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 ENDEDDECEMBER31,
 2008                                   
| |                                                                               |                                                                                      
| | 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.                                                                                                                                                                                                                                               
|þ Yes o 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 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.                          
|þ                                                                                                                                                                                                                                                                                                                                                                       

---



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. $3,428,849 on June 30, 2008.

Indicated the number of shares outstanding of each of the registrants
classes of common stock, as of the latest practicable date. 37,962,488 shares
of common stock are issued and outstanding as of April 6, 2009.

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 identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980). None.

2

---



TABLE OF CONTENTS

| |             |                                                                                                                |  |          | 
| | ----------- | -------------------------------------------------------------------------------------------------------------- |  | -------- | 
| |             |                                                                                                                |  | Page No. | 
| | Part I      |                                                                                                                |  |          | 
| | Item 1.     | Business.                                                                                                      |  | 4        | 
| | Item 1A.    | Risk Factors                                                                                                   |  | 11       | 
| | Item 1B.    | Unresolved Staff
Comments.                                                                                     |  | 14       | 
| | Item 2.     | Properties.                                                                                                    |  | 14       | 
| | Item 3.     | Legal Proceedings.                                                                                             |  | 14       | 
| | Item 4.     | Submission of Matters to a Vote of
Security
 Holders.                                                          |  | 14       | 
| | Part II    
| | Item 5.     | Market for Registrants Common
Equity,
 Related Stockholder Matters and Issuer Purchases of Equity Securities. |  | 14       | 
| | 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.                                                                  |  | 23       | 
| | Item 9.     | Changes In and Disagreements With
 Accountants on Accounting and Financial Disclosure.                         |  | 23       | 
| | Item 9A.(T) | Controls and
Procedures.                                                                                       |  | 23       | 
| | Item 9B.    | Other Information.                                                                                             |  | 24       | 
| | Part III   
| | Item 10.    | Directors, Executive Officers and
Corporate
 Governance.                                                       |  | 24       | 
| | Item 11.    | Executive Compensation.                                                                                        |  | 28       | 
| | Item 12.    | Security Ownership of Certain
Beneficial
 Owners and Management and Related Stockholder Matters.               |  | 32       | 
| | Item 13.    | Certain Relationships and Related
 Transactions, and Director Independence.                                    |  | 34       | 
| | Item 14.    | Principal Accountant Fees and
Services.                                                                        |  | 35       | 
| | Part IV    
| | Item 15.    | Exhibits, Financial Statement
Schedules.                                                                       |  | 36       | 

| |            |  |  |  | 
| | ---------- |  |  |  | 
| | SIGNATURES

3

---



Table of Contents

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 ability to operate as a going concern and to raise
sufficient capital to fund its operations, acceptance of the Companys
products, the Companys dependence on distributors and a few significant
customers, risks associated with international operations and international
distribution and other factors. 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.

We operate
through:

|  |                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------
| | Puradyn
 Filter Technologies Incorporated  parent company                                                   
| | Puradyn
 Filter Technologies, Ltd. (Ltd., Puradyn, Ltd) - a wholly owned
 subsidiary established in 2000.

Products

The core
product, the patented Puradynbypass
oil filtration system, is offered in two 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.

4

---



Table of Contents

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 5 to 7 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
fourteen 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 8 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 ten 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 pelletized chemicals are added to the
 filtering media 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 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, will
 address 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 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.                                                                                                                                                                                                                                                                                                                                                                                                           
| 
| | In late 2009, the Extreme Duty (XD) Element, which is 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,
 will address the next level of emission reduction beginning in 2010.                                                                                                          

When the
Element is changed, an insignificant amount of make-up oil is added to replace
any oil retained in the used

5

---



Table of Contents

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 (See Warranties). 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 several OEMs including Deere & Company, Detroit
Diesel Corporation, Caterpillar, Inc., Ford Motor Company, Mack Trucks, Inc.,
Cummins Engine Company, Inc., Daimler Chrysler Corporation, 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.

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:

|  |                                                                                                                                                             
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

6

---



Table of Contents

|  |                                                                                                                                                                                                                                                                                      
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 105 domestic and 35 international active
distributors. However there are additional potential distributors that
participate in other programs; such as Freightliner, Western Star, 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.

The Company
has warehouse distributors located throughout North America and we previously utilize 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.

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
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.

Puradyn,
Ltd. operates from the U.K. to generate distribution and sales in Europe, the
Middle East, the former Soviet Union, South Africa and Scandinavia. 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

7

---



Table of Contents

have encountered in introducing an innovative technology in their
territories. Puradyn, Ltd. has successfully commenced or completed various
evaluation programs, including those of two large international generator
manufacturers, four truck OEMs, one construction equipment OEM and one diesel
engine OEM. One of the worlds largest OEMs of medium-size power generators
approved and began purchasing the Puradynfrom
Puradyn, Ltd. in 2002.

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 twelve 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
2004 we were awarded a new five-year contract on the Vehicular Multiple Award
Schedule, New Technologies, which replaced the earlier schedule on which we had
currently been. This enables us to offer our Puradynsystem to all federal 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 (to
December 2009) with three five-year options.

We are
dependent upon sales to a limited number of customers. During 2008 and 2007 two
customers together accounted for approximately 34% and 44%, respectively, of
the Companys consolidated net sales. These two customers individually
accounted for greater than 10% each of net sales, or approximately $570,000 and
$791,000 and approximately $419,000 and $485,000, respectively in 2007 and
2008.

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 26% of our 2007 consolidated net sales and 16% of our 2008
consolidated net sales.

At December
31, 2008 there were four customers, whose trade receivable balances equaled or
exceeded 5% of total receivables, representing approximately 16%, 11%, 8%, and
5% 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 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.

8

---



Table of Contents

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, 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 55% and 65% of consolidated net sales in 2008
and 2007, 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 November 2008, 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;                                                                                                                       
| |  | 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.

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

9

---



Table of Contents

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.

We applied
for a utility patent application for improved filtration efficiency using CGP®,
a process for chemical grafting that can significantly increase the life of the
filter Element and further safely extend oil drain intervals. 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.

In 2008, we
applied for 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.

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 address; 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. Today, catalytic
converters and particulate traps in addition to using exhaust gas recirculation
(EGR) are required to meet these new emission standards. Due to the
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 is being formulated to meet more-stringent 2010 regulations.

As more
engine manufacturers move to these new 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.

10

---



Table of Contents

The
conservation of energy, oil, and natural resources has become an important part
of the 2009 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 March 27,
 2009, the Company had 15 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.

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.

11

---



Table of Contents

WE HAVE
A HISTORY OF LOSSES AND OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM HAS
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, 2008. For the years ended December 31,
2008 and 2007, we reported net losses of $2,644,547 and $2,441,101. At December
31, 2008, we had an accumulated deficit of approximately $48.5 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, 2008 and 2007 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 $2.3 million and approximately $1.8 million in 2008
and 2007, respectively. Our net sales declined approximately 13% for 2008 from
2007 while our operating expenses increased approximately 1%. Our net sales
have never been sufficient to fund our operating expenses. During 2008 and in
to 2009 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 2009 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. In addition, we are also reviewing cost of
material increases, some of which were passed through to our customers as
product price increases beginning January 2009 which we expect to improve our
margins in 2009. 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 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, 2008, we had a working
capital of $244,621 as compared to working capital of $365,917 at December 31,
2007. 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, 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
OUR CHAIRMAN AND CEO APPROXIMATELY $6.4 MILLION WHICH IS DUE BY DECEMBER 31,
2010.

Since March 2002, our CEO
has been providing funding to us for working capital on an unsecured basis. At
December 31, 2008, we owed him approximately $6.4 million. As extended, this
loan is due on December 31, 2010 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

12

---



Table of Contents

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 2008 two customers individually
accounted for approximately 18% and approximately 16% (for a total of
approximately 34%) of our net sales. During 2007 two customers together
accounted for approximately 44% 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.

The decline in our sales
to our largest customer in the U.K., competition from a former employee and the
general business downturn during 2008 have already impacted and contributed to
the cancellation of our Master Distributor Agreement with FSL. There is no further
significant sales decline anticipated in 2009, although the company will be
seeking to replace the Master Distributor in Europe. There is a risk that
business will not improve appreciably until a new Master Distributor is named.

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 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.

13

---



Table of Contents

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

At
December 31, 2008, we had 35,838,551 shares of our common stock issued and
outstanding and the following securities, which are exercisable into shares of
our common stock, were outstanding:

| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 3,214,072 shares of our common stock issuable upon
 the exercise of warrants with exercise prices ranging from $0.75 to $2.00 per
 share; and    
| |   |                                                                                                                                                  
| |  | 1,767,900 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,
including purchasers of shares in this offering.

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 broker 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 we pay rent of approximately $179,000 per year which will increase 3%
annually during the term of the lease.

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

None.

|        |                                                      
|------- | -----------------------------------------------------
|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF
 SECURITY HOLDERS.

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

14

---



Table of Contents

prices,
without retail mark-up, markdown or commission, and may not represent actual
transactions.

|                                        |  |      |       |     |  |       | 
|--------------------------------------- |  | ---- | ----- | --- |  | ----- | 
|                                        |  | High |       | Low | 
|Fiscal 2007                             |  |      |       |     |  |       | 
|First
 quarter ended March 31, 2007     |  |      | $0.96 |     |  | $0.56 | 
|Second
 quarter ended June 30, 2007     |  |      | $0.80 |     |  | $0.40 | 
|Third
 quarter ended September 30, 2007 |  |      | $0.50 |     |  | $0.30 | 
|Fourth
 quarter ended December 31, 2007 |  |      | $0.60 |     |  | $0.32 | 
|                                        |  |      |       |     |  |       | 
|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 | 
|                                        |  |      |       |     |  |       | 

On
March 30, 2009, the last sale price of our common stock as reported on the
OTCBB was $0.28. As of March 30, 2009, there were approximately 301 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
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.

