. Kroger joined Puradyn July 3, 2000 as
President and Chief Operating Officer and was appointed to the Board of
Directors in November 2000. He was also appointed to the Board of Puradyn, Ltd.
In December 2000, Mr. Kroger was with Detroit Diesel Corporation from 1989 to
the time he joined our company, serving in various executive positions prior to
his appointment in 1998 to the position of Vice President and General Manager
of Series 30/40 Product. From 1987 to 1989 he was Vice President of R.E.S.
Leasing and of VE Corporation. Prior to this, from 1971 to 1987, he held
several management positions with Caterpillar Corporation.

Lieutenant
General (Retired) John S. Caldwell, Jr. was appointed
to the Puradyn Board of Directors on August 25, 2005 and is also the Chairman
of the Compensation Committee. Gen. Caldwell served as the Armys top ranking
officer for Acquisition, Logistics and Technology when he retired in January
2004. Also served as Director of the 50,000-person Army Acquisition Workforce,
responsible for personnel development and training policy and key assignment
recommendations. Prior to these positions, Gen. Caldwell served as the
Commanding General of the US Army Tank-Automotive and Armaments Command
(TACOM), in which capacity he developed, fielded and supported lethality,
survivability and mobility capabilities for approximately 70% of the Armys
ground force. Served 4 years as the Project Manager, Abrams Tank System,
leading R&D, production, quality assurance, procurement and logistical
support of the Armys tank program, a $600 million R&D, $15 billion procurement
program with major international components. General Caldwell currently
consults in various capacities, including Senior Vice President, The Spectrum
Group. General Caldwell holds the degrees of Bachelor of Science from the US
Military Academy, West Point, in New York; Master in Mechanical Engineering
from Georgia Institute of Technology in Atlanta, GA, and the Industrial College
of the Armed Forces. General

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Caldwell has been a member of the board of Taser International since
2007.

Forrest
D. Hayeswas
appointed to the Board of Directors in 2005; Chairman of Audit Committee and a
member of the Compensation Committee.Mr. Hayes served as Vice President and CFO of
Wastequip, Inc., a privately owned manufacturer of waste equipment in 1990 and
1991, and from 1992 to 2000, as a member of the Wastequip Board of Directors.
Mr. Hayes was President and CEO of Brittany Corporation, a privately owned
manufacturer of auto/truck parts from 1992 to 2000, and as Vice-Chairman
through 2003. Prior to this, Mr. Hayes served as a CPA with Arthur Andersen
from 1954 to 1990 in various capacities including Managing Partner of Cleveland
and Cincinnati, Ohio offices. Mr. Hayes was a member of the board of The Town
and Country Trust from 2005-2006 and currently serves on the board of Polychem
Corporation and Brittany Corporation, LLC.

Dominick
Telesco was
appointed to the Puradyn Board of Directors on December 19, 2006. In addition
to Puradyn, Mr. Telesco also serves on the Boards of Lydian Private Bank, the Palm
Beach County Cultural Council and the United Way of Palm Beach. Mr. Telesco is
Chairman of the Board of 3 Logistics Corporation and Datelco, Inc. Mr. Telesco
is also a member of the Board of Governors of the Palm Beach Branch of John
Hopkins Hospital; and President of Boxwood Association, Inc.

Charles
W. Walton, Ph.D. was appointed to the Puradyn Board of
Directors on August 25, 2005 and is a member of the Audit Committee. Dr. Walton
is Chairman Emeritus of Wastequip, Inc., which he founded in 1989 with the goal
of consolidating the equipment segment of the waste management industry. As a
result of over 25 successful acquisitions and internal growth, Wastequip is now
the largest supplier of equipment in the industry. It was recently purchased by
Odyssey Investor Partners, a private equity firm headquartered in New York.
Prior to founding Wastequip, Dr. Walton was President and Chief Executive
Officer of Sudbury, Inc., a Fortune 500 diversified manufacturing company,
which he co-founded in 1983. In 1987, he was awarded the Dively
Entrepreneurship Award by Case Western Reserve Weather head School of
Management and the Harvard Business School Club of Cleveland. Dr. Walton holds
the degrees of Bachelor of Science in Foreign Service and PhD. in economics
from Georgetown University, Washington, D.C

Alan
J. Sandler joined our company in June 1998
and has served in various positions including President (June 1998 until
January 2000), Vice President (January 2000 to present), Chief Operating
Officer (June 1998 to January 2000), Chief Administrative Officer (February
2000 to present) Secretary (June 1998 to President), Chief Financial Officer
(June 1998 to March 2001 and August 2001 to March 2002), and Director (June
1998 to December 2004). Prior to joining our company, from 1995 until 1997 Mr.
Sandler served as President and Chief Executive Officer to Hood Depot, Inc., a
national restaurant supply manufacturer/distributor. From 1979 to 1995 he was
President and Chief Executive Officer of Sandler & Sons Dental Supply
Company, a regional dental supply and equipment distributor. Previous to this
position he was a Vice President of Gardner Advertising Company, a national
advertising agency, from 1965 to 1979.

Cindy
Lea Gimler has served as Chief Financial
Officer since February 2005 and from October 2003 until October 2004 she held
the position of Accounting Manager with our company. Prior to her employment
with our company, she served as Controller of Bio-Engineered Supplements &
Nutrition, Inc., a nutrition products company, from October 2004 through
February 2005. Ms Gimler also served as Chief Financial Officer of Universal
Jet Aviation, a private jet charter company, from August 2000 through July 2003
and as Accounting Manager for Singer Asset Finance Co., LLC from July 1999
through August 2000. From November 1989 through August 2000 she was employed as
an Accountant and Financial Analyst for Oxbow Corporation, an energy finance
company. Ms. Gimler received a Masters of Business Administration and a
Bachelor of Business Administration from Florida Atlantic University and is a CPA
in the State of Florida.

There
are no family relationships between any of the executive officers and
directors, except as set forth above. Each director is elected at our annual
meeting of stockholders and holds office until the next annual meeting of
stockholders, or until his successor is elected and qualified.

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Compliance With Section 16(a) of the Exchange Act

Based
solely upon a review of Forms 3 and 4 and amendments thereto furnished to us
under Rule 16a-3(d) of the Securities Exchange Act during the fiscal year ended
December 31, 2009 and Forms 5 and amendments thereto furnished to us with
respect to the fiscal year ended December 31, 2009, as well as any written
representation from a reporting person that no Form 5 is required, we are aware
of 1 officer, director or 10% or greater stockholder that failed to file on a
timely basis, as disclosed in the aforementioned Forms, reports required by
Section 16(a) of the Securities Exchange Act during the fiscal year ended
December 31, 2009 except Mr. Dominick Telesco, a member of our Board of
Directors, who failed to timely file a Form 4 reporting one transaction. This
report was subsequently filed.

Code of Ethics

We
have adopted a Business Ethics and Conflicts of Interest Statement outlining
business ethics and conflicts of interest for all officers, directors and
employees of the Company, including procedures for prompt internal reporting of
violations of the code to the appropriate persons.

You
will find a copy of our Business Ethics and Conflicts of Interest Statement
posted on our website at http://www.puradyn.com under Investor
Relations, or you may write to us at Puradyn Investor Relations, 2017 High
Ridge Road, Boynton Beach, FL 33426. Our Code of Ethics applies to all
directors, officers and employees. We will provide a copy to you upon request
at no charge.

Committees of the Board of Directors

We
do not have a policy regarding the consideration of any director candidates
which may be recommended by our stockholders, including the minimum
qualifications for director candidates, nor has our Board of Directors
established a process for identifying and evaluating director nominees. We have
not adopted a policy regarding the handling of any potential recommendation of
director candidates by our stockholders, including the procedures to be
followed. Our Board has not considered or adopted any of these policies as we
have never received a recommendation from any stockholder for any candidate to
serve on our Board of Directors. We do not anticipate that any of our
stockholders will make such a recommendation in the near future. While there
have been no nominations of additional directors proposed, in the event such a
proposal is made, all members of our Board will participate in the
consideration of director nominees.

Our
Board of Directors has created both an Audit Committee and a Compensation
Committee.

Audit Committee

The
Audit Committee of the Board of Directors, which operates under a written charter,
reviews our financial reporting process on behalf of the Board of Directors.
Management has the primary responsibility for the financial statements and the
reporting process including the system of internal controls. The Audit
Committee of the Board of Directors is composed of two independent directors,
Mr. Forrest D. Hayes (Chairperson) and Dr. Charles W. Walton.

The Board
has determined that Mr. Hayes satisfies the criteria as an audit committee
financial expert as established by the SEC under 407(d) (5) of Regulation S-K.
In general, an audit committee financial expert is an individual member of
the audit committee or Board of Directors who:

| |   |                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | understands
 generally accepted accounting principles and financial statements,                                                                         
| |  | is
 able to assess the general application of such principles in connection with
 accounting for estimates, accruals and reserves,                      
| |  | has
 experience preparing, auditing, analyzing or evaluating financial statements
 comparable to the breadth and complexity to our financial statements,
| |  | understands
 internal controls over financial reporting, and                                                                                            
| |  | understands
 audit committee functions.                                                                                                                 

The
audit committee met four times in 2009.

Compensation
Committee

On November
20, 2008, the Board of Directors formally adopted a compensation committee
charter that was

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incorporated
into the by-laws of the Company. The charter defines the purpose and
responsibilities of the Compensation Committee.

The
Compensation Committee is a standing committee appointed by the Board of
Directors. The Committee is comprised of a minimum of two independent board
members; currently, General John S. Caldwell (Chairperson) and Mr. Forrest D.
Hayes, one of which shall be designated as Chairperson, The Committee has the
authority to determine the compensation of the organizations executive
officers and other employees as the Committee deems appropriate.

In
consultation with senior management, the Committee may review, establish, or
approve general compensation philosophy, policies and implementation of
compensation, with respect to employees or independent contractors. In addition
to the salary compensation, the Committee may review and approve other forms of
compensation, such as incentive compensation, equity-based, deferred
compensation and benefit plans. The Committee shall meet a minimum of once per
year and prepare minutes of all meetings and shall distribute said minutes to
all Board of Directors for approval.

You
will find a copy of our Compensation Committee Charter posted on our website at http://www.puradyn.com under Investor Relations, or you may write to us at
Puradyn Investor Relations, 2017 High Ridge Road, Boynton Beach, FL 33426. We
will provide a copy to you upon request at no charge.

|         |                         
|-------- | ------------------------
|ITEM 11. | EXECUTIVE
 COMPENSATION.

The following
table summarizes all compensation recorded by us in the last completed fiscal
year for

| |   |                                                                                                                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our
 principal executive officer or other individual serving in a similar
 capacity,                                                                                                                                                                                                                                        
| |  | our two most
 highly compensated executive officers other than our principal executive officer
 who were serving as executive officers at December 31, 2009 as that term is
 defined under Rule 3b-7 of the Securities Exchange Act of 1934. In the case
 of our company this includes two key employees of our company, and
| |  | up to two
 additional individuals for whom disclosure would have been required but for
 the fact that the individual was not serving as an executive officer at
 December 31, 2009.                                                                                                                                         

For
definitional purposes in this annual report these individuals are sometimes
referred to as the named executive officers. The value attributable to any option awards is
computed in accordance with FASB ASC 718, Compensation-Stock
Compensation. During each of fiscal 2008 and fiscal 2009, two
of the executive officers listed below have deferred approximately 50% of their
base wages and/or annual increases. The amounts included below reflect wages
actually earned during the respective periods.

|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|-------------------------------- |  |  | --------- |  |  | ---------------- | ------- |  | --------------- | - | - | ----------------------- |  | - | ------------------------ |  |  | ---------------------------------------------------- | ------ |  | -------------------------------------------------------- | - | - | --------------------------------- |  | - | --------------- |  |  | - | ------ |  |  | - | ------- | 
|SUMMARY
 COMPENSATION TABLE     
|NAME
 ANDPRINCIPAL POSITION
 (A) |  |  | YEAR
 (B) |  |  | SALARY
 ($)
 (C) |         |  | BONUS
 ($)
 (D) |   |   | STOCK
 AWARDS
 ($)
 (E) |  |   | OPTION
 AWARDS
 ($)
 (F) |  |  | NON-EQUITY
 
 INCENTIVE PLAN
 COMPENSATION
 ($)
 (G) |        |  | NONQUALIFIED 
 DEFERRED
 COMPENSATION
 EARNINGS ($)
 (H) |   |   | ALL
 OTHER COMPENSATION
 ($)
 (I) |  |   | TOTAL
 ($)
 (J) | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|Joseph
 V. Vittoria 1            |  |  | 2009      |  |  | $                |        |  |                 | $ |  |                         |  | $ |                         |  |  | $                                                    |       |  |                                                          | $ |  |                                   |  | $ |                |  |  | $ |       |  |  | $ |        | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|                                 |  |  | 2008      |  |  |                  |        |  |                 |   |  |                         |  |   |                         |  |  |                                                      |       |  |                                                          |   |  |                                   |  |   |                |  |  |   |       |  |  |   |        | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|Kevin
 Kroger 2                  |  |  | 2009      |  |  |                  | 185,920 |  |                 |   |  |                         |  |   |                         |  |  |                                                      |       |  |                                                          |   |  |                                   |  |   |                |  |  |   | 11,656 |  |  |   | 197,576 | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|                                 |  |  | 2008      |  |  |                  | 186,315 |  |                 |   |  |                         |  |   |                         |  |  |                                                      | 18,000 |  |                                                          |   |  |                                   |  |   |                |  |  |   | 15,634 |  |  |   | 219,949 | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|Alan
 Sandler 3                  |  |  | 2009      |  |  |                  | 112,238 |  |                 |   |  |                         |  |   |                         |  |  |                                                      |       |  |                                                          |   |  |                                   |  |   |                |  |  |   | 627    |  |  |   | 112,865 | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|                                 |  |  | 2008      |  |  |                  | 112,238 |  |                 |   |  |                         |  |   |                         |  |  |                                                      | 46,000 |  |                                                          |   |  |                                   |  |   |                |  |  |   |       |  |  |   | 1,238   | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|Cindy
 Gimler 4                  |  |  | 2009      |  |  |                  | 100,100 |  |                 |   |  |                         |  |   |                         |  |  |                                                      |       |  |                                                          |   |  |                                   |  |   |                |  |  |   |       |  |  |   | 100,100 | 
|                                 |  |  |           |  |  |                  |         |  |                 |   |   |                         |  |   |                          |  |  |                                                      |        |  |                                                          |   |   |                                   |  |   |                 |  |  |   |        |  |  |   |         | 
|                                 |  |  | 2008      |  |  |                  | 100,100 |  |                 |   |  |                         |  |   |                         |  |  |                                                      | 6,000  |  |                                                          |   |  |                                   |  |   |                |  |  |   |       |  |  |   | 106,100 | 

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1          Mr.
Vittoria, who is also the Chairman of our Board of Directors, serves as our
Chief Executive Officer.

2          Mr.
Kroger serves as our Chief Operating Officer. All Other Compensation in the
foregoing table represents the aggregate dollar amount of a car allowance
received by Mr. Kroger during each fiscal year, disability and life insurance
premiums we pay on his behalf, as well as 95%, of the $6,750 annual lease of
the Florida apartment to provide accommodations for Company use. This
percentage is based on his usage of the apartment, which was leased throughout
2008, expired on December 31, 2008 and was not renewed until December, 2009,
effective beginning January 1, 2010. Annual salary deferral of $102,920, which
is included in his salary for 2008 and 2009 in the foregoing table, is payable
at such time as the company achieves a positive cash flow or on an emergency
basis, as approved by the CEO.

