General

Sales of the Company's products, the puraDYNฎ 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;

• 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 Puradyn system.
• 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 Puradynsystem 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

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.

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

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.

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)
                                                        Increase
                                  2008       2007     (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)
                                                        Increase
                                  2008       2007     (Decrease)
                  Gross sales   $  2,686   $  3,126   $       440

   Sales returns & allowances         10        (43 )         (53 )

                    Net sales   $  2,696   $  3,083   $      (387 )

                                                        Increase
                                  2008       2007     (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 Sales Net 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.

Cost of Sales Cost 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 Wages Salaries 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 Expenses Selling 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.

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