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, 2008.

|                                    |  |                                                                                                          |           |                                                                                      |   |                                                                                                                                                        |  |  |           | 
|----------------------------------- |  | -------------------------------------------------------------------------------------------------------- | --------- | ------------------------------------------------------------------------------------ | - | ------------------------------------------------------------------------------------------------------------------------------------------------------ |  |  | --------- | 
|                                    |  | Number of
 securities to be
  issued upon
 exercise of
 outstanding
 options, warrants
 and rights 
 (a) |           | 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) (c) | 
|Plan category                       |  |                                                                                                          |           |                                                                                      |   |                                                                                                                                                        |  |  |           | 
|Plans
 approved by stockholders:    |  |                                                                                                          |           |                                                                                      |   |                                                                                                                                                        |  |  |           | 
|1996
 Stock Option Plan             |  |                                                                                                          | 5,150     |                                                                                      | $ | .38                                                                                                                                                    |  |  | NA        | 
|1999
 Stock Option Plan             |  |                                                                                                          | 1,647,750 |                                                                                      |   | 2.16                                                                                                                                                   |  |  | 1,352,250 | 
|2000
 Non-Employee Directors Plan   |  |                                                                                                          | 110,00    |                                                                                      |   | .46                                                                                                                                                    |  |  | 290,000   | 
|                                    |  |                                                                                                          |           |                                                                                      |   |                                                                                                                                                        |  |  |           | 
|Plans
 not approved by stockholders |  |                                                                                                          | 0         |                                                                                      |   | N/A                                                                                                                                                    |  |  | N/A       | 

15

---



Table of Contents

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

Recent Sales of Unregistered Securities

On
November 21, 2008 the Company received a loan from Mr. Dominick Telesco, a
shareholder, who is also a Board member, in the amount of $100,000 which was
converted to 833,333 shares of common stock at a price of $0.12 per share with
warrants to purchase 208,333 shares of common stock exercisable at a price of
$1.25 per share and an expiration date of November 20, 2013. We used the
proceeds for working capital. The investor was an accredited investor and the
transaction was exempt from registration under the Securities Act of 1933 in
reliance on exemptions provided by Section 4(2) of that act.

|        |                         
|------- | ------------------------
|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
140 active distributors in the U.S. and internationally. The number of
distributors will constantly 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 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, Western Star
 and others;

16

---



Table of Contents

|                                                                                                                                                         |   |                                                                                                                                                                                                                                               
|-------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                         |  | 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 November 2008 we
 announced the growing number of Florida and national municipalities using the
 Puradynsystem.                                                                                                                            
|                                                                                                                                                         |  | In September 2008, we
 announced that Avis Budget Group will be installing the Puradyn system as standard
 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.                         
|                                                                                                                                                         |  | During 2008 received
 initial and repeat orders from the Foreign Military Sales program, the
 government-government method for selling U.S. defense equipment, services,
 and training, to supply the Puradyn systems for the line haul fleet.
|                                                                                                                                                         |  | In July 2008 we
 received a contract from the U.S. Army to supply the Puradyn system to outfit
 JERRVvehicles used in combat in Iraq and Afghanistan.                                                                                         
|                                                                                                                                                         |  | In April 2008, an
 international distributor placed purchase orders totaling over $1.1 million
 for shipment over 2008 and 2009. This is the Companys first order to date of
 this magnitude.                                                
|                                                                                                                                                         |  | The November 2007
 announcement that a fleet of 100 trucks have exceeded 100 million miles
 without an oil-related oil change during the course of an eight-year period using
 the Puradyn
 system.                                           

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
2009; 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 2008 was below
management expectation with only a increase in Puradyn product sales over 2008.

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 twelve 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 2007, total international sales accounted
for 65% of the Companys consolidated net sales. However, in 2008 the
substantial decline in international sales to approximately 55% of our total
net revenues in the 2008 is attributable to competition from a former employee
in the U.K.

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. At this time, we anticipate the need for at least two salespersons and
one sale support person. We will be adding application engineers and product
engineers 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

17

---



Table of Contents

area, even though it is
very demanding due to response need to meet their needs, is also rewarding in
the aspect that it provides a steady flow of material requirements for our
manufacturing area giving us more stability in 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 2009 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 will continue to be applied each
January and are in the range of 3% to 7%.

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, 2008 and 2007 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.

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.

18

---



Table of Contents

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 SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. 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 SAB No. 104, Revenue Recognition in Financial Statements.
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
December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
160, Noncontrolling Interests in Consolidated Financial Statements  an
amendment of ARB No. 51. This statement improves the relevance, comparability,
and transparency of the financial information that a reporting entity provides
in its consolidated financial statements by establishing accounting and
reporting standards that require; the ownership interests in subsidiaries held
by parties other than the parent and the amount of consolidated net income
attributable to the parent and to the noncontrolling interest be clearly
identified and presented on the face of the consolidated statement of income,
changes in a parents ownership interest while the parent retains its
controlling financial interest in its subsidiary be accounted for consistently,
when a subsidiary is deconsolidated, any retained noncontrolling equity
investment in the former subsidiary be initially measured at fair value, entities
provide sufficient disclosures that clearly identify and distinguish between
the interests of the parent and the interests of the noncontrolling owners.
SFAS No. 160 affects those entities that have an outstanding noncontrolling
interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS
No. 160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008. Early adoption is prohibited.
The adoption of this statement is not expected to have a material effect on the
Companys financial statements.

In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133
(SFAS 161). This statement is intended to improve transparency in financial
reporting by requiring enhanced disclosures of an entitys derivative
instruments and hedging activities and their effects on

19

---



Table of Contents

the entitys financial
position, financial performance, and cash flows. SFAS 161 applies to all
derivative instruments within the scope of SFAS 133. Accounting for Derivative
Instruments and Hedging Activities (SFAS 133) as well as related hedged items,
bifurcated derivatives, and nonderivative instruments that are designed and qualify
as hedging instruments. Entities with instruments subject to SFAS 161 must
provide more robust qualitative disclosures and expanded quantitative
disclosures. SFAS 161 is effective prospectively for financial statements issue
for fiscal years and interim periods beginning after November 15, 2008, with
early application permitted. The adoption of this statement is not expected to
have a material effect on the Companys financial statements.

In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS No. 162 identifies the sources of accounting
principles and provides entities with a framework for selecting the principles
used in preparation of financial statements that are presented in conformity
with GAAP. The current GAAP hierarchy has been criticized because it is
directed to the auditor rather than the entity, it is complex, and it ranks
FASB Statements of Financial Accounting Concepts, which are subject to the same
level of due process as FASB Statements of Financial Accounting Standards,
below industry practices that are widely recognized as generally accepted but
that are not subject to due process. The Board believes the GAAP hierarchy
should be directed to entities because it is the entity (not its auditors) that
is responsible for selecting accounting principles for financial statements
that are presented in conformity with GAAP. SFAS 162 is effective 60 days
following the SECs approval of PCAOB Auditing Standard No. 6, Evaluating
Consistency of Financial Statements (AS/6). The adoption of FASB 162 is not
expected to have a material impact on the Companys financial position.

In
May 2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee
Insurance Contracts-an interpretation of FASB Statement No. 60. Diversity
exists in practice in accounting for financial guarantee insurance contracts by
insurance enterprises under FASB Statement No. 60, Accounting and Reporting by
Insurance Enterprises. This results in inconsistencies in the recognition and
measurement of claim liabilities. This Statement requires that an insurance
enterprise recognize a claim liability prior to an event of default (insured
event) when there is evidence that credit deterioration has occurred in an
insured financial obligation. This Statement requires expanded disclosures
about financial guarantee insurance contracts. The accounting and disclosure
requirements of the Statement will improve the quality of information provided
to users of financial statements. SFAS 163 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The adoption of FASB 163 is not
expected to have a material impact on the Companys financial position.

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 SFAS No. 52, Foreign Currency Translation (SFAS 52).
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, 2008 as well as 2007 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, 2008
and 2007, we recorded a foreign currency exchange rate loss of approximately
$535000 and a gain of approximately $87,000, 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 1.9973 on December 31, 2007
to 1.4479 on December 31, 2008 as compared to 1.9266 on December 31, 2006 to
1.9973 on December 31, 2007.

20

---



Table of Contents

Results of Operations

Year
Ended December 31, 2008 (2008) as Compared to Year Ended December 31, 2007
(2007)

The
following table sets forth (amounts in thousands) the Companys operating
information for 2008 and 2007:

|                              |  |                |        |      |   |                      |   |   |      |  
|----------------------------- |  | -------------- | ------ | ---- | - | -------------------- | - | - | ---- | -
|                              |  | (in thousands)
|                              |  | 2008           |        | 2007 |   | Increase
 (Decrease) |  
|Net sales                     |  | $              | 2,696  |      | $ | 3,083                |   | $ | (387 | )
|                             
|Operating costs and expenses: |  |                |        |      |   |                      |   |   |      |  
|Cost of products
 sold        |  |                | 2,456  |      |   | 2,832                |   |   | (376 | )
|Salaries and
 wages           |  |                | 1,014  |      |   | 1,075                |   |   | (61  | )
|Selling and
 administrative   |  |                | 1,559  |      |   | 1,061                |   |   | 498  |  
|                              |  |                | 5,029  |      |   | 4,968                |   |   | 61   |  
|                              |  |                |        |      |   |                      |   |   |      |  
|Loss from operations          |  |                | (2,333 | )    |   | (1,885               | ) |   | (448 | )
|                              |  |                |        |      |   |                      |   |   |      |  
|Other income (expense):       |  |                |        |      |   |                      |   |   |      |  
|Interest income               |  |                | 2      |      |   | 33                   |   |   | (31  | )
|Interest expense              |  |                | (313   | )    |   | (589                 | ) |   | 276  |  
|Total other expense           |  |                | (311   | )    |   | (556                 | ) |   | 245  |  
|                             
|Net loss                      |  | $              | (2,644 | )    | $ | (2,441               | ) | $ | 203  |  
|                              |  |                |        |      |   |                      |   |   |      |  
|                              |  | (in thousands)
|                              |  | 2008           |        | 2007 |   | Increase
 (Decrease) |  
|Gross sales                   |  | $              | 2,686  |      | $ | 3,126                |   | $ | 440  |  
|                             
|Sales returns &
 allowances   |  |                | 10     |      |   | (43                  | ) |   | (53  | )
|                             
|Net sales                     |  | $              | 2,696  |      | $ | 3,083                |   | $ | (387 | )
|                              |  |                |        |      |   |                      |   |   |      |  
|                              |  | 2008           |        | 2007 |   | Increase
 (Decrease) |  
|US domestic sales             |  | $              | 1,220  |      | $ | 1,520                |   | $ | (300 | )
|                             
|US international sales        |  |                | 753    |      |   | 353                  |   |   | 400  |  
|                             
|UK sales                      |  |                | 723    |      |   | 1,210                |   |   | (487 | )
|                             
|Net Sales                     |  | $              | 2,696  |      | $ | 3,083                |   | $ | (387 | )

Net SalesNet sales decreased by
approximately $387,000, or 13%, from approximately $3,083,000 in 2007 to
approximately $2,696,000 in 2008. Domestic sales generated from the U.S.
operations decreased approximately $300,000, or approximately 20%, in 2008 as
compared to 2007, while international sales increased approximately $400,000,
or approximately 113%, in 2008 as compared to 2007.

Sales
to two customers individually accounted for approximately 18% and 16% (for a
total 34%) and 26% and 18% (for a total of 44%) of net sales for 2008 and 2007,
respectively.

The
UK subsidiarys net sales decreased by approximately $487,000, or approximately
40%, from approximately $1,210,000 for 2007 compared to approximately $723,000
for 2008. Sales to their top customer has decreased during 2008 and were
approximately $419,000, or 58% of their net sales, as compared to approximately
$791,000, or 65% for 2007. The UK sales decreased significantly as the UK
office was moved and then later closed. We believe that the marketing of a
competitive product to our customers by our former UK Managing Director has
contributed to a decline in its international sales volume.

The
mix of product sold continues to change as unit sales revenues have increased
to approximately 50% of net sales for 2008, as compared to approximately 44%
for 2007.

21

---



Table of Contents

Cost of SalesCost of sales
decreased by
approximately $376,000, or 13%, from approximately $2,832,000 in 2007 to
approximately $2,456,000 in 2008. Cost of products sold, as a percentage of
sales, decreased from approximately 92% for 2007 to approximately 91% for 2008.
The majority of the decrease in our overall cost of sales is attributable to
the 13% decline in net sales.  There were also decreases attributable to
reductions in inventory shrinkage, indirect and direct factory wages and
freight out expenses of approximately $222,000, $41,000, $79,000 and $52,000
respectively. Additionally, in accordance with a UK Master Distributor
agreement, the Company was reimbursed approximately $44,000 of their
manufacturing expenses. These decreases were offset by increases in inventory
allowance and warranty expense of approximately $117,000 and $45,000
respectively.

