Back to GetFilings.com

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC  20549

***
FORM 10-K

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. 

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 Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sales price of the Common Stock as of June 28, 2002, was approximately $2,681,000.

The number of outstanding shares of the Registrant’s Common Stock as of March 17, 2003 was 29,789,598.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held on June 25, 2003, are incorporated by reference into Part III.

Page 1 of 56

Exhibit Index on Sequentially Numbered Page 55

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

          This Annual Report on Form 10-K contains forward-looking statements relating to future events or the future financial performance of the Registrant, including but not limited to statements contained in “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Factors Which May Affect Future Operating Results.”  Readers are cautioned that such statements, which may be identified by words including “anticipates,” “believes,” “intends,” “estimates,” “expects,” and similar expressions, are only predictions or estimations and are subject to known and unknown risks and uncertainties.  In evaluating such statements, readers should consider the various factors identified in this Annual Report on Form 10-K, including, but not limited to, matters set forth in “Factors Which May Affect Future Operating Results,” which could cause actual events, performance or results to differ materially from those indicated by such statements.

PART I

ITEM 1.  Business

General Description of Business

          Prolong International Corporation (the “Registrant” or “PIC”) is a Nevada corporation that was incorporated on August 24, 1981 as Giguere Industries, Incorporated (“Giguere”).  On September 14, 1981, Giguere consummated a merger with Medical International, Inc., a Utah corporation, pursuant to which Giguere was the surviving entity.  Prior to the merger with Giguere, Medical International, Inc. had completed an offering of its common stock which was exempt from registration under the Securities Act of 1933, as amended, by reason of Regulation A thereunder.  All of the outstanding shares of Medical International, Inc. common stock were exchanged for shares of Giguere as part of the plan of merger.  Subsequent to the merger, Giguere conducted operations for several years until it liquidated its assets in order to satisfy its creditors and discontinued operations in 1987.  Giguere was inactive and held no significant assets from 1987 to June 21, 1995.

          On June 21, 1995, Giguere acquired all of the outstanding common stock of Prolong Super Lubricants, Inc., a Nevada corporation (“PSL”), in a share exchange with PSL’s then existing shareholders (the “Reorganization”) and changed its name from Giguere to Prolong International Corporation.  Since the Reorganization, PIC has changed its focus from being a company without operations, a business or significant assets, to that of a holding company for its wholly-owned operating subsidiary, PSL.  On December 4, 1998, PIC formed Prolong International Holdings Ltd. (“PIHL”), a Cayman Islands company, as a wholly-owned subsidiary.  On the same day, PIHL formed Prolong International Ltd. (“PIL”), a Cayman Islands company, as its wholly-owned operating subsidiary.  PIC, through PSL, PIHL and PIL (referred to collectively in the operational context with PIC as “Prolong” or “the Company”), is engaged in the manufacture, sale and worldwide distribution of a line of high performance lubrication and automotive appearance products, several of which are based on a patented extreme pressure lubricant additive for use in metal lubrication, commonly referred to as anti-friction metal treatment (“AFMT”).

          On February 5, 1998, PIC entered into a definitive agreement with EPL Pro-Long, Inc., a California Corporation (“EPL”), under which PIC purchased the business assets of EPL.  Under the terms of the agreement, PIC purchased the principal assets and assumed certain liabilities of EPL for approximately 2,981,035 shares of PIC’s common stock, $0.001 par value per share (the “PIC Common Stock”).  With the purchase, PIC acquired the patents for the anti-friction metal treatment (“AFMT”) technology and related trademarks and, as a result, owns the exclusive, worldwide rights to manufacture, sell and distribute lubrication and other products based on AFMT and owning the “Prolong” name.  Prior to this transaction, PIC, through PSL, held an exclusive license from EPL to use AFMT and the “Prolong” name.  This transaction closed on November 20, 1998.  On November 25, 1998, the U.S. District Court in San Diego, California (the “Court”) granted a temporary restraining order without a hearing in response to a purported class action filed by a group of plaintiffs representing less than 2% of the outstanding shares of EPL’s common stock against PIC, PSL, EPL and certain of their respective former and current officers and directors.  On October 12, 2001 the case was settled as a class action, dismissing all of the claims with prejudice.  In settlement, PIC issued 1,350,695 additional shares of its common stock to EPL, out of which one-third of those shares were distributed to certain of plaintiff’s attorneys and two-thirds of those shares were distributed to EPL shareholders.  PIC agreed to waive its claim to reimbursement for EPL’s accrued expenses of approximately

Page 2

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

$430,000 as additional purchase consideration.  The acquisition of the assets of EPL by PIC is now completed and all associated litigation has been dismissed.  See “Legal Proceedings”.

          Prior to fiscal 1996, PIC raised capital primarily through the issuance of PIC Common Stock in private placements.  During 1997 and 1998, working capital was generated primarily through operations. Working capital for 2000, 2001 and 2002 was generated through operations, the utilization of the Company’s line of credit with a bank and new financing in the form of subordinated debt.