3          Mr.
Sandler serves as our Chief Administrative Officer. All Other Compensation in
the foregoing table represents the amounts for reimbursement of Social Security
and Medicare premiums. Annual salary deferral of $62,000, which is included in
his salary for 2008 and 2009 in the foregoing table, is payable at such time as
the company achieves a positive cash flow or on an emergency basis, as approved
by the CEO.

4          Ms.
Gimler serves as our Chief Financial Officer. Annual salary deferral of
$20,100, which is included in her salary for 2008 and 2009 in the foregoing
table, is payable at such time as the company achieves a positive cash flow or
on an emergency basis, as approved by the CEO.

How our Executive Officers Compensation is Determined

Mr.
Vittoria, who has served as our Chief Executive Officer since October 2006, is
not a party to an employment agreement with the Company. He receives no
compensation and does not participate in any of the Companys insurance plans.

On
July 3, 2000, the Company entered into an employment agreement, with an initial
term of three years, with Mr. Kroger, who serves as our President and Chief
Operating Officer. Thereafter, the contract was amended on December 23, 2002
and July 3, 2003. The contract provided for an annual salary of $166,000,
minimum bonuses of $50,000, $80,000 and $80,000, respectively, for the years
2000 through 2002; 300,000 qualified stock options; a one-year salary severance
clause, and certain insurance and auto allowance compensations. On December 23,
2002, it was agreed that the President receive 100,000 shares of common stock
in lieu of the $80,000 bonus due to be paid. Mr. Kroger is also entitled to
paid health insurance, a life insurance and disability policy, a $1,000 per month
car allowance, four weeks paid vacation and other executive benefits which may
be made available from time to time. During 2008, the Company paid a $6,750
Florida apartment lease to provide accommodations for Company use by Mr.
Kroger, of which 95% has been allocated to Mr. Kroger, based on his usage. This
lease was not effective during 2009, however, was renewed in December, 2009,
effective beginning January 1, 2010. Upon entering into the agreement we
granted Mr. Kroger 10-year options to purchase 300,000 shares of our common
stock at the then fair market value of our common stock which vested in equal
installments on the first, second, third and fourth anniversary date of the
agreement. The agreement also contains customary indemnification, non-compete,
confidentiality and invention assignment clauses. The term of the agreement
continues on a year-to-year basis on the same terms and conditions as were in
effect at the time of renewal. The agreement may be terminated by us upon Mr.
Krogers death or disability, by us for good cause as defined in the agreement,
or by either party without cause. In the event the agreement is terminated on
Mr. Krogers death, by us for cause or by him without cause, we do not owe any
severance benefits. If the agreement is terminated as a result of his
disability, we are required to pay him a lump sum equal to the greater of the
base salary then in effect for the remaining term of the agreement or for one
year. If the agreement is terminated by us without cause or by Mr. Kroger in
the event of a change of control of our company, we are required to pay him a
lump sum equal to the greater of the base salary then in effect for the
remaining term of the agreement or for one year, together with any declared but
unpaid bonus. The addendum dated July 3, 2003 discontinued the bonus provision
of the contract but all other terms and conditions of the contract remain in
effect. During the fiscal year 2009, Mr. Krogers base annual salary was
$185,920 with approximately $102,920 deferred annually, with all other terms
and conditions of his employment agreement intact.

Mr.
Sandler, who has served as our Chief Administrative Officer since January 2000,
is not a party to an

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Table of Contents

employment
agreement with the Company. His compensation was determined by the Compensation
Committee of our Board of Directors. The Compensation Committee considered a
number of factors in determining Mr. Sandlers compensation including the scope
of his duties and responsibilities to our company and the time he devotes to
our business. The Compensation Committee did not consult with any experts or
other third parties in determining the amount of Mr. Sandlers compensation.
During the fiscal year 2009 Mr. Sandlers compensation package included a base
annual salary of $112,000, with approximately $62,000 deferred annually,
deferred until such time as the company reaches a positive cash flow, 100,000
employee stock options, exercisable at $.26 per share, with a four-year vesting
period from date of grant, 100,000 employee stock options exercisable at $.30
per share with a two-year vesting period from date of grant, and
company-provided insurance benefits and reimbursement of his Social Security
and Medicare premiums. The amount of payable to Mr. Sandler can be increased at
any time upon the determination of the Compensation Committee of our Board of
Directors.

Ms.
Gimler, who has served as our Chief Financial Officer since 2005, accepted and signed an employment offer outlining
the terms of her employment with the Company. Her compensation is
determined by the Compensation Committee of our Board of Directors. The
Compensation Committee considered a number of factors in determining Ms.
Gimlers compensation including the scope of her duties and responsibilities to
our company and the time she devotes to our business. The Compensation
Committee did not consult with any experts or other third parties in
determining the amount of Ms. Gimlers compensation. In 2008 Ms. Gimlers
compensation package includes a base annual salary of $100,100, with
approximately $20,100 deferred annually, deferred until such time as the
company reaches a positive cash flow, 60,000, 25,000 and 50,000 employee stock
options exercisable at $.14, $.40 and $.93 per share, respectively, with a
four-year vesting period from date of grant, and Company-provided insurance
benefits. The amount payable to Ms. Gimler can be increased at any time upon
the determination of the Compensation Committee of our Board of Directors. The
Company also has an agreement with Ms. Gimler whereby should there be a change in
ownership of the Company and employment is terminated without cause, then the
successor will pay Ms. Gimlers base salary for a period of six months, in the
same manner as paid during her employment.

Outstanding Equity Awards at Fiscal Year End

The
following table provides information concerning unexercised options, stock that
has not vested and equity incentive plan awards for each named executive
officer outstanding as of December 31, 2009:

|                   |  |               |                                                                             |  |  |                                                                             |  |  |                                                                                                        |  |  |   |                              |  |  |                          |  |  |                                                                  |  |  |                                                                           |  |  |                                                                                                                   |  |  |                                                                                                                                   | 
|------------------ |  | ------------- | --------------------------------------------------------------------------- |  |  | --------------------------------------------------------------------------- |  |  | ------------------------------------------------------------------------------------------------------ |  |  | - | ---------------------------- |  |  | ------------------------ |  |  | ---------------------------------------------------------------- |  |  | ------------------------------------------------------------------------- |  |  | ----------------------------------------------------------------------------------------------------------------- |  |  | --------------------------------------------------------------------------------------------------------------------------------- | 
|OPTION
 AWARDS     |  | STOCK
 AWARDS |                                                                            
|Name               |  |               | Number of 
 securities 
 underlying 
 unexercised options
 (#)
 exercisable |  |  | Number of
 securities
 underlying
 unexercised 
 options
 (#) unexercisable |  |  | Equity 
 incentive plan
 awards:
 Number of
 securities
 underlyingunexercised
 unearned
 options
 (#) |  |  |   | Option
 exercise
 price
 ($) |  |  | Option
 expiration
 date |  |  | Number
 of sharesor units
 of stock
 that have
 not
 vested
 (#) |  |  | Market
 value of
 shares or
 units of
 stock
 that
 have not
 vested
 ($) |  |  | Equity
 incentive
 plan awards:
 Number of
 unearned 
 shares, units
 or other
 rights that
 have not
 vested (#) |  |  | Equity
 incentive
 plan awards:
 Market or
 payout value
 of unearned
 shares, units
 or other
 rights that
 have not
 vested (#) | 
|                   |  |               |                                                                             |  |  |                                                                             |  |  |                                                                                                        |  |  |   |                              |  |  |                          |  |  |                                                                  |  |  |                                                                           |  |  |                                                                                                                   |  |  |                                                                                                                                   | 
|(a)                |  |               | (b)                                                                         |  |  | (c)                                                                         |  |  | (d)                                                                                                    |  |  |   | (e)                          |  |  | (f)                      |  |  | (g)                                                              |  |  | (h)                                                                       |  |  | (i)                                                                                                               |  |  | (j)                                                                                                                               | 
|                   |  |               |                                                                             |  |  |                                                                             |  |  |                                                                                                        |  |  |   |                              |  |  |                          |  |  |                                                                  |  |  |                                                                           |  |  |                                                                                                                   |  |  |                                                                                                                                   | 
|Joseph V. Vittoria |  |               | 100.000                                                                     |  |  |                                                                            |  |  |                                                                                                       |  |  |   | .95                          |  |  | 4/13/10                  |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 80,000                                                                      |  |  |                                                                            |  |  |                                                                                                       |  |  |   | 1.25                         |  |  | 11/15/11                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 150,000                                                                     |  |  |                                                                            |  |  |                                                                                                       |  |  |   | 1.25                         |  |  | 3/24/13                  |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 71,429                                                                      |  |  |                                                                            |  |  |                                                                                                       |  |  |   | 1.25                         |  |  | 3/26/18                  |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 80,645                                                                      |  |  |                                                                            |  |  |                                                                                                       |  |  |   | 1.25                         |  |  | 4/4/13                   |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 86,207                                                                      |  |  |                                                                            |  |  |                                                                                                       |  |  |   | 1.25                         |  |  | 5/9/13                   |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 92,593                                                                      |  |  |                                                                            |  |  |                                                                                                       |  |  |   | .50                          |  |  | 7/17/14                  |  |  |                                                                  |  |  |                                                                           |  |  |                                                                                                                   |  |  |                                                                                                                                   | 
|Kevin Kroger       |  |               | 25,000                                                                      |  |  | 75,000                                                                      |  |  |                                                                                                       |  |  | $ | 0.26                         |  |  | 06/10/18                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 100,000                                                                     |  |  |                                                                            |  |  |                                                                                                       |  |  |   | 1.70                         |  |  | 01/10/13                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 300,000                                                                     |  |  |                                                                            |  |  |                                                                                                       |  |  |   | 9.25                         |  |  | 07/03/10                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               |                                                                             |  |  |                                                                             |  |  |                                                                                                        |  |  |   |                              |  |  |                          |  |  |                                                                  |  |  |                                                                           |  |  |                                                                                                                   |  |  |                                                                                                                                   | 
|Alan Sandler       |  |               | 25,000                                                                      |  |  | 75,000                                                                      |  |  |                                                                                                       |  |  | $ | 0.26                         |  |  | 06/10/18                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 100,000                                                                     |  |  |                                                                            |  |  |                                                                                                       |  |  | $ | 0.30                         |  |  | 08/05/18                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               |                                                                             |  |  |                                                                             |  |  |                                                                                                        |  |  |   |                              |  |  |                          |  |  |                                                                  |  |  |                                                                           |  |  |                                                                                                                   |  |  |                                                                                                                                   | 
|Cindy Gimler       |  |               | 50,000                                                                      |  |  |                                                                            |  |  |                                                                                                       |  |  | $ | 0.93                         |  |  | 02/26/15                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 12,500                                                                      |  |  | 12,500                                                                      |  |  |                                                                                                       |  |  | $ | 0.40                         |  |  | 09/26/17                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 
|                   |  |               | 15,000                                                                      |  |  | 45,000                                                                      |  |  |                                                                                                       |  |  | $ | 0.14                         |  |  | 12/29/18                 |  |  |                                                                 |  |  |                                                                          |  |  |                                                                                                                  |  |  |                                                                                                                                  | 

30

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Table of Contents

Incentive and
Non-qualified Stock Option and Stock Award Plans

The
Board of Directors adopted the 2000 Non-Employee Directors Plan (the
Directors Plan) on November 8, 2000 under which options to purchase 400,000
shares have been authorized for issuance. The Directors Plan will provide a
means for us to attract and retain highly qualified persons to serve as
non-employee directors and advisory directors.

Each
member of the Board of Directors was automatically granted 5,000 options at the
date of commencement of the Directors Plan and on their initial election as
new members to the Board of Directors. Each director receives an additional
5,000 options at the close of each annual meeting of stockholders.
Additionally, each director automatically receives 2,500 options for each
committee of the Board on which the director serves. Options are granted at a
price equal to the fair market value of the stock on the date of grant, are
exercisable commencing two years following grant, and will expire five years
from the date of grant. In the event a person ceases to serve on the Board of
Directors, the outstanding options expire one year from the date of cessation
of service. The Board of Directors administers the Directors Plan.

Our
1999 Stock Option Plan (the 1999 Plan) and the 1996 Stock Option Plan (the
1996 Plan), were adopted on September 15, 1999 and amended in June 2000, and
on July 31, 1996, respectively. The plans were adopted to increase proprietary
interest in our company of our employees, consultants, and non-employee
directors and to align more closely their interests with the interests of our
stockholders. The plans may also serve to enhance our ability to attract and
retain the services of experienced and highly qualified employees and non-employee
directors. The 1999 Stock Option Plan expired on September 15, 2009.

Under
the 1999 Plan and 1996 Plan, we reserved an aggregate of 3,000,000 and
2,200,000 shares, respectively, of common stock for issuance pursuant to
options granted under the plans. The Compensation Committee of the Board of
Directors administers the plans including, without limitation, the selection of
the persons who will be granted plan options under the plans, the type of plan
options to be granted, the number of shares subject to each plan option and the
plan option price.

Options
granted under the 1996 Plan and the 1999 Plan may either be options qualifying
as incentive stock options under Section 422 of the Internal Revenue Code of
1986, as amended, or non-qualified options. In addition, the plans also allow
for the inclusion of a reload option provision, which permits an eligible
person to pay the exercise price of the plan option with shares of common stock
owned by the eligible person and receive a new plan option to purchase shares
of common stock equal in number to the tendered shares. Any incentive option
granted under the plans must provide for an exercise price of not less than
100% of the fair market value of the underlying shares on the date of such
grant, but the exercise price of any incentive option granted to an eligible
employee owning more than 10% of our common stock must be at least 110% of such
fair market value as determined on the date of the grant. The term of each plan
option and the manner in which it may be exercised is determined by the Board
of the Directors or the Committee, provided that no plan option may be
exercisable more than 10 years after the date of its grant and, in the case of
an incentive option granted to an eligible employee owning more than 10% of our
common stock, no more than five years after the date of the grant.

The
exercise price of non-qualified options is determined by the Board of Directors
or the Committee and cannot be less than the par value of our common stock. The
per share purchase price of shares subject to plan options granted under the
plans may be adjusted in the event of certain changes in our capitalization,
but any such adjustment will not change the total purchase price payable upon the
exercise in full of plan options granted under the plans. Our officers,
directors, key employees and consultants are eligible to receive non-qualified
options under the plans. Only our officers, directors and employees who are
employed by us are eligible to receive incentive options.

All
plan options are generally non-assignable and nontransferable, except by will
or by the laws of descent and

31

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distribution, and during the lifetime of the optionee, may be exercised
only by such optionee. If an optionees employment is terminated for any
reason, other than his death or disability or termination for cause, or if an
optionee is not our employee but is a member of our Board of Directors and his
service as a director is terminated for any reason, other than death or
disability, the plan option granted to him generally will lapse to the extent
unexercised on the earlier of the expiration date or one year following the
date of termination. If the optionee dies during the term of his employment,
the plan option granted to him generally will lapse to the extent unexercised
on the earlier of the expiration date of the plan option or the date one year
following the date of the optionees death. If the optionee is permanently and
totally disabled within the meaning of Section 22 (c)(3) of the Internal
Revenue Code of 1986, the plan option granted to him generally lapses to the
extent unexercised on the earlier of the expiration date of the option or one
year following the date of such disability.

The Board
of Directors or the Committee may amend, suspend or terminate the plans at any
time, except that no amendment shall be made which:

| |   |                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increases the total number of shares subject to the plans or changes
 the minimum purchase price therefore (except in either case in the event of
 adjustments due to changes in ours capitalization),
| |  | extends the term of any plan option beyond 10 years, or                                                                                                                                               
| |  | extends the termination date of the plan.                                                                                                                                                             

The 1996
Plan terminated on July 31, 2006. During 2009, options to purchase 5,150 which
were granted under the 1996 Plan prior to its termination expired. The 1999
plan terminated on September 15, 2009.