Salaries and WagesSalaries and wages
decreased approximately $61,000 or 6% for 2008 as compared to 2007. This
decrease is the result of a decrease in salaries and wages of approximately $75,000
generated in the UK office, as the UK Director resigned December 1, 2007. This
decrease was partially offset by additional salaries and wages expenses
incurred in the US office, in the areas of engineering hours and quality
personnel of approximately $7,000 and $48,000 respectively, as well as cost of
living increases of approximately 8%.

Selling and Administrative ExpensesSelling
and administrative expenses increased by approximately $498,000 or
approximately 47% from approximately $1,061,000 for 2007 to approximately
$1,559,000 for 2008. The majority of the increase was attributable to an
increase in exchange rate loss of approximately $622,000. There was also an
increase in stock based compensation expense of approximately $44,000, the majority
of which was attributable to expense associated with the granting of warrants.
These increases were partially offset by decreases in travel, entertainment and
meals, depreciation, patents, depreciation and a reimbursement of expenses from
the UK Master Distributor of approximately $133,000, $22,000, $20,000 and
$29,000, respectively. The majority of the decrease in travel related expense
was attributable to reduced travel following the resignation of the U.K. office
director. Expenses related to the U.K. office also decreased due to the
relocation of the facility to our Master Distributors site in July, 2008,
thereby eliminated most of their office expenses.

Interest IncomeInterest income
decreased
approximately $31,000, from income of approximately $33,000 for 2007 to
approximately $2,000 for 2008. This decrease is attributable to a reserve
established, effective October 1, 2007, against shareholder loan interest that
was previously accruing at approximately $12,000 per quarter.

Interest ExpenseInterest expense
decreased by approximately
$276,000, or approximately 47%,
for 2008 as compared to 2007. Approximately $80,000 of this increase is
attributable to a reserve established during the period ending September 30,
2007, toward the accumulation of interest recorded on a shareholder note
receivable. Approximately $196,000 of the decrease is due to a decrease in the
interest rate on the outstanding balance of the stockholder notes payable. We
pay interest monthly on the notes payable to stockholder at prime rate less
..5%, with rates reset as often as the federal reserve changes interest rates,
which was a weighted average of 4.53% for the 2008, as compared to 7.20% for
2007

Liquidity
and Capital Resources

As
of December 31, 2008, we had cash and cash equivalents of approximately
$117,000 as compared to cash and cash equivalents of approximately $112,000 at
December 31, 2007. At December 31 2008, we had working capital of approximately
$244,000 and our current ratio (current assets to current liabilities) was 1.16
to 1. At December 31, 2007 we had working capital of approximately $366,000 and
our current ratio was 1.20 to 1. The decrease in working capital and current
ratio is primarily attributable to a decrease in accounts payable of
approximately $427,000 offset by a decreases in accounts receivable and
inventory of approximately $200,000 and $138,000 respectively and increases in
accrued liabilities which represents deferred salaries and benefits, warranty
expense, interest expense and estimated recurring vendor expenses of
approximately $232,000.

We
have incurred net losses each year since inception and at December 31, 2008 we
had an accumulated deficit of $48,469,757. Our net sales are not sufficient to
fund our operating expenses. Historically, we 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. During 2007, we raised a total of $1.475 million in
capital from an institutional investor and current stockholders and during 2008
we raised a net additional $1.820 million . In addition, as of December 31,
2008, we owe our CEO $6.4 million for funds he has advanced to us from time to
time for working capital. Interest expense on this loan was approximately
$305,000 for the year ended December 31, 2008.

22

---



Table of Contents

We
do not currently have any commitments for capital expenditures. Currently,
without additional equity investments, we expect our operating cash flows will
suffice through April 2009. While we anticipate cash flows from 2009 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 $6. 4 million which is due on
December 31, 2010 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. 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 2009. 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.

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.

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

Our
financial statements are contained in pages F-1 through F-20 which appear at
the end of this annual report.

|        |                                                                                       
|------- | --------------------------------------------------------------------------------------
|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,

23

---



Table of Contents

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, 2008, 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 we maintain
disclosure controls and procedures that are 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, 2008. 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. Based on this evaluation, our management concluded that,
as of December 31, 2007, our internal control over financial reporting was
effective based on those criteria.

This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting. Our
managements report was not subject to attestation by our 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.

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        |  | 73  |  | Chairman
 of the Board of Directors and Chief Executive Officer      
|Kevin
 G. Kroger           |  | 57  |  | President,
 Chief Operating Officer and Director                     
|John
 S. Caldwell (2)      |  | 64  |  | Director                                                             
|Forrest
 D. Hayes (1), (2) |  | 76  |  | Director                                                             
|Dominick
 Telesco          |  | 79  |  | Director                                                             
|Charles
 W. Walton (1)     |  | 76  |  | Director                                                             
|Alan
 J. Sandler           |  | 70  |  | Vice
 President, Chief Administrative Officer and Corporate Secretary
|Cindy
 Lea Gimler          |  | 42  |  | Chief
 Financial Officer                                             

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

24

---



Table of Contents

Joseph V. Vittoria. Mr. Vittoria was
appointed to the Board of Directors and appointed as Chairman on February 8,
2000. Mr. Vittoria was Chairman and Chief Executive Officer of Travel Services
International, Inc. where he served from 1998 to 2000. From 1987 to 1997, Mr.
Vittoria served as Chairman and Chief Executive Officer of Avis, Inc. and was
President and Chief Operating Officer of Avis, Inc. from 1982 to 1987. Mr.
Vittoria also serves as Chairman of the Board of Great Wolf Resorts (since
November 2006) and is a member of the Board of Vectrix (since May 2008).

Kevin G. Kroger. Mr. 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.

Alan J. Sandler. Mr. 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. Ms. 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.

Lieutenant General (Retired) John S.
Caldwell, Jr.
General Caldwell was appointed to our Board of Directors on August 25, 2005 and
serves as Chairman of the Compensation Committee. General Caldwell served as
the Armys top ranking officer for Acquisition, Logistics and Technology when
he retired in January 2004. In that capacity, he was responsible to the
Assistant Secretary for the direction and oversight of the Armys Research,
Development and Acquisition (RDA) programs valued at approximately $20 billion
per year. He was also Director of the 50,000-person Army Acquisition Workforce,
responsible for personnel development and training policy and key assignment
recommendations. Since February 2007, General Caldwell has served as Senior
Vice-President of QSS Group, an IT services company supporting Federal
agencies, until such time as it was acquired by Perot Systems. General Caldwell
is currently employed as a consultant and serves on the board of several
companies, including TASER International. 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.

Forrest D. Hayes. Mr. Hayes was
appointed
to our Board of Directors on November 10, 2005. Mr. Hayes is Chairman of the
Audit Committee and a member of Compensation Committee. Mr. Hayes served as
Vice President and Chief Financial Officer 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 Chief Executive Officer of Brittany Corporation, a
privately-owned manufacturer of auto/truck parts from 1992 to 2000, and
Vice-Chairman from 2000 through 2003. Prior to this, Mr. Hayes served as a CPA
with Arthur Andersen from 1954 to 1990 in various capacities

25

---



Table of Contents

including Managing
Partner, of the Cleveland and Cincinnati, Ohio offices. Mr. Hayes currently
serves on the boards of Polychem Corporation and Brittany Stamping LLC.

Dominick Telesco. Mr. Telesco was
appointed
to our Board of Directors on December 19, 2006. Mr. Telesco has been President
and CEO of Boxwood Associates, Inc. for the past 6 years, on the Board of
Directors of Lydian Private Bank, the Palm Beach United Way, the Palm Beach
County Cultural Council, Boxwood Association, Inc. and has served as Chairman
of the Board of 3 Logistics Corporation.

Charles W. Walton, Ph.D.. Dr. Walton
was
appointed to our 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, Inc. which is owned by Odyssey Investment Partners,
a private equity firm, is now the largest supplier of equipment in the industry
with approximately $500 million in sales and 30 manufacturing plants in North
America and Mexico. Prior to founding Wastequip, Inc. 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 Weatherhead School of
Management and the Harvard Business School Club of Cleveland. Dr. Walton holds
the degrees of Bachelor of Science in Foreign Service and Ph.D. in economics
from Georgetown University, Washington, D.C.

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.

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, 2008 and Forms 5 and amendments thereto furnished to us with
respect to the fiscal year ended December 31, 2008, as well as any written
representation from a reporting person that no Form 5 is required, we are not
aware that any officer, director or 10% or greater stockholder 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, 2008.

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.

26

---



Table of Contents

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 2008.

In
this context, the chairperson has met and held discussions with management and
the independent auditors. Management represented to the committee that
Puradyns consolidated financial statements were prepared in accordance with
accounting principles generally accepted in the United States, and the
committee has reviewed and discussed the consolidated financial statements with
management and the independent auditors. The committee discussed with the
independent auditors matters required to be discussed by Statement on Auditing
Standards No. 61, Communication with Audit Committees, as amended.

In
addition, the committee has discussed with the independent auditors the
auditors independence from the Company and its management, including the
matters in the written disclosures required by the Independence Standards Board
Standard No. 1, Independence Discussions with Audit Committees.

The
committee discussed with our independent auditors the overall scope and plans
for their respective audit. The committee meets with the independent auditors
with and without management present, to discuss the results of their
examinations, the evaluations of Puradyns internal controls, and the overall
quality of our financial reporting.

Compensation Committee

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

27

---



Table of Contents

|         |                        
|-------- | -----------------------
|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, 2008 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, 2008.                                                                                                                                          

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 FAS 123R. During each of fiscal 2007 and
fiscal 2008, 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 AND PRINCIPAL POSITION (A) |  |  | YEAR(B) |  |  | SALARY($)(C) |         |  | BONUS($)(D) |   |   | STOCKAWARDS($)(E) |  |   | OPTIONAWARDS($)(F) |  |  | NON-EQUITY
 INCENTIVE PLAN
 COMPENSATION
 ($)(G) |   |  | NONQUALIFIED
 DEFERRED COMPENSATION
 EARNINGS ($)(H) |   |   | ALLOTHER
 COMPENSATION($)(I) |  |   | TOTAL($)(J) | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|Joseph
 V. Vittoria 1           |  |  | 2008    |  |  | $            |        |  |             | $ |  |                   |  | $ |                   |  |  | $                                                |  |  |                                                      | $ |  |                              |  | $ |            |  |  | $ |       |  |  | $ |        | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|                                |  |  | 2007    |  |  |              |        |  |             |   |  |                   |  |   |                   |  |  |                                                  |  |  |                                                      |   |  |                              |  |   |            |  |  |   |       |  |  |   |        | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|Kevin
 Kroger 2                 |  |  | 2008    |  |  |              | 186,315 |  |             |   |  |                   |  |   |                   |  |  |                                                  |  |  |                                                      |   |  |                              |  |   |            |  |  |   | 9,221  |  |  |   | 195,536 | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|                                |  |  | 2007    |  |  |              | 186,315 |  |             |   |  |                   |  |   |                   |  |  |                                                  |  |  |                                                      |   |  |                              |  |   |            |  |  |   | 21,089 |  |  |   | 207,404 | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|Alan
 Sandler 3                 |  |  | 2008    |  |  |              | 112,238 |  |             |   |  |                   |  |   |                   |  |  |                                                  |  |  |                                                      |   |  |                              |  |   |            |  |  |   |       |  |  |   | 112,238 | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|                                |  |  | 2007    |  |  |              | 112,238 |  |             |   |  |                   |  |   |                   |  |  |                                                  |  |  |                                                      |   |  |                              |  |   |            |  |  |   |       |  |  |   | 112,238 | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|Cindy
 Gimler 4                 |  |  | 2008    |  |  |              | 100,100 |  |             |   |  |                   |  |   |                   |  |  |                                                  |  |  |                                                      |   |  |                              |  |   |            |  |  |   |       |  |  |   | 100,000 | 
|                                |  |  |         |  |  |              |         |  |             |   |   |                   |  |   |                    |  |  |                                                  |   |  |                                                      |   |   |                              |  |   |             |  |  |   |        |  |  |   |         | 
|                                |  |  | 2007    |  |  |              | 96,716  |  |             |   |  |                   |  |   |                   |  |  |                                                  |  |  |                                                      |   |  |                              |  |   |            |  |  |   |       |  |  |   | 96,716  | 

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 as well as the amount of
disability and life insurance premiums we pay on his behalf. Annual salary deferral
of $83,000, 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. Annual salary deferral of
$62,000, 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, payable at such time as the company achieves a positive cash flow or
on an emergency basis, as approved by the CEO.