Products

          Prolong markets a variety of products, some of which are based on AFMT.  AFMT is a patented extreme-pressure lubricant formula which can be blended with many other lubricants and formulations to create a wide variety of individual lubricant products with superior extreme pressure friction fighting characteristics.  AFMT can also be blended with other constituents to create additional products, which may be added to Prolong’s product line. AFMT bonds to the metal surfaces with which it comes into contact, resulting in reduced friction and heat buildup when subjected to pressure.  Prolong believes that AFMT is most effective in extreme pressure applications, where metal-to-metal contact occurs in severe conditions, such as: gears (at the contact point where the teeth of the gear touch each other - for example in hypoid gears); engines (at the contact points where metal to metal pressure squeezes out the normal boundary lubrication - for example where the camshaft contacts the lifters; where the main bearings contact the crankshaft; where the rod bearings contact the rod and the bearing cap); and machinery (at the metal to metal contact points where surface or boundary lubrication breaks down metal contacts under heavy loads - for example in a steel mill where rolling steel contacts steel rollers).

          AFMT is composed of petroleum distillates and other chemicals and contains no solid particles.  Typically, performance enhancing lubrication additive formulations contain solid particles such as lead, molybdenum disulphides, PTFE resins, Teflon ™,  fluorocarbon resins or fluorocarbon micropowder.  Prolong believes that the primary disadvantage to particulate material in lubricant additives is that it tends to distribute unevenly and can result in excessive particulate build-up.  Because AFMT contains no solid particles, Prolong believes that there is no risk of excessive buildup, because the lubrication “film coat” is uniform and microscopically thin.

          The friction fighting characteristics of AFMT have been documented by The Foundation for Scientific and Industrial Research at the Norwegian Institute of Technology, Trondheim, Norway.  This independent testing laboratory was commissioned in 1987 by the principals of Prolong Technology of Canada, Inc. d.b.a. Prolong International, the entity from which EPL acquired the patented AFMT formula.  The tests were conducted at the expense of Prolong Technology of Canada, Inc. and at the request of customers for in-depth scientific data.  The friction fighting characteristics are further documented in U.S. Patent No. 4,844,825, which outlines various tests conducted on AFMT precedent to the issuance of the patent.

          AFMT exhibits both the “hydrostatic” and “boundary” principles of lubrication.  Specifically, all surfaces tend to attract some substances from the environment.  Such substances or films may be only a few molecules thick, and are absorbed into the surface.  The strength of the absorption depends upon the electronic structure of “polarized” molecules, which tend to absorb perpendicularly to the surface.  Warren Prince, Ph.D., a registered mechanical engineer and machine and product design specialist was commissioned and retained by Prolong to analyze and test its product formulation and found that AFMT operates by attaching to the metal at the microscopic level, evenly and uniformly.  Prolong believes that once this chemical/electrical action takes place through absorption, only very extreme heat, grinding away of the surface area, or the introduction of material with a stronger molecular adhesion will alter the surface bonding.  As a result, third party tests performed on AFMT have demonstrated that it is impervious to many elements and chemicals and its benefits continue beyond the initial application.

          Prolong believes that the use of AFMT in lubrication products provides many advantages for its users.  For example, in clinical testing by third parties, the use of AFMT resulted in reduced friction in mechanical devices.  This, in turn, caused the operating temperatures of the machinery to drop due to the reduction in heat-generating friction.  Prolong believes that in the long term, this combination of friction and temperature reduction leads to a

Page 3

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

longer operating life for the machinery and lower repair bills.  Given the foregoing advantages demonstrated by AFMT, Prolong has identified a broad market for its lubricant products.

          Prolong believes that the following are examples of some of the applications of AFMT-based lubricant products:

          Prolong markets the following products, each of which can be utilized in multiple applications:

          LUBRICANTS

          Prolong Anti-Friction Metal Treatment “AFMT” - This is Prolong’s fundamental lubricating oil which is made according to a patented formula for use as an extreme pressure lubricant.  It is packaged in concentrate form and is designed to be added by the customer to the lubrication oils in engines, gears, and other machinery.

          Prolong Engine Treatment and Engine Treatment Booster - Formulated for use in the lubrication of internal combustion engines, Prolong believes that this product helps mitigate friction, heat and wear under extreme pressure conditions in engines.  Prolong Engine Treatment is suitable for use in both gasoline and diesel engines.

          Prolong Transmission Treatment - Formulated for use in both automatic and manual transmissions and for other applications, such as heavy-duty industrial gearboxes where metal gears are operated under high pressure, this product is designed to improve lubrication where metal meets metal.

          Prolong Heavy Duty Gear & Differential Treatment – Formulated for use in both automatic and manual heavy-duty transmissions and for other applications, such as heavy-duty industrial gearboxes where metal gears are operated under high pressure, this product is designed to improve lubrication where metal meets metal.

          Prolong High Performance Multi-Purpose EP-2 Grease - This product is formulated to provide a wide range of lubricating benefits to industrial equipment under extreme pressure, high and low temperature extremes, and potential water washout conditions.  Prolong believes that this product represents a substantial improvement in lubrication performance relative to other products on the market in applications benefiting from an extreme pressure grease formulation.

          Prolong “SPL100” Super Penetrating Lubricant - This product is formulated to lubricate, penetrate, and prevent corrosion, free sticky mechanisms, displace moisture, stop squeaks, and reduce friction and wear.  This product can also serve as a light duty machining, tapping and drilling fluid.