As of
December 31, 2009, under the Directors Plan, options to purchase 145,000
shares of common stock were outstanding. As of December 31, 2009, under the
1996 Plan, there were no non-qualified options outstanding and, under the 1999
Plan, incentive stock options to purchase 1,685,075 shares of common stock were
outstanding and non-qualified options to purchase 80,000 shares of common stock
were outstanding.

Director
Compensation

Each member of the Board of Directors is automatically granted 5,000
options upon election or appointment as a new member of the Board of Directors.
Each director receives an additional 5,000 options at the close of each annual
meeting of stockholders or on the anniversary of their appointment to the
Board. Additionally, each director automatically received 2,500 options for
each committee of the Board on which the director serves. Options are granted
at a price equal to the fair market value of the stock on the date of grant,
are exercisable commencing two years following grant, and will expire five
years from the date of grant. In the event a person ceases to serve on the
Board of Directors, the outstanding options expire one year from the date of
cessation of service.

The following table provides information concerning the compensation of
our Board members for their services as members of our Board of Directors for
2009. The value
attributable to any option awards is computed in accordance with FASB ASC Topic
718.

|                       |  |  |                                |        |  |               |  |   |                |  |   |                                           |  |  |                                                |   |  |                          |  |   |       |  |  |   |  |  |   |       | 
|---------------------- |  |  | ------------------------------ | ------ |  | ------------- |  | - | -------------- |  | - | ----------------------------------------- |  |  | ---------------------------------------------- | - |  | ------------------------ |  | - | ----- |  |  | - |  |  | - | ----- | 
|Director Compensation 
|Name                   |  |  | Fees
 earned
 or paid in
 cash |        |  | Stock
 awards |  |   | Option
 awards |  |   | Non-equity
 incentive
 plan
 compensation |  |  | Nonqualified
 deferred
 compensation
 earnings |   |  | All
 other
 compensation |  |   | Total | 
|                       |  |  | ($)                            |        |  | ($)           |  |   | ($)            |  |   | ($)                                       |  |  | ($)                                            |   |  | ($)                      |  |   | ($)   | 
|                       |  |  |                                |        |  |               |  |   |                |  |   |                                           |  |  |                                                |   |  |                          |  |   |       | 
|(a)                    |  |  | (b)                            |        |  | (c)           |  |   | (d)            |  |   | (e)                                       |  |  | (f)                                            |   |  | (g)                      |  |   | (h)   | 
|Joseph
 V. Vittoria    |  |  |                                |       |  |               |  |  |                |  | $ |                                          |  |  |                                                |  |  |                          |  |  |       |  |  |  |  |  | $ |      | 
|John
 S. Caldwell (1)  |  |  |                                |       |  |               |  |  |                |  |   | 1,950                                     |  |  |                                                |  |  |                          |  |  |       |  |  |  |  |  |   | 1,950 | 
|Forrest
 D. Hayes (2)  |  |  |                                |       |  |               |  |  |                |  |   | 1,900                                     |  |  |                                                |  |  |                          |  |  |       |  |  |  |  |  |   | 1,900 | 
|Kevin
 G. Kroger       |  |  |                                |       |  |               |  |  |                |  |   |                                          |  |  |                                                |  |  |                          |  |  |       |  |  |  |  |  |   |      | 
|Dominick
 Telesco (3)  |  |  |                                | 4,000- |  |               |  |  |                |  |   | 600                                       |  |  |                                                |  |  |                          |  |  |       |  |  |  |  |  |   | 4,600 | 
|Charles
 W. Walton (4) |  |  |                                |       |  |               |  |  |                |  |   | 1,950                                     |  |  |                                                |  |  |                          |  |  |       |  |  |  |  |  |   | 1,950 | 

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | On August 28,
 2009, General Caldwell was granted options to purchase 7,500 shares of common
 stock at an exercise price of $0.34 per share, vesting on August 25, 2011 and
 expiring on August 25, 2014.                                                                                                                                                                                                                                                                                                                                                                                                    
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(2) | On November 12,
 2009, Mr. Hayes was granted options to purchase 10,000 shares of common stock
 at an exercise price of $0.25 per share, vesting on November 10, 2011 and
 expiring on November 10, 2014.                                                                                                                                                                                                                                                                                                                                                                                                    
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(3) | On December 21,
 2009, Mr. Telesco was granted options to purchase 5,000 shares of common
 stock at an exercise price of $0.16 per share, vesting on December 18, 2011
 and expiring on December 18, 2014. On October 20, 2009, the Company entered
 into a consulting agreement with Boxwood Associates, Inc., whereby the
 Company pays $2,000 monthly for management and strategic development services
 performed. The contract will remain in effect until December 31, 2010, unless
 terminated by either party providing 30 days written notice. Mr. Telesco is
 President of Boxwood Associates, Inc.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(4) | On August 28,
 2009, Dr. Walton was granted options to purchase 7,500 shares of common stock
 at an exercise price of $0.34 per share, vesting on August 25, 2011 and
 expiring on August 25, 2014.                                                                                                                                                                                                                                                                                                                                                                                                          

|         |                                                                                                
|-------- | -----------------------------------------------------------------------------------------------
|ITEM 12. | SECURITY OWNERSHIP
 OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

At
April 13, 2010 we had 43,947,125 shares of our common stock issued and
outstanding. The following table sets forth information regarding the
beneficial ownership of our common stock as March 31, 2010 by:

| |   |                                                                                         
| | - | ----------------------------------------------------------------------------------------
| |  | each person known by us to be the beneficial owner of more than 5% of
 our common stock;
| |  | each of our directors;                                                                  
| |  | each of our named executive officers; and                                               
| |  | our named executive officers, directors and director nominees as a
 group.              

Unless
otherwise indicated, the business address of each person listed is in care of
2017 High Ridge Road, Boynton Beach, Florida 33426. The percentages in the
table have been calculated on the basis of treating as outstanding for a
particular person, all shares of our common stock outstanding on that date and
all shares of our common stock issuable to that holder in the event of exercise
of outstanding options, warrants, rights or conversion privileges owned by that
person at that date which are exercisable within 60 days of that date. Except
as otherwise indicated, the persons listed below have sole voting and
investment power with respect to all shares of our common stock owned by them,
except to the extent that power may be shared with a spouse.

|                                                                                |  |  |                                             |            |  |            |  |      |  
|------------------------------------------------------------------------------- |  |  | ------------------------------------------- | ---------- |  | ---------- |  | ---- | -
|Name of Beneficial
 Owner                                                       |  |  | Amount and Nature
 of
 Beneficial Ownership |            |  | % of Class | 
|Joseph V. Vittoria (1)                                                          |  |  |                                             | 5, 677,189 |  |            |  | 11.4 | %
|Kevin G. Kroger (2)                                                             |  |  |                                             | 1,117,633  |  |            |  | 1.6  | %
|Alan J. Sandler (3)                                                             |  |  |                                             | 183,392    |  |            |  |      | *
|Cindy Lea Gimler (4)                                                            |  |  |                                             | 81,500     |  |            |  |      | *
|Lieutenant General John S. Caldwell, Jr. US
 Army (retired)(5)                  |  |  |                                             | 72,500     |  |            |  |      | *
|Forrest D. Hayes (6)                                                            |  |  |                                             | 30,000     |  |            |  |      | *
|Dominick Telesco (7)                                                            |  |  |                                             | 6,283,195  |  |            |  | 14.0 | %
|Dr. Charles W. Walton (8)                                                       |  |  |                                             | 422,857    |  |            |  |      | *
|All officers and directors as a group
 (eight persons) (1)(2)(3)(4)(5)(6)(7)(8) |  |  |                                             | 13,868,266 |  |            |  | 27.0 | %
|Quantum Industrial Partners, LDC (9)                                            |  |  |                                             | 4,570,000  |  |            |  | 10.4 | %
|Glenhill Capital Management, LP (10)                                            |  |  |                                             | 4,364,661  |  |            |  | 9.9  | %

|    |                                                                   |                                                                                                  
|--- | ----------------------------------------------------------------- | -------------------------------------------------------------------------------------------------
|*   | represents less than 1%                                          
|    |                                                                  
|(1) | The number of shares beneficially owned by Mr. Vittoria includes:
|    |                                                                  | warrants to purchase 100,000 shares of common stock at $0.95 per
 share through April 14, 2010;  
|    |                                                                  | warrants to purchase 80,000 shares of common stock at $1.25 per share
 through November 15, 2011;
|    |                                                                  | warrants to purchase 150,000 shares of common stock at $1.25 per
 share through March 24, 2013;  
|    |                                                                  | warrants to purchase 71,429 shares of common stock at $1.25 per share
 through March 26, 2013;   

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|    |                                                                 |                                                                                                     
|--- | --------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------
|    |                                                                | warrants to purchase 80,645 shares of common stock at $1.25 per share
 through April 4, 2013;       
|    |                                                                | warrants to purchase 86,207 shares of common stock at $1.25 per share
 through May 9, 2013; and     
|    |                                                                | warrants to purchase 92,593 shares of common stock at $.50 per share
 through July 17, 2014.        
|    |                                                                
|(2) | The number of shares beneficially owned by Mr. Kroger includes:
|    |                                                                | options to purchase 300,000 shares of common stock at $9.25 per share
 through July 3, 2010;        
|    |                                                                | options to purchase 100,000 shares of common stock at $1.70 per share
 through January 10, 2013; and
|    |                                                                | options to purchase 25,000 shares of common stock at $.26 per share
 through June 10, 2018.         

The number
of shares beneficially owned by Mr. Kroger excludes unvested options to
purchase 75,000 shares of our common stock at an exercise price of $.26 per
share through June 10, 2018.

|    |                                                                  |                                                                                                  
|--- | ---------------------------------------------------------------- | -------------------------------------------------------------------------------------------------
|(3) | The number of shares beneficially owned by Mr. Sandler includes:
|    |                                                                 | options to purchase 100,000 shares of common stock at $.30 per share
 through August 5, 2018; and
|    |                                                                 | options to purchase 25,000 shares of common stock at $.26 per share
 through June 10, 2018.      

The number
of shares beneficially owned by Mr. Sandler excludes unvested options to
purchase 75,000 shares of our common stock at an exercise price of $.26 per
share through June 10, 2018.

|    |                                                                 |                                                                                                      
|--- | --------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------
|(4) | The number of shares beneficially owned by Ms. Gimler includes:
|    |                                                                | options to purchase 50,000 shares of common stock at $0.93 per share
 through February 28, 2015;     
|    |                                                                | options to purchase 12,500 shares of common stock at $0.40 per share
 through September 26, 2017; and
|    |                                                                | options to purchase 15,000 shares of common stock at $0.140 per share
 through December 29, 2018.    

The number
of shares beneficially owned by Ms. Gimler excludes unvested options to
purchase 12,500 shares of our common stock at an exercise price of $.40 per
share through September 26, 2017 and unvested options to purchase 45,000 shares
of our common stock at an exercise price of $.14 per share through December 29,
2018.

|    |                                                                       |                                                                                                 
|--- | --------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------
|(5) | The number of shares beneficially owned by General Caldwell includes:
|    |                                                                      | options to purchase 5,000 shares of common stock at $0.42 per share
 through August 25, 2010;   
|    |                                                                      | options to purchase 2,500 shares of common stock at $0.68 per share
 through November 30, 2010; 
|    |                                                                      | options to purchase 7,500 shares of common stock at $0.37 per share
 through August 25, 2011;   
|    |                                                                      | options to purchase 50,000 shares of common stock at $0.97 per share
 through March 9, 2015; and
|    |                                                                      | options to purchase 7,500 shares of common stock at $0.37 per share
 through August 25, 2012.   

The number
of shares beneficially owned by General Caldwell excludes unvested options to
purchase 7,500 shares of common stock at $0.38 per share through September 22,
2013 and unvested options to purchase 7,500 shares of common stock at $0.34 per
share through August 28, 2014.

|    |                                                                |                                                                                                     
|--- | -------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------
|(6) | The number of shares beneficially owned by Mr. Hayes includes:
|    |                                                               | options to purchase 7,500 shares of common stock at $1.00 per share
 through November 10, 2010;     
|    |                                                               | options to purchase 2,500 shares of common stock at $0.68 per share
 through November 30, 2010;     
|    |                                                               | options to purchase 10,000 shares of common stock at $0.37 per share
 through November 10, 2011; and
|    |                                                               | options to purchase 10,000 shares of common stock at $0.37 per share
 through November 10, 2012.    

The number
of shares beneficially owned by Mr. Hayes excludes unvested options to purchase
10,000 shares of common stock at $0.38 per share through September 22, 2013 and
unvested options to purchase 10,000 shares of common stock at $.25 per share
through November 10, 2014.

|    |                                                                  |                                                                                                 
|--- | ---------------------------------------------------------------- | ------------------------------------------------------------------------------------------------
|(7) | The number of shares beneficially owned by Mr. Telesco includes:
|    |                                                                 | warrants to purchase 100,000 shares of common stock at $1.25 per
 share through October 1, 2011;
|    |                                                                 | warrants to purchase 150,000 shares of common stock at $1.25 per
 share through March 24, 2013; 
|    |                                                                 | warrants to purchase 81,967 shares of common stock at $1.25 per share
 through May 14, 2013;    
|    |                                                                 | warrants to purchase 92,593 shares of common stock at $1.25 per share
 through July 1, 2013;    

34

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Table of Contents

| |   |                                                                                                   
| | - | --------------------------------------------------------------------------------------------------
| |  | warrants to purchase 208,333 shares of common stock at $1.25 per
 share through November 20, 2013;
| |  | warrants to purchase 100,000 shares of common stock at $.50 per share
 through February 3, 2014;  
| |  | warrants to purchase 138,889 shares of common stock at $.50 per share
 through May 6, 2014;       
| |  | options to purchase 5,000 shares of common stock at $.66 per share
 through December 18, 2011; and
| |  | options to purchase 5,000 shares of common stock at $.47 per share
 through December 17, 2012     

The number
of shares beneficially owned by Mr. Telesco excludes unvested options to
purchase 5,000 shares of common stock at $0.47 per share through December 19,
2013 and options to purchase 5,000 shares of common stock at $.16 per share
through December 18, 2014.

|    |                                                                 |                                                                                                  
|--- | --------------------------------------------------------------- | -------------------------------------------------------------------------------------------------
|(8) | The number of shares beneficially owned by Dr. Walton includes:
|    |                                                                | options to purchase 5,000 shares of common stock at $0.42 per share
 through August 25, 2010;    
|    |                                                                | options to purchase 2,500 shares of common stock $0.68 per share
 through November 30, 2010;     
|    |                                                                | warrants to purchase 21,429 shares of common stock at $1.25 per share
 through October 1, 2011;  
|    |                                                                | options to purchase 7,500 shares of common stock at $0.37 per share
 through August 25, 2011; and
|    |                                                                | options to purchase 7,500 shares of common stock at $0.37 per share
 through August 25, 2012.    

The number
of shares beneficially owned by Dr. Walton excludes unvested options to
purchase 7,500 shares of common stock at $0.38 per share through September 22,
2013 and options to purchase 7,500 shares of common stock at $0.34 per share
through August 25, 2014.

(9)The
address for Quantum Industrial Partners, LTDC is c/o Curacao Corporation
Company, N.V., Kaya Flamboyan, Willenstad Curacao, Netherlands, Antilles.

(10)The
address for Glenhill Capital Management, LP is 598 Madison Avenue, 12th Floor,
New York, NY 10022. The number of shares beneficially owned by Glenhill Capital
Management, LP includes warrants to purchase 89,286 shares of common stock at
$1.25 per share through October 1, 2011.