28

---



Table of Contents

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. 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 2008, Mr. Krogers base annual salary was $186,315 with
approximately $103,315 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 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
2008 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. 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, is not a party to an
employment agreement 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 of payable to Ms. Gimler can
be increased at any time upon the determination of the Compensation Committee
of our Board of Directors.

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, 2008:

29

---



Table of Contents

|                    |  |  |                                                                     |  |  |                                                                       |  |  |                                                                                                |  |  |                           |      |  |                        |          |  |                                                             |     |  |                                                                   |     |  |                                                                                                         |     |  |                                                                                                                         |     | 
|------------------- |  |  | ------------------------------------------------------------------- |  |  | --------------------------------------------------------------------- |  |  | ---------------------------------------------------------------------------------------------- |  |  | ------------------------- | ---- |  | ---------------------- | -------- |  | ----------------------------------------------------------- | --- |  | ----------------------------------------------------------------- | --- |  | ------------------------------------------------------------------------------------------------------- | --- |  | ----------------------------------------------------------------------------------------------------------------------- | --- | 
|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
underlying
unexercised
unearned
options
(#) |  |  | Option
exercise
price
($) |      |  | Option
expiration
date |          |  | Number
of shares
or units
of stock
that have
not
vested
(#) |     |  | Market
value of
shares or
units of
stock
that
have not
vested
($) |     |  | 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 |  |  | 150,000                                                             |  |  |                                                                      |  |  |                                                                                               |  |  | $                         | 2.00 |  |                        | 2/2/09   |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  | 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   |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  |                                                                     |  |  |                                                                       |  |  |                                                                                                |  |  |                           |      |  |                        |          |  |                                                             |     |  |                                                                   |     |  |                                                                                                         |     |  |                                                                                                                         |     | 
|Kevin Kroger        |  |  |                                                                     |  |  | 100,000                                                               |  |  |                                                                                               |  |  | $                         | 0.26 |  |                        | 06/10/18 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  | 100,000                                                             |  |  |                                                                      |  |  |                                                                                               |  |  |                           | 1.70 |  |                        | 01/10/13 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  | 300,000                                                             |  |  |                                                                      |  |  |                                                                                               |  |  |                           | 9.25 |  |                        | 07/03/10 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  |                                                                     |  |  |                                                                       |  |  |                                                                                                |  |  |                           |      |  |                        |          |  |                                                             |     |  |                                                                   |     |  |                                                                                                         |     |  |                                                                                                                         |     | 
|Alan Sandler        |  |  |                                                                     |  |  | 100,000                                                               |  |  |                                                                                               |  |  | $                         | 0.26 |  |                        | 06/10/18 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  | 50,000                                                              |  |  | 50,000                                                                |  |  |                                                                                               |  |  | $                         | 0.30 |  |                        | 08/05/18 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  |                                                                     |  |  |                                                                       |  |  |                                                                                                |  |  |                           |      |  |                        |          |  |                                                             |     |  |                                                                   |     |  |                                                                                                         |     |  |                                                                                                                         |     | 
|Cindy Gimler        |  |  | 50,000                                                              |  |  |                                                                      |  |  |                                                                                               |  |  | $                         | 0.93 |  |                        | 02/26/15 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  | 6,250                                                               |  |  | 18,750                                                                |  |  |                                                                                               |  |  | $                         | 0.40 |  |                        | 09/26/17 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 
|                    |  |  |                                                                     |  |  | 60,000                                                                |  |  |                                                                                               |  |  | $                         | 0.14 |  |                        | 12/29/18 |  |                                                             |    |  |                                                                   |    |  |                                                                                                         |    |  |                                                                                                                         |    | 

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.

30

---



Table of Contents

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 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. As of September 30, 2008 options to purchase
5,150 which were granted under the 1996 Plan prior to its termination remain
outstanding. Unless the plan has been suspended or terminated by the Board of
Directors, the 1999 Plan will terminate on September 15, 2009. Any such
termination will not affect the validity of any plan options previously granted
thereunder.

As of
December 31, 2008, under the Directors Plan, options to purchase 115,000
shares of common stock were outstanding. As of December 31, 2008, under the
1996 Plan, non-qualified options to purchase 5,150 shares of common stock were
outstanding and, under the 1999 Plan, incentive stock options to purchase
1,647,750 shares of common stock were outstanding and non-qualified options to
purchase 80,000 shares of common stock were outstanding.

31

---



Table of Contents

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 2008. The value attributable to any option awards is
computed in accordance with FAS 123R.

|                      |  |  |                                |   |  |                 |  |   |                |  |   |                                            |  |  |                                                   |   |  |                           |  |   |       |  |  |   |  |  |   |       | 
|--------------------- |  |  | ------------------------------ | - |  | --------------- |  | - | -------------- |  | - | ------------------------------------------ |  |  | ------------------------------------------------- | - |  | ------------------------- |  | - | ----- |  |  | - |  |  | - | ----- | 
|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)  |  |  |                                |  |  |                 |  |  |                |  |   | 2,025                                      |  |  |                                                   |  |  |                           |  |  |       |  |  |  |  |  |   | 2,025 | 
|Forrest D. Hayes (2)  |  |  |                                |  |  |                 |  |  |                |  |   | 2,700                                      |  |  |                                                   |  |  |                           |  |  |       |  |  |  |  |  |   | 2,700 | 
|Kevin G. Kroger       |  |  |                                |  |  |                 |  |  |                |  |   |                                           |  |  |                                                   |  |  |                           |  |  |       |  |  |  |  |  |   |      | 
|Dominick Telesco (4)  |  |  |                                |  |  |                 |  |  |                |  |   | 500                                        |  |  |                                                   |  |  |                           |  |  |       |  |  |  |  |  |   | 500   | 
|Charles W. Walton (5) |  |  |                                |  |  |                 |  |  |                |  |   | 2,025                                      |  |  |                                                   |  |  |                           |  |  |       |  |  |  |  |  |   | 2,025 | 

|    |                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | On September 22,
 2008, General Caldwell was granted options to purchase 7,500 shares of common
 stock at an exercise price of $0.38 per share, vesting on September 22, 2010
 and expiring on September 22, 2010.
|    |                                                                                                                                                                                                                   
|(2) | On September 22,
 2008, Mr. Hayes was granted options to purchase 10,000 shares of common stock
 at an exercise price of $0.38 per share, vesting on September 22, 2010 and
 expiring on September 22, 2010.      
|    |                                                                                                                                                                                                                   
|(3) | On December
 23, 2008, Mr. Telesco was granted options to purchase 5,000 shares of common
 stock at an exercise price of $0.14 per share, vesting on December 23, 2010
 and expiring on December 23, 2013.        
|    |                                                                                                                                                                                                                   
|(4) | On September 22,
 2008, Dr. Walton was granted options to purchase 7,500 shares of common stock
 at an exercise price of $0.38 per share, vesting on September 22, 2010 and
 expiring on September 22, 2010.      

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

At April 7,
2009 we had 37,962,488 shares of our common stock issued and outstanding. The
following table sets forth information regarding the beneficial ownership of
our common stock as March 30, 2009 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

32

---



Table of Contents

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, 214,226 |              |  | 13.5 | %
|Kevin G. Kroger (2)                                                             |  |                                             | 1,092,633  |              |  | 2.8  | %
|Alan J. Sandler (3)                                                             |  |                                             | 108,392    |              |  |      | *
|Cindy Lea Gimler (4)                                                            |  |                                             | 60,250     |              |  |      | *
|Lieutenant General John S. Caldwell, Jr. US
 Army (retired)(5)                  |  |                                             | 65,000     |              |  |      | *
|Forrest D. Hayes (6)                                                            |  |                                             | 20,000     |              |  |      | *
|Dominick Telesco (7)                                                            |  |                                             | 5,588,751  |              |  | 14.4 | %
|Dr. Charles W. Walton (8)                                                       |  |                                             | 415,357    |              |  | 1.1  |  
|All officers and directors as a group
 (eight persons) (1)(2)(3)(4)(5)(6)(7)(8) |  |                                             | 12,564,609 |              |  | 32.6 | %
|Quantum Industrial Partners, LDC
(9)                                            |  |                                             | 4,570,000  |              |  | 12.0 | %
|Glenhill Capital Management, LP
(10)                                            |  |                                             | 4,364,661  |              |  | 11.5 | %

|    |                                                                    |                                                                                                   
|--- | ------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------
|*   | represents
 less than 1%                                          
|    |                                                                    |                                                                                                   
|(1) | The number
 of shares beneficially owned by Mr. Vittoria includes:
|    |                                                                   | warrants to
 purchase 150,000 shares of common stock at $2.00 per share through February
 2, 2009;
|    |                                                                   | 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;   
|    |                                                                   | warrants to
 purchase 80,645 shares of common stock at $1.25 per share through April 4,
 2013; and
|    |                                                                   | warrants to
 purchase 86,207 shares of common stock at $1.25 per share through May 9,
 2013.      
|    |                                                                    |                                                                                                   
|(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; and 
|    |                                                                   | options to
 purchase 100,000 shares of common stock at $1.70 per share through January
 10, 2013. 

The number
of shares beneficially owned by Mr. Kroger excludes unvested options to
purchase 100,000 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 excludes unvested options to
purchase 100,000 shares of our common stock at an exercise price of $.26 per
share through June 10, 2018 and unvested options to purchase 100,000 shares of
our common stock at an exercise price of $.30 per share through August 5, 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; and
|    |                                                                 | options to
 purchase 6,500 shares of common stock at $0.40 per share through September
 26, 2017.    

The number
of shares beneficially owned by Ms. Gimler excludes unvested options to
purchase 18,750 shares of our common stock at an exercise price of $.40 per
share through September 26, 2017.

|    |                                                                        |                                                                                                   
|--- | ---------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------
|(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; and
|    |                                                                       | options to
 purchase 50,000 shares of common stock at $0.97 per share through March 9,
 2015.     

The number
of shares beneficially owned by General Caldwell excludes unvested options to
purchase 7,500 shares of common stock at $0.37 per share through August 25,
2012 and unvested options to purchase 7,500 shares of common stock at $0.38 per
share through September 22, 2013.

33

---



Table of Contents

|    |                                                                 |                                                                                                     
|--- | --------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------
|(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; and
|    |                                                                | options to
 purchase 10,000 shares of common stock at $0.37 per share through November
 10, 2011.   