          Prolong Multipurpose Precision Oil – The product is formulated as a fine, light oil for use in lubricating precision tools and equipment.  The product is designed to provide smooth lubrication, which Prolong believes results in optimal operation of precision equipment and tools and extension of useful life.

          Prolong “Ultra-Cut 1” Water Soluble Cutting Fluid - This product is formulated to lubricate and cool metal tools and parts during machining operations.  This product can be used in Computer Numerically Controlled (“CNC”) metal turning and machining operations.  Prolong believes that the use of this product will provide higher feed rates and operating speeds, finer surface finishes, and improved cutting tool life.

Page 4

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

          FUEL ADDITIVES

          Prolong Fuel System Cleaner - This product is formulated to help optimize fuel efficiency by lubricating the “top end” of internal combustion engines and by helping clean and maintain fuel injectors and other fuel system components.  This product is designed to help maintain peak engine performance and optimize overall mileage.  The formula is EPA registered and is compatible with all grades of gasoline.

          Prolong “Fast-Fuel”™ Octane Power Boost – This product is a specially formulated gasoline additive that is designed to help boost octane, help restore lost horsepower, help improve fuel mileage and help mitigate knocks, pings and engine hesitation.

          Prolong “Fast-Fuel”™ Injector Cleaner – This product is formulated as a fuel additive designed to help remove deposits on clogged fuel injectors and intake valves, to help clean dirty fuel injectors, to help keep carburetors, combustion chambers, manifolds and ports clean, and consequently help maintain optimum engine performance and optimum mileage.

          CAR CARE & APPEARANCE

          Prolong Paint Sealant - Prolong Paint Sealant is designed to give durable shine and protection to a vehicle’s paint.  The wipe on, wipe off formula is easily applied with the patented Prolong refillable applicator.

          Prolong Waterless Wash - This product is designed to both wash and shine a vehicle in as little as 15 minutes through a simple spray and wipe technique, without using water.  Special lubricating agents encapsulate and lift dirt particles to clean safely without scratching, leaving a smooth, shiny, protected finish.  The product removes bugs, tar, tree sap, road film and bird droppings.

          Prolong Super Protectant -This product is formulated to provide durable protection to vinyl, rubber and plastic surfaces.  An easy-to-use patented applicator is included with this product.

          Prolong Super Cleaner - This product combines a multi-purpose cleaner, degreaser and stain remover into one product.  It is designed to be strong enough to degrease an engine, remove brake dust and clean whitewalls, yet gentle enough to remove food stains and ground-in dirt from carpets and fabric seats without damaging the underlying fabric.

          Prolong Super Glass Cleaner - Unlike household cleaners, Prolong Super Glass Cleaner is designed specifically for road grime, oily film, bugs and dirt found on car windows.  This product is designed to leave windows clean and streak-free and has been formulated without ammonia to be safe for tinted windows.

          Along with PSL’s current variety of lubricant products, there are other lubricant products, which Prolong believes could be successfully and beneficially formulated in the future using AFMT technology and derivatives thereof that would result in products with improved lubrication performance.  Although there can be no assurances that Prolong will have the financial or other resources to develop, manufacture and market any such additional lubricant products, the following is a partial list of such additional lubricant products:

          High Performance Motor Oil
          High Performance Synthetic Motor Oil
          Motorcycle Engine & Transmission Treatment
          Gun Oil & Cleaner
          Gear/Differential Treatment
          Heavy Duty Diesel Fuel Conditioner
          Hydraulic System Treatment
          Chain Oil
          2-Cycle Engine Oil
          Power Steering Treatment
          Radiator Treatment

Page 5

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

          Compressor Treatment
          Shock Absorber Lubricants
          Brake Cleaner
          Assembly Lube

Current Markets For Prolong’s Products

          PIC’s strategy is to successfully direct Prolong’s product line to a number of different markets, each of which is currently large, representing significant future revenue potential for PIC.  Although PIC is currently actively addressing both the consumer automotive and consumer household markets described below, PIC’s strategy is to adapt Prolong’s product line and address the commercial, industrial governmental and international markets described below:

          Consumer Automotive - The consumer automotive market consists of automobiles, light trucks, motorhomes, motorcycles, snowmobiles, jet skis, and other fuel burning vehicles.  The owners of these vehicles represent a significant source of customers for Prolong’s lubricants, fuel additives, appearance products and other future additions to the Prolong product line.  Recognizing this fact, this market has been the primary target of Prolong’s marketing efforts to date.

          Consumer Household - The consumer household lubrication market is a potentially lucrative segment of the industry which could prove receptive to Prolong’s products for uses as varied as fishing reels, guns, windows, sliding doors, garage doors, sewing machines, electric hair clippers, bicycles, tricycles, scooters, skateboards, garage door openers, lawn mowers, snow blowers, drills, saws, door locks, hinges, rusted bolts, and virtually anything made of metal that must be lubricated in order to maintain performance.  Prolong currently manufactures “SPL100® Super Penetrating Lubricant, and Prolong Multipurpose Precision Oil” for this market.

          Consumer Marine – The consumer marine market includes both freshwater and salt-water boats and small ships, from outboard fishing skiffs to pleasure boats, yachts and other marine vessels.  Prolong formulates products for the harsh marine environments, including Prolong Marine Grease, Prolong Marine Engine Treatment and Prolong Marine Penetrate Spray & Fogging Oil.