Securities Authorized for Issuance under Equity Compensation
Plans

The
following table sets forth securities authorized for issuance under any equity
compensation plans approved by our stockholders as well as any equity
compensation plans not approved by our stockholders as of December 31, 2009.

|                                    |  |  |                                                                                                   |           |  |                                                                                    |  |      |                                                                                                                                               |  |  |           | 
|----------------------------------- |  |  | ------------------------------------------------------------------------------------------------- | --------- |  | ---------------------------------------------------------------------------------- |  | ---- | --------------------------------------------------------------------------------------------------------------------------------------------- |  |  | --------- | 
|                                    |  |  | Number of
 securities to be
 issued upon
 exercise of
 outstanding
 options, warrants
 and rights |           |  | Weighted
 average
 exercise price of
 outstanding options,
 warrants and rights(b) |  |      | Number of
 securities
 remaining available
 for future issuance
 under equity
 compensation plans
 (excluding securities
 reflected in column | 
|                                    |  |  | (a)                                                                                               |           |  |                                                                                    |  |      | (a) (c)                                                                                                                                       | 
|Plan category                       |  |  |                                                                                                   |           |  |                                                                                    |  |      |                                                                                                                                               |  |  |           | 
|Plans
 approved by stockholders:    |  |  |                                                                                                   |           |  |                                                                                    |  |      |                                                                                                                                               |  |  |           | 
|1996
 Stock Option Plan             |  |  |                                                                                                   |          |  |                                                                                    |  |     |                                                                                                                                               |  |  | NA        | 
|1999
 Stock Option Plan             |  |  |                                                                                                   | 1,765,075 |  |                                                                                    |  | 2.08 |                                                                                                                                               |  |  | 1,234,925 | 
|2000
 Non-Employee Directors Plan   |  |  |                                                                                                   | 145,00    |  |                                                                                    |  | .41  |                                                                                                                                               |  |  | 285,000   | 
|                                    |  |  |                                                                                                   |           |  |                                                                                    |  |      |                                                                                                                                               |  |  |           | 
|Plans
 not approved by stockholders |  |  |                                                                                                   | 0         |  |                                                                                    |  | N/A  |                                                                                                                                               |  |  | N/A       | 

A
description of each of these plans is contained earlier in this report under
Part III, Item 11. Executive Compensation - Stock Option Plans.

35

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Table of Contents

|                                                                                            | 
|------------------------------------------------------------------------------------------- | 
|ITEM 13.          CERTAIN RELATIONSHIPS AND RELATED TRANSACTION, AND DIRECTOR INDEPENDENCE.

In July
2001, we received promissory notes from two of our officers, Messrs. Richard C.
Ford and Alan J. Sandler, for the exercise of their vested stock options in the
amount of $875,256 and bearing interest of 5.63%. The principal and accrued
interest are due upon the earlier of the expiration of the original option
periods, which range from July 2008 to December 2009, or upon the sale of the
common stock acquired by the execution of the options. During 2009, we recorded
approximately $43,000 of interest reserves relating to these stockholder notes.

As of
December 31, 2009, all three notes, totaling $756,250, from Mr. Ford were
delinquent. The Company is in litigation with Mr. Ford, attempting to obtain
some or all of the underlying collateral or payment of the note.

In July
2008 we received from Mr. Sandler, an executive officer, a stock certificate
for 260,000 shares of our common stock, which served as collateral for a loan
in the principal amount of $97,500 made to him in July 2001 as satisfaction for
the principal amount of the loan. Accrued but unpaid interest in the amount of
$41,000 at December 31, 2009 remains outstanding.

On March
28, 2002, we executed a letter agreement with Mr. Vittoria, our CEO and
Chairman, whereby he agreed to initially fund up to $2.5 million. The letter
agreement, as currently amended, provides that he will fund up to $6.1 million
to us on a unsecured basis. During March of each year, 2006 through 2010,
the maturity date for the agreement was extended annually from December 31,
2007 to December 31, 2011.

Amounts
drawn bear interest at the prime rate per annum payable monthly and are due
December 31, 2011 or (i) at such time as we have raised an additional $7
million over the $3.5 million raised in prior offerings, or (ii) at such time
as we are operating within sufficient cash flow parameters to sustain
operations, or (iii) until a disposition of our company, such as an acquisition
or merger, occurs. In consideration entering into this loan agreement, we
granted Mr. Vittoria common stock purchase warrants to purchase a total of
475,000 shares of our common stock at an exercise price equal to the closing
market price on the dates of grant. During 2009, the Company paid $1,013,000 in
principal payments and borrowed a total of $430,713. As of December 31, 2009,
we have drawn $5.7 million of the available funds, and paid approximately $148,000
in related interest.

On
May 8, 2009, the Company modified the exercise price of 100,000 warrants
previously issued to Mr. Dominick Telesco, a member of its Board of Directors,
on February 3, 2009 from $1.25 per share to $.50 per share. These warrants were
previously issued to Mr. Telesco as consideration for a loan to the Company. In
connection therewith, the Company recognized an expense of $11,000 as a result
of this modification.

On October
20, 2009, the Company entered into a consulting agreement with Boxwood
Associates, Inc., whereby the company pays $2,000 monthly for management and
strategic development services performed. The contract will remain in effect
until December 31, 2010, unless terminated by either party providing 30 days
written notice. Mr. Dominick Telesco, a shareholder, is President of Boxwood
Associates, Inc.

On
November 10, 2009 the Company received a loan from Mr. Dominick Telesco, a
shareholder, who is also a Board member, in the amount of $25,000. The proceeds
were used for working capital and terms for repayment or conversion to equity
have not been determined.

Director Independence

John S.
Caldwell, Forrest D. Hayes, Dominick Telesco and Charles W. Walton qualify as
independent within the meaning of Rule 5605 of the NASDAQ Marketplace Rules.

|         |                                         
|-------- | ----------------------------------------
|ITEM 14. | PRINCIPAL
 ACCOUNTANT FEES AND SERVICES.

Webb and
Company, P.A. served
as our independent registered public accounting firm for fiscal 2009 and fiscal
2008. The following table shows the fees that were billed for the audit and
other services provided by such firm for fiscal 2009 and fiscal 2008.

36

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Table of Contents

|                    |  |  |             |        |  |             |   |        | 
|------------------- |  |  | ----------- | ------ |  | ----------- | - | ------ | 
|                    |  |  | Fiscal 2009 |        |  | Fiscal 2008 |  
|                    |  |  |             |        |  |             |   |        | 
|Audit
 Fees         |  |  | $           | 36,928 |  |             | $ | 36,130 | 
|Audit-Related
 Fees |  |  |             | 930    |  |             |   | 975    | 
|Tax
 Fees           |  |  |             |       |  |             |   |       | 
|All
 Other Fees     |  |  |             |       |  |             |   | 2,350  | 
|Total               |  |  | $           | 37,858 |  |             | $ | 39,455 | 

Audit
Fees  This category
includes the audit of our annual financial statements, review of financial
statements included in our Form 10-Q Quarterly Reports and services that are
normally provided by the independent auditors in connection with engagements
for those fiscal years. This category also includes advice on audit and
accounting matters that arose during, or as a result of, the audit or the
review of interim financial statements.

Audit-Related
Fees  This category
consists of assurance and related services by the independent auditors that are
reasonably related to the performance of the audit or review of our financial
statements and are not reported above under Audit Fees. The services for the
fees disclosed under this category include consultation regarding our
correspondence with the SEC and other accounting consulting.

Tax
Fees  This category
consists of professional services rendered by our independent auditors for tax
compliance and tax advice. The services for the fees disclosed under this
category include tax return preparation and technical tax advice.

All
Other Fees  This
category consists of fees for other miscellaneous items.

Our
Board of Directors has adopted a procedure for pre-approval of all fees charged
by our independent auditors. Under the procedure, the Board approves the
engagement letter with respect to audit, tax and review services. Other fees
are subject to pre-approval by the Board, or, in the period between meetings,
by a designated member of Board. Any such approval by the designated member is
disclosed to the entire Board at the next meeting. The audit and tax fees paid
to the auditors with respect to fiscal year 2009 were pre-approved by the
entire Board of Directors.

PART IV

|         |                                         
|-------- | ----------------------------------------
|ITEM 15. | EXHIBITS, FINANCIAL
 STATEMENT SCHEDULES

The
following documents are filed as a part of this report or are incorporated by
reference to previous filings, if so indicated:

|            |  |             |                                                                                                              
|----------- |  | ----------- | -------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description
|3.1         |  |             | Amended and Restated Certificate of Incorporation dated December 30,
 1996 (2)                               
|3.2         |  |             | Certificate of Amendment to Certificate of Incorporation dated
 February 3, 1998 (3)                         
|3.3         |  |             | Bylaws (1)                                                                                                   
|4.1         |  |             | Form of common stock certificate (8)                                                                         
|4.2         |  |             | Form of Class A Warrant issued to Mr. Vittoria (9)                                                           
|4.3         |  |             | Form of $1.25 common stock purchase warrant (7)                                                              
|10.1        |  |             | 1996 Stock Option Plan (1)                                                                                   
|10.2        |  |             | 1999 Stock Option Plan (4)                                                                                   
|10.3        |  |             | 2000 Non-Employee Directors Plan (5)                                                                        
|10.4        |  |             | 2002 Audit Committee Charter (6)                                                                             
|10.5        |  |             | Agreement between T/F Systems, Inc. and T/F Purifiner, Inc. dated
 March 1, 1991 (1)                         
|10.6        |  |             | Asset Purchase Agreement between T/F Systems, Inc. and T/F Purifiner,
 Inc. dated December 31, 1995 (1)      
|10.7        |  |             | Lease
 Amendment #2 between Puradyn Filter Technologies, Inc. and Premier Gateway
 Center at Quantum LLP (10)

37

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Table of Contents

|      |  |  |                                                                                                                                             
|----- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------
|10.8  |  |  | Master Distributor Agreement dated February 18, 2008 by and between
 Puradyn Filter Technologies Incorporated and Filter Solutions Ltd. (11)
|10.9  |  |  | Employment Agreement dated July 3, 2000 between Puradyn Filter
 Technologies Incorporated and Kevin Kroger, as amended (11)                 
|10.10 |  |  | Extension of Note from Mr. Vittoria (12)                                                                                                    
|10.11 |  |  | Consulting Agreement dated October 20, 2009 between Puradyn Filter
 Technologies Incorporated and Mr. Dominick Telesco                      
|10.12 |  |  | Extension of Note from Mr. Vittoria*                                                                                                        
|14.1  |  |  | Business Ethics and Conflicts of Interest Statement (6)                                                                                     
|21.1  |  |  | Subsidiaries of the registrant (11)                                                                                                         
|31.1  |  |  | Section 302 certification of Chief Executive Officer *                                                                                      
|31.2  |  |  | Section 302 certification of Chief Financial Officer *                                                                                      
|32.1  |  |  | Section 906 certification of Chief Executive Officer *                                                                                      
|32.2  |  |  | Section 906 certification of Chief Financial Officer *                                                                                      
|99.1  |  |  | Form of Subscription Agreement (11)                                                                                                         

|  |                 | 
|- | --------------- | 
|  |                
|* | filed
 herewith

|     |                                                                                                                                                                                                       
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1)  | Incorporated by reference from the exhibits to the registration
 statement on Form 10-SB, SEC File No. 001-11991, as filed with the Securities
 and Exchange Commission, on July 30, 1996, as amended.
|(2)  | Incorporated by reference from the exhibit to the Current Report on
 Form 8-K as filed on January 9, 1997.                                                                                            
|(3)  | Incorporated by reference from the exhibit to the Current Report on
 Form 8-K/A as filed on February 12, 1998.                                                                                        
|(4)  | Incorporated by reference to the registration statement on Form S-8,
 SEC File No. 333-91379, as filed with the Securities and Exchange Commission
 on November 22, 1999.                             
|(5)  | Incorporated by reference from the exhibits to the Annual Report on
 Form 10-KSB/A for the fiscal year ended December 31, 2000.                                                                       
|(6)  | Incorporated by reference from the exhibits to the Annual Report on
 Form 10-KSB for the fiscal year ended December 31, 2003.                                                                         
|(7)  | Incorporated by reference to the Current Report on Form 8-K as filed
 on October 10, 2006.                                                                                                            
|(8)  | Incorporated by reference to exhibits to the Form 8-A as filed with
 the Securities and Exchange Commission on December 6, 2001.                                                                      
|(9)  | Incorporated by reference to exhibits to the Quarterly Report on Form
 10-QSB for the period ended March 31, 2005.                                                                                    
|(10) | Incorporated by reference to the exhibits to the Quarterly Report on
 Form 10-Q for the period ended June 30, 2008.                                                                                   
|(11) | Incorporated by reference to the registration statement on Form S-1,
 SEC File No. 333-155,054, as declared effective on November 14, 2008, as
 amended.                                              
|(12) | Incorporated by reference to the Annual Report on Form 10-K for the
 fiscal year ended December 31, 2008.                                                                                             

38

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Table of Contents

SIGNATURES

In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

| |                                                        |                                       | 
| | ------------------------------------------------------ | ------------------------------------- | 
| | Puradyn Filter
 Technologies Incorporated (Registrant) |                                      
| |                                                        |                                       | 
| | By: /s/                                                | Joseph V. Vittoria                    | 
| |                                                        | Chairman and Chief
 Executive Officer | 
| | Date:                                                  | April 15, 2010                        | 

In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.

Date:     April
15, 2010

|    |  |                                                                                
|--- |  | -------------------------------------------------------------------------------
|By: |  | /s/ Joseph
 V. Vittoria                                                        
|    |  | Joseph V. Vittoria                                                             
|    |  | Chief
 Executive Officer and Chairman of the Board, principal executive officer
|By: |  |                                                                                
|    |  | /s/ Alan J.
 Sandler                                                           
|    |  | Alan J. Sandler                                                                
|    |  | Vice
 President, Chief Administrative Officer and Secretary                    
|By: |  |                                                                                
|    |  | /s/ Cindy
 Lea Gimler                                                          
|    |  | Cindy Lea Gimler, Chief
 Financial Officer                                     
|    |  | principal
 financial and accounting officer                                    
|By: |  |                                                                                
|    |  | /s/ Kevin G.
 Kroger                                                           
|    |  | Kevin G. Kroger, President
 and Chief                                          
|    |  | Operating
 Officer and Director                                                
|By: |  |                                                                                
|    |  | /s/ John S.
 Caldwell                                                          
|    |  | John S.
 Caldwell, Director                                                    
|By: |  |                                                                                
|    |  | /s/ Forrest
 D. Hayes                                                          
|    |  | Forrest D. Hayes, Director                                                     
|By: |  |                                                                                
|    |  | /s/ Charles
 W. Walton                                                         
|    |  | Charles W.
 Walton, Director                                                   
|By: |  |                                                                                
|    |  | /s/ Dominick Telesco                                                           
|    |  | Dominick Telesco, Director                                                     

39

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Table of Contents

Report of Independent Registered Public Accounting Firm

Board of
Directors and Stockholders 
Puradyn Filter Technologies Incorporated

We have
audited the accompanying consolidated balance sheets of Puradyn Filter
Technologies Incorporated (the Company) as of December 31, 2009 and 2008, and
the related consolidated statements of operations, changes in stockholders
deficit and cash flows for the two years then ended. These financial statements
are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company has
determined that it is not required to have, nor were we engaged to perform, an
audit of its internal control over financial reporting. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

In our
opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Puradyn Filter Technologies
Incorporated at December 31, 2009 and 2008, and the results of their operations
and their cash flows for the two years then ended in conformity with accounting
principles generally accepted in the United States of America.

The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 2, the Company has
suffered recurring losses from operations, its total liabilities exceed its
total assets, and it has relied on cash inflows from an institutional investor
and current stockholder. These conditions raise substantial doubt about the
Companys ability to continue as a going concern. Managements plans in regards
to these matters are also described in Note 2. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.

| |                            
| | ---------------------------
| | /s/ Webb and
 Company, P.A.