The
number of shares beneficially owned by Mr. Hayes excludes unvested options to
purchase 10,000 shares of common stock at $0.37 per share through November 10,
2012 and unvested options to purchase 10,000 shares of common stock at $.38 per
share through September 22, 2013.

|    |                                                                   |                                                                                                  
|--- | ----------------------------------------------------------------- | -------------------------------------------------------------------------------------------------
|(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; and
|    |                                                                  | options to
 purchase 5,000 shares of common stock at $.66 per share through December 18,
 2011.  

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 17,
2012 and options to purchase 5,000 shares of common stock at $.14 per share
through December 19, 2013.

|    |                                                                  |                                                                                                     
|--- | ---------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------
|(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; and
|    |                                                                 | options to
 purchase 7,500 shares of common stock at $0.37 per share through August 25,
 2011.      

The number
of shares beneficially owned by Dr. Walton excludes unvested options to
purchase 7,500 shares of common stock at $0.37 per share through August 25,
2012 and options to purchase 7,500 shares of common stock at $0.38 per share
through September 22, 2013.

(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.

|         |                                                                            
|-------- | ---------------------------------------------------------------------------
|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED
 TRANSACTIONS, 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 2008, we recorded
approximately $47,000 of interest reserves relating to these stockholder notes.

In July
2008, we extended the expiration date by six months of a loan of $123,750,
which bears interest at 5.63% per annum and is collateralized by 300,000 shares
of our common stock, made to Mr. Ford, a former executive officer and director,
in July 2001. The loan matured on April 8, 2009, however, is in the process of
being extended for three months.

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
$38,000 at December 31, 2008 remains outstanding.

34

---



Table of Contents

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 2009, the
maturity date for the agreement was extended annually from December 31, 2007 to
December 31, 2010. During the years ended 2007 and 2008, respectively, Mr.
Vittoria allowed the company to increase the loan an additional $50,000 and
$118,000 respectively.

Amounts drawn bear interest at the prime rate per annum payable monthly
and are due December 31, 2010 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. As of December 31, 2008, we have
drawn the entire $6.1 million of the available funds, together with an
additional $100,000 and paid approximately $157,000 in related interest.

On
January 20, 2009 the Company received a loan from Mr. Dominick Telesco, a
shareholder, who is also a Board member, in the amount of $100,000. 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 directors as the term is used in Item 7(d)(3)(iv) of Schedule
14A of the Securities Exchange Act of 1934, as amended.

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

Webb and
Company, P.A. served
as our independent registered public accounting firm for fiscal 2008 and fiscal
2007. The following table shows the fees that were billed for the audit and
other services provided by such firm for fiscal 2008 and fiscal 2007.

|                   |  |  |             |        |  |             |   |        | 
|------------------ |  |  | ----------- | ------ |  | ----------- | - | ------ | 
|                   |  |  | Fiscal 2008 |        |  | Fiscal 2007 |  
|                   |  |  |             |        |  |             |   |        | 
|Audit Fees         |  |  | $           | 36,130 |  |             | $ | 29,638 | 
|Audit-Related Fees |  |  |             | 975    |  |             |   | 9,718  | 
|Tax Fees           |  |  |             |       |  |             |   |       | 
|All Other Fees     |  |  |             | 2,350  |  |             |   | 4,989  | 
|Total              |  |  | $           | 39,455 |  |             | $ | 44,345 | 

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

35

---



Table of Contents

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 2008
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)                                
|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 to 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.                                               

36

---



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 10, 2009                        | 

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
10, 2009

|    |  |                                                                                
|--- |  | -------------------------------------------------------------------------------
|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                                                     

37

---



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, 2008 and 2007, 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, 2008 and 2007, 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
March 10, 2009

Report of
Independent Registered Public Accounting Firm

F-1

---



Table of Contents

Puradyn Filter Technologies Incorporated
Consolidated Balance Sheets

|                                                                                                                                  |  |              |             |      |   |             |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | ---- | - | ----------- | -
|                                                                                                                                  |  | December 31, |            
|                                                                                                                                  |  |              |            
|                                                                                                                                  |  | 2008         |             | 2007 |  
|Assets                                                                                                                            |  |              |             |      |   |             |  
|Current assets:                                                                                                                   |  |              |             |      |   |             |  
|Cash and cash equivalents                                                                                                         |  | $            | 116,802     |      | $ | 112,270     |  
|Accounts receivable, net of allowance for
 uncollectible accounts of $22,970 and $46,870, respectively                            |  |              | 182,660     |      |   | 382,279     |  
|Inventories, net                                                                                                                  |  |              | 1,337,309   |      |   | 1,475,380   |  
|Prepaid expenses and other current assets                                                                                         |  |              | 184,537     |      |   | 181,648     |  
|Total current assets                                                                                                              |  |              | 1,821,308   |      |   | 2,151,577   |  
|                                                                                                                                  |  |              |             |      |   |             |  
|Property and equipment, net                                                                                                       |  |              | 122,915     |      |   | 162,838     |  
|Other noncurrent assets                                                                                                           |  |              | 40,930      |      |   | 40,930      |  
|Deferred financing costs, net                                                                                                     |  |              | 8,419       |      |   | 18,522      |  
|Total assets                                                                                                                      |  | $            | 1,993,572   |      | $ | 2,373,867   |  
|                                                                                                                                  |  |              |             |      |   |             |  
|Liabilities and stockholders deficit                                                                                             |  |              |             |      |   |             |  
|Current liabilities:                                                                                                              |  |              |             |      |   |             |  
|Accounts payable                                                                                                                  |  | $            | 305,645     |      | $ | 732,388     |  
|Accrued liabilities                                                                                                               |  |              | 1,148,536   |      |   | 916,055     |  
|Current portion of capital lease obligation                                                                                       |  |              | 1,859       |      |   | 1,048       |  
|Deferred revenues                                                                                                                 |  |              | 120,647     |      |   | 136,169     |  
|Total current liabilities                                                                                                         |  |              | 1,576,687   |      |   | 1,785,660   |  
|                                                                                                                                  |  |              |             |      |   |             |  
|Capital lease obligation, less current
 portion                                                                                   |  |              | 5,280       |      |   | 7,139       |  
|                                                                                                                                  |  |              |             |      |   |             |  
|Notes Payable - stockholders                                                                                                      |  |              | 6,367,702   |      |   | 6,250,000   |  
|                                                                                                                                  |  |              |             |      |   |             |  
|Total Long Term Liabilities                                                                                                       |  |              | 6,372,982   |      |   | 6,257,139   |  
|                                                                                                                                  |  |              |             |      |   |             |  
|Total Liabilities                                                                                                                 |  |              | 7,949,669   |      |   | 8,042,799   |  
|                                                                                                                                  |  |              |             |      |   |             |  
|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  35,838,351 and 29,400,638, respectively |  |              | 35,839      |      |   | 29,401      |  
|Additional paid-in capital                                                                                                        |  |              | 43,301,010  |      |   | 41,329,330  |  
|Deferred compensation                                                                                                             |  |              | (118,736    | )    |   |            |  
|Notes receivable from stockholders                                                                                                |  |              | (966,531    | )    |   | (1,064,031  | )
|Accumulated deficit                                                                                                               |  |              | (48,469,757 | )    |   | (45,825,210 | )
|Accumulated other comprehensive income                                                                                            |  |              | 262,078     |      |   | (138,422    | )
|Total stockholders deficit                                                                                                       |  |              | (5,956,097  | )    |   | (5,668,932  | )
|Total liabilities and stockholders deficit                                                                                       |  | $            | 1,993,572   |      | $ | 2,373,867   |  

See accompanying notes to consolidated
financial statements.

F-2

---



Table of Contents

Puradyn Filter Technologies Incorporated

Consolidated Statements of Operations

|                                                             |  |                          |            |      |   |            |  
|------------------------------------------------------------ |  | ------------------------ | ---------- | ---- | - | ---------- | -
|                                                             |  | Years
 Ended December 31 |           
|                                                             |  | 2008                     |            | 2007 |  
|                                                             |  |                          |            |      |   |            |  
|Net sales                                                    |  | $                        | 2,695,640  |      | $ | 3,082,873  |  
|                                                             |  |                          |            |      |   |            |  
|Costs and
 expenses:                                         |  |                          |            |      |   |            |  
|Cost of products sold                                        |  |                          | 2,455,916  |      |   | 2,831,560  |  
|Salaries and wages                                           |  |                          | 1,013,438  |      |   | 1,074,519  |  
|Selling and administrative                                   |  |                          | 1,559,394  |      |   | 1,061,828  |  
|Total Operating Costs                                        |  |                          | 5,028,748  |      |   | 4,967,907  |  
|Loss from
 operations                                        |  |                          | (2,333,108 | )    |   | (1,885,034 | )
|                                                             |  |                          |            |      |   |            |  
|Other (expense) income:                                      |  |                          |            |      |   |            |  
|Interest income                                              |  |                          | 2,291      |      |   | 32,516     |  
|Interest expense                                             |  |                          | (313,730   | )    |   | (588,583   | )
|Total other expense                                          |  |                          | (311,439   | )    |   | (556,067   | )
|                                                             |  |                          |            |      |   |            |  
|Income taxes                                                 |  |                          |           |      |   |           |  
|                                                             |  |                          |            |      |   |            |  
|                                                             |  |                          |            |      |   |            |  
|Net loss                                                     |  | $                        | (2,644,547 | )    | $ | (2,441,101 | )
|                                                             |  |                          |            |      |   |            |  
|Basic and diluted loss per
 common share                     |  | $                        | (.08       | )    | $ | (.09       | )
|                                                             |  |                          |            |      |   |            |  
|Basic and diluted weighted average common shares
Outstanding |  |                          | 33,088,770 |      |   | 28,322,903 |  

See accompanying notes to consolidated financial statements.

F-3

---



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) |            | TotalStockholdersDeficit |  
|                                                                     |  |                       |            |        |   |                              |   |                        |            |                                      |   |                      |   |                                                  |            |                           |   |             |   |   |          |   |   |            |  
|Balance at December 31, 2006                                         |  |                       | 27,310,352 |        | $ | 27,310                       |   | $                      | 39,774,531 |                                      | $ |                     |   | $                                                | (1,136,656 | )                         | $ | (43,384,109 | ) | $ | (152.709 | ) | $ | (4,871,633 | )
|Foreign currency translation adjustment                              |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                           |   |            |   |   | 14,287   |   |   | 14,287     |  
|Net loss                                                             |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                           |   | (2,441,101  | ) |   |         |   |   | (2,441,101 | )
|Total comprehensive loss                                             |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  |           |                           |   |            |   |   |         |   |   | (2,426,814 | )
|Exercise of stock options                                            |  |                       | 76,000     |        |   | 76                           |   |                        | 28,424     |                                      |   |                      |   |                                                  |           |                           |   |            |   |   |         |   |   | 28,500     |  
|Issuance of common stock in private Placement, net of issuance
costs |  |                       | 2,014,286  |        |   | 2,015                        |   |                        | 1,472,985  |                                      |   |                      |   |                                                  |           |                           |   |            |   |   |         |   |   | 1,475,000  |  
|Issuance of warrants to investors                                    |  |                       |           |        |   |                             |   |                        | 34,200     |                                      |   |                      |   |                                                  |           |                           |   |            |   |   |         |   |   | 34,200     |  
|Forgiveness of stockholder loans                                     |  |                       |            |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  | 21,506     |                           |   |            |   |   |         |   |   | 21,506     |  
|Interest receivable related to notes receivable from
stockholders    |  |                       |           |        |   |                             |   |                        |           |                                      |   |                      |   |                                                  | 51,119     |                           |   |            |   |   |         |   |   | 51,119     |  
|Compensation expense associated with option modification             |  |                       |           |        |   |                             |   |                        | 1,202      |                                      |   |                      |   |                                                  |           |                           |   |            |   |   |         |   |   | 1,202      |  
|                                                                    
|Compensation expense associated with unvested option awards          |  |                       |           |        |   |                             |   |                        | 17,988     |                                      |   |                      |   |                                                  |           |                           |   |            |   |   |         |   |   | 17,988     |  
|                                                                     |  |                       |            |        |   |                              |   |                        |            |                                      |   |                      |   |                                                  |            |                           |   |             |   |   |          |   |   |            |  
|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     |                           |   |            |   |   |         |   |   |           |  
|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     |                                      |   |                      |   |                                                  |            |                           |   |             |   |   |          |   |   | 51,868     |  
|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 | )

See accompanying notes to consolidated
financial statements.