          Commercial – Prolong has developed a product line and has begun to develop a market for Prolong products in the trucking industry.  A substantial portion of the distribution of goods in this country occurs via truck shipments.  Consequently, trucks operated in this industry consume large quantities of oil and diesel fuel.  Prolong believes that the use of its products in the long-haul trucking industry may provide an economic advantage to truck operators because of the increased operating efficiency demonstrated by engines treated with AFMT-based products.  Prolong believes that this increased efficiency may directly result in a reduction in fuel costs and overall transportation costs.  Further, the use of AFMT-based products may provide additional savings to this industry in the form of reduced service and repair costs over the useful like of the trucks duet to AFMT’s propensity to reduce engine wear and the wear of other “treated” components.

          Industrial - The commercial and industrial market encompasses an enormous variety of major and minor manufacturers.  This market includes businesses such as steel mills, automobile manufacturers, aircraft manufacturers, paper mills, electric motor manufacturers, petrochemical manufacturers, oil refineries, mining operations and electrical generating facilities, all of which require lubricants and Prolong believes would benefit from the increased performance of Prolong’s products.  Even more numerous are the smaller industrial facilities, such as machine shops and other fabrication businesses throughout the world.  Prolong further believes that businesses engaged in stamping, molding, die casting, boring, drilling, honing and a number of other similar operations could realize significant cost savings by using the full line of Prolong’s products.  Prolong anticipates pursuing the industrial market through a network of manufacturer’s sales representatives and through established industrial distributors.

Page 6

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

Future Markets For Prolong’s Products

          Prolong believes the following to be significant opportunities for expansion of its marketing efforts into diverse niches of the lubricant market.  There can be no assurances that Prolong will be successful at penetrating any of these potential markets.

          Government - The government market is not only very large, but Prolong believes it is also extremely varied. It includes cities, counties, states and all of the federal government agencies.  Prolong believes that these agencies collectively purchase, operate, and maintain a significant investment in trucks, automobiles, buses, tanks, airplanes, helicopters, boats, ships, radar equipment, guns, miscellaneous equipment and tools, as well as many other mechanisms, all of which require adequate lubrication.  The federal government represents potential sales by Prolong to many different agencies such as the Department of Defense, NASA, Department of Energy, Department of Transportation and other federal governmental agencies.  Procurement procedures require that products used in or on military equipment must be manufactured according to certain military specifications (“MIL Specs”).  Prolong intends to apply for and receive United States MIL Specs for certain of its products, and to market products not only to the United States military, but to foreign militaries as well.  Prolong plans to develop the military market, both here and abroad, through the utilization of specialists who are familiar with military procurement procedures and with the special needs of the military services.  Potential sales to state governments include users such as the National Guard, highway patrol, state police and other state agencies.  Both county and city governments are potential Prolong customers for use by police, fire, water, gas, waste management and other local departments.  Public transportation entities are major potential customers for Prolong’s products, and Prolong intends to focus its efforts to market products to these entities at the various levels of government.  Prolong believes that rapid transit districts throughout the country are facing a serious problem with noisy and polluting diesel buses.  The Los Angeles Rapid Transit District, for example, has 3,300 buses and is currently under heavy public and regulatory pressure to reduce emissions.  In addition to diesel buses, there are a significant number of other vehicles currently operated by county and city public transportation agencies which Prolong believes, if treated with its products, could run cleaner, quieter, last longer and would burn less fuel.

          Agricultural Applications - The agricultural industry represents another potentially significant market for Prolong’s products.  Modern agricultural machinery and equipment tend to be highly complex and are often subjected to harsh working environments.  As a result of the harsh environments, the machinery and equipment operates inefficiently and results in increased fuel consumption and a decreased productive life-cycle due to increased mechanical wear.  Prolong believes that the use of its products could save the agriculture industry substantial sums by reducing these industry wide losses caused by friction and contaminants.

Geographic Markets

          Prolong currently markets its products in the United States, Canada, Mexico, Puerto Rico, Central America, China, Hong Kong, Japan, Thailand, Sub-Saharan Africa, Brazil, Chile, Germany, Turkey, Hungary and Slovakia and intends to continue developing distributor relationships in other foreign countries.  Prolong’s current focus is to identify distributors that possess the expertise and industry relationships necessary to assist it in further penetrating retail sales channels in the various markets identified above, with a primary focus on the consumer automotive and industrial lubricant markets.  Prolong intends to selectively grant distributorships to established companies on a country-by-country basis.  Prolong intends to build on these relationships and to continue to expand sales and revenues in the international marketplace.  There can be no assurance that Prolong will be able to successfully penetrate any foreign markets.  Prolong has patent protection on its AFMT technology in several of the EEC member countries.

          International sales comprised 7.8%, 6.7%, and 9.7% of PIC’s revenues in 2000, 2001, and 2002 respectively.  Prolong consummates such sales through independent distributors and, as such, has nominal assets attributable to its international sales.