Boynton Beach,
Florida 
April 15, 2010

F-1

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Table of Contents

Puradyn Filter Technologies Incorporated 
Consolidated Balance Sheets

|                                                                                                                                    |  |              |             |      |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | ---- | - | ----------- | -
|                                                                                                                                    |  | December 31, |            
|                                                                                                                                    |  |              |             |      |   |             |  
|                                                                                                                                    |  | 2009         |             | 2008 |  
|Assets                                                                                                                              |  |              |             |      |   |             |  
|Current assets:                                                                                                                     |  |              |             |      |   |             |  
|Cash and cash equivalents                                                                                                           |  | $            | 140,266     |      | $ | 116,802     |  
|Accounts receivable, net of allowance for
 uncollectible accounts of $36,772 and $22,970, respectively                              |  |              | 97,072      |      |   | 182,660     |  
|Inventories, net                                                                                                                    |  |              | 851,069     |      |   | 1,337,309   |  
|Prepaid expenses and other current assets                                                                                           |  |              | 115,074     |      |   | 184,537     |  
|Total current assets                                                                                                                |  |              | 1,203,481   |      |   | 1,821,308   |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Property and equipment, net                                                                                                         |  |              | 132,856     |      |   | 122,915     |  
|                                                                                                                                   
|Other noncurrent assets                                                                                                             |  |              | 40,725      |      |   | 40,930      |  
|                                                                                                                                   
|Deferred financing costs, net                                                                                                       |  |              | 4,027       |      |   | 8,419       |  
|Total assets                                                                                                                        |  | $            | 1,381,089   |      | $ | 1,993,572   |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Liabilities and stockholders deficit                                                                                               |  |              |             |      |   |             |  
|Current liabilities:                                                                                                                |  |              |             |      |   |             |  
|Accounts payable                                                                                                                    |  | $            | 177,032     |      | $ | 305,645     |  
|Accrued liabilities                                                                                                                 |  |              | 1,148,318   |      |   | 1,148,536   |  
|Current portion of capital lease obligation                                                                                         |  |              | 3,271       |      |   | 1,859       |  
|Deferred revenues                                                                                                                   |  |              | 73,336      |      |   | 120,647     |  
|Total current liabilities                                                                                                           |  |              | 1,401,957   |      |   | 1,576,687   |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Capital lease obligation, less current
 portion                                                                                     |  |              | 1,989       |      |   | 5,280       |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Notes Payable - stockholders                                                                                                        |  |              | 5,710,414   |      |   | 6,367,702   |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Total Long Term Liabilities                                                                                                         |  |              | 5,712,403   |      |   | 6,372,982   |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Total Liabilities                                                                                                                   |  |              | 7,114,360   |      |   | 7,949,669   |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Commitments and contingencies                                                                                                       |  |              |            |      |   |            |  
|                                                                                                                                    |  |              |             |      |   |             |  
|Stockholders deficit:                                                                                                              |  |              |             |      |   |             |  
|Preferred stock, $.001 par value:                                                                                                   |  |              |            |      |   |             |  
|Authorized shares  500,000;
 None issued and outstanding                                                                           |  |              |             |      |   |             |  
|Common stock, $.001 par value, 
 Authorized shares  50,000,000; 
 Issued and outstanding  43,370,935 and 35,838,351, respectively |  |              | 43,371      |      |   | 35,839      |  
|Additional paid-in capital                                                                                                          |  |              | 45,407,337  |      |   | 43,301,010  |  
|Deferred compensation                                                                                                               |  |              |            |      |   | (118,736    | )
|Notes receivable from stockholders                                                                                                  |  |              | (790,209    | )    |   | (966,531    | )
|Accumulated deficit                                                                                                                 |  |              | (50,540,355 | )    |   | (48,469,757 | )
|Accumulated other comprehensive income                                                                                              |  |              | 146,584     |      |   | 262,078     |  
|Total stockholders deficit                                                                                                         |  |              | (5,733,272  | )    |   | (5,956,097  | )
|Total liabilities and stockholders deficit                                                                                         |  | $            | 1,381,089   |      | $ | 1,993,572   |  

See accompanying notes to consolidated
financial statements.

F-2

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Table of Contents

Puradyn Filter Technologies Incorporated

Consolidated Statements of Operations

|                                                              |  |                         |            |      |   |            |  
|------------------------------------------------------------- |  | ----------------------- | ---------- | ---- | - | ---------- | -
|                                                              |  | Years Ended December 31 |           
|                                                              |  | 2009                    |            | 2008 |  
|                                                              |  |                         |            |      |   |            |  
|Net sales                                                     |  | $                       | 1,911,451  |      | $ | 2,695,640  |  
|                                                              |  |                         |            |      |   |            |  
|Costs and expenses:                                           |  |                         |            |      |   |            |  
|Cost of products sold                                         |  |                         | 1,766,434  |      |   | 2,455,916  |  
|Salaries and wages                                            |  |                         | 1,001,438  |      |   | 1,013,438  |  
|Selling and administrative                                    |  |                         | 880,899    |      |   | 1,559,394  |  
|Total Operating Costs                                         |  |                         | 3,648,771  |      |   | 5,028,748  |  
|Loss from operations                                          |  |                         | (1,737,320 | )    |   | (2,333,108 | )
|                                                              |  |                         |            |      |   |            |  
|Other (expense) income:                                       |  |                         |            |      |   |            |  
|Interest income                                               |  |                         | (175,672   | )    |   | 2,291      |  
|Interest expense                                              |  |                         | (157,606   | )    |   | (313,730   | )
|Total other expense                                           |  |                         | (333,278   | )    |   | (311,439   | )
|                                                              |  |                         |            |      |   |            |  
|Income taxes                                                  |  |                         |           |      |   |           |  
|                                                              |  |                         |            |      |   |            |  
|Net loss                                                      |  | $                       | (2,070,598 | )    | $ | (2,644,547 | )
|                                                              |  |                         |            |      |   |            |  
|Basic and diluted loss per common share                       |  | $                       | (.05       | )    | $ | (.08       | )
|                                                              |  |                         |            |      |   |            |  
|Basic and diluted weighted average common
 shares Outstanding |  |                         | 39,963,227 |      |   | 33,088,770 |  

See accompanying notes to consolidated
financial statements.

F-3

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Table of Contents

Puradyn Filter Technologies Incorporated
Consolidated Statements of Changes in Stockholders Deficit

|                                                                     |  |                       |            |        |   |                              |   |                        |            |                                      |   |                      |   |                                                  |            |                               |   |             |   |   |          |   |   |            |  
|-------------------------------------------------------------------- |  | --------------------- | ---------- | ------ | - | ---------------------------- | - | ---------------------- | ---------- | ------------------------------------ | - | -------------------- | - | ------------------------------------------------ | ---------- | ----------------------------- | - | ----------- | - | - | -------- | - | - | ---------- | -
|                                                                     |  | Common
 Stock
 Shares |            | Amount |   | Additional
 Paid-in
 Capital |   | Deferred
 Compensation |            | Notes
 Receivable
 From Stockholders |   | Accumulated
 Deficit |   | Accumulated
 Other
 Comprehensive
 Income (Loss) |            | Total
 Stockholders
 Deficit |  
|                                                                     |  |                       |            |        |   |                              |   |                        |            |                                      |   |                      |   |                                                  |            |                               |   |             |   |   |          |   |   |            |  
|Balance at December 31, 2007                                         |  |                       | 29,400,638 |        | $ | 29,401                       |   | $                      | 41,329,330 |                                      | $ |                     |   | $                                                | (1,064,031 | )                             | $ | (45,825,210 | ) | $ | (138,422 | ) | $ | (5,668,932 | )
|Foreign currency translation adjustment                              |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                               |   |            |   |   | 400,500  |   |   | 400,500    |  
|Net loss                                                             |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                               |   | (2,644,547  | ) |   |         |   |   | (2,644,547 | )
|Total comprehensive loss                                             |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                               |   |            |   |   |         |   |   | (2,244,047 | )
|Stock Certificate Cancellation                                       |  |                       | (260,000   | )      |   | (260                         | ) |                        | (97,240    | )                                    |   |                      |   |                                                  | 97,500     |                               |   |            |   |   |         |   |   | 97,500     |  
|Issuance of common stock in private Placement, net of issuance costs |  |                       | 6,397,713  |        |   | 6,398                        |   |                        | 1,813,602  |                                      |   |                      |   |                                                  |           |                               |   |            |   |   |         |   |   | 1,820,,000 |  
|Issuance of warrants to investors                                    |  |                       |           |        |   |                             |   |                        | 45,000     |                                      |   |                      |   |                                                  |           |                               |   |            |   |   |         |   |   | 45,000     |  
|Issuance of shares and warrants to vendors                           |  |                       | 300,000    |        |   | 300                          |   |                        | 158,450    |                                      |   | (118,736             | ) |                                                  |           |                               |   |            |   |   |         |   |   | 40,014     |  
|                                                                     |  |                       |            |        |   |                              |   |                        |            |                                      |   |                      |   |                                                  |            |                               |   |             |   |   |          |   |   |            |  
|Compensation expense associated with unvested option awards          |  |                       |           |        |   |                             |   |                        | 51,868     |                                      |   |                      |   |                                                  |           |                               |   |            |   |   |         |   |   | 17,988     |  
|                                                                     |  |                       |            |        |   |                              |   |                        |            |                                      |   |                      |   |                                                  |            |                               |   |             |   |   |          |   |   |            |  
|Balance at December 31, 2008                                         |  |                       | 35,838,351 |        |   | 35,839                       |   |                        | 43,301,010 |                                      |   | (118,736             | ) |                                                  | (966,531   | )                             |   | (48,469,757 | ) |   | 262,078  |   |   | (5,956,097 | )
|                                                                     |  |                       |            |        |   |                              |   |                        |            |                                      |   |                      |   |                                                  |            |                               |   |             |   |   |          |   |   |            |  
|Foreign currency translation adjustment                              |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                               |   |            |   |   | (115,494 | ) |   | (115,494   | )
|Net loss                                                             |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                               |   | (2,070,598  | ) |   |         |   |   | (2,070,598 | )
|Total comprehensive loss                                             |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                               |   |            |   |   |         |   |   | (2,186,093 | )
|Issuance of common stock in private Placement, net of issuance costs |  |                       | 7,514,728  |        |   | 7,514                        |   |                        | 1,975,244  |                                      |   |                      |   |                                                  |           |                               |   |            |   |   |         |   |   | 1,982,758  |  
|Reserve accrued interest                                             |  |                       |           |        |   |                             |   |                        |           |                                      |   |                     |   |                                                  | 176,322    |                               |   |            |   |   |         |   |   | 176,322    |  
|Issuance of shares and warrants to vendors                           |  |                       | 17,856     |        |   | 18                           |   |                        | 94,232     |                                      |   | 118,736              |   |                                                  |           |                               |   |            |   |   |         |   |   | 212,986    |  
|Compensation expense associated with unvested option awards          |  |                       |            |        |   |                              |   |                        | 36,851     |                                      |   |                      |   |                                                  |            |                               |   |             |   |   |          |   |   | 36,851     |  
|Balance at December 31, 2009                                         |  |                       | 43,370,935 |        | $ | 43,371                       |   | $                      | 45,407,337 |                                      | $ |                     |   | $                                                | (790,209   | )                             | $ | (50,540,355 | ) | $ | 146,584  |   | $ | (5,733,272 | )

See accompanying notes to consolidated financial statements.

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Table of Contents

Puradyn Filter Technologies Incorporated 
Consolidated Statements of Cash Flows

|                                                                               |  |                           |            |      |   |            |  
|------------------------------------------------------------------------------ |  | ------------------------- | ---------- | ---- | - | ---------- | -
|                                                                               |  | Years Ended
 December 31, |           
|                                                                               |  | 2009                      |            | 2008 |  
|Operating activities                                                           |  |                           |            |      |   |            |  
|Net loss                                                                       |  | $                         | (2,070,598 | )    | $ | (2,644,547 | )
|Adjustments to reconcile net loss to net cash used in operating
 activities:   |  |                           |            |      |   |            |  
|Depreciation and amortization                                                  |  |                           | 38,593     |      |   | 61,301     |  
|Provision for bad debts                                                        |  |                           | 13,801     |      |   | 50,421     |  
|Provision for obsolete and slow moving inventory                               |  |                           | 81,125     |      |   | 43,235     |  
|Amortization of deferred financing costs included in interest expense          |  |                           | 4,393      |      |   | 10,103     |  
|Interest receivable from stockholders notes                                   |  |                           | 176,321    |      |   |           |  
|Deferred Compensation                                                          |  |                           | 118,736    |      |   | (118,736   | )
|Compensation expense on stock-based arrangements with vendors                  |  |                           |           |      |   | 158,450    |  
|Compensation expense on stock-based arrangements with employees and
 investors |  |                           | 131,084    |      |   | 97,168     |  
|Loss on disposal of fixed assets                                               |  |                           |           |      |   | (1,850     | )
|Changes in operating assets and liabilities:                                   |  |                           |            |      |   |            |  
|Accounts receivable                                                            |  |                           | 71,786     |      |   | 149,198    |  
|Inventories                                                                    |  |                           | 405,115    |      |   | 94,836     |  
|Prepaid expenses and other current assets                                      |  |                           | 69,463     |      |   | (2,890     | )
|Other noncurrent assets                                                        |  |                           | 205        |      |   |           |  
|Accounts payable                                                               |  |                           | (128,613   | )    |   | (288,727   | )
|Accrued liabilities                                                            |  |                           | (218       | )    |   | 94,465     |  
|Deferred revenues                                                              |  |                           | (47,312    | )    |   | (15,522    | )
|Net cash used in operating activities                                          |  |                           | (1,136,119 | )    |   | (2,313,095 | )
|Investing activities                                                           |  |                           |            |      |   |            |  
|Purchases of property and equipment                                            |  |                           | (49,260    | )    |   | (24,091    | )
|Net cash used in investing activities                                          |  |                           | (49,260    | )    |   | (24,091    | )
|Financing activities                                                           |  |                           |            |      |   |            |  
|Proceeds from sale of common stock (net)                                       |  |                           | 1,982,776  |      |   | 1,820,000  |  
|Proceeds from notes payable to stockholders                                    |  |                           | 355,713    |      |   | 117,702    |  
|Payment of notes payable to stockholder                                        |  |                           | (1,013,000 | )    |   |           |  
|Payment of capital lease obligations                                           |  |                           | (1,879     | )    |   | (1,048     | )
|Net cash provided by financing activities                                      |  |                           | 1,323,610  |      |   | 1,936,654  |  
|Effect of exchange rate changes on cash and cash equivalents                   |  |                           | 115,494    |      |   | 405,064    |  
|Net increase in cash and cash equivalents                                      |  |                           | 23,464     |      |   | 4,532      |  
|Cash and cash equivalents at beginning of period                               |  |                           | 116,802    |      |   | 112,270    |  
|Cash and cash equivalents at end of period                                     |  | $                         | 140,266    |      | $ | 116,802    |  
|Supplemental cash flow information                                             |  |                           |            |      |   |            |  
|Cash paid for interest                                                         |  | $                         | 147,871    |      | $ | 285,093    |  
|Cash paid for taxes                                                            |  | $                         |           |      | $ |           |  
|Noncash investing and financing activities                                     |  |                           |           |      |   |           |  
|Stock options issued in lieu of compensation                                   |  | $                         | 55,010     |      | $ | 158,450    |  
|See
 accompanying notes to consolidated financial statements.                 