F-4

---



Table of Contents

Puradyn Filter Technologies Incorporated
Consolidated Statements of Cash Flows

|                                                                               |  |                           |            |      |   |            |  
|------------------------------------------------------------------------------ |  | ------------------------- | ---------- | ---- | - | ---------- | -
|                                                                               |  | Years Ended
 December 31, |           
|                                                                               |  | 2008                      |            | 2007 |  
|Operating activities                                                           |  |                           |            |      |   |            |  
|Net loss                                                                       |  | $                         | (2,644,547 | )    | $ | (2,441,101 | )
|Adjustments to reconcile net loss to net cash used in operating
 activities:   |  |                           |            |      |   |            |  
|Depreciation and amortization                                                  |  |                           | 61,301     |      |   | 96,001     |  
|Gain on sale of assets                                                         |  |                           |           |      |   | 578        |  
|Provision for bad debts                                                        |  |                           | 50,421     |      |   | (3,079     | )
|Provision for obsolete and slow moving inventory                               |  |                           | 43,235     |      |   | (62,564    | )
|Amortization of deferred financing costs included in interest
expense          |  |                           | 10,103     |      |   | 22,227     |  
|Interest receivable from stockholders notes                                   |  |                           |           |      |   | 72,626     |  
|Deferred Compensation                                                          |  |                           | (118,736   | )    |   |            |  
|Compensation expense on stock-based arrangements with
vendors                  |  |                           | 158,450    |      |   | 19,190     |  
|Compensation expense on stock-based arrangements with employees and
 investors |  |                           | 97,168     |      |   | 34,200     |  
|Loss on disposal of fixed assets                                               |  |                           | (1,850     | )    |   |           |  
|Changes in operating assets and liabilities:                                   |  |                           |            |      |   |            |  
|Accounts receivable                                                            |  |                           | 149,198    |      |   | 118,687    |  
|Inventories                                                                    |  |                           | 94,836     |      |   | (140,360   | )
|Prepaid expenses and other current assets                                      |  |                           | (2,890     | )    |   | (7,633     | )
|Other noncurrent assets                                                        |  |                           |           |      |   |           |  
|Accounts payable                                                               |  |                           | (288,727   | )    |   | 277,656    |  
|Accrued liabilities                                                            |  |                           | 94,465     |      |   | 168,617    |  
|Deferred revenues                                                              |  |                           | (15,522    | )    |   | 36,254     |  
|Net cash used in operating activities                                          |  |                           | (2,313,095 | )    |   | (1,808,701 | )
|                                                                               |  |                           |            |      |   |            |  
|Investing activities                                                           |  |                           |            |      |   |            |  
|Proceeds from sale of property and equipment                                   |  |                           |           |      |   | 5,458      |  
|Purchases of property and equipment                                            |  |                           | (24,091    | )    |   | (60,878    | )
|Net cash used in investing activities                                          |  |                           | (24,091    | )    |   | (55,420    | )
|                                                                               |  |                           |            |      |   |            |  
|Financing activities                                                           |  |                           |            |      |   |            |  
|Proceeds from sale of common stock (net)                                       |  |                           | 1,820,000  |      |   | 1,475,000  |  
|Proceeds from exercise of stock options                                        |  |                           |           |      |   | 28,500     |  
|Proceeds from notes payable to stockholders                                    |  |                           | 117,702    |      |   | 1,191,000  |  
|Payment of notes payable to stockholder                                        |  |                           |           |      |   | (780,000   | )
|Payment of capital lease obligations                                           |  |                           | (1,048     | )    |   | (5,931     | )
|Net cash provided by financing activities                                      |  |                           | 1,936,654  |      |   | 1,908,569  |  
|Effect of exchange rate changes on cash and cash
equivalents                   |  |                           | 405,064    |      |   | 12,647     |  
|Net increase in cash and cash equivalents                                      |  |                           | 4,532      |      |   | 57,095     |  
|Cash and cash equivalents at beginning of period                               |  |                           | 112,270    |      |   | 55,175     |  
|Cash and cash equivalents at end of period                                     |  | $                         | 116,802    |      | $ | 112,270    |  
|Supplemental cash flow information                                             |  |                           |            |      |   |            |  
|Cash paid for interest                                                         |  | $                         | 285,093    |      | $ | 453,916    |  
|Cash paid for taxes                                                            |  | $                         |           |      | $ |           |  
|Noncash investing and financing activities                                     |  |                           |           |      |   |           |  

See accompanying notes to consolidated
financial statements.

F-5

---



Table of Contents

Puradyn Filter Technologies Incorporated

Notes to Consolidated Financial Statements

December 31, 2008

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
December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No.
160, Noncontrolling Interests in Consolidated Financial Statements  an
amendment of ARB No. 51. This statement improves the relevance, comparability,
and transparency of the financial information that a reporting entity provides
in its consolidated financial statements by establishing accounting and
reporting standards that require: (i) the ownership interests in subsidiaries
held by parties, other than the parent, and the amount of consolidated net
income attributable to the parent and to the noncontrolling interest be clearly
identified and presented on the face of the consolidated statement of income,
(ii) changes in a parents ownership interest while the parent retains its
controlling financial interest in its subsidiary be accounted for consistently,
(iii) that when a subsidiary is deconsolidated, any retained noncontrolling
equity investment in the former subsidiary be initially measured at fair value,
and (iv) that entities provide sufficient disclosures that clearly identify and
distinguish between the interests of the parent and the interests of the
noncontrolling owners. SFAS No. 160 affects those entities that have an
outstanding noncontrolling interest in one or more subsidiaries or that
deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2008. Early adoption is prohibited. The adoption of this statement is not
expected to have a material effect on our financial statements.

In
March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133
(SFAS 161). This statement is intended to improve transparency in financial
reporting by requiring enhanced disclosures of an entitys derivative
instruments and hedging activities and their effects on the entitys financial
position, financial performance, and cash flows. SFAS 161 applies to all
derivative instruments within the scope of SFAS 133. Accounting for Derivative
Instruments and Hedging Activities (SFAS 133) as well as related hedged items,
bifurcated derivatives, and nonderivative instruments that are designed and
qualify as hedging instruments. Entities with instruments subject to SFAS 161
must provide more robust qualitative disclosures and expanded quantitative
disclosures. SFAS 161 is effective prospectively for financial statements issue
for fiscal years and interim periods beginning after November 15, 2008, with
early application permitted. The adoption of this statement is not expected to
have a material effect on our financial statements.

In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS No. 162 identifies the sources of accounting
principles and provides entities with a framework for selecting the principles
used in preparation of financial statements that are presented in conformity
with GAAP. The current GAAP hierarchy has been criticized because it is
directed to the auditor rather than the entity, it is complex, and it ranks
FASB Statements of Financial Accounting Concepts, which are subject to the same
level of due process as FASB Statements of Financial Accounting Standards,
below industry practices that are widely recognized as generally accepted but
that are not subject to due process. The Board believes the GAAP hierarchy
should be directed to entities because it is the entity (not its auditors) that
is responsible for selecting accounting principles for financial statements
that are presented in conformity with GAAP. SFAS

F-6

---



Table of Contents

162
is effective 60 days following the SECs approval of PCAOB Auditing Standard
No. 6, Evaluating Consistency of Financial Statements (AS/6). The adoption of
FASB 162 is not expected to have a material impact on our financial position.

In
May 2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee
Insurance Contracts-an interpretation of FASB Statement No. 60. Diversity
exists in practice in accounting for financial guarantee insurance contracts by
insurance enterprises under FASB Statement No. 60, Accounting and Reporting by
Insurance Enterprises. This results in inconsistencies in the recognition and
measurement of claim liabilities. This Statement requires that an insurance
enterprise recognize a claim liability prior to an event of default (insured
event) when there is evidence that credit deterioration has occurred in an
insured financial obligation. This Statement requires expanded disclosures
about financial guarantee insurance contracts. The accounting and disclosure
requirements of the Statement will improve the quality of information provided
to users of financial statements. SFAS 163 is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those fiscal years. The adoption of FASB 163 is not
expected to have a material impact on our financial position

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 at
the customers site are shipped, there are no uncertainties surrounding
customer acceptance and for which collectability is reasonably assured in
accordance with Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statementsas
amended and interpreted. Cash received by the Company prior to revenue
recognition is recorded as deferred revenues. 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
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, 2008 and December 31, 2007, 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,
2008 and December 31, 2007, 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

F-7

---



Table of Contents

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

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 $10,103 and $22,227 for the
years ended December 31, 2008 and 2007, respectively. Accumulated amortization
of deferred financing costs as of December 31, 2008 and December 31, 2007 was
$672,731 and $662,628, 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

In connection with the adoption of FIN 45, 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, 2008 and December 31, 2007, respectively:

|                                              |  |          |         |          |   |         |  
|--------------------------------------------- |  | -------- | ------- | -------- | - | ------- | -
|                                              |  | 12/31/08 |         | 12/31/07 |  
|Balance as
 of beginning of year              |  | $        | 89,809  |          | $ | 71,759  |  
|Less:
 Payments made                          |  |          | (20,674 | )        |   | (10,895 | )
|Change in
 prior period estimate              |  |          |        |          |   | 1,397   |  
|Add:
 Provision for current period warranties |  |          | 79,014  |          |   | 27,548  |  
|Balance as
 of end of year                    |  | $        | 148,149 |          | $ | 89,809  |  

F-8

---



Table of Contents

Guarantees
None

Comprehensive Income

SFAS
No. 130, Reporting Comprehensive Income
(SFAS 130) 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 as reported in the consolidated statement of changes in
stockholders equity (deficit). 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, 2008 and 2007 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, 2008 and
2007, advertising costs incurred by the Company totaled approximately $8,000
and $17,000, 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, 2008 and 2007, engineering and development costs incurred by the Company
totaled approximately $18,000 and $31,000, 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 SFAS No. 52, Foreign Currency Translation(SFAS 52).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 2008 and 2007 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, 2008
and 2007, the Company recorded a foreign currency exchange rate loss of
approximately $535,000 and a gain of approximately $87,000, 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 SFAS No. 109, Accounting for Income Taxes(SFAS 109).
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 SFAS 123R 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 SFAS 123R on
straight line basis over the service periods of

F-9

---



Table of Contents

each
award. We have estimated forfeiture rates based on our historical experience.
Stock option compensation expense for the year ended December 31, 2008 has been
recognized as a component of cost of goods sold and general and administrative
expenses in the accompanying Consolidated Financial Statements.

In
2008 and 2007, respectively, 772,500 and 200,000 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 SFAS 123R.

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 SFAS 123 and
EITF 96-18, Accounting for Equity
Investments That are Issued to Other Than Employees for Acquiring or in
Conjunction with Selling Goods or Services, including related
amendments and interpretations. The related expense is recognized over the
period the services are provided.