Page 7

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

Marketing And Distribution Of The Products

          Prolong distributes its products through both national and regional automotive aftermarket stores, traditional automotive aftermarket stores, mass merchandisers, installers, independent distributors, and directly to consumer end-users via direct response television sales and the internet.  Currently, Prolong has approximately 450 distributors in the United States.  Additionally, Prolong has ten international distributors located in Europe, Asia, Africa and South America.  Prolong currently employs a direct sales force of 5 people to service its distributors. The Company utilizes contract warehouses located in Southern California to store and ship its products.

          Prolong’s major automotive retailers include AutoZone, CSK Auto, Pep Boys, Advance Auto, Canadian Tire and other regional and independent automotive retailers.

          In the traditional automotive aftermarket arena, Prolong distributes through General Parts, Inc./CarQuest, Genuine Parts Company/NAPA/ARC and hundreds of additional traditional automotive aftermarket locations.

          Prolong’s mass retailers include Wal-Mart, Target Stores and Meijer Stores.  Additionally, Prolong products are distributed through approximately 500 car dealerships and approximately 200 professional installers throughout the United States.

          The Company sells its products online through its website at www.prolong.com.  Fulfillment of direct sales to online customers is done on site at the Company’s headquarters.  The Prolong website has e-commerce capabilities as well as general product and Company information.  Prolong intends to continue to develop its website during 2003 and to further utilize the Internet as a means of marketing and distributing its products directly to the public, as well as communicating with its shareholders and the public in general.  The products offered by Prolong have been marketed through endorsements by well-known spokespersons, event sponsorships, spot television ads, print and electronic media, trade shows, motorsports, direct response television advertisements, radio, press releases, public relations, in-store point of sale materials and promotions, sweepstakes, and through the Internet on Prolong’s website, www.prolong.com.

          In the area of product endorsements, Prolong has an ongoing agreement by which it retained the services of Al Unser to endorse and promote Prolong’s products.  Mr. Unser has agreed to make certain appearances to assist in marketing the products and has agreed to license his name and likeness in connection with the marketing of Prolong’s products.

          In order to support the thousands of retail establishments that carry Prolong’s products, Prolong provides and/or participates in a number of marketing programs with retailers related to promoting and advertising its products, which expenditures are commonly known as Marketing Fund Allowances.  The expenditures include, but are not limited to, in store point-of-sale materials, placement in high traffic areas, printing of fliers and brochures, in store promotions and sweepstakes, and various other marketing tools that are traditionally used to promote products at the retail level.

          From time to time, Prolong utilizes direct response television advertising, commonly called infomercials, in order to educate the public about the benefits and features of Prolong products, to promote the brand, and to sell products directly to consumer end users.  To date, Prolong has premiered three separate infomercials.  Results through the infomercials vary from program to program and from time slot to time slot but in general have been beneficial to Prolong due to the fact that they provide television exposure at reduced costs from traditional television spot advertising, as well as fill the market demand for mail order purchases.  In general, Prolong believes that no more than 5% to 10% of its customers will buy Prolong products through infomercials and mail order delivery, but Prolong does believe that there is a wide viewing audience that is exposed to its products through the infomercials and that a portion of such audience ultimately purchases Prolong products at a retail establishment.  Prolong intends to air infomercials from time to time so long as they are economically viable, help to build the brand throughout the marketplace, and drive retail sales.

Page 8

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

Competition

          The market for Prolong’s products is highly competitive and is expected to remain so in the future.  The basic formula of Prolong’s lubricant products has not changed materially since its development in 1986.  The formula was granted a United States patent on July 4, 1989.  Rapid technological advances, frequent new product introductions and evolving industry standards, characterize the market for Prolong’s products.  Some of Prolong’s principal competitors include other providers of specialized lubrication products, such as The Clorox Company (STP ®) and Pennzoil-Quaker State Company (Slick 50 ®), both of which market engine treatments.  Other competitive engine treatment brands include Duralube ®, and Z-MAX™.  Prolong’s competitors also include major oil brands such as Shell, Chevron, Castrol, and other companies that manufacture lubrication products, such as WD-40 Company.  Competition for appearance products comes principally from companies such as Turtle Wax, Inc., Meguiar’s, Inc., Pennzoil-Quaker State Company and The Clorox Company.  Further, Prolong believes that major oil and consumer products companies not presently offering products that compete directly with those offered by Prolong may enter Prolong’s markets in the future.

          Increased competition could result in price reductions, reduced gross margins, and a loss of market share, any of which could have a material adverse effect on PIC’s business, financial condition and results of operations.  In addition, many of Prolong’s competitors have significantly greater financial, technical, research and product development, marketing and other resources and greater market recognition than Prolong.  Several of Prolong’s competitors also currently have, or may develop or acquire, substantial customer bases in the automotive and other related industries.  As a result of these factors, Prolong’s competitors may be able to respond more quickly than Prolong to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sale of their products.  Additionally, other dealers and distributors may offer similar lubrication and appearance products at prices below those offered by Prolong, appealing to the price-sensitive segment of the market.  While Prolong believes that the prices for Prolong lubrication and appearance products are competitive for the level of quality obtained by the customer, Prolong relies on PSL’s brand name recognition for selling high quality, state of the art products.  There can be no assurance that Prolong will be able to compete successfully against current and future competitors or that competitive pressures faced by Prolong will not materially adversely affect PIC’s business, financial condition and results of operations.