Puradyn Filter Technologies Incorporated


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Table of Contents

Notes to Consolidated Financial Statements

December 31, 2009

1. Significant Accounting Policies

Organization

Puradyn Filter Technologies Incorporated (the Company), a Delaware
corporation, is engaged in the manufacturing, distribution and sale of bypass
oil filtration systems under the trademark Puradyn® primarily to
companies with large fleets of vehicles and secondarily to original vehicle
equipment manufacturer aftermarket programs. The Company holds the exclusive
worldwide manufacturing and marketing rights for the Puradyn products pursuant
to licenses for two patents and through direct ownership of various other
patents.

Puradyn Filter Technologies, Ltd. (Ltd.), a wholly owned subsidiary in
the United Kingdom, sells and distributes the Companys products in Europe, the
Middle East and certain African countries. The results of the operations of
Ltd. have been included in the Companys statements of operations since Ltd.s
formation on June 1, 2000.

New Accounting Pronouncements

In June 2009, the FASB issued FASB ASC 860 Accounting for Transfers of
Financial Assets. FASB ASC 860 improves the relevance, representational
faithfulness, and comparability of the information that a reporting entity
provides in its financial statements about a transfer of financial assets; the
effects of a transfer on its financial position, financial performance, and
cash flows; and a transferors continuing involvement, if any, in transferred
financial assets. FASB ASC 860 is effective as of the beginning of each reporting
entitys first annual reporting period that begins after November 15, 2009, for
interim periods within that first annual reporting period and for interim and
annual reporting periods thereafter. The Company is evaluating the impact the
adoption of FASB ASC 860 will have on its financial statements.

In June 2009, the FASB issued FASB ASC 810 Consolidations. FASB ASC
810 is effective as of the beginning of each reporting entitys first annual
reporting period that begins after November 15, 2009, for interim periods
within that first annual reporting period, and for interim and annual reporting
periods thereafter. The Company is evaluating the impact the adoption of FASB
ASC 810 will have on its financial statements.

In June 2009, the FASB issued FASB ASC 105 GAAP. The FASB Accounting
Standards Codification (Codification) will be the single source of
authoritative nongovernmental U.S. generally accepted accounting principles.
Rules and interpretive releases of the SEC under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants. ASC 105 is
effective for interim and annual periods ending after September 15, 2009. All
existing accounting standards are superseded as described in ASC 105. All other
accounting literature not included in the Codification is nonauthoritative. The
Company has updated references accordingly and it has no affect on the
financial position or results of operation.

In October 2009, the FASB issued Accounting Standards Update (ASU)
Number 2009-13, Revenue Recognition (ASC 605) Multiple-Deliverable Revenue
Arrangements a consensus of the FASB Emerging Issues Task Force. This ASU
establishes a new selling price hierarchy to use when allocating the sales
price of a multiple element arrangement between delivered and undelivered
elements. This ASU is generally expected to result in revenue recognition for
more delivered elements than under current rules and is required to be adopted
prospectively for new or materially modified agreements as of January 1, 2011.
The Company is evaluating the impact of this ASU, but does not expect adoption
to have a material impact on its financial statements.

In January 2010, the Financial Accounting Standards Board (FASB)
issued amendments to the accounting guidance on noncontrolling interests in
consolidated financial statements. This accounting guidance clarifies that the
scope of the decrease in ownership provisions of the original guidance applies
to (1) a subsidiary or group of assets that is a business, (2) a subsidiary
that is a business and is transferred to an equity method investee or joint
venture and (3) an exchange of a group of assets that constitutes a business
for a noncontrolling interest in an entity (including an equity method investee
or joint venture). This accounting guidance also clarifies that the decrease in
ownership provisions of the original guidance does not apply to sales of in
substance real estate, even if they involve businesses. The accounting guidance
expands the disclosures

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Table of Contents

about the deconsolidation of a subsidiary or derecognition of a group
of assets. For entities that have previously adopted the accounting guidance on
noncontrolling interests in consolidated financial statements, this accounting
guidance is effective beginning in the first annual or interim reporting period
ending on or after December 15, 2009 and should be applied retrospectively to
the first period in which the original guidance was adopted. The adoption and
retrospective application of this accounting guidance did not have a material
impact on our financial statements.

Principles of Consolidation

The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiary, Puradyn Filter Technologies, Ltd. All
significant intercompany transactions and balances have been eliminated.

Revenue Recognition

The Company recognizes revenue from product sales to customers,
distributors and resellers when products that do not require further services
or installation by the Company are shipped, when there are no uncertainties
surrounding customer acceptance and when collectability is reasonably assured
in accordance with FASB ASC 605, Revenue
Recognition, as amended and interpreted. Cash received by the
Company prior to shipment is recorded as deferred revenue. Sales are made to
customers under terms allowing certain limited rights of return and other
limited product and performance warranties for which provision has been made in
the accompanying condensed consolidated financial statements.

Amounts billed to customers in sales transactions related to shipping
and handling, represent revenues earned for the goods provided and are included
in net sales. Costs of shipping and handling are included in cost of products
sold.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents include all highly liquid investments with
original maturities of three months or less at the time of purchase. At
December 31, 2009 and December 31, 2008, the Company did not have any cash
equivalents.

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable,
prepaid expenses and other assets, accounts payable, accrued liabilities and
notes payable to stockholder approximate their fair values as of December 31,
2009 and December 31, 2008, respectively, because of their short-term natures.

Accounts Receivable

Accounts receivable are recorded at fair value on the date revenue is
recognized. The Company provides allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to repay their obligation.
If the financial condition of the Companys customers were to deteriorate,
resulting in an impairment of their ability to repay, additional allowances may
be required. The Company provides for potential uncollectible accounts
receivable based on specific customer identification and historical collection
experience adjusted for existing market conditions. If market conditions
decline, actual collection experience may not meet expectations and may result
in decreased cash flows and increased bad debt expense.

The policy for determining past due status is based on the contractual
payment terms of each customer, which are generally net 30 or net 60 days. Once
collection efforts by the Company and its collection agency are exhausted, the
determination for charging off uncollectible receivables is made.

Inventories

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Inventories are stated at the lower of cost or market using the first
in, first out (FIFO) method. Production costs, consisting of labor and
overhead, are applied to ending finished goods inventories at a rate based on
estimated production capacity. Excess production costs are charged to cost of
products sold. Provisions have been made to reduce excess or obsolete
inventories to their net realizable value.

Deferred Financing Costs

The Company capitalizes financing costs and amortizes them using the
effective interest method over the term of the related debt. Amortization of
deferred financing costs is included in interest expense and totaled $4,392 and
$10,103 for the years ended December 31, 2009 and 2008, respectively.
Accumulated amortization of deferred financing costs as of December 31, 2009
and December 31, 2008 was $677,123 and $672,731, respectively.

Property and Equipment

Property and equipment are stated at cost. Depreciation and
amortization are provided using the straight-line method over the estimated
useful lives of the related assets, except for assets held under capital
leases, for which the Company records depreciation and amortization based on
the shorter of the assets useful life or the term of the lease. The estimated
useful lives of property and equipment range from 3 to 5 years. Upon sale or
retirement, the cost and related accumulated depreciation and amortization are
eliminated from their respective accounts, and the resulting gain or loss is
included in results of operations. Repairs and maintenance charges, which do
not increase the useful lives of the assets, are charged to operations as
incurred.

Impairment of Long-Lived Assets

Management assesses the recoverability of its long-lived assets when
indicators of impairment are present. If such indicators are present,
recoverability of these assets is determined by comparing the undiscounted net
cash flows estimated to result from those assets over the remaining life to the
assets net carrying amounts. If the estimated undiscounted net cash flows are
less than the net carrying amount, the assets would be adjusted to their fair
value, based on appraisal or the present value of the undiscounted net cash
flows.

Product Warranty Costs

As required by FASB ASC 460, Guarantees,
the Company is including the following disclosure applicable to its product
warranties.

The Company accrues for warranty costs based on the expected material
and labor costs to provide warranty replacement products. The methodology used
in determining the liability for warranty cost is based upon historical
information and experience. The Companys warranty reserve is calculated as the
gross sales multiplied by the historical warranty expense return rate.

The following table shows the changes in the aggregate product warranty
liability for the year ended December 31, 2009 and December 31, 2008,
respectively:

|                                              |  |                   |          |                   |   |         |  
|--------------------------------------------- |  | ----------------- | -------- | ----------------- | - | ------- | -
|                                              |  | December 31, 2009 |          | December 31, 2008 |  
|Balance as
 of beginning of year              |  | $                 | 148,149  |                   | $ | 89,809  |  
|Less:
 Payments made                          |  |                   | (7,050   | )                 |   | (20,674 | )
|Change in
 prior period estimate              |  |                   | (108,533 | )                 |   |        |  
|Add:
 Provision for current period warranties |  |                   | 7,434    |                   |   | 79,014  |  
|Balance as
 of end of year                    |  | $                 | 40,000   |                   | $ | 148,149 |  

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GuaranteesNone

Comprehensive Income

FASB ASC 220, Comprehensive Income,
establishes rules for reporting and displaying of comprehensive income and its
components. Comprehensive income is the sum of net loss as reported in the
consolidated statements of operations and other comprehensive income
transactions Other comprehensive income transactions that currently apply to
the Company result from changes in exchange rates used in translating the
financial statements of its wholly owned subsidiary, Ltd. Comprehensive income
as of December 31, 2009 and 2008 is not shown net of taxes because the
Companys deferred tax asset has been fully offset by a 100% valuation
allowance.

Advertising Costs

Advertising costs are expensed as incurred. During the years ended
December 31, 2009 and 2008, advertising costs incurred by the Company totaled
approximately $10,000 and $8,000, respectively, and are included in selling and
administrative expenses in the accompanying consolidated statements of
operations.

Engineering and Development

Engineering and development costs are expensed as incurred. During the
years ended December 31, 2009 and 2008, engineering and development costs
incurred by the Company totaled approximately $41,000 and $18,000,
respectively, and are included in selling and administrative expenses in the
accompanying consolidated statements of operations.

Foreign Currency Translation

The financial statements of the Companys foreign subsidiary have been
translated into U.S. dollars in accordance with FASB ASC 830, Foreign Currency Matters.All balance
sheet accounts have been translated using the exchange rate in effect at the
balance sheet date. Income statement amounts have been translated using an
appropriately weighted average exchange rate for the year. The translation
gains and losses resulting from the changes in exchange rates during 2009 and
2008 have been reported in accumulated other comprehensive income, except for
gains and losses resulting from the translation of intercompany receivables and
payables, which are included in earnings for the period. During the years ended
December 31, 2009 and 2008, the Company recorded a foreign currency exchange
rate gains and losses of approximately $121,000 and approximately $535,000,
respectively, which is included in selling and administrative expenses in the
accompanying consolidated statements of operations.

Income Taxes

The Company accounts for income taxes under FASB ASC 740, Income Taxes. Deferred income tax assets
and liabilities are determined based upon differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.

Stock Option Plans

We adopted FASB ASC 718, Compensation-Stock
Compensation, effective January 1, 2006 using the modified prospective
application method of adoption which requires us to record compensation cost
related to unvested stock awards as of December 31, 2005 by recognizing the
amortized grant date fair value in accordance with provisions of FASB ASC 718
on straight line basis over the service periods of each award. We have
estimated forfeiture rates based on our historical experience. Stock option
compensation expense for the year ended December 31, 2009 has been recognized
as a component of cost of goods sold and general and administrative expenses in
the accompanying Consolidated Financial Statements.In 2009 and 2008,
respectively, 334,575 and 772,500 options were granted at fair market value on
the date of grant pursuant to the Stock Option Plan.

The Company leases its employees from a payroll leasing company. The
Companys leased employees meet the definition of employees as specified by FIN
44 for purposes of applying FASB ASC 718.

Stock options and warrants issued to consultants and other
non-employees as compensation for services provided to the Company are
accounted for based on the fair value of the services provided or the estimated
fair market value of the option or warrant, whichever is more reliably
measurable in accordance with FASB ASC 505, Equity,and FASB ASC 718, Compensation-Stock Compensation,
including related amendments and interpretations. The related expense is
recognized over the period the services are provided.

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Credit Risk

The Company minimizes the concentration of credit risk associated with its
cash and cash equivalents by maintaining its cash and cash equivalents with
high quality federally insured financial institutions. However, cash balances
in excess of the FDIC insured limit of $250,000 are at risk. At December 31,
2009 and December 31, 2008, respectively, the Company did not have cash
balances above the FDIC insured limit. The Company performs ongoing evaluations
of its significant trade accounts receivable customers and generally does not
require collateral. An allowance for doubtful accounts is maintained against
trade accounts receivable at levels which management believes is sufficient to
cover probable credit losses. There are concentrations of credit risk with
respect to trade receivables due to the amounts owed by four customers at
December 31, 2009 whose trade receivable balances each represented
approximately 22%, 19%, 13%, and 12% for a total of 66% of total accounts
receivable. There are concentrations of credit risk with respect to trade
receivables due to the amounts owed by four customers at December 31, 2008
whose trade receivable balances each represented approximately 29%, 12%, 10%,
and 6% for a total of 57% of total accounts receivable. The loss of business
from one or a combination of the Companys significant customers, or an
unexpected deterioration in their financial condition, could adversely affect
the Companys operations.

Basic and Diluted Loss Per Share

FASB ASC 260, Earnings per Share,
requires a dual presentation of basic and diluted earnings per share. However,
because of the Companys net losses, the effects of stock options and warrants
would be anti-dilutive and, accordingly, are excluded from the computation of
earnings per share. The number of such shares excluded from the computations of
diluted loss per share totaled 6,336,100 in 2009 and 4,981,972 in 2008.

Reclassifications

Certain prior year amounts have been reclassified to conform to the
current year presentation.

2. Issues Affecting Liquidity and
Managements Plans

The Companys financial statements
have been prepared on the basis that it will operate as a going concern, which
contemplates the realization of assets and satisfaction of liabilities in the
normal course of business. The Company has incurred net losses each year since
inception and has relied on the sale of its stock from time to time and loans
from third parties and from related parties to fund its operations.

These recurring operating losses, liabilities exceeding assets and the
reliance on cash inflows from an institutional investor and current stockholder
have led the Companys independent registered public accounting firm Webb &
Company to include a statement in its audit report relating to the Companys
audited consolidated financial statements for the year ended December 31, 2009
expressing substantial doubt about the Companys ability to continue as a going
concern.

The Company has been addressing the liquidity and working capital
issues and continues to attempt to raise additional capital with institutional
and private investors and current stockholders. Cost reductions were and
continue to be implemented by the Company, including acquiring alternative
suppliers for raw materials and volume purchase discounts when appropriate, and
the company expects to see results from these reductions, as well as other cost
reduction plans through 2010.

Additionally, we continue to address liquidity concerns because of
inadequate revenue growth. As a result, cash flow from operations is
insufficient to cover our liquidity needs for the immediate future. The Company
is in the process of aggressively seeking to raise capital and is exploring
financing availability and options with investment bankers, funds, private
sources, members of management and existing shareholders. The Company has implemented
further measures to preserve its ability to operate, including organizational
changes, deferral of salaries, reduction in personnel and renegotiating
creditor and collection arrangement. There can be no assurance that the Company
will be able to raise the additional capital needed or reduce the level of
expenditures in order to sustain operations.

The Company has sustained losses since inception in 1987 and used net
cash in operations of approximately $1,136,000 and $2,313,000 during the years
ended December 31, 2009 and 2008, respectively. As a result, the Company has
had to rely principally on private equity funding, including the conversion of
debt into stock, as well as stockholder loans to fund its activities to date.

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Table of Contents

On February 2, 2004, the stockholder amended the original loan
agreements to extend the maturity dates to December 31, 2005 and to waive the
funding requirement mandating maturity terms until such time as the Company has
raised an additional $7.0 million over the $3.5 million raised in the Companys
recent private placement offering; or until such time as the Company is
operating within sufficient cash flow parameters, as defined, to sustain its
operations; or until a disposition of the Company occurs.