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 for December 31, 2008 and $100,000 for
December 31, 2007 are at risk. At December 31, 2008 and December 31, 2007,
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, 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

The
Company follows SFAS No. 128, Earnings Per
Share (SFAS 128), which 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
4,981,972 in 2008 and 3,636,543 in 2007.

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, 2007
expressing substantial doubt about the Companys ability to continue as a going
concern.

F-10

---



Table of Contents

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 the company expects to see results from these
reductions, as well as other cost reduction plans through 2008. Additionally,
the Company is reviewing cost of material increases, which are expected to be
passed through to its customers as product price increases beginning January
2009.

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 $2,313,000 and $1,809,000 during the years
ended December 31, 2008 and 2007, 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.

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 2009, the stockholder
extended the maturity date of the loan agreement annually, which currently
expires on December 31, 2010.

The Company experienced an increase in cash used in operations in 2008
but does not anticipate this increase to occur in 2009; 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 April 2009. 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 2009.
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, 2008 and December 31, 2007, inventories consisted of
the following:

|                     |  |                   |           |                   |   |           |  
|-------------------- |  | ----------------- | --------- | ----------------- | - | --------- | -
|                     |  | December 31, 2008 |           | December 31, 2007 |  
|                     |  |                   |           |                   |  
|Raw
 materials       |  | $                 | 946,429   |                   | $ | 780,979   |  
|Finished
 goods      |  |                   | 505,039   |                   |   | 779,005   |  
|Valuation
 allowance |  |                   | (114,159  | )                 |   | (84,604   | )
|                     |  | $                 | 1,337,309 |                   | $ | 1,475,380 |  

F-11

---



Table of Contents

4. Prepaid Expenses and Other Current Assets

At
December 31, 2008 and December 31, 2007, prepaid expenses and other current
assets consisted of the following:

|                                            |  |                   |         |                   |   |         | 
|------------------------------------------- |  | ----------------- | ------- | ----------------- | - | ------- | 
|                                            |  | December 31, 2008 |         | December 31, 2007 |  
|                                            |  |                   |         |                   |   |         | 
|Prepaid
 expenses                           |  | $                 | 117,746 |                   | $ | 101,857 | 
|Deferred
 costs related to deferred revenue |  |                   | 66,791  |                   |   | 79,791  | 
|                                            |  | $                 | 184,537 |                   | $ | 181,648 | 

5. Property and Equipment

At December
31, 2008 and December 31, 2007, property and equipment consisted of the
following:

|                                                |  |                   |            |                   |   |            |  
|----------------------------------------------- |  | ----------------- | ---------- | ----------------- | - | ---------- | -
|                                                |  | December 31, 2008 |            | December 31, 2007 |  
|                                                |  |                   |            |                   |   |            |  
|Machinery
 and equipment                        |  | $                 | 977,183    |                   | $ | 1,077,501  |  
|Furniture
 and fixtures                         |  |                   | 54,870     |                   |   | 101,555    |  
|Leasehold improvements                          |  |                   | 122,622    |                   |   | 122,622    |  
|Website development                             |  |                   | 72,960     |                   |   | 72,960     |  
|Computer hardware and
 software                 |  |                   | 93,929     |                   |   | 119,262    |  
|                                                |  |                   | 1,321,564  |                   |   | 1,493,900  |  
|Less
 accumulated depreciation and amortization |  |                   | (1,198,649 | )                 |   | (1,331,062 | )
|                                                |  | $                 | 122,915    |                   | $ | 162,838    |  

Depreciation
and amortization expense of property and equipment for the years ended December
31, 2008 and 2007 is $61,301 and $96,001, respectively, of which approximately
$12,000 and $18,000 is included in cost of products sold and approximately
$49,000 and $78,000 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, 2008, $34,970 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%. The total minimum lease payments over the
term of the lease aggregate approximately $956,000.

The
Company leased a condominium in Ocean Ridge, Florida to provide accommodations
for Company use. The lease expired on December 31, 2008 and was not renewed.

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.

Rent
expense under all operating leases for the years ended December 31, 2008 and
2007 totaled approximately $282,000 and $314,000, respectively, of which
approximately $214,000 and $224,000 is included in cost of products sold and
approximately $68,000 and $72,000 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 $995 of accumulated amortization,
in the accompanying consolidated balance sheet.

F-12

---



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  |                   |   |         | 

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

|                                         |  |                |         |                   |   |         | 
|---------------------------------------- |  | -------------- | ------- | ----------------- | - | ------- | 
|                                         |  | Capital Leases |         | Operating
 Leases |  
|2008                                     |  | $              | 5,479   |                   | $ | 149,524 | 
|2009                                     |  |                | 5,479   |                   |   | 53,103  | 
|2010                                     |  |                | 5,479   |                   |   | 39,282  | 
|2011                                     |  |                | 2,283   |                   |   |         | 
|2012 and
 thereafter                     |  |                |        |                   |   |         | 
|Total
 minimum lease payments            |  |                | 18,720  |                   | $ | 241,909 | 
|Less amount
 representing interest       |  |                | (10,533 | )                 |   |         | 
|                                         |  |                |         |                   |   |         | 
|Present
 value of minimum lease payments |  | $              | 8,187   |                   |   |         | 

7. Accrued Liabilities

At December 31, 2008 and December 31, 2007, accrued liabilities
consisted of the following:

|                                                        |  |                   |           |                   |   |         | 
|------------------------------------------------------- |  | ----------------- | --------- | ----------------- | - | ------- | 
|                                                        |  | December 31, 2008 |           | December 31, 2007 |  
|Accrued wages and benefits                              |  | $                 | 862,347   |                   | $ | 680,342 | 
|Accrued expenses relating to vendors and
 others        |  |                   | 84,326    |                   |   | 73,610  | 
|Deferral of straight-line rent expense                  |  |                   |          |                   |   | 16,790  | 
|                                                        |  |                   |           |                   |   |         | 
|Accrued warranty costs                                  |  |                   | 148,149   |                   |   | 89,809  | 
|Accrued interest payable relating to
 stockholder notes |  |                   | 53,714    |                   |   | 55,504  | 
|                                                        |  | $                 | 1,148,536 |                   | $ | 916,055 | 

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 (2.9% at December 31, 2008), 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

F-13

---



Table of Contents

other financing over $7.0 million. In March 2006, March, 2007 and March
2008, the maturity date for the agreement was extended to December 31, 2007,
December 31, 2008 and December 31, 2010, respectively.

At December
31, 2008 and December 31, 2007, respectively, the Company had drawn all of the
$6.1 million of available funds together with an additional $167,000 and
$150,000, respectively. Additionally, the Company received loans from one board
member totaling $100,000 at December 31, 2008 and loans from two board members
totaling $100,000 at December 31, 2007.

In April
2005, the maturity date of the 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, 2008 and 2007, the Company incurred interest expense
of approximately $283,000 and $481,000, respectively, on its draws, which is
included in interest expense in the accompanying consolidated statements of operations.

Maturities of
Long-Term Obligations for Five Years and Beyond

Long-term obligations consisted of the following at December 31, 2008
and December 31, 2007:

|                              |  |                   |           |                   |   |           |  
|----------------------------- |  | ----------------- | --------- | ----------------- | - | --------- | -
|                              |  | December 31, 2008 |           | December 31, 2007 |  
|Notes
 payable to stockholder |  | $                 | 6,367,702 |                   | $ | 6,250,000 |  
|Capital
 lease obligation     |  |                   | 7,139     |                   |   | 8,187     |  
|                              |  |                   | 6,374,841 |                   |   | 6,258,187 |  
|Less:
 current maturities     |  |                   | (1,859    | )                 |   | (1,048    | )
|                              |  | $                 | 6,372,982 |                   | $ | 6,257,139 |  

The minimum
annual principal payments of notes payable and capital lease obligations at
December 31, 2008 and December 31, 2007 were:

|     |  |                   |           |                   |   |           | 
|---- |  | ----------------- | --------- | ----------------- | - | --------- | 
|     |  | December 31, 2008 |           | December 31, 2007 |  
|2008 |  | $                 |          |                   | $ | 1,048     | 
|2009 |  |                   | 1,859     |                   |   | 6,251,859 | 
|2010 |  |                   | 6,370,972 |                   |   | 3,270     | 
|2011 |  |                   | 2,010     |                   |   | 2,010     | 
|     |  | $                 | 6,374,841 |                   | $ | 6,258,187 | 

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:

|                                                     |  |      |            |      |   |            |  
|---------------------------------------------------- |  | ---- | ---------- | ---- | - | ---------- | -
|                                                     |  | 2008 |            | 2007 |  
|                                                     |  |      |            |      |  
|United
 States                                       |  | $    | (2,043,434 | )    | $ | (2,455,387 | )
|Foreign                                              |  |      | (601,114   | )    |   | 14,286     |  
|                                                     |  |      |            |      |   |            |  
|Intercompany
 elimination                            |  |      |           |      |   |           |  
|                                                     |  |      |            |      |  
|Loss from
 continuing operations before income taxes |  | $    | (2,644,548 | )    | $ | (2,441,101 | )

F-14

---



Table of Contents

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

|                                        |  |      |             |      |   |             |  
|--------------------------------------- |  | ---- | ----------- | ---- | - | ----------- | -
|                                        |  | 2008 |             | 2007 |  
|                                        |  |      |             |      |   |             |  
|Deferred tax assets:                    |  |      |             |      |   |             |  
|Net operating loss carryforwards        |  | $    | 14,854,359  |      | $ | 14,163,096  |  
|Depreciation and amortization           |  |      | 84,998      |      |   | 78,177      |  
|Accrued expenses and reserves           |  |      | 93,225      |      |   | 58,801      |  
|Impairment loss                         |  |      | 78,304      |      |   | 78,304      |  
|Compensatory stock options and warrants |  |      | 76,871      |      |   | 57,354      |  
|Capital Loss Carryover                  |  |      | 42,686      |      |   | 40,630      |  
|Other                                   |  |      | 17,872      |      |   | 16,917      |  
|Total deferred tax assets               |  |      | 15,248,315  |      |   | 14,493,279  |  
|Valuation allowance                     |  |      | (15,248,315 | )    |   | (14,493,279 | )
|Net deferred tax assets                 |  | $    |            |      | $ |            |  

SFAS 109 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 $15,248,315 and $14,493,279
against its net deferred taxes is necessary as of December 31, 2008 and
December 31, 2007, respectively. The change in valuation allowance for the
years ended December 31, 2008 and 2007 is $755,036 and $932,207 respectively.

At December 31, 2008 and December 31, 2007, respectively, the Company
had approximately $40,860,651 and $38,990,150, 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:

|                                                |  |      |        |      |  |        |   
|----------------------------------------------- |  | ---- | ------ | ---- |  | ------ | --
|                                                |  | 2008 |        | 2007 | 
|Federal
 statutory taxes                        |  |      | (34.00 | )%   |  | (34.00 | )%
|State income
 taxes, net of federal tax benefit |  |      | (3.63  | )    |  | (3.63  | ) 
|Nondeductible
 items                            |  |      | 0.12   |      |  | 0.16   |   
|Change in
 valuation allowance                  |  |      | 37.59  |      |  | 38.39  |   
|Other                                           |  |      | (.12   | )    |  | (.92   | ) 
|                                                |  |      |       | %    |  |       | % 

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.

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.

F-15

---



Table of Contents

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.

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.