          Prolong believes that its current competitive edge lies with the superior lubrication performance of its products relative to that of its competitors, the awareness of its brand among consumers, the value offered by the brand as perceived by consumers and its distribution channels.  In order for Prolong to draw attention to the superior performance of its products, Prolong is treating and marketing its products as a unique specialty line of high performance products as opposed to a high volume product line.

Production

          The AFMT formula contained in certain of Prolong’s products and the formulas for such products themselves are comprised of petroleum-based components, which are readily available from several suppliers.  Prolong does not foresee any shortages of supply in the near future.  While Prolong is working actively with each of its suppliers to increase production of the components, there can be no assurance that each supplier will be able to meet its production in time to satisfy Prolong’s requirements or that alternative suppliers will be able to meet any such deficiency on an ongoing basis.  If Prolong is unable to obtain sufficient quantities of the components, or if such components do not meet Prolong’s quality standards, delays or reductions in product shipments could occur which would have a material adverse effect on PIC’s business, financial condition and results of operations.

          In addition to the potential deficiency in supply of the AFMT components, such components are also subject to significant price volatility beyond the control or influence of Prolong.  Prices for the components of the quality sought by Prolong are dependent on the origin, supply and demand at the time of purchase.  Prices can be affected by multiple factors in the producing countries, including weather and political and economic conditions.  Additionally, petroleum products, upon which Prolong relies for its AFMT formula, have been affected in the past, and may be affected in the future, by the actions of certain organizations and associations, such as the Organization of Petroleum Exporting Countries (“OPEC”), that have historically attempted to establish price controls on petroleum products through agreements establishing export quotas or restricting petroleum supplies worldwide.  No

Page 9

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

assurance can be given that OPEC (or others) will not succeed in raising the price of petroleum components or that, in such event, Prolong will be able or choose to maintain its gross margins quickly by raising its prices without effecting demand.  Increases in the prices for the components, whether due to the failure of its suppliers to perform, conditions affecting the component-producing countries, or otherwise, could have a material adverse effect on PIC’s results of operations.

          The production of Prolong’s products is comprised of contract manufacturers mixing the components pursuant to the AFMT and other proprietary formulas and bottling the resulting mixtures in packaging specified by Prolong.  Prolong’s current contract manufacturers have the capacity to produce its products in relatively high volumes.  By utilizing existing third party manufacturing facilities, Prolong avoids the large capital expenditures associated with mixing and packaging operations, as well as costly management of human resources.  At present, there are facilities located throughout the world that are capable of mixing and packaging the components into finished products.  Prolong has not entered into any long term contracts with respect to the supply or production of its lubricant products, preferring to take advantage of competition among suppliers and manufacturers.

Customers

          In 2002, Prolong’s sales to automotive aftermarket retail chain stores, mass merchandisers, and independent distributors comprised approximately 87.0% of its revenues while sales to international, commercial, industrial and other customers comprised 13.0% of total revenues.  In 2002, four retail customers (AutoZone, Wal-Mart, Pep Boys and CSK Auto) comprised approximately 66.9% of its revenues.

Intellectual Property

          On November 20, 1998, PIC acquired substantially all of the assets of EPL, including EPL’s U.S. and foreign patents pertaining to the AFMT technology and related U.S. And foreign trademarks. Prior to this transaction, PIC, through PSL, held an exclusive license from EPL to use AFMT and the “Prolong” name.  As a result of the transaction, PIC owns the exclusive rights to manufacture, distribute and sell products based on the patented technology in the U.S. And in certain foreign countries, and to use the “Prolong” trade name and trademarks.

          The U.S. patent relating to the AFMT technology (U.S. Patent No. 4,844,825, hereinafter “the ‘825 patent”) expires on November 18, 2007.  There are a number of foreign patents corresponding to the ‘825 patent as well.  In addition, PSL has obtained a federally registered patent in the United States for a “Sponge Applicator Device” (U.S. Patent No. 6,010,268) and SPONGE APPLICATOR (U.S. Design Patent No. 414005), which applicator is currently included in the various appearance product packages marketed by Prolong.  PSL has obtained or applied for trademark registration protection in numerous countries for various trademarks utilized in the marketing and promotion of Prolong lubricant products.  Currently, PSL holds the following federally registered trademarks in the United States: PROLONG and the related design (U.S. Reg. Nos. 2,136,672 and 2,136,576), PROLONG SUPER LUBRICANTS (U.S. Reg. No. 2,136,577), NO EQUAL IN THE WORLD & DESIGN (U.S. Reg. No. 2,129,784), NO EQUAL IN THE WORLD (Word Mark) (U.S. Reg. No. 2,270,653), SPL100 (U.S. Reg. No. 2,022,220), THE ULTIMATE IN PROTECTION & PERFORMANCE (U.S. Reg. No. 2,129,785), PSL’s Oil Drop Logo (U.S. Reg. No. 2,135,230), TRIGGER SPRAY BOTTLE CONFIGURATION (U.S. Reg. No. 2,376,247), and TRIGGER SPRAY BOTTLE BLUE COLOR (U.S. Reg. No. 2,376,248).