In April 2005, the maturity date of the loan agreement was extended to
December 31, 2006. As consideration of this extension, this stockholder was
granted an additional 100,000 common stock purchase warrants at an exercise
price equal to the closing market price of the Companys stock on the date of
grant. In March of 2006 and in subsequent Marchs through 2010, the stockholder
extended the maturity date of the loan agreement annually, which currently
expires on December 31, 2011.

The Company experienced a decrease in cash used in operations in 2009
and anticipates this will continue to decrease in 2010; however, additional
cash will still be needed to support operations. Management believes that the
commitments received from its stockholder, the funds received from its recent current
private placement offering, as well as cash from sales and current working
capital will be sufficient to sustain its operations at its current level
through July 2010. However, if budgeted sales levels are not achieved and/or
significant unanticipated expenditures occur, the Company may have to modify
its business plan, reduce or discontinue some of its operations or seek a buyer
for all or part of its assets to continue as a going concern through 2010.
There can be no assurance that the Company will be able to raise the additional
capital needed to continue as a going concern.

3. Inventories

At December 31, 2009 and December 31, 2008 inventories consisted of the
following:

|                     |  |                   |          |                   |   |           |  
|-------------------- |  | ----------------- | -------- | ----------------- | - | --------- | -
|                     |  | December 31, 2009 |          | December 31, 2008 |  
|                    
|Raw
 materials       |  | $                 | 942,135  |                   | $ | 946,429   |  
|Finished
 goods      |  |                   | 68,164   |                   |   | 505,039   |  
|Valuation
 allowance |  |                   | (159,230 | )                 |   | (114,159  | )
|                     |  | $                 | 851,069  |                   | $ | 1,337,309 |  

4.
Prepaid Expenses and Other Current Assets

At December 31, 2009 and December 31, 2008, prepaid expenses and other
current assets consisted of the following:

|                                            |  |                   |         |                   |   |         | 
|------------------------------------------- |  | ----------------- | ------- | ----------------- | - | ------- | 
|                                            |  | December 31, 2009 |         | December 31, 2008 |  
|                                           
|Prepaid
 expenses                           |  | $                 | 72,289  |                   | $ | 117,746 | 
|Deferred
 costs related to deferred revenue |  |                   | 42,785  |                   |   | 66,791  | 
|                                            |  | $                 | 115,074 |                   | $ | 184,537 | 

5. Property and Equipment

At December 31, 2009 and December 31, 2008, property and equipment
consisted of the following:

|                                                |  |                   |            |                   |   |            |  
|----------------------------------------------- |  | ----------------- | ---------- | ----------------- | - | ---------- | -
|                                                |  | December 31, 2009 |            | December 31, 2008 |  
|                                               
|Machinery
 and equipment                        |  | $                 | 977,129    |                   | $ | 977,183    |  
|Furniture
 and fixtures                         |  |                   | 54,870     |                   |   | 54,870     |  
|Leasehold
 improvements                         |  |                   | 122,622    |                   |   | 122,622    |  
|Website
 development                            |  |                   | 72,960     |                   |   | 72,960     |  
|Computer
 hardware and software                 |  |                   | 101,651    |                   |   | 93,929     |  
|                                                |  |                   | 1,329,232  |                   |   | 1,321,564  |  
|Less
 accumulated depreciation and amortization |  |                   | (1,196,376 | )                 |   | (1,198,649 | )
|                                                |  | $                 | 132,856    |                   | $ | 122,915    |  

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Table of Contents

Depreciation and amortization expense of property and equipment for the
years ended December 31, 2009 and 2008 is approximately $38,593 and $61,301,
respectively, of which approximately $9,000 and $12,000 is included in cost of
products sold and approximately $30,000 and $49,000 is included in selling and
administrative costs, respectively, in the accompanying consolidated statements
of operations.

6. Leases

The Company leases its office and warehouse facilities in Boynton
Beach, Florida under a long-term non-cancellable lease agreement, which
contains renewal options and rent escalation clauses. A $235,000 security
deposit was paid in 2002, which was refunded ratably on an annual basis over
the first three years of the lease term beginning on the last day of the first
lease year, provided there has been no Event of Default, as defined, by the
Company. Of this amount, $66,667 was paid to the Company in November 2003,
January 2005 and January 2006, respectively. As of December 31, 2009, $29,275
is included in noncurrent assets in the accompanying consolidated balance
sheet. During 2008, this lease was renewed effective August 1, 2008 and expires July 31, 2013 and
contains an annual increase of 3%. During June 2009, an amendment to the lease
agreement was reached, temporarily reducing the monthly rent. The total minimum
lease payments over the term of the lease was reduced from an aggregate of
approximately $956,000 to approximately $925,000, or approximately 3%.

The Company leased a condominium in Ocean Ridge, Florida to provide
accommodations for Company use, primarily for Mr. Kevin Kroger, the Companys
Chief Operating Officer. The lease expense of $6,750, 95% of which is allocated
to Mr. Kroger, based on usage, expired on December 31, 2008 and was not renewed
until December, 2009, effective beginning January 1, 2010.

The Companys wholly owned subsidiary, Ltd., rented office space in
Devon, England under a lease that extended through March 31, 2002 and was
subsequently extended on a month-to-month basis. In September 2003, Ltd. moved
to new office space by assuming the existing lease, which expired in August
2004, was renegotiated in September 2005 and expires in September 2010, but
contained a cancellation clause, which was exercised during 2008. Effective August
15, 2008, the Companys lease for the facility in Exeter was terminated and the
Company relocated its office from Exeter to Newbury, to the facility of its
Master Distributor, Filter Solutions Ltd. In March, 2009, all remaining assets
from that facility, including inventory, was returned to our Boynton Beach
facility.

Rent expense under all operating leases for the years ended December
31, 2009 and 2008 totaled approximately $288,000 and $282,000, respectively, of
which approximately $226,000 and $214,000 is included in cost of products sold
and approximately $62,000 and $68,000 is included in selling and administrative
costs, respectively, in the accompanying consolidated statements of operations.

In May 2007, the Company entered into a capital lease obligation for
the purchase of approximately $8,525 of office equipment, which is included in
property and equipment, net of approximately $1,705 of accumulated
amortization, in the accompanying consolidated balance sheet.

Future minimum lease commitments due for facilities and equipment
leases under non-cancellable capital and operating leases at December 31, 2009
are as follows:

|                                         |  |                |        |                    |   |         | 
|---------------------------------------- |  | -------------- | ------ | ------------------ | - | ------- | 
|                                         |  | Capital Leases |        | Operating 
 Leases |  
|2010                                     |  | $              | 5,445  |                    |   | 186,457 | 
|2011                                     |  |                | 2,269  |                    |   | 192,054 | 
|2012                                     |  |                |       |                    |   | 197,812 | 
|2013                                     |  |                |       |                    |   | 117,383 | 
|2014 and
 thereafter                     |  |                |       |                    |   |        | 
|Total
 minimum lease payments            |  |                | 7,714  |                    | $ | 693,706 | 
|Less amount
 representing interest       |  |                | (2,454 | )                  |   |         | 
|Present
 value of minimum lease payments |  | $              | 5,260  |                    |   |         | 

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Table of Contents

Future minimum lease commitments due for facilities and equipment
leases under non-cancellable capital and operating leases at December 31, 2008
are as follows:

|                                         |  |                |        |                    |   |         | 
|---------------------------------------- |  | -------------- | ------ | ------------------ | - | ------- | 
|                                         |  | Capital Leases |        | Operating 
 Leases |  
|2009                                     |  | $              | 5,479  |                    | $ | 184,151 | 
|2010                                     |  |                | 5,479  |                    |   | 189,675 | 
|2011                                     |  |                | 2,283  |                    |   | 192,046 | 
|2012                                     |  |                |       |                    |   | 197,807 | 
|2013 and
 thereafter                     |  |                |       |                    |   | 117,382 | 
|Total
 minimum lease payments            |  |                | 13,241 |                    | $ | 955,556 | 
|Less amount
 representing interest       |  |                | (6,102 | )                  |   |         | 
|                                         |  |                |        |                    |   |         | 
|Present
 value of minimum lease payments |  | $              | 7,139  |                    |   |         | 

7. Accrued Liabilities

At December
31, 2009 and December 31, 2008, accrued liabilities consisted of the following:

|                                                        |  |                   |           |                   |   |           | 
|------------------------------------------------------- |  | ----------------- | --------- | ----------------- | - | --------- | 
|                                                        |  | December 31, 2009 |           | December 31, 2008 |  
|Accrued
 wages and benefits                             |  | $                 | 918,788   |                   | $ | 862,347   | 
|Accrued
 expenses relating to vendors and others        |  |                   | 212,785   |                   |   | 84,326    | 
|Accrued
 warranty costs                                 |  |                   | 40,000    |                   |   | 148,149   | 
|Accrued
 interest payable relating to stockholder notes |  |                   | 53,656    |                   |   | 53,714    | 
|                                                        |  | $                 | 1,148,318 |                   | $ | 1,148,536 | 

8. Long-Term Debt

Notes Payable to
Stockholder

Beginning on March 28, 2002 the Company executed a binding agreement
with one of its stockholders, who is also a Board member, to fund up to $6.1
million. Under the terms of the agreements, the Company can draw amounts as
needed to fund operations. Amounts drawn bear interest at the prime rate per
annum (2.45% at December 31, 2009), payable monthly and were to become due and
payable on December 31, 2005 or upon a change in control of the Company or
consummation of any other financing over $7.0 million. Beginning In March 2006,
annually, through March, 2010, the maturity date for the agreement was extended
annually from December 31, 2007, to December 31, 2011.

At December 31, 2009 and December 31, 2008, respectively, the Company
had drawn approximately $5.7 and all of the available $6.1 million of available
funds together with an additional $167,000.

Additionally, the Company has loans outstanding from one board member
totaling $25,000 and $100,000 at December 31, 2009 and December 31, 2008,
respectively.

In April 2005, the maturity date of the stockholder loan agreement was
extended from December 31, 2005 to December 31, 2006. As consideration of this
extension, this stockholder was granted an additional 100,000 common stock
purchase warrants at an exercise price equal to the closing market price of the
Companys stock on the date of grant, for a period of five years.

During the years ended December 31, 2009 and 2008, the Company incurred
interest expense of approximately $148,000 and $283,000, respectively, on its
draws, which is included in interest expense in the accompanying consolidated
statements of operations.

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Table of Contents

Maturities of
Long-Term Obligations for Five Years and Beyond

Long-term obligations consisted of the following at December 31, 2009
and December 31, 2008:

|                              |  |                   |           |                   |   |           |  
|----------------------------- |  | ----------------- | --------- | ----------------- | - | --------- | -
|                              |  | December 31, 2009 |           | December 31, 2008 |  
|Notes
 payable to stockholder |  | $                 | 5,710,414 |                   | $ | 6,367,702 |  
|Capital
 lease obligation     |  |                   | 5,260     |                   |   | 7,139     |  
|                              |  |                   | 5,715,674 |                   |   | 6,374,841 |  
|Less:
 current maturities     |  |                   | (3,271    | )                 |   | (1,859    | )
|                              |  | $                 | 5,712,403 |                   | $ | 6,372,982 |  

The minimum annual principal payments of notes payable and capital
lease obligations at December 31, 2009 and December 31, 2008 were:

|     |  |                   |           |                   |   |           | 
|---- |  | ----------------- | --------- | ----------------- | - | --------- | 
|     |  | December 31, 2009 |           | December 31, 2008 |  
|2009 |  | $                 |          |                   | $ | 1,859     | 
|2010 |  |                   | 3,271     |                   |   | 6,370,972 | 
|2011 |  |                   | 5,712,403 |                   |   | 2,010     | 
|2012 |  |                   |          |                   |   |          | 
|     |  | $                 | 5,715,674 |                   | $ | 6,374,841 | 

9. Income Taxes

The United States and foreign components of loss from continuing
operations before income taxes are as follows for the years ended December 31:

|                                                     |  |      |            |      |   |            |  
|---------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                     |  | 2009 |            | 2008 |  
|                                                     |  |      |            |      |  
|United
 States                                       |  | $    | (2,203,482 | )    | $ | (2,043,434 | )
|Foreign                                              |  |      | 132,884    |      |   | (601,114   | )
|                                                     |  |      |            |      |   |            |  
|Intercompany
 elimination                            |  |      |           |      |   |           |  
|                                                     |  |      |            |      |   |            |  
|Loss from
 continuing operations before income taxes |  | $    | (2,070,598 | )    | $ | (2,644,548 | )

The significant components of the Companys net deferred tax assets are
as follows for the years ended December 31:

|                                        |  |      |             |      |   |             |  
|--------------------------------------- |  | ---- | ----------- | ---- | - | ----------- | -
|                                        |  | 2009 |             | 2008 |  
|                                        |  |      |             |      |   |             |  
|Deferred tax
 assets:                   |  |      |             |      |   |             |  
|                                       
|Net operating loss carryforwards        |  | $    | 15,699,664  |      | $ | 14,854,359  |  
|Depreciation and amortization           |  |      | 75,307      |      |   | 84,998      |  
|Accrued expenses and reserves           |  |      | 86,054      |      |   | 93,225      |  
|Impairment loss                         |  |      | 78,304      |      |   | 78,304      |  
|Compensatory stock options and warrants |  |      | 76,871      |      |   | 76,871      |  
|Capital Loss Carryover                  |  |      | 44,739      |      |   | 42,686      |  
|Other                                   |  |      | 18,544      |      |   | 17,872      |  
|Total
 deferred tax assets              |  |      | 16,079,483  |      |   | 15,248,315  |  
|Valuation
 allowance                    |  |      | (16,079,483 | )    |   | (15,248,315 | )
|Net deferred
 tax assets                |  | $    |            |      | $ |            |  

FASB ASC 740, Income Taxes,requires
a valuation allowance to reduce the deferred tax assets reported if, based on
the weight of the evidence, it is more likely than not that some portion or all
of the deferred tax assets will not be realized. After consideration of all the
evidence, both positive and negative, management has determined that a full
valuation allowance of $16,079,483 and $15,248,315 against its net deferred
taxes is necessary as of December 31, 2009 and December 31, 2008,

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Table of Contents

respectively. The change in valuation allowance for the years ended
December 31, 2009 and 2008 is $830,168 and $755,036 respectively.

At December 31, 2009 and December 31, 2008, respectively, the Company
had approximately $43,073,510 and $40,860,651, respectively, of U.S. net
operating loss carryforwards remaining, which expire beginning in 2016. The
Company will record the benefit of approximately $1,352,373 of the net
operating loss carryforwards through additional paid-in capital if and when the
net operating loss carryforwards are utilized, as such amounts relate to the
unrecognized tax benefit from stock option exercises.

As a result of certain ownership changes, the Company may be subject to
an annual limitation on the utilization of its U.S. net operating loss
carryforwards pursuant to Section 382 of the Internal Revenue Code. A study to
determine the effect, if any, of this change, has not been undertaken.

A reconciliation of the Companys income taxes to amounts calculated at
the federal statutory rate is as follows for the years ended December 31:

|                                                |  |      |        |      |  |        |   
|----------------------------------------------- |  | ---- | ------ | ---- |  | ------ | --
|                                                |  | 2009 |        | 2008 | 
|Federal
 statutory taxes                        |  |      | (34.00 | )%   |  | (34.00 | )%
|State income
 taxes, net of federal tax benefit |  |      | (3.63  | )    |  | (3.63  | ) 
|Nondeductible
 items                            |  |      | 0.09   |      |  | 0.12   |   
|Change in
 valuation allowance                  |  |      | 37.68  |      |  | 37.59  |   
|Other                                           |  |      | (.14   | )    |  | (.12   | ) 
|                                                |  |      |       | %    |  |       | % 

10. Commitments and Contingencies

Agreements

On October 1, 2008, the Company entered into a one-year, non-exclusive
agreement with Emerging Markets Consulting LLC (EMC) for investor relation
services. The Company agreed to pay 300,000 shares of commons stock priced at
$0.325 plus 175,000 warrants with an exercise price of $0.75 and 175,000
warrants with an exercise price of $1.25 and an expiration date for all
warrants of October 1, 2013. On January 1, 2010, this contract was renewed. At
that time, the company agreed to pay EMC 60,000 shares of common stock within
two weeks of the agreement and 20,000 shares of common stock at the end of each
month, throughout each month during 2010, within which the agreement is in
force.

On October 20, 2009, the Company entered into a consulting agreement
with Boxwood Associates, Inc., whereby the Company pays $2,000 monthly for
management and strategic development services performed. The contract will
remain in effect until December 31, 2010, unless terminated by either party
providing 30 days written notice. Mr. Telesco is President of Boxwood
Associates, Inc.

11. Stock Options

The Company has three stock option plans, one adopted in 1996 and
amended in July 1997 (the 1996 Option Plan), one adopted in September 1999
and amended in June 2000 (the 1999 Option Plan), and one adopted on November
8, 2000 (the Directors Plan). The 1996 Option Plan provides for the granting
of up to 2,200,000 options, the 1999 Option Plan provides for the granting of
up to 3,000,000 options and the Directors Plan provides for the granting of up
to 400,000 options.

Both the 1996 and 1999 Plan provide for the granting of both incentive
and non-qualified stock options to key personnel, including officers,
directors, consultants and advisors to the Company, at the discretion of the
Board of Directors. Each plan limits the exercise price of the options at no
less than the quoted market price of the common stock on the date of grant. The
option term is determined by the Board of the Directors or the Compensation
Committee, provided that no option may be exercisable more than 10 years after
the date of its grant and, in the case of an Incentive Option granted to an
eligible employee owning more than 10% of the Companys common stock, no more
than five years after the date of the grant. Generally, under the 1996 and 1999
plans, options to employees vest over four years at 25% per annum, except for
certain grants to employees that vest 50% upon grant with remaining amounts
over two years at 25% per annum.

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Table of Contents

The Directors Plan provides for the granting of non-qualified options
to members of the Board of Directors at exercise prices not less than the
quoted market price of the common stock on the date of grant and options expire
five years from the date of grant. In the event a person ceases to serve on the
Board of Directors, the outstanding options expire one year from the date of
cessation of service. Such options may be exercised commencing two years from
the date of grant.

During each of 2009 and 2008, 30,000 of options were issued to
non-employee Directors.

Additional information concerning the activity in the three option
plans is as follows:

|                                                 |  |         |           |                                    |   |         |  |                                    |           |   |   |      | 
|------------------------------------------------ |  | ------- | --------- | ---------------------------------- | - | ------- |  | ---------------------------------- | --------- | - | - | ---- | 
|                                                 |  | 2009    |           | 2008                               |  
|                                                 |  | Options |           | Weighted
 Average
 Exercise
 Price |   | Options |  | Weighted
 Average
 Exercise
 Price |          
|                                                
|Outstanding, beginning of year                   |  |         | 1,767,900 |                                    | $ | 2.15    |  |                                    | 1,766,900 |   | $ | 2.65 | 
|Granted                                          |  |         | 334,575   |                                    |   | .30     |  |                                    | 772,500   |   |   | .26  | 
|Exercised                                        |  |         |          |                                    |   |         |  |                                    |          |   |   |      | 
|Cancelled                                        |  |         | (105,000  | )                                  |   | .81     |  |                                    | (124,000  | ) |   | 1.08 | 
|Expired                                          |  |         | (87,400   | )                                  |   | 1.06    |  |                                    | (647,500  | ) |   | 1.48 | 
|Outstanding, end of year                         |  |         | 1,910,075 |                                    |   | 1.95    |  |                                    | 1,767,900 |   |   | 2.15 | 
|Exercisable, end of year                         |  |         | 1,053,000 |                                    | $ | 3.30    |  |                                    | 929,150   |   | $ | 3.83 | 
|Options available for future grant, end of
 year |  |         | 1,489,925 |                                    |   |         |  |                                    | 1,637,250 |   |   |      | 

Summarized information with respect to options outstanding under the
three option plans at December 31, 2009 is as follows:

|                         |  |                     |           |                                                  |  |                               |  |                     |      |                                   |  |           |  |   |      | 
|------------------------ |  | ------------------- | --------- | ------------------------------------------------ |  | ----------------------------- |  | ------------------- | ---- | --------------------------------- |  | --------- |  | - | ---- | 
|                         |  | Options Outstanding |           | Options Exercisable                              | 
|Range of
 Exercise Price |  | Number
 Outstanding |           | Remaining
 Average
 Contractual
 Life (In Years) |  | WeightedAverageExercise Price |  | Number
 Exercisable |      | Weighted
 Average
 Exercise Price | 
|$0.14 
 $1.70           |  |                     | 1,522,075 |                                                  |  | 5.21                          |  | $                   | .47  |                                   |  | 665,000   |  | $ | .72  | 
|$1.86 $4.50             |  |                     | 88,000    |                                                  |  | 2.66                          |  |                     | 2.69 |                                   |  | 88,000    |  |   | 2.69 | 
|$8.50 $9.25             |  |                     | 300,000   |                                                  |  | .50                           |  |                     | 9.25 |                                   |  | 300,000   |  |   | 9.25 | 
|                         |  |                     |           |                                                  |  |                               |  |                     |      |                                   |  |           |  |   |      | 
|Totals                   |  |                     | 1,910,075 |                                                  |  | 4.81                          |  | $                   | 2.15 |                                   |  | 1,053,000 |  | $ | 3.32 | 

Summarized information with respect to options outstanding under the
three option plans at December 31, 2008 is as follows:

|                         |  |                     |           |                                                  |  |                                   |  |                     |      |                                   |  |         |  |   |      | 
|------------------------ |  | ------------------- | --------- | ------------------------------------------------ |  | --------------------------------- |  | ------------------- | ---- | --------------------------------- |  | ------- |  | - | ---- | 
|                         |  | Options Outstanding |           | Options Exercisable                              | 
|Range of Exercise
 Price |  | Number
 Outstanding |           | Remaining
 Average
 Contractual
 Life (In Years) |  | Weighted
 Average
 Exercise Price |  | Number
 Exercisable |      | Weighted
 Average
 Exercise Price | 
|$0.21 
 $1.70           |  |                     | 1,363,400 |                                                  |  | 5.89                              |  | $                   | .55  |                                   |  | 524,650 |  | $ | .97  | 
|$1.86 $4.50             |  |                     | 104,500   |                                                  |  | 3.02                              |  |                     | 2.63 |                                   |  | 104,500 |  |   | 2.63 | 
|$8.50 $9.25             |  |                     | 300,000   |                                                  |  | .50                               |  |                     | 9.25 |                                   |  | 300,000 |  |   | 9.25 | 
|Totals                   |  |                     | 1,767,900 |                                                  |  | 5.25                              |  | $                   | 2.15 |                                   |  | 929,150 |  | $ | 3.81 | 

F-16

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Table of Contents

12. Common Stock

On January 8, 2009 the Company extended again the expiration date by
six months for a loan of $123,750, interest bearing at a rate of 5.63% and
collateralized by 300,000 shares of common stock, made to a former employee of
the Company. The new expiration date of the loan was April 8, 2009. As the note
was not paid when due and is currently in default, the Company has exercised
its rights to the collateral and made demand for payment by filing a lawsuit
against the employee on July 7, 2009 for non-payment of three promissory notes,
each dated July 25, 2001

On May 1, 2009 the Company received proceeds of $100,000 from the sale
of 689,655 shares of common stock at a price of $0.145 per share and as part of
the offering, awarded 172,414 warrants to purchase one share of common stock at
an exercise price of $0.50 on or prior to May 1, 2014.

On May 7, 2009, the Company converted $100,000 previously received as a
stockholder loan in January 2009, into 555,555 shares of common stock at a
price of $.18 per share, the closing price of the Companys stock on May 6,
2009. In connection with the issuance of common stock, the Company issued
warrants to purchase 138,889 shares of common stock at a price of $.50, which
expire on May 6, 2014.

On May 8, 2009, the Company modified the exercise price of 100,000
warrants previously issued to Dominick Telesco on February 3, 2009 from $1.25
to $.50. These warrants were previously issued to Mr. Telesco as consideration
for a loan to the Company and the price of the warrants was modified to reflect
the current market price of other investments.

On July 17, 2009, the Company converted $100,000 received as a
stockholder loan into 370,370 shares of common stock at a price of $.27 per
share, the closing price of the Companys stock on July 17, 2009. In connection
with the issuance of common stock, the Company issued warrants to purchase
92,593 shares of common stock at a price of $.50, which expire on July 17,
2014.

On July 17, 2009 the Company received proceeds of $100,000 from the
sale of 370,370 shares of common stock at a price of $0.27 per share and as
part of the offering, awarded 92,593 warrants to purchase one share of common
stock at an exercise price of $0.50 on July 17, 2014.

Between August 1, 2009 and August 12, 2009, the Company received
proceeds of $700,000 from seven investors for the sale of 2,115,752 shares of
common stock at prices of $.31 and $.34 per share and as part of the offering,
awarded 211,575 warrants to purchase common stock at a price of $.50, which
expire in August 2014.

On September 15, 2009, the Company received proceeds of $100,000 from
an investor for the sale of 333,333 shares of common stock at a price of $.30
per share and as part of the offering, awarded 33,333 warrants to purchase
common stock at a price of $.50, which expire September 15, 2014.

On November 6, 2009, the Company received proceeds of $100,000 from an
investor for the sale of 400,000 shares of common stock at a price of $.25 per
share and as part of the offering, awarded 40,000 warrants to purchase common
stock at a price of $.50, which expire November 6, 2014.

On December 28, 2009, the Company received proceeds of $100,000 from an
investor for the sale of 555,556 shares of common stock at a price of $.18 per
share and as part of the offering, awarded 55,556 warrants to purchase common
stock at a price of $.50, which expire December 24, 2014.

13. Warrants

At December 31, 2009 and 2008, 4,426,025 and 3,214,072 shares,
respectively, of common stock have been reserved for issuance under outstanding
warrants. All of the warrants are fully vested and have expiration dates
ranging from April 13, 2010 to March 26, 2018. Information concerning the
Companys warrant activity is as follows:

|                                       |  |                            |           |                            |   |         |  |       |           |   |   |      | 
|-------------------------------------- |  | -------------------------- | --------- | -------------------------- | - | ------- |  | ----- | --------- | - | - | ---- | 
|                                       |  | 2009                       |           | 2008                       |  
|                                       |  | Weighted Average
 Exercise |           | Weighted Average
 Exercise |  
|                                       |  | Options                    |           | Price                      |   | Options |  | Price |          
|                                       |  |                            |           |                            |   |         |  |       |           |   |   |      | 
|Outstanding,
 at the beginning of year |  |                            | 3,214,072 |                            | $ | 1.25    |  |       | 1,869,643 |   | $ | 1.25 | 
|Granted                                |  |                            | 1,361,953 |                            |   | .50     |  |       | 1,949,429 |   | $ | 1.21 | 
|Exercised                              |  |                            |          |                            |   |        |  |       |          |   |   |     | 
|Expired                                |  |                            | (150,000  | )                          |   | 2.00    |  |       | (605,000  | ) | $ | 1.10 | 
|Outstanding,
 at the end of year       |  |                            | 4,426,025 |                            | $ | .99     |  |       | 3,214,072 |   | $ | 1.25 | 

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Table of Contents

In consideration of the stockholder loan agreement (Item 12), the
Company has granted the stockholder a total of 475,000 common stock purchase
warrants at an exercise price equal to the closing market price of the
Companys stock on the dates of grant. On March 28, 2002, the Company recorded
a deferred charge of $318,000. The deferred charge was initially amortized over
the commitment period and subsequently revised to include the repayment period,
as amended. During the years ended December 31, 2009 and 2008, the Company had
amortized approximately $2,000 and $5,000, respectively, of such costs, which
are included in interest expense in the accompanying consolidated statements of
operations.

On March 14, 2003, the Company recorded a deferred charge of $212,500.
The deferred charge is being amortized over the repayment period of 21.5
months. During the years ended December 31, 2009 and 2008, the Company had
amortized approximately $2,000 and $3,000 respectively, which is included in
interest expense in the accompanying consolidated statement of operations.

During 2009, the Company received cash proceeds of $1,982,759 from
seventeen investors for the purchase of 7,532,585 shares of common stock at
prices ranging from $.145 to $.34. As part of the offering, the Company awarded
1,361,953 warrants to purchase one share of common stock at an exercise price
of $1.25 on or prior to August 23, 2017.

14. Major Customers

During 2009 and 2008, two customers together accounted for
approximately 33% and 34%, respectively, of the Companys net sales. In 2009,
there were two customers that individually accounted for greater than 10% of
net sales, or approximately $417,000 and $205,000, while in 2008 there were two
customers that individually accounted for greater than 10% of net sales, or
approximately $485,000 and $419,000. There were four customers at December 31,
2009, whose trade receivable balances equaled or exceeded 5% of total receivables,
representing approximately 22%, 19%, 13%, and 12% respectively, of total
accounts receivable. There were four customers at December 31, 2008, whose
trade receivable balances equaled or exceeded 5% of total receivables,
representing approximately 29%, 12%, 10%, and 6% respectively, of total
accounts receivable. The loss of business from one or a combination of the
Companys significant customers could adversely affect its operations.

15. Geographic Information

The Company has two lines of product, which it manufactures and
distributes from its locations in the United States and the United Kingdom.
Distribution from the United Kingdom ceased in March, 2009, when the facility
closed and the remaining assets were shipped to the United States. Information
with respect to sales activity and long-lived assets (consisting entirely of
property and equipment) in the United States and United Kingdom is as follows:

|                            |  |                        |           |      |   |           | 
|--------------------------- |  | ---------------------- | --------- | ---- | - | --------- | 
|                            |  | Year Ended December 31 |          
|                            |  | 2009                   |           | 2008 |  
|                            |  |                        |           |      |   |           | 
|Net sales:                  |  |                        |           |      |   |           | 
|United States               |  | $                      | 1,864,345 |      | $ | 1,972,704 | 
|United Kingdom              |  |                        | 71,598    |      |   | 722,936   | 
|                            |  | $                      | 1,935,943 |      | $ | 2,695,640 | 
|                            |  |                        |           |      |   |           | 
|Long-lived
 assets by area: |  |                        |           |      |   |           | 
|United States               |  | $                      | 132,856   |      | $ | 122,309   | 
|United Kingdom              |  |                        |          |      |   | 606       | 
|                            |  | $                      | 132,856   |      | $ | 122,915   | 

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Table of Contents

16. Subsequent Events

On January 1, 2010 the Company renewed its agreement with EMC,
effective for one year, beginning January 1, 2010. In connection with this
agreement, on January 14, 2010 the Company issued 60,000 shares of common stock
at $.23 and on February 1, 2010 and March 1, 2010, the company issued 20,000
shares of common stock, at a price of $.20 per share.

On February 1, 2010, the Company issued 176,508 warrants to Mr. Reyes,
in conjunction with his efforts in raising over $400,000 in equity in the prior
month. The exercise price of these warrants range from $.18 to $.30 and will
expire February 1, 2015.

On March 4,, 2010, the repayment date of the stockholder loan was
extended from December 31, 2010 to December 31, 2011.

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