On May 23, 2007 the Company extended the expiration date of 11,650
vested stock options for a terminated employee who left the company in May
2005. The exercise price of the options ranges from $.38 to $2.15. In
accordance with SFAS 123, incremental compensation cost was recognized in an
amount equal to the excess of the fair value of the modified award over the
fair value of the original award immediately before the modification. The
Company recorded approximately $1,202 of compensation expense related to this
modification, which was included in the consolidated statement of operations
for the year ended December 31, 2007.

During each of 2008 and 2007, 30,000 and 55,000 respectively, of
options were issued to non-employee Directors.

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

|                                                 |  |         |           |                                    |   |         |  |                                    |           |   |   |      | 
|------------------------------------------------ |  | ------- | --------- | ---------------------------------- | - | ------- |  | ---------------------------------- | --------- | - | - | ---- | 
|                                                 |  | 2008    |           | 2007                               |  
|                                                 |  | Options |           | Weighted
 Average
 Exercise
 Price |   | Options |  | Weighted
 Average
 Exercise
 Price |          
|Outstanding,
 beginning of year                  |  |         | 1,766,900 |                                    | $ | 2.65    |  |                                    | 1,880,400 |   | $ | 3.10 | 
|Granted                                          |  |         | 772,500   |                                    |   | .26     |  |                                    | 200,000   |   |   | .40  | 
|Exercised                                        |  |         |          |                                    |   |         |  |                                    | (76,000   | ) |   | .38  | 
|Cancelled                                        |  |         | (124,000  | )                                  |   | 1.08    |  |                                    | (130,000  | ) |   | 4.28 | 
|Expired                                          |  |         | (647,500  | )                                  |   | 1.48    |  |                                    | (107,500  | ) |   | 5.86 | 
|Outstanding,
 end of year                        |  |         | 1,767,900 |                                    |   | 2.15    |  |                                    | 1,766,900 |   |   | 2.65 | 
|Exercisable,
 end of year                        |  |         | 929,150   |                                    | $ | 3.83    |  |                                    | 1,505,650 |   | $ | 3.03 | 
|Options
 available for future grant, end of year |  |         | 1,637,250 |                                    |   |         |  |                                    | 2,135,750 |   |   |      | 

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

---



Table of Contents

Summarized
information with respect to options outstanding under the three option plans at
December 31, 2007 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            |  |                     | 1,218,400 |                                                  |  | 5.56                              |  | $                   | .84  |                                   |  | 957,150   |  | $ | 0.92 | 
|$1.86  $4.50            |  |                     | 198,500   |                                                  |  | 4.03                              |  |                     | 2.39 |                                   |  | 198,500   |  |   | 2.39 | 
|$8.50  $9.25            |  |                     | 350,000   |                                                  |  | 1.59                              |  |                     | 9.14 |                                   |  | 350,000   |  |   | 9.14 | 
|                         |  |                     |           |                                                  |  |                                   |  |                     |      |                                   |  |           |  |   |      | 
|Totals                   |  |                     | 1,766,900 |                                                  |  | 4.97                              |  | $                   | 2.65 |                                   |  | 1,505,650 |  | $ | 3.03 | 

12. Common Stock

In June 2007, the Company received cash proceeds of $975,000 from an
accredited investor for the purchase of 1,300,000 shares of common stock at
$0.75 per share as part of a private offering.

In August 2007, the Company converted $500,000 previously received in
the form of advances into purchases of 714,286 shares of common stock at $0.70
per share.

In February 2008, the Company received cash proceeds of $324,000 from
an accredited investor for the purchase of 900,000 shares of common stock at
$0.36 per share. As part of the offering, the Company awarded 225,000 warrants
to purchase one share of common stock at an exercise price of $1.25 on or prior
to February 5, 2018. This same investor had previously purchased 1.3 million
shares of common stock in a June 2007 private offering priced at $0.75 per
share, bringing the total shares of Puradyn common stock purchased by this
investor to 2,200,000.

In March 2008, the Company converted $520,000 previously received in
the form of advances into purchases of 297,714 shares of common stock at $0.35
per share. As part of the offering, the Company awarded 371,429 warrants to
purchase one share of common stock at an exercise price of $1.25 on or prior to
March 26, 2018.

During May and June 2008 the Company received gross proceeds of
approximately $.400 million for an aggregate of 1,352,166 shares of common
stock from private investors, with purchase prices ranging from $0.28 to $.31
per share of common stock. Each four shares purchased will entitle the
purchaser to receive common stock purchase warrants to purchase one share of
common stock at an exercise price of $1.25 on or prior to June 5, 2013.

During the June through August 2008, the Company had received gross
proceeds of approximately $480 million for an aggregate of 1,826,500 shares of
common stock from a confidential private placement offering, with purchase
prices ranging from $0.25 to $.33 per share of common stock. Each four shares
purchased will entitle the purchaser to receive common stock purchase warrants
to purchase one share of common stock at an exercise price of $1.25 on or prior
to August 25, 2013.

On October 1, 2008, the Company agreed to pay to Emerging Markets, LLC,
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.

In December 2008, the Company converted $100,000 previously received in
the form of advances into purchases of 833,333 shares of common stock at $0.12
per share. As part of the offering, the Company awarded 208,333 warrants to
purchase one share of common stock at an exercise price of $1.25 on or prior to
November 20, 2013.

F-17

---



Table of Contents

13. Warrants

At December 31, 2008 and 2007, 3,214,072 and 1,869,643 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 February 2, 2009 to March 26, 2018. Information concerning the
Companys warrant activity is as follows:

|                                       |  |                            |           |                            |   |         |  |       |           |  |   |      | 
|-------------------------------------- |  | -------------------------- | --------- | -------------------------- | - | ------- |  | ----- | --------- |  | - | ---- | 
|                                       |  | 2008                       |           | 2007                       |  
|                                       |  | Weighted Average
 Exercise |           | Weighted Average
 Exercise |  
|                                       |  | Options                    |           | Price                      |   | Options |  | Price |          
|                                      
|Outstanding,
 at the beginning of year |  |                            | 1,869,643 |                            | $ | 1.25    |  |       | 1,589,643 |  | $ | 0.99 | 
|Granted                                |  |                            | 1,949,429 |                            |   | 1.21    |  |       | 380,000   |  | $ | 1.25 | 
|Exercised                              |  |                            |          |                            |   |        |  |       |          |  |   |     | 
|Expired                                |  |                            | (605,000  | )                          |   | 1.10    |  |       | 100,000   |  | $ | 4.05 | 
|Outstanding,
 at the end of year       |  |                            | 3,214,072 |                            | $ | 1.25    |  |       | 1,869,643 |  | $ | 1.25 | 

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, 2008 and 2007, the Company had
amortized approximately $5,000 and $6,000 of such costs, respectively, 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, 2008 and 2007, the Company had
amortized approximately $3,000 and $4,000 respectively, which is included in
interest expense in the accompanying consolidated statement of operations.

In June 2007, the Company received cash proceeds of $975,000 from an
accredited investor for the purchase of 1,300,000 shares of common stock at
$0.75 per share as part of a private offering. As part of the offering, the
Company awarded 380,000 warrants to purchase one share of common stock at an
exercise price of $1.25 on or prior to August 23, 2017.

As part of the offering in February 2008, the Company awarded 225,000
warrants to purchase one share of common stock at an exercise price of $1.25 on
or prior to February 5, 2018.

As part of the shareholder loans converted to common shared in March
2008, the Company granted shareholders 371,429 warrants to purchase one share
of common stock at an exercise price of $1.25 on or prior to March 26, 2018.

As part of the May and June 2008 private placement offering, the
Company granted to investors 338,041 warrants to purchase one share of common
stock at an exercise price of $1.25 on or prior to June 5, 2013.

As part of the June through August 2008 private placement offering, the
Company granted to investors 456,626 warrants to purchase one share of common stock
at an exercise price of $1.25 on or prior to August 25, 2013.

On October 1, 2008, as part of the payment for services, the Company
granted Emerging Markets, LLC 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.

As part of the shareholder loans converted to common shared in November
2008, the Company granted a shareholder 208,333 warrants to purchase one share
of common stock at an exercise price of $1.25 on or prior to November 20, 2013.

14. Major Customers

During 2008 and 2007, two customers together accounted for
approximately 34% and 44%, respectively, of the Companys net sales. In 2008,
there were two customers that individually accounted for greater than 10% of
net sales, or approximately $485,000 and $419,000, while in 2007 there were two
customers that individually accounted for greater than 10% of net sales, or
approximately $791,000 and $570,000. 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

F-18

---



Table of Contents

total accounts receivable.
There were five customers at December 31, 2007, whose trade receivable balances
equaled or exceeded 5% of total receivables, representing approximately 24%,
10%, 8%, 8% and 7% 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.
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 |          
|                            |  | 2008                   |           | 2007 |  
|Net sales:                  |  |                        |           |      |   |           | 
|United States               |  | $                      | 1,972,704 |      | $ | 1,873,017 | 
|United Kingdom              |  |                        | 722,936   |      |   | 1,209,856 | 
|                            |  | $                      | 2,695,640 |      | $ | 3,082,873 | 
|                            |  |                        |           |      |   |           | 
|Long-lived
 assets by area: |  |                        |           |      |   |           | 
|United States               |  | $                      | 41,232    |      | $ | 153,139   | 
|United Kingdom              |  |                        | 606       |      |   | 9,699     | 
|                            |  | $                      | 41,838    |      | $ | 162,838   | 

16. Subsequent Events

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 will be April 8, 2009.

On March 5,
2009 Puradyn Filter Technologies Incorporated filed a Certificate of Amendment
to its Certificate of Incorporation increasing the number of authorized shares
of its common stock from 40,000,000 shares to 50,000,000 shares effective close
of business on March 25, 2009. The par value of the common stock did not change
as a result of this charter amendment.

The
Certificate of Amendment were adopted by our Board of Directors on January 30,
2009, and by the holders of a majority of our outstanding common stock by the
written consent dated March 4, 2009, all as described in greater detail in our
definitive Information Statement on Schedule C as filed with the Securities and
Exchange Commission on March 4, 2009.

In February
2009, the Company formally terminated its Master Distributor Agreement with
Filter Solutions Ltd (FSL), whereby FSL had assumed distributorship for the
United Kingdom, Mainland Europe and Ireland.

On February
5, 2009, the Company signed a Letter of Intent with SOMS Technologies, LLC
summarizing the principal terms of a proposed joint development and joint
marketing transaction.

On February
23, 2009, the repayment date of the stockholder loan was extended from December
31, 2009 to December 31, 2010.

During
February 2009, the Company received proceeds to $476,000 from the sale of
1,724,137 shares of common stock at $.28 per share.

On February
5, 2009, the Company converted $100,000 previously received in the form of
advances into purchases of 400,000 shares of common stock at $0.25 per share.
As part of the offering, the Company awarded 100,000 warrants to purchase one share of common
stock at an exercise price of $1.25 on or prior to February 3, 2014.

F-19

---



Table of Contents

During
the quarter ending March 31, 2009, the Company received shareholder loans
totaling $100,000.

On March 4,
2009, the Company awarded Mark Rodino 425,000 warrants to purchase 425,000
shares of common stock at $.50 per share for consultancy services on behalf of
the Company resulting in equity funding of approximately $1 million during the
past 18 months. The warrants expire on March 3, 2014. The Company recorded an
expense of approximately $89,250 for this award in March, 2009.

On March 5,
2009 the Company entered into an Investor Advisory Agreement with Blue Skies
Holdings, LLC and Egleston Incorporated.

F-20

---