Royalty Agreements

          In 1996, Prolong entered into a service and endorsement contract with Al Unser-whereby Prolong agreed to pay royalties on all net lubricant retail sales at rates that varied during each year of the agreement.  The current applicable royalty rate though the balance of the term of the agreement, October 31, 2004, is 0.6%.  For each year during the term of the agreement, the Company pays a guaranteed minimum payment of $75,000.  The maximum annual payment during the balance of the term is $125,000.  During 2002, Prolong expended $71,147 under this agreement.

Page 10

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

Employees

          As of March 17, 2003, PIC and its subsidiaries collectively employed 22 full-time employees, including 3 executive officers, and no part-time employees.  None of Prolong’s employees are represented by a labor organization and PIC considers the relationships with its employees to be good.

Available Information

          Prolong’s corporate information website is www.prolong.com/corporateinfo.aspx.  Prolong makes available through this website under “Stock Information – EDGAR,” free of charge, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after Prolong electronically files or furnishes such materials to the U.S. Securities and Exchange Commission.

ITEM 2.  Properties

          PSL leases approximately 29,442 square feet of office and warehouse space in a two-story building located at 6 Thomas in Irvine, California, pursuant to a five-year lease that terminates on December 31, 2006, with an option to renew for one additional five-year period.  The monthly lease obligation for fiscal 2003 is $33,500, of which approximately $2,695 is being paid to PSL by subtenants for the use of a portion of the space.  PIC considers the present facilities to be adequate for Prolong’s current operations and for those reasonably expected to be conducted during the next twelve months.  PIC may sublease space within the premises from time to time; depending upon the space needs of the Company and is presently subleasing space within the premises.  Further, PIC believes that any additional space, if required, will be available on commercially reasonable terms.

ITEM 3.  Legal Proceedings

          On April 8, 1997, a lawsuit was filed by Francis Helman et al v EPL and PIC et al in the Court of Common Pleas, Columbiana County, Ohio as a purported class action alleging breach of fiduciary duty, breach of oral and written contract, and fraud, in thirteen original causes of action related to a claim of right to become a shareholder of PIC. Management believes that there is no merit to the plaintiffs’ complaint, is vigorously defending against the claims, and does not believe the outcome will have a material adverse affect on the Company’s financial position or results of operations.

          In February 1999, PSL entered into a negotiated Consent Order with the FTC concerning the standards for adequate substantiation of engine treatment advertising claims, among other items.  As a follow on to the FTC matter, four separate lawsuits were filed by individuals purporting to act as class representatives for consumers seeking redress based on various allegations of false advertising, unfair competition, violation of various state consumer laws, fraud, deceit, negligent misrepresentation, breach of warranty and seeking equitable relief.  All four of the suits have been settled with court approval; namely Fernandes et al v PSL, Bowland et al v PSL, Mata et al v PSL, and Kachold et al v PSL, and the period for appeal has expired.  In settlement, the Company will offer a discount cash rebate on certain of its products through four major distributors by means of an in-store coupon for a period of six months, with the coupons expiring eighteen months from the date of settlement.  In addition, the Company will reimburse plaintiff’s legal counsel as a group in an amount not to exceed $66,000.  Settlement of these suits has no material adverse affect on the Company’s financial position or results of operation, as the Company has fully accrued for the settlements.

          PIC and its subsidiaries are subject to other legal proceedings, claims, and litigation arising in the ordinary course of business.  PIC’s management does not expect that the ultimate costs to resolve these matters will have a material adverse affect on PIC’s consolidated financial position, results of operations or cash flows.

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

          No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2002.

Page 11

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

PART II

ITEM 5.  Market for Registrant’s Common Equity and Related Stockholder Matters

Price Range of Common Stock

          PIC’s Common Stock is currently trading on AMEX under the symbol “PRL.”  High and low sales prices as furnished by AMEX for each quarter during 2001 and 2002 are as indicated below.

          PIC has authorized 150,000,000 shares of Common Stock, having a par value of $0.001 per share.  As of March 17, 2003, the number of holders of record of Common Stock is approximately 723 and the high and low sales prices as reported by AMEX, were $0.08 and $0.07, respectively.  PIC has not declared any cash dividends since inception, and does not intend to do so in the foreseeable future.  PIC currently intends to retain its earnings for the operation and expansion of its business.  PIC does not have any restrictions on its ability to pay dividends on common equity.

Recent Sales of Unregistered Securities

          On November 13, 2002, PIC issued warrants to purchase an aggregate of 2,062,500 shares of Common Stock to a total of seven accredited investors in connection with the sale and issuance of an aggregate principal amount of $750,000 of 15.00% subordinated promissory notes.  The warrants have five year terms and entitle the holder to acquire shares of PIC’s Common Stock at a price of $0.09 per share.  Additionally, each warrant may be exercised as a result of a “net issue” or “easy sale” exercise by the holder.

          The sales of the aforementioned warrants and 15.00% subordinated promissory notes were deemed to be exempt from registration under the Securities Act of 1933, as amended (the “1933 Act”), in reliance on Section 4(2) of the 1933 Act or Regulation D promulgated thereunder.  PIC has reason to believe that each investor was familiar with or had access to information concerning the operations and financial condition of PIC, and each investor represented that he, she or it was an accredited investor and was acquiring the securities for investment only and not with a view to or for sale in connection with any distribution thereof.  At the time of the issuances, the warrants and the 15.00% subordinated promissory notes were deemed to be restricted securities for purposes of the 1933 Act and the instruments representing such securities (and the share certificates to be issued upon exercise of the warrants) bear legends to that effect.

Page 12

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

ITEM 6.  Selected Financial Data

          The following selected financial data is qualified by reference to, and should be read in conjunction with, the consolidated financial statements, related notes and other information included elsewhere in this Annual Report on Form 10-K as well as “Management’s Discussion And Analysis Of Financial Condition And Results Of Operations.”  The financial data set forth below for the years ended December 31, 1998, 1999 and 2000, respectively, is derived from the consolidated financial statements of the Company that have been audited by Deloitte & Touche LLP.  The financial data for the years ended December 31, 2001 and 2002, respectively, is derived from the consolidated financial statements of the Company that have been audited by Haskell & White LLP.

ITEM 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

          The following discussion and analysis of the Registrant’s financial condition and results of operations should be read in conjunction with the Financial Statements and the notes thereto included elsewhere in this Annual Report on Form 10-K.

General

          Since the Reorganization in June 1995, management of Prolong has concentrated a significant portion of its efforts and resources on the marketing and sale of Prolong’s consumer oriented products, through traditional retail distribution and through direct response television advertising.  Management believes that it has attained a significant level of brand and product identification and Prolong has focused its efforts to expand sales of its consumer lubrication products into commercial and industrial channels, as well as international markets.

          The lubricant business is extremely competitive.  Prolong’s business requires that it compete with larger, better financed entities, most of which have brand names which are well established in the marketplace.  Although Prolong, in the opinion of management, has unique products which have superior performance characteristics relative to the well known products available in the marketplace, Prolong remains at a distinct disadvantage and will be required to expend substantial sums in order to promote brand name identity and product acceptance among its prospective customers.  In order to establish brand name identity, Prolong has relied primarily on its direct response television programs and intends from time to time to utilize this means to gain product recognition for purposes of directly increasing sales as well as increasing retail, commercial and industrial and governmental sales resulting from broader public knowledge of its products.

Risk Factors And Forward Looking Statements

          This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that

Page 13

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

involve risks and uncertainties.  In addition, the Company may from time to time make oral forward looking statements.  The words “estimate,” “project,” “potential,” “intended,” “expect,” “anticipate,” “believe” and similar expressions or words are intended to identify forward looking statements.  The forward looking statements included herein are based on current expectations, which involve a number of risks and uncertainties and assumptions regarding the Company’s business and technology.  These assumptions involve judgments with respect to, among other things, future economic and competitive conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company.  Although the Company believes that the assumptions underlying the forward looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the results contemplated in forward looking statements will be realized and actual results may differ materially.  In light of the significant uncertainties inherent in the forward looking information included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved.  The Company undertakes no obligation to publicly release the result of any revisions to these forward looking statements that may be made to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

          Because of the risk factors discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other factors that may affect the Company’s operating results, past financial performance should not be considered an indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

Critical Accounting Policies and Estimates

          The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period.  The Company regularly evaluates its estimates and assumptions related to allowances for doubtful accounts, sales returns and allowances, inventory reserves, goodwill and purchased intangible asset valuations, deferred income tax asset valuation allowances, warranty reserves, litigation and other contingencies.  The Company bases its estimates and assumptions on historical experience, forecasted operating results and expected trends, and on various other factors that it believes 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.  To the extent there are material differences between the Company’s estimates and the actual results, its future results of operations will be affected.  The Company believes the following critical accounting policies require it to make significant judgments and estimates in the preparation of its consolidated financial statements:

          Revenue, Receivables and Inventory

          The Company recognizes product revenue upon concluding that all of the fundamental criteria for revenue recognition have been met.  The criteria are usually met at the time of product shipment.  In addition, the Company records reductions to revenue for estimated product returns and allowances such as competitive pricing programs.  Should actual product returns or pricing adjustments exceed the Company’s estimates, additional reductions to revenue would result.  The Company provides reserves for estimated product warranty costs at the time revenue is recognized.  The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments.  If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances could be required.  The Company writes down its inventory for estimated obsolescence.  If actual market conditions are less favorable than those projected by management, additional inventory write-downs could be required.

          Goodwill and Purchased Intangible Assets

          The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired. Goodwill

Page 14

PROLONG INTERNATIONAL CORPORATION AND SUBSIDIARIES

and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests.  Management obtains an annual independent, third party valuation of the Company to assist it in the performance of annual impairment tests.  The amounts and useful lives assigned to intangible assets impact future amortization.

          Deferred Taxes

          If the Company determines that it is more likely than not that it will not realize all or part of its net deferred tax assets in the future, it will record a valuation allowance against the deferred tax assets, which allowance will be charged to income tax expense in the period of such determination.  Management considers the scheduled reversal of deferred tax liabilities, tax planning strategies and future taxable income in assessing the realizability of deferred tax assets.  Management also considers the weight of both positive and negative evidence in determining whether a valuation allowance is needed.

Results of Operations

          The following table sets forth certain financial data as a percentage of net sales for the periods indicated: