UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
 
 FORM
10-Q
 
 x
              
              QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For
the quarterly period ended September 30, 2009
 or
 
 o
              
              TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For
the transition period
from                    
to
 
 Commission
File Number 0-29185
 
 SAVE
THE WORLD AIR, INC.
 (Exact
name of registrant as specified in its charter)
 
 Nevada
              52-2088326(State
      or other jurisdiction of
                incorporation
      or organization)
              (I.R.S.
      Employer
                Identification
      No.)
 
 235
Tennant Avenue
 Morgan
Hill, California 95037
 (Address,
including zip code, of principal executive offices
 (408) 778-0101
 (Registrant’s
telephone number, including area code)
 
 Securities
registered pursuant to Section 12(b) of the Exchange Act:
None.
 
 Securities
registered pursuant to Section 12(g) of the Exchange Act: Common Stock,
$0.001 par value.
 
 Check
whether the Registrant (1) 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  x   No

  Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).    YES  o    NO   ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
 See the definitions of “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 Large
      accelerated filero
              Accelerated
      filer  oNon-accelerated
      filer  o  (Do
      not check if a smaller reporting company)
              Smaller
      reporting company  x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes o
  No x
 
 The
number of shares of the Registrant’s Common Stock outstanding as of
 November 12, 2009 was 69,627,597 shares.
 
 
 1
 
 SAVE
THE WORLD AIR, INC.
 FORM
10-Q
 INDEX
 
 PagePART
      I
              3ITEM
      1. Financial Statements
              3Condensed
      consolidated balance sheets (unaudited)
              3Condensed
      consolidated statements of operations (unaudited)
              4Condensed
      consolidated statement of changes in stockholders’ deficiency
      (unaudited)
              5Condensed
      consolidated statements of cash flows (unaudited)
              14Notes
      to condensed consolidated financial statements
      (unaudited)
              16ITEM
      2. Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
              29ITEM
      3. Quantitative and Qualitative Disclosure About Market
      Risk
              38ITEM
      4. Controls and Procedures
              38PART
      II
              40ITEM
      1. Legal Proceedings
              40ITEM
      1A. Risk Factors
              41ITEM
      2. Unregistered Sales of Equity Securities and Use of
      Proceeds
              41ITEM
      3. Defaults Upon Senior Securities
              42ITEM
      4. Submission of Matters to a Vote of Security
    Holders
              42ITEM
      5. Other Information
              43ITEM
      6. Exhibits
              43SIGNATURES
              44EXHIBIT
      INDEX
              45EXHIBIT
      31.1EXHIBIT
      31.2EXHIBIT
      32
 
 
 2
 
 PART
I
 Item 1.
Financial Statements
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 
 September
      30, 2009
                (unaudited)
              
              
              December
      31,
                2008ASSETSCurrent
      assetsCash
              
              $
              8,378
              
              
              $
              59,346Other
      current assets
              
              
              13,195
              
              
              
              33,275Total
      current assets
              
              
              21,573
              
              
              
              92,621Property and Equipment, net of
      accumulated depreciationand amortization of $136,149
      and $111,193, respectively
              
              
              107,013
              
              
              
              131,969Other
      assets
              
              
              11,020
              
              
              
              11,250Total
      assets
              
              $
              139,606
              
              
              $
              235,840LIABILITIES
      AND STOCKHOLDERS’ DEFICIENCYCurrent
      liabilitiesAccounts
      payable-related parties
              
              $
              170,750
              
              
              $
              93,003Accounts
      payable-License Agreements
              
              
              852,750
              
              
              
              716,500Accounts
      payable-other
              
              
              497,269
              
              
              
              384,467Accrued
      expenses
              
              
              1,126,119
              
              
              
              803,795Accrued
      professional fees
              
              
              455,999
              
              
              
              390,535Loans
      payable-related parties and shareholders
              
              
              102,628
              
              
              
              78,280Convertible
      debentures, net-related parties
              
              
              56,832
              
              
              
              12,466Convertible
      debentures, net-others
              
              
              898,545
              
              
              
              290,659Total
      current liabilities
              
              $
              4,160,892
              
              
              
              2,769,705Commitments
      and contingenciesStockholders’
      deficiencyCommon
      stock, $.001 par value: 200,000,000 shares authorized, 65,959,620 and
      62,940,891 shares issued and outstanding at September 30, 2009 and
      December 31, 2008, respectively
              
              
              65,960
              
              
              
              62,941Common
      stock to be issued (97,059 shares at December 31,
    2008)
              
              
              -
              
              
              
              16,500Additional
      paid-in capital
              
              
              41,938,994
              
              
              
              40,129,758Deficit
      accumulated during the development stage
              
              
              (46,026,240)
              
              
              
              (42,743,064
              )Total
      stockholders’ deficiency
              
              
              (4,021,286)
              
              
              
              (2,533,865
              )Total
      liabilities and stockholders’ deficiency
              
              $
              139,606
              
              
              $
              235,840
 
 
 See notes
to condensed consolidated financial statements.
 
 
 3
 
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
 
 Three
      months ended
                September
      30,
              
              
              Nine
      months ended
                September
      30,
              
              
              For
      the Period FromFebruary
      18, 1998 (Date of Inception) through2009
              
              
              2008
              
              
              2009
              
              
              2008
              
              
              September
      30, 2009Net
      sales
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              69,000Cost
      of goods sold
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              24,120Gross
      profit
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              44,880Operating
      expenses
              
              
              488,281
              
              
              
              1,148,887
              
              
              
              1,923,703
              
              
              
              2,428,889
              
              
              
              31,850,643Research
      and development expenses
              
              
              12,517
              
              
              
              109,822
              
              
              
              274,577
              
              
              
              432,184
              
              
              
              5,733,170Non-cash
      patent settlement costs
              
              
              
              -
              
              
              -
              
              
              
              
              -
              
              
              -
              
              
              
              1,610,066Loss
      before other income (expense)
              
              
              (500,798)
              
              
              
              (1,258,709)
              
              
              
              (2,198,280)
              
              
              
              (2,861,073)
              
              
              
              (39,148,999
              )Other
      income (expense)Other
      income (expense)
              
              
              -
              
              
              
              (30)
              
              
              
              -
              
              
              
              533
              
              
              
              (1,140
              )Interest
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              2
              
              
              
              16,342Interest
      expense
              
              
              (250,616)
              
              
              
              (220,400
              )
              
              
              (1,084,896)
              
              
              
              (708,959)
              
              
              
              (7,039,202
              )Loss
      on sale of equipment
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              (9,683)
              
              
              
              (14,426
              )Settlement
      of debt due Morale/Matthews
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              (927,903)
              
              
              
              (927,903
              )Settlement
      of litigation and debt
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              52,070
              
              
              
              1,089,088Net
      loss
              
              $
              (751,414)
              
              
              $
              (1,4,79,139)
              
              
              $
              (3,283,176)
              
              
              $
              (4,455,013)
              
              
              $
              (46,026,240
              )Net
      loss per share, basic and diluted
              
              $
              (0.01)
              
              
              $
              (0.03)
              
              
              $
              (0.05)
              
              
              $
              (0.10)Weighted
      average shares outstanding, basic and diluted
              
              
              65,653,349
              
              
              
              47,312,880
              
              
              
              64,891,529
              
              
              
              45,374,117
 
 See notes
to condensed consolidated financial statements.
 
 
 4
  SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 Price
      per
                
                
                Common
      Stock
                
                
                Common
                  Stock
                  to
      be
                
                
                Additional
                  Paid-in
                
                
                Deferred
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                Total
                  Stockholders’Share
                
                
                Shares
                
                
                Amount
                
                
                Issued
                
                
                Capital
                
                
                Compensation
                
                
                Stage
                
                DeficiencyBalance, February 18,
      1998  (date of inception)
                
                
                
                
                
                —
                
                
                $
                —
                
                
                $
                —
                
                
                $
                —
                
                
                $
                —
                
                
                $
                —
                
                $
                —Issuance
      of common stock on April 18, 1998
                
                
                .0015 -
      .01
                
                
                
                10,030,000
                
                
                
                10,030
                
                
                
                —
                
                
                
                14,270
                
                
                
                —
                
                
                
                —
                
                
                24,300Net
      loss
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (21,307
                )
                
                (21,307
                )Balance,
      December 31, 1998
                
                
                
                
                
                
                10,030,000
                
                
                $
                10,030
                
                
                $
                —
                
                
                
                14,270
                
                
                $
                —
                
                
                $
                (21,307
                )
                $
                2,993Issuance
      of common stock on May 18, 1999
                
                
                1.00 -
      6.40
                
                
                
                198,003
                
                
                
                198
                
                
                
                —
                
                
                
                516,738
                
                
                
                —
                
                
                
                —
                
                
                516,936Issuance
      of common stock for ZEFS on September 14, 1999
                
                
                .001
                
                
                
                5,000,000
                
                
                
                5,000
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                5,000Stock
      issued for professional services on May 18, 1999
                
                
                0.88
                
                
                
                69,122
                
                
                
                69
                
                
                
                —
                
                
                
                49,444
                
                
                
                —
                
                
                
                —
                
                
                49,513Net
      loss
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (1,075,264
                )
                
                (1,075,264
                )Balance,
      December 31, 1999
                
                
                
                
                
                
                15,297,125
                
                
                $
                15,297
                
                
                $
                —
                
                
                $
                580,452
                
                
                $
                —
                
                
                $
                (1,096,571
                )
                $
                (500,822
                )
   (continued)
 5
 
 SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                Common
      Stock
                
                Common
                  Stock
                  to
      be
                
                Additional
                  Paid-in
                
                Deferred
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                Total
                  Stockholders’Share
                
                Shares
                
                
                Amount
                
                Issued
                
                Capital
                
                Compensation
                
                Stage
                
                DeficiencyBalance,
      December 31, 1999
                
                
                
                15,297,125
                
                
                $
                15,297
                
                $
                —
                
                $
                580,452
                
                $
                —
                
                $
                (1,096,571
                )
                $
                (500,822
                )Issuance
      of common stock for services
                $0.38 -
      $5.31
                
                
                305,810
                
                
                
                306
                
                
                —
                
                
                588,704
                
                
                —
                
                
                —
                
                
                589,010Stock
      issued for employee compensation on February 8, 2000
                $1.03-$5.31
                
                
                42,000
                
                
                
                42
                
                
                —
                
                
                137,378
                
                
                —
                
                
                —
                
                
                137,420Stock
      issued for directors fees
                $3.38-$4.44
                
                
                56,000
                
                
                
                56
                
                
                —
                
                
                195,584
                
                
                —
                
                
                —
                
                
                195,640Common
      stock cancelled
                
                
                
                (55,000
                )
                
                
                (55
                )
                
                
                
                
                (64,245
                )
                
                
                
                
                
                
                
                (64,300
                )Net
      loss
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                —
                
                
                —
                
                
                (1,270,762
                )
                
                (1,270,762
                )Balance,
      December 31, 2000
                
                
                
                15,645,935
                
                
                
                15,646
                
                
                —
                
                
                1,437,873
                
                
                —
                
                
                (2,367,333
                )
                
                (913,814
                )Issuance
      of common stock for services
                $0.25-$1.65
                
                
                1,339,912
                
                
                
                1,340
                
                
                —
                
                
                1,031,231
                
                
                —
                
                
                —
                
                
                1,032,571Stock
      issued for directors fees
                $0.60-$0.95
                
                
                1,100,000
                
                
                
                1,100
                
                
                
                
                
                1,008,900
                
                
                
                
                
                
                
                
                1,010,000Intrinsic
      value of options issued to employees
                
                
                
                
                
                
                
                
                
                
                
                
                
                2,600,000
                
                
                (2,600,000)
                
                
                
                
                
                —Fair
      value of options issued to non-employees
                
                
                
                
                
                
                
                
                
                
                
                
                
                142,318
                
                
                
                
                
                
                
                
                142,318Amortization
      of deferred compensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                191,667
                
                
                
                
                
                191,667Net
      loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (2,735,013
                )
                
                (2,735,013
                )Balance,
      December 31, 2001
                
                
                
                18,085,847
                
                
                $
                18,086
                
                $
                —
                
                $
                6,220,322
                
                $
                (2,408,333
                )
                $
                (5,102,346
                )
                $
                (1,272,271
                )
   (continued)
 6
 
 SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                
                Common
      Stock
                
                Common
                  Stock
                  to
      be
                
                
                Additional
                  Paid-in
                
                
                Deferred
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                
                Total
                  Stockholders’Share
                
                
                Shares
                
                
                Amount
                
                Issued
                
                
                Capital
                
                
                Compensation
                
                
                Stage
                
                
                DeficiencyBalance,
      December 31, 2001
                
                
                
                
                
                18,085,847
                
                
                $
                18,086
                
                $
                —
                
                
                $
                6,220,322
                
                
                $
                (2,408,333
                )
                
                $
                (5,102,346
                )
                
                $
                (1,272,271
                )Stock
      issued for directors fees
                
                
                0.40
                
                
                
                2,150,000
                
                
                
                2,150
                
                
                —
                
                
                
                857,850
                
                
                
                —
                
                
                
                —
                
                
                
                860,000Common
      stock sold (2,305,000
                  shares)
                
                
                0.15-0.25
                
                
                
                —
                
                
                
                —
                
                
                389,875
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                389,875Fair
      value of options issued to non-employees for services
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                
                54,909
                
                
                
                (54,909
                )
                
                
                —
                
                
                
                —Amortization
      of deferred compensation
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                
                —
                
                
                
                891,182
                
                
                
                —
                
                
                
                891,182Net
      loss
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (2,749,199
                )
                
                
                (2,749,199
                )Balance,
      December 31, 2002
                
                
                
                
                
                
                20,235,847
                
                
                
                20,236
                
                
                389,875
                
                
                
                7,133,081
                
                
                
                (1,572,060)
                
                
                
                (7,851,545
                )
                
                
                (1,880,413
                )Common
      stock issued previously paid for
                
                
                0.15-0.25
                
                
                
                2,305,000
                
                
                
                2,305
                
                
                (433,750
                )
                
                
                431,445
                
                
                
                —
                
                
                
                —
                
                
                
                —Sale
      of common stock
                
                $
                0.25
                
                
                
                9,504,000
                
                
                
                9,504
                
                
                
                
                
                
                2,366,439
                
                
                
                —
                
                
                
                —
                
                
                
                2,375,943Issuance
      of common stock for services
                
                $
                0.55
                
                
                
                83,414
                
                
                
                83
                
                
                —
                
                
                
                45,794
                
                
                
                —
                
                
                
                —
                
                
                
                45,877Common
      stock issued for convertible debt
                
                $
                0.25
                
                
                
                2,000,000
                
                
                
                2,000
                
                
                
                
                
                
                498,000
                
                
                
                —
                
                
                
                —
                
                
                
                500,000Finders’
      fees related to stock issuances
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                43,875
                
                
                
                (312,582
                )
                
                
                —
                
                
                
                —
                
                
                
                (268,707
                )Common
      stock
                  sold
      (25,000
                  shares)
                
                
                0.25
                
                
                
                —
                
                
                
                —
                
                
                6,250
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                6,250Amortization
      of deferred comp
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                
                —
                
                
                
                863,727
                
                
                
                —
                
                
                
                863,727Net
      loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (2,476,063
                )
                
                
                (2,476,063
                )Balance,
      December 31, 2003
                
                
                
                
                
                
                34,128,261
                
                
                $
                34,128
                
                $
                6,250
                
                
                $
                10,162,177
                
                
                $
                (708,333
                )
                
                $
                (10,327,608
                )
                
                $
                (833,386
                )
   (continued)
 7
 
 SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                
                Common
      Stock
                
                Common
                  Stock
                  to
      be
                
                Additional
                  Paid-in
                
                
                Deferred
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                
                Total
                  Stockholders’Share
                
                
                Shares
                
                
                Amount
                
                Issued
                
                Capital
                
                
                Compensation
                
                
                Stage
                
                
                DeficiencyBalance,
      December 31, 2003
                
                
                
                
                
                34,128,261
                
                
                $
                34,128
                
                $
                6,250
                
                $
                10,162,177
                
                
                $
                (708,333
                )
                
                $
                (10,327,608
                )
                
                $
                (833,386
                )Common
      stock issuedpreviously
      paid for
                
                $
                .25
                
                
                
                25,000
                
                
                
                25
                
                
                (6,250)
                
                
                6,225
                
                
                
                
                
                
                
                
                
                
                
                —Sale
      of common stock
                
                $
                1.00
                
                
                
                1,272,500
                
                
                
                1,273
                
                
                119,000
                
                
                1,271,227
                
                
                
                —
                
                
                
                —
                
                
                
                1,391,500Stock
      issued for services
                
                $
                .15-$1.70
                
                
                
                1,268,560
                1,
                
                
                1,268
                
                
                
                
                
                1,388,663
                
                
                
                
                
                
                
                
                
                
                
                1,389,931Stock
      issued for directors fees
                
                $
                1.50
                
                
                
                50,000
                
                
                
                50
                
                
                —
                
                
                74,950
                
                
                
                —
                
                
                
                —
                
                
                
                75,000Common
      stock issued for convertible debt
                
                $
                1.53
                
                
                
                60,000
                
                
                
                60
                
                
                
                
                
                91,740
                
                
                
                —
                
                
                
                —
                
                
                
                91,800Common
      stock issued upon exercise of warrants and options
                
                $
                .20
      -$.40
                
                
                
                960,500
                
                
                
                960
                
                
                —
                
                
                193,240
                
                
                
                —
                
                
                
                —
                
                
                
                194,200Common
      stock issued for patent settlement
                
                $
                1.24
                
                
                
                20,000
                
                
                
                20
                
                
                
                
                
                24,780
                
                
                
                
                
                
                
                
                
                
                
                24,800Fair
      value of warrants issued
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,614,138
                
                
                
                
                
                
                
                
                
                
                
                1,614,138Fair
      value of options issued to employees
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                248,891
                
                
                
                (248,891
                )
                
                
                —
                
                
                
                —Fair
      value of options issued to non-employees
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                55,381
                
                
                
                (55,381
                )
                
                
                —
                
                
                
                —Amortization
      of deferred compensation
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                —
                
                
                
                936,537
                
                
                
                —
                
                
                
                936,537Finders’
      fees related to stock issuances
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (88,384
                )Net
      loss
                
                
                
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                —
                
                
                
                —
                
                
                
                (6,803,280
                )
                
                
                (6,803,280
                )Balance,
      December 31, 2004
                
                
                
                
                
                
                37,784,821
                
                
                $
                37,784
                
                $
                119,000
                
                $
                15,043,028
                
                
                $
                (76,068
                )
                
                $
                (17,130,888
                )
                
                $
                (2,007,144
                )
    (continued)
 8
  SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                Common
      Stock
                
                Common
                  Stock
                  to
      be
                
                Additional
                  Paid-in
                
                
                Deferred
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                
                Total
                  Stockholders’Share
                
                Shares
                
                
                Amount
                
                Issued
                
                Capital
                
                
                Compensation
                
                
                Stage
                
                
                DeficiencyBalance,
      December 31, 2004
                
                
                
                37,784,821
                
                
                $
                37,784
                
                $
                119,000
                
                $
                15,043,028
                
                
                $
                (76,068
                )
                
                $
                (17,130,888
                )
                
                $
                (2,007,144
                )Common
      stock issued previously paid for
                $1.00
                
                
                119,000
                
                
                
                119
                
                
                (119,000
                )
                
                118,881
                
                
                
                —
                
                
                
                —
                
                
                
                —Sale
      of common stock
                $1.00
                
                
                1,530,500
                
                
                
                1,530
                
                
                
                
                
                1,528,970
                
                
                
                —
                
                
                
                —
                
                
                
                1,530,500Common
      stock issued upon exercise of warrants
                $.40
      - $1.00
                
                
                500
                
                
                
                1
                
                
                —
                
                
                199
                
                
                
                —
                
                
                
                —
                
                
                
                200Common
      stock to be issued for settlement of payables
                
                
                
                
                
                
                
                
                
                
                612,521
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                612,521Fair
      value of options issued for settlement costs
                
                
                
                
                
                
                
                
                
                
                
                
                
                31,500
                
                
                
                
                
                
                
                
                
                
                
                31,500Fair
      value of warrants issued
                
                
                
                
                
                
                
                
                
                
                
                
                
                18,462
                
                
                
                
                
                
                
                
                
                
                
                18,462Fair
      value of warrants issued and intrinsic value of beneficial conversion
      associated with convertible notes
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,453,181
                
                
                
                
                
                
                
                
                
                
                
                1,453,181Fair
      value of options issued to employees
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                243,750
                
                
                
                (243,750
                )
                
                
                —
                
                
                
                —Amortization
      of deferred compensation
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                —
                
                
                
                177,631
                
                
                
                —
                
                
                
                177,631Finders’
      fees related to stock issuances
                
                
                
                
                
                
                
                
                
                
                
                
                
                (109,840
                )
                
                
                
                
                
                
                
                
                
                
                (109,840
                )Common
      stock cancelled
                
                
                
                (8,047,403
                )
                
                
                (8,047
                )
                
                
                
                
                8,047
                
                
                
                
                
                
                
                
                
                
                
                —Net
      loss
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                —
                
                
                
                —
                
                
                
                (3,115,186
                )
                
                
                (3,115,186
                )Balance,
      December 31, 2005
                
                
                
                31,387,418
                
                
                $
                31,387
                
                $
                612,521
                
                $
                18,336,178
                
                
                $
                (142,187
                )
                
                $
                (20,246,074
                )
                
                $
                (1,408,175
                )
   (continued)
 9
 
 SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                Common
      Stock
                
                Common
                  Stock
                  to
      be
                
                Additional
                  Paid-in
                
                
                Deferred
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                
                Total
                  Stockholders’Share
                
                Shares
                
                
                Amount
                
                Issued
                
                Capital
                
                
                Compensation
                
                
                Stage
                
                
                DeficiencyBalance,
      December 31, 2005
                
                
                
                31,387,418
                
                
                $
                31,387
                
                $
                612,521
                
                $
                18,336,178
                
                
                $
                (142,187)
                
                
                $
                (20,246,074
                )
                
                $
                (1,408,175
                )Common
      stock issued previously paid for
                
                
                
                846,549
                
                
                
                847
                
                
                (612,521
                )
                
                611,674
                
                
                
                —
                
                
                
                —
                
                
                
                —Sale
      of common stock
                $1.00
      - $1.89
                
                
                1,360,537
                
                
                
                1,360
                
                
                60,000
                
                
                2,401,048
                
                
                
                —
                
                
                
                —
                
                
                
                2,462,408Common
      stock issued upon exercise of warrants
                $.50
      - $1.50
                
                
                2,583,533
                
                
                
                2,584
                
                
                —
                
                
                1,794,944
                
                
                
                —
                
                
                
                —
                
                
                
                1,797,528Common
      stock to be issued for convertible debt
                $.70
                
                
                3,416,186
                
                
                
                3,417
                
                
                
                
                
                2,356,449
                
                
                
                
                
                
                
                
                
                
                
                2,359,866Common
      stock to be issued for  out of line of credit
                $.55
      - $1.22
                
                
                487,483
                
                
                
                487
                
                
                
                
                
                379,610
                
                
                
                
                
                
                
                
                
                
                
                380,097Fair
      value of options issued to employees
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                2,253,263
                
                
                
                
                
                
                
                —
                
                
                
                2,253,263Fair
      value of options issued for settlement costs
                
                
                
                
                
                
                
                
                
                
                
                
                
                31,500
                
                
                
                
                
                
                
                
                
                
                
                31,500Fair
      value of warrants issued for services
                
                
                
                
                
                
                
                
                
                
                
                
                
                463,627
                
                
                
                
                
                
                
                
                
                
                
                463,627Fair
      value of warrants issued and intrinsic value of beneficial conversion
      associated with convertible notes
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,259.696
                
                
                
                
                
                
                
                
                
                
                
                1,259,696Write
      off of  deferred compensation
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                (142,187
                )
                
                
                142,187
                
                
                
                —
                
                
                
                —Finders’
      fees related to stock issuances
                
                
                
                
                
                
                
                
                
                
                
                
                
                (284,579
                )
                
                
                
                
                
                
                
                
                
                
                (284,579
                )Fees
      paid on equity line of credit
                
                
                
                
                
                
                
                
                
                
                
                
                
                (30,402
                )
                
                
                
                
                
                
                
                
                
                
                (30,402
                )Net
      loss
                
                
                
                —
                
                
                
                —
                
                
                —
                
                
                —
                
                
                
                —
                
                
                
                (10,181,523
                )
                
                
                (10,181,523
                )Balance,
      December 31, 2006
                
                
                
                40,081,757
                
                
                $
                40,082
                
                $
                60,000
                
                $
                29,430,821
                
                
                $
                —
                
                
                $
                (30,427,597
                )
                
                $
                (896,694
                )
  (continued)
 10
 
 SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                Common
      Stock
                
                
                Common
                  Stock
                  to
      be
                
                
                Additional
                  Paid-in
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                
                Total
                  Stockholders’Share
                
                Shares
                
                
                Amount
                
                
                Issued
                
                
                Capital
                
                
                Stage
                
                
                DeficiencyBalance,
      December 31, 2006
                
                
                
                40,081,757
                
                
                $
                40,082
                
                
                $
                60,000
                
                
                $
                29,430,821
                
                
                $
                (30,427,597
                )
                
                $
                (896,694
                )Common
      stock issued previously paid for
                
                
                
                2,597,524
                
                
                
                2,598
                
                
                
                (60,000
                )
                
                
                57,402
                
                
                
                —
                
                
                
                —Common
      stock to be issued for convertible debt
                $.17
      - $.53
                
                
                1,910,711
                
                
                
                1,911
                
                
                
                
                
                
                
                524,569
                
                
                
                
                
                
                
                526,480Common
      stock  issued for  put of line of
    credit
                $.27
      - $.73
                
                
                1,880,421
                
                
                
                1,880
                
                
                
                
                
                
                
                990,175
                
                
                
                
                
                
                
                992,055Common
      stock granted for services
                
                
                
                
                
                
                
                
                
                
                
                4,000
                
                
                
                
                
                
                
                
                
                
                
                4,000Fair
      value of options issued to employees
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                67,592
                
                
                
                —
                
                
                
                67,592Fair
      value of warrants issued for services
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                35,340
                
                
                
                
                
                
                
                35,340Fair
      value of warrants issued and intrinsic value of beneficial conversion
      associated with convertible notes
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,253,548
                
                
                
                
                
                
                
                1,253,548Fees
      paid on equity line of credit
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (79,364
                )
                
                
                
                
                
                
                (79,364
                )Net
      loss
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (6,262,743
                )
                
                
                (6,262,743
                )Balance,
      December 31, 2007
                
                
                
                46,470,413
                
                
                $
                46,471
                
                
                $
                4,000
                
                
                $
                32,280,083
                
                
                $
                (36,690,340
                )
                
                $
                (4,359,786
                )
    (continued)
 11
 
 SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                Common
      Stock
                
                
                Common
                  Stock
                  to
      be
                
                
                Additional
                  Paid-in
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                
                Total
                  Stockholders’Share
                
                Shares
                
                
                Amount
                
                
                Issued
                
                
                Capital
                
                
                Stage
                
                
                DeficiencyBalance,
      December 31, 2007
                
                
                
                46,470,413
                
                
                $
                46,471
                
                
                $
                4,000
                
                
                $
                32,280,083
                
                
                $
                (36,690,340
                )
                
                $
                (4,359,786
                )Common
      stock issued for convertible debt
                $.17
      - $.53
                
                
                5,575,082
                
                
                
                5,574
                
                
                
                16,500
                
                
                
                1,936,171
                
                
                
                —
                
                
                
                1,958,245Common
      stock issued for Morale/ Matthews settlement
                $.38
                
                
                7,421,896
                
                
                
                7,422
                
                
                
                —
                
                
                
                2,776,289
                
                
                
                —
                
                
                
                2,783,711Common
      stock issued for services
                $.17
      - $.49
                
                
                2,398,850
                
                
                
                2,399
                
                
                
                —
                
                
                
                516,230
                
                
                
                —
                
                
                
                518,629Common
      stock issued upon exercise of warrants
                $.50
                
                
                1,064,650
                
                
                
                1,065
                
                
                
                —
                
                
                
                531,260
                
                
                
                —
                
                
                
                532,325Fair
      value of options issued as compensations
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                645,745
                
                
                
                —
                
                
                
                645,745Fair
      value of warrants issued and intrinsic value of beneficial conversion
      associated with convertible notes
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                1,323,077
                
                
                
                —
                
                
                
                1,323,077Fair
      value of warrants issued to PIPE holders
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                116,913
                
                
                
                —
                
                
                
                116,913Common
      stock issued for services
                0.17
                
                
                10,000
                
                
                
                10
                
                
                
                (4,000
                )
                
                
                3,990
                
                
                
                —
                
                
                
                —Net
      loss
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (6,052,724
                )
                
                
                (6,052,724Balance,
      December 31, 2008
                
                
                
                62,940,891
                
                
                $
                62,941
                
                
                $
                16,500
                
                
                $
                40,129,758
                
                
                $
                (42,743,064
                )
                
                $
                (2,533,865
                )
    (continued)
  12
 
 SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
  Price
      per
                
                Common
      Stock
                
                
                Common
                  Stock
                  to
      be
                
                
                Additional
                  Paid-in
                
                
                Deficit
                  Accumulated
                  During
      the
                  Development
                
                
                Total
                  Stockholders’Share
                
                Shares
                
                
                Amount
                
                
                Issued
                
                
                Capital
                
                
                Stage
                
                
                DeficiencyBalance,
      December 31, 2008
                
                
                
                62,940,891
                
                
                $
                62,941
                
                
                $
                16,500
                
                
                $
                40,129,758
                
                
                $
                (42,743,064
                )
                
                $
                (2,533,865
                )Common
      stock issued for convertible debt
                0.15
      - 0.50
                
                
                2,165,026
                
                
                
                2,165
                
                
                
                (16,500
                )
                
                
                474,464
                
                
                
                —
                
                
                
                460,129Common
      stock issued for services
                0.17
      - 0.49
                
                
                340,000
                
                
                
                340
                
                
                
                —
                
                
                
                137,160
                
                
                
                —
                
                
                
                137,500Common
      stock issued for settlement of accounts payable
                0.27
                
                
                430,370
                
                
                
                431
                
                
                
                0
                
                
                
                103,983
                
                
                
                —
                
                
                
                104,414Common
      stock issued upon exercise ofoptions
                0.27
                
                
                83,333
                
                
                
                83
                
                
                
                0
                
                
                
                22,417
                
                
                
                —
                
                
                
                22,500Fair
      value of warrants issuedfor
      note payable
                —
                
                
                —
                
                
                
                
                
                
                
                
                
                
                
                1,248
                
                
                
                
                
                
                
                1,248Fair
      value of options issued as compensation
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                67,801
                
                
                
                —
                
                
                
                67,801Fair
      value of warrants issued and intrinsic value of beneficial conversion
      associated with convertible notes
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                1,002,163
                
                
                
                —
                
                
                
                1,002,163Net
      loss
                —
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                (3,283,176
                )
                
                
                (3,283,176
                )Balance,
      September 30, 2009 (unaudited)
                
                
                
                65,959,620
                
                
                $
                65,960
                
                
                $
                —
                
                
                $
                41,938,994
                
                
                $
                (46,026,240
                )
                
                $
                (4,021,286
                )
   See notes
to condensed consolidated financial statements.
 
 13
 
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 Nine months
      ended
              
              
              February
      18, 1998September
      30,
              
              
              September
      30,
              
              
              (inception)
      to2009
              
              
              2008
              
              
              September
      30, 2009Cash
      flows from operating activitiesNet
      loss
              
              $
              (3,283,176
              )
              
              $
              (4,455,013)
              
              
              $
              (46,026,240
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Write
      off of intangible assets
              
              
              -
              
              
              
              -
              
              
              
              505,000Settlement
      of litigation and debt
              
              
              -
              
              
              
              -
              
              
              
              (1,017,208
              )Settlement
      of debt due Morale/Matthews
              
              
              -
              
              
              
              927,903
              
              
              
              927,903Stock
      based compensation and warrant expense
              
              
              67,801
              
              
              
              599,754
              
              
              
              3,682,723Issuance
      of common stock for services
              
              
              137,500
              
              
              
              51,879
              
              
              
              5,341,731Issuance
      of options for legal settlement
              
              
              -
              
              
              
              -
              
              
              
              31,500Issuance
      of warrants for legal settlement
              
              
              -
              
              
              
              -
              
              
              
              4,957Issuance
      of warrants for financing fees
              
              
              1,248
              
              
              
              116,913
              
              
              
              153,501Non-cash
      increase in convertible notes recorded as expense
              
              
              -
              
              
              
              89,470
              
              
              
              163,962Patent
      acquisition cost
              
              
              -
              
              
              
              -
              
              
              
              1,610,066Addition
      of Interest Expense to Convertible Note Principal
              
              
              58,100
              
              
              
              -
              
              
              
              58,100Amortization
      of issuance costs and original issue debt discounts including beneficial
      conversion feature-part of interest expense
              
              
              994,476
              
              
              
              733,805
              
              
              
              6,612,785Amortization
      of deferred compensation
              
              
              -
              
              
              
              -
              
              
              
              3,060,744Loss
      on disposition of assets
              
              
              -
              
              
              
              9,683
              
              
              
              14,426Depreciation
      and amortization
              
              
              24,956
              
              
              
              28,551
              
              
              
              418,085Bad
      debt
              
              
              -
              
              
              
              1,380
              
              
              
              1,380Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              -
              
              
              
              -
              
              
              
              (1,380
              )Other
      current assets
              
              
              20,080
              
              
              
              (14,292)
              
              
              
              (13,195
              )Other
      assets
              
              
              230
              
              
              
              (6,750)
              
              
              
              (11,020
              )Accounts
      payable and accrued expenses
              
              
              841,501
              
              
              
              430,111
              
              
              
              4,529,111Net
      cash used in operating activities
              
              
              (1,137,284
              )
              
              
              (1,486,606
              )
              
              
              (19,953,069
              )Cash
      flows from investing activitiesPurchase
      of property and equipment
              
              
              -
              
              
              
              (345)
              
              
              
              (553,452
              )Proceeds
      from sale of equipment
              
              
              -
              
              
              
              17,478
              
              
              
              17,478Net
      cash provided by (used in) investing activities
              
              
              -
              
              
              
              17,133
              
              
              
              (535,974
              )Cash
      flows from financing activitiesNet
      proceeds under equity line of credit
              
              
              -
              
              
              
              -
              
              
              
              1,262,386Increase
      (decrease) in payables to related parties and
      shareholder
              
              
              24,348
              
              
              
              (6,387)
              
              
              
              634,412Advances
      from founding executive officer
              
              
              -
              
              
              
              -
              
              
              
              517,208Net
      proceeds from issuance of convertible notes and
    warrants
              
              
              1,107,320
              
              
              
              974,000
              
              
              
              7,567,743Repayment
      of convertible notes
              
              
              (45,352)
              
              
              
              -
              
              
              
              (271,602
              )Net
      proceeds from issuance of common stock
              
              
              -
              
              
              
              532,325
              
              
              
              10,787,274Net
      cash provided by financing activities
              
              
              1,086,316
              
              
              
              1,499,938
              
              
              
              20,497,421Net
      increase (decrease) in cash
              
              
              (50,968)
              
              
              
              30,465
              
              
              
              8,378Cash, beginning of
      period
              
              
              59,346
              
              
              
              47,660
              
              
              
              —Cash, end of
      period
              
              $
              8,378
              
              
              $
              78,125
              
              
              $
              8,378
  
 (continued)
 14
 
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
 
 Nine
      months ended
              
              
              February
      18, 1998September
      30,
              
              
              September
      30,
              
              
              (inception)
      to2009
              
              
              2008
              
              
              September
      30, 2009Supplemental
      disclosures of cash flow informationCash
      paid during the period forInterest
              
              $
              9,736
              
              
              $
              988
              
              
              $
              146,135Income
      taxes
              
              $
              -
              
              
              $
              -
              
              
              $
              5,882Non-cash
      investing and financing activitiesAcquisition
      of intangible asset through advance from related party and issuance of
      common stock
              
              $
              -
              
              
              $
              -
              
              
              $
              505,000Deferred
      compensation for stock options issued for services
              
              
              -
              
              
              
              -
              
              
              
              3,202,931Purchase
      of property and equipment financed by advance from related
      party
              
              
              -
              
              
              
              -
              
              
              
              3,550Conversion
      of related party debt to equity
              
              
              --
              
              
              
              -
              
              
              
              515,000Issuance
      of common stock in settlement of payable
              
              
              104,414
              
              
              
              -
              
              
              
              204,895Cancellation
      of stock
              
              
              -
              
              
              
              -
              
              
              
              8,047Conversion
      of accounts payable and accrued expenses to common stock
      issued
              
              
              -
              
              
              
              -
              
              
              
              612,521Conversion
      of related party debt to convertible debentures
              
              
              -
              
              
              
              -
              
              
              
              45,000Conversion
      of convertible debentures to common stock
              
              
              460,129
              
              
              
              -
              
              
              
              5,391,808Issuance
      of shares for settlement of loans and other payable to
      Morale/Matthews
              
              
              -
              
              
              
              2,783,711
              
              
              
              2,783,711Write
      off of deferred compensation
              
              
              -
              
              
              
              
              
              
              
              142,187Non-cash
      equity-warrant valuation and intrinsic value of beneficial conversion
      associated with convertible notes
              
              
              1,002,163
              
              
              
              314,460
              
              
              
              6,408,578Proceeds
      of exercise of options applied toaccounts
      payable
              
              
              22,500
              
              
              
              -
              
              
              
              22,500
 
  See notes
to condensed consolidated financial statements.
 
 15
 
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NINE
MONTHS ENDED SEPTEMBER 30, 2009 (UNAUDITED)
 
 
 
 1.  Organization
and basis of presentation
 
 Basis
of presentation
 
 The
accompanying unaudited condensed consolidated financial statements of Save the
World Air, Inc. (the "Company") have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information and pursuant to the requirements for reporting on Form
10-Q and Regulation S-K for scaled disclosures for smaller reporting companies.
Accordingly, they do not include all the information and footnotes required by
accounting principles generally accepted in United States of America for
complete financial statements. However, such information reflects all
adjustments (consisting solely of normal recurring adjustments), which are, in
the opinion of management, necessary for the fair presentation of the
consolidated financial position and the consolidated results of operations.
Results shown for interim periods are not necessarily indicative of the results
to be obtained for a full fiscal year.
 
 The
condensed consolidated balance sheet information as of December 31, 2008 was
derived from the audited consolidated financial statements included in the
Company's Annual Report on Form 10-K filed with the SEC. These interim financial
statements should be read in conjunction with that report.
 
 Going
Concern
 Since its
inception, the Company has been primarily engaged in organizational and
pre-operating activities. The Company has generated insignificant revenues and
has incurred accumulated losses of  $46,026,240 from February 18, 1998
(Inception) through September 30, 2009. As reflected in the accompanying
condensed consolidated financial statements, the Company had a net loss of
$3,283,176 and a negative cash flow from operations of $1,137,284 for the nine
months ended September 30, 2009, and had a working capital deficiency of
$4,139,319 and a stockholders' deficiency of $4,021,286 at September 30,
2009.   The Company is currently unable to meet its cash obligations
and is in default of certain of its convertible note agreements and its
obligations under its license agreements with Temple University (see Note
8).   As a result, the Company's independent registered public
accounting firm, in their report on the Company's 2008 consolidated financial
statements, raised substantial doubt about the Company's ability to continue as
a going concern.
 
 Our
operations to date have been funded through issuances of our common stock
and convertible notes whereby we raised an aggregate $18,355,017 from
February 18, 1998 (inception) through September 30, 2009. Based on our current
operating plan, we believe that we do not have sufficient cash and cash
equivalents to implement our operating plan. We will need to obtain additional
financing in addition to the funds already raised through the sale of equity
securities to fund our cash needs and continue our operations. Additional
financing, whether through public or private equity or debt financing,
arrangements with stockholders or other sources to fund operations, may not be
available, or if available, may be on terms unacceptable to us. Our ability to
maintain sufficient liquidity is dependent on our ability to raise additional
capital. If we issue additional equity securities to raise funds, the ownership
percentage of our existing stockholders would be reduced. New investors may
demand rights, preferences or privileges senior to those of existing holders of
our common stock. Debt incurred by us would be senior to equity in the ability
of debt holders to make claims on our assets. The terms of any debt issued could
impose restrictions on our operations. If adequate funds are not available to
satisfy either medium or long-term capital requirements, our operations and
liquidity could be materially adversely affected and we could be forced to cut
back our operations.
 
 Description
of business
 
 Save the
World Air, Inc. (“STWA”) designs, licenses and develops products to increase
engine performance, reduce harmful emissions and increase fuel
efficiency.  The Company is a green technology company that leverages
a suite of patented, patent-pending and licensed intellectual properties related
to the treatment of fuels. Technologies patented by or licensed to us utilize
either magnetic or uniform electrical fields to alter physical characteristics
of fuels and are designed to create cleaner combustion. Cleaner combustion has
been shown to improve performance, enhance fuel economy and/or reduce harmful
emissions in laboratory testing.
 
 The
Company has three product lines; MAG ChargRTM and ECO ChargRTM, ELEKTRATM and AOT
(Applied Oil Technology).  The Company believes development of MAG
ChargR is complete and it will be ready to be manufactured by the end of the
fourth quarter 2009.  We believe the ELEKTRA is nearing the end of the
product development cycle which we believe will culminate in an upcoming SAE
(Society of Automotive Engineers) test to prove and certify the level of fuel
savings.  AOT is in the research and development phase.
   16
  The
Company was incorporated on February 18, 1998, as a Nevada corporation,
under the name Mandalay Capital Corporation. The Company changed its name to
Save the World Air, Inc. on February 11, 1999, following the acquisition of
marketing and manufacturing rights of the ZEFS technologies.
   2. 
Summary of significant accounting policies
 
 Development
stage enterprise
 
 The
Company is a development stage enterprise.  All losses accumulated since
the inception of the Company have been considered as part of the Company’s
development stage activities.
 
 The
Company’s focus is on product development and marketing of proprietary devices
that are designed to reduce harmful emissions, and improve fuel efficiency and
engine performance on equipment and vehicles driven by internal combustion
engines and has not yet generated meaningful revenues.  The
technologies are called “ZEFS”, “MK IV”, “ELEKTRA” and “CAT-MATE”. The Company
is currently marketing its ECO and MAG ChargR products incorporating ZEFS and MK
IV technologies, worldwide; and the Company is in the early stages of developing
ELEKTRA products.  Expenses have been funded through the sale of
company stock, convertible notes and the exercise of warrants.  The
Company has taken actions to secure the intellectual property rights to the
ZEFS, MK IV and CAT-MATE devices and is the worldwide exclusive licensee for
patent pending technologies associated with the development of
ELEKTRA.
 
 Estimates
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing the
Company’s financial statements. Actual results could differ from those
estimates.
 
 Loss
per share
 
 Basic
loss per share is computed by dividing net loss available to common stockholders
by the weighted average number of common shares outstanding during the period.
Diluted loss per share reflects the potential dilution, using the treasury stock
method, that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the loss of the Company. In computing diluted
loss per share, the treasury stock method assumes that outstanding options and
warrants are exercised and the proceeds are used to purchase common stock at the
average market price during the period. Options and warrants may have a dilutive
effect under the treasury stock method only when the average market price of the
common stock during the period exceeds the exercise price of the options and
warrants. For the nine month periods ended September 30, 2009 and 2008, the
dilutive impact of outstanding stock options of 4,851,225 and 4,301,225
respectively, and outstanding warrants of 11,847,436 and 11,676,034 have been
excluded because their impact on the loss per share is
anti-dilutive.
 
 Stock-based
compensation
  The
Company periodically issues stock options and warrants to employees and
non-employees in capital raising transactions, for services and for financing
costs.  Stock-based compensation is measured at the grant date, based
on the fair value of the award, and is recognized as expense over the requisite
service period.  Options vest and expire according to terms
established at the grant date.
 
 Fair
value of financial instruments
 
 The
Company uses various inputs in determining the fair value of its investments and
measures these assets on a recurring basis.  Financial assets recorded
at fair value in the consolidated balance sheets are categorized by the level of
objectivity associated with the inputs used to measure their fair
value.  Authoritative guidance provided by the FASB defines the
following levels directly related to the amount of subjectivity associated with
the inputs to fair valuation of these financial assets:
 *           Level
1 - quoted prices in active markets for identical investments
 *           Level
2 - other significant observable inputs (including quoted prices for similar
investments, market corroborated inputs, etc.)
 *           Level
3 - significant unobservable inputs (including the Company’s own assumptions in
determining the fair value of investments)
 
 17
 
 The
inputs or methodology used for valuing securities are not necessarily an
indication of the credit risk associated with investing in those
securities.  The following table provides the fair value measurements
of applicable Company financial assets that are measured at fair value on a
recurring basis according to the fair value levels defined by authoritative
guidance from the Financial Accounting Standards Board as of September 30, 2009
and December 31, 2008.
 
 Recent
accounting pronouncements
 
 In June
2009, the FASB issued authoritative guidance on accounting standards
codification and the hierarchy of generally accepted accounting principles.” The
FASB Accounting Standards CodificationTM (“Codification”) has become the source
of authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
accordance with GAAP. All existing accounting standard documents are superseded
by the Codification and any accounting literature not included in the
Codification will not be authoritative. However, rules and interpretive releases
of the Securities Exchange Commission (“SEC”) issued under the authority of
federal securities laws will continue to be sources of authoritative GAAP for
SEC registrants. The FASB authoritative guidance is effective for interim and
annual reporting periods ending after September 15, 2009. Therefore, beginning
with our quarter ending September 30, 2009, all references made by it to GAAP in
its consolidated financial statements now use the new Codification numbering
system. The Codification does not change or alter existing GAAP and, therefore,
it does not have an impact on our financial position, results of operations and
cash flows.
  On July
1, 2009, the Company adopted authoritative guidance issued by the FASB on
business combinations. The guidance retains the fundamental requirements that
the acquisition method of accounting (previously referred to as the purchase
method of accounting) be used for all business combinations, but requires a
number of changes, including changes in the way assets and liabilities are
recognized and measured as a result of business combinations. It also requires
the capitalization of in-process research and development at fair value and
requires the expensing of acquisition-related costs as incurred. We have applied
this guidance to business combinations completed since July 1,
2009.  Adoption of the new guidance did not have a material impact on
our financial statements.
  In
October 2009, the FASB issued authoritative guidance on revenue recognition that
will become effective for the Company beginning July 1, 2010, with earlier
adoption permitted.  Under the new guidance on arrangements that
include software elements, tangible products that have software components that
are essential to the functionality of the tangible product will no longer be
within the scope of the software revenue recognition guidance, and
software-enabled products will now be subject to other relevant revenue
recognition guidance.  We believe adoption of this new guidance will
not have a material impact on our financial statements.
  In May 2009, the FASB issued new
requirements for reporting subsequent events. These requirements set forth the
period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial statements, the circumstances under
which an entity should recognize events or transactions occurring after the
balance sheet date in its financial statements, and disclosures that an entity
should make about events or transactions that occurred after the balance sheet
date. Disclosure of the date through which an entity has evaluated subsequent
events and the basis for that date is also required.
  Other
recent accounting pronouncements issued by the FASB did not or are not believed
by management to have a material impact on the Company's present or future
consolidated financial statements.
 
 
 3.  Certain relationships
and related transactions
 
 Loans
from related parties and shareholders
 
 In May
2007, August 2007 and May 2009, a former officer and incumbent director of the
Company loaned $31,404, $50,000 and $5,000 to the Company. These amounts are
unsecured, bear interest at 6% per annum and are due on demand.  At
September 30, 2009 and December 31, 2008, the balance of these loans including
interest was $81,583 and 78,280, respectively.
   18
 
 In April
2009, a shareholder loaned $47,000 to the Company.  The loan was
unsecured; bears interest at 10% and matured on June 23, 2009.  The
loan also included the issuance of a warrant to purchase 10,000 shares of the
Company’s common stock.  The warrant is exercisable on a cash basis
only at a price of $0.50 per share, and is exercisable for a period of two years
from the date of issuance. The warrant was valued at $1,248 and was reflected as
a financing cost in the accompanying statement of operations.  As of
September 30, 2009 the loan and interest have been paid in full.
 
 In April
2009, a shareholder loaned $25,000 to the Company.  The loan was
unsecured, bears interest at 10%, per annum and is due on demand.  The
balance owing at September 30, 2009 including interest was $21,045.
 
 In June
2009 and August 2009 an officer and director of the Company advanced $17,100 to
the Company.  As of September 30, 2009, these advances have been paid
in full.
 
 Accounts
Payable to related parties
 
 As
of September 30, 2009 and December 31, 2008, the Company had accounts
payable to related parties in the amount of $170,750, which was composed of
$118,539 in unpaid Directors Fees and $52,211 in unreimbursed expenses
incurred by Officers and Directors.  As of December 31, 2008, the
Company had accounts payable to related parties in the amount of $93,003, which
was composed of $59,705 in unpaid Directors Fees, $33,298 in
unreimbursed expenses incurred by Officers and Directors.
 
 Marketing
and promotional services agreement with related party
 
 In July
2006, the Company entered into an agreement with SS Sales and Marketing Group
(“SS Sales”), to provide exclusive marketing and promotional services in the
western United States and western Canada  (the “Territory”) for the
Company’s products.  The agreement has a term of five years unless
sooner terminated by either party on 30 days’ notice.  In the event of
termination, SS Sales will be entitled to receive all commissions payable
through the date of termination.  SS Sales is owned by Nathan Shelton,
who has served as one of the directors of the Company since February 12,
2007.  There were no payments made to SS Sales for the nine month
periods ending September 30, 2009 and 2008.
 
 
 4.  Loans and other payables due to
Morale/Matthews
 
 Leodis
Matthews, through his law firm, Matthews & Partners, (“Matthews”) serves as
outside legal counsel to the Company.  Morale Orchards, LLC (“Morale”)
is owned by Jacqueline Alexander, the wife of Leodis
Matthews.
 
 In 2006
and 2007, Morale purchased two convertible promissory notes totaling
$1,225,000.  The notes were unsecured; convertible into 1,595,588
shares of common stock, due one year from the date issued, and had an implied
interest rate of 22.5%.  Warrants to purchase 797,794 shares of common
stock were issued with the notes.  As of January 31, 2008, the notes
were in default, and the total amount due for the notes was $1,362,212,
including penalties and interest.  In addition to the two notes, the
Company borrowed $20,000 from Morale on October 30, 2007.  At January
31, 2008, the Company was also indebted to Matthews $472,762 for past legal
fee.
 
 Effective
January 31, 2008, the Company, Morale, and Matthews agreed to a settlement of
the Company’s loans due Morale and fees due Matthews.   Morale
agreed to waive all accrued interest on the notes after January 31, 2008, and
Morale and Matthews agreed to accept 7,421,896 shares of common stock of the
Company as payment of the notes payable and fees.
 
 On March
10, 2008, the Company issued 5,530,848 shares of the Company’s common stock
valued at $2,101,722 to Morale for the conversion of the notes (totaling
$1,362,212) and cancellation of $20,000 Note.   Also on March 10,
2008, the Company issued 1,891,048 shares of the Company’s common stock valued
at $718,598 to Matthews in exchange for settlement of the legal fees due
Matthews of $472,762.
 
 The fair
value of the shares of common stock issued was determined to be $0.38 per share,
based on the closing price of the Company’s common stock on January 31, 2008,
for a total settlement of $2,820,320.  As a result of the issuance of
shares of common stock, the Company incurred additional non-cash costs of
$927,903 that have been reflected as costs to settle outstanding debt in the
accompanying condensed consolidated statement of operations for the nine months
ended September 30, 2008.
 
 
 19
  5.  Convertible
Debentures
 
 Convertible
debentures consist of the following:
 
 Maturity
      dates
              
              September
      30,
                2009
              
              
              December
      31,
                20082007
      Winter Offering
              February
      29, 2009
              
              $
              —
              
              
              $
              66,0002008
      Summer Offering
              August
      31, 2009
              
              
              375,100
              
              
              
              341,0002008
      Fall Offering
              October
      31, 2009
              
              
              127,820
              
              
              
              152,0202008
      Winter Offering
              December
      5, 2009
              
              
              117,700
              
              
              
              337,7002009
      Winter Offering – I
              April
      26, 2009
              
              
              202,148
              
              
              
              —2009
      Winter Offering – II
              March
      12, 2010
              
              
              161,502
              
              
              
              —2009
      Spring
              April
      30, 2010
              
              
              143,000
              
              
              
              —2009
      Summer
              September
      29, 2012
              
              
              467,500
              
              
              
              —Sub-total
              
              
              
              1,594,770
              
              
              
              896,720Less,
      remaining debt discount
              
              
              
              (639,393
              )
              
              
              (593,595
              )955,377
              
              
              
              303,125Less:
      Convertible debentures, net, related parties
              
              
              
              (56,832
              )
              
              
              (12,466
              )Convertible
      debentures, net, others
              
              
              $
              898,545
              
              
              $
              290,659
   20
 
 2008
Summer Offering
 
 From July
17, 2008 to August 31, 2008,  the Company conducted an offering (the
“2008 Summer Offering”) of up to $600,000 aggregate face amount of its
convertible notes “the”2008 Summer Offering) with a small number of accredited
investors. Of this amount $484,000 aggregate face amount of the 2008 Summer
Notes were sold for an aggregate purchase price of $440,000 net
proceeds.  Therefore, while the stated interest rate on the 2008
Summer Notes is 0%, the implied interest rate on the 2008 Summer Notes is
10%.  The 2008 Summer Notes will mature on the first anniversary of the
date of issuance.  The 2008 Summer Notes are convertible, at the
option of the noteholders, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Summer Offering (the “Conversion Price”).  Up
to 1,423,530 Conversion Shares are issuable at a Conversion Price of $0.34 per
share.
 
 Each of
the investors in the 2008 Summer Offering received, for no additional
consideration, a warrant (the “ 2008 Summer Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Summer Notes) are
convertible (the “2008 Summer Warrant Shares”). Each 2008 Summer Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 711,764, 2008 Summer Warrant Shares are initially issuable upon exercise of
the 2008 Summer Warrants.  As of September 30, 2009, investors have
converted $143,000 of the Convertible Notes into 420,589 shares of the
Company’s common stock.  On September 2, 2009, the Company was in
default on the outstanding notes of $341,000. The balance at September 30, 2009
was $375,100 which includes the 10% default penalty.
 
 The
aggregate value of the Summer 2008 Offering Warrants issued in connection with
the August 31, 2008 closing were valued at $92,711 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of 4.27%; dividend yield of 0%; volatility factors of the expected market price
of common stock of 137.95%; and an expected life of two years (statutory term)
and vest immediately upon issuance.  The Company also determined that
the notes contained a beneficial conversion feature of $179,416.  The
value of the 2008 Summer Offering Warrants, the beneficial conversion feature,
and the transaction fees of $44,000 are considered as debt discount and were
amortized over the life of the Note.
 
 2008
Fall Offering
 
 From
September 8, 2008 to October 31, 2008, the Company conducted an offering (the
“2008 Fall Offering”) of up to $500,000 aggregate face amount of its Convertible
Notes.  A total of $198,220 aggregate face amount of the 2008 Fall
Notes were sold for an aggregate purchase price of $180,200 net
proceeds.  Therefore, while the stated interest on the 2008 Fall Notes
is 0%, the implied interest rate on the 2008 Fall Notes is 10%.  The
2008 fall notes will mature on the first anniversary of the date of
issuance.  The 2008 Fall Notes are convertible, at the option of the
noteholders, into shares of common stock of the Company (the “Conversion
Shares”) at a conversion price equal to the average of the closing bid price of
the Company’s common stock for the five trading days preceding the closing date
of the 2008 Fall Offering (the “Conversion Price”).  Up to 1,321,466
Conversion Shares are issuable at a Conversion Price of $0.15 per
share.
 
 Each of
the investors in the 2008 Fall Offering received, for no additional
consideration, a warrant (the “ 2008 Fall Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Fall Notes) are
convertible (the “2008 Fall Warrant Shares”). Each 2008 Fall Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 660,734 2008 Fall Warrant Shares are initially issuable upon exercise of the
2008 Fall Warrants.  As of September 30, 2009, investors have
converted $70,400 of the Convertible Notes into 469,333 shares of the Company’s
common stock.  The outstanding balance at September 30, 2009 was
$127,820.
 
 The
aggregate value of the Fall 2008 Offering Warrants issued in connection with the
October 31, 2008 closing were valued at $53,320 using the Black-Scholes option
valuation model with the following assumptions; risk-free interest rate of
4.68%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 145.98%; and an expected life of two years (statutory term) and
vest immediately upon issuance.  The Company also determined that the
notes contained a beneficial conversion feature of $126,880.  The
value of the Fall 2008 Offering Warrants, the beneficial conversion feature, and
the transaction fees of $18,020 are considered as debt discount and are being
amortized over the life of the Note.
 
 2008
Winter Offering
 
 From
November 24, 2008 to December 5, 2008, the Company conducted an offering (the
“2008 Winter Offering”) of up to $500,000 aggregate face amount of its
Convertible Notes.  A total of $524,700 aggregate face amount of the
2008 Winter Notes were sold for an aggregate purchase price of $477,000 net
proceeds.  Therefore, while the stated interest on the 2008 Winter
Notes is 0%, the implied interest rate on the 2008 Winter Notes is
10%.  The 2008 Winter Notes will mature on the first anniversary of
the date of issuance.  The 2008 Winter Notes are convertible, at the
option of the noteholders, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Winter Offering (the “Conversion Price”).  Up
to 3,086,470 Conversion Shares are issuable at a Conversion Price of $0.17 per
share.
 
  21
  Each of
the investors in the 2008 Winter Offering received, for no additional
consideration, a warrant (the “ 2008 Winter Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Winter Notes) are
convertible (the “2008 Winter Warrant Shares”). Each 2008 Winter Warrant is
exercisable on a cash basis only at a price of $0.30 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 1,543,235 2008 Winter Warrant Shares are initially issuable upon exercise of
the 2008 Winter Warrants.  As of September 30, 2009, investors have
converted $407,000 of the Convertible Notes into 2,394,117 shares of
the Company’s common stock.  The outstanding balance at September 30,
2009 was $117,700.
 
 The
aggregate value of the Winter 2008 Offering Warrants issued in connection with
the December 5, 2008 closing were valued at $168,925 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of 3.42%; dividend yield of 0%; volatility factors of the expected market price
of common stock of 153.56%; and an expected life of two years (statutory term)
and vest immediately upon issuance.  The Company also determined that
the notes contained a beneficial conversion feature of $308,075.  The
value of the Winter 2008 Offering Warrants, the beneficial conversion feature,
and the transaction fees of $47,700 are considered as debt discount and are
being amortized over the life of the Note.
 
 2009
Winter Offering I
 
 From
January 13, 2009, through January 26, 2009, Save the World Air, Inc. (the
“Company”) conducted and concluded a private offering (the “Winter 2009 Offering
I”) of up to $250,000 aggregate face amount of its convertible notes (the
“Winter 2009 Notes”) with 8 accredited investors. A total of $250,000 aggregate
face amount of the Winter 2009 Notes were sold for an aggregate purchase price
of $250,000.  The Winter 2009 Notes bear interest at 10% per annum,
payable at maturity. The Winter 2009 Notes mature three months from their date
of issuance and are currently in default.  The Winter 2009 Notes are
convertible, at the option of the noteholder, into shares of common stock of the
Company (the “Conversion Shares”) at an initial conversion price equal to the
average of the closing bid price of the Company’s common stock for the five
trading days preceding the closing dates of the Winter 2009 Offering (the
“Conversion Price”). Up to 694,444 Conversion Shares are initially issuable at a
Conversion Price of $0.36 per share.
 
 Each of
the investors in the Winter 2009 Offering received, for no additional
consideration, a warrant (the “Winter 2009 Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Winter 2009 Notes are
convertible (the “Warrant Shares”).  Each Winter 2009 Warrant is
exercisable on a cash basis only at an initial price of $0.50 per share, and is
exercisable immediately upon issuance and for a period of two (2) years from the
date of issuance. Up to 347,722 Warrant Shares are initially issuable on
exercise of the Winter 2009 Warrants.
 
 The
aggregate value of the Winter 2009 Offering Warrants issued in connection with
the January 26, 2009 closing were valued at $66,178 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of 0.85%; dividend yield of 0%; volatility factors of the expected market price
of common stock of 151.42%; and an expected life of two years (statutory
term) and vest immediately upon issuance.  The Company also determined
that the notes contained a beneficial conversion feature of
$183,822.  The value of the Winter 2009 Offering Warrants and the
beneficial conversion feature are considered as debt discount and were amortized
over the life of the notes.
 
 As of
September 30, 2009, investors have converted $25,000 of the Convertible Notes
into 69,444 shares of the Company’s common stock. As of April 26, 2009, the
Company was in default in the amount of $225,000.  The Company has
paid $45,352 as a partial redemption of the defaulted convertible
notes.  The outstanding balance at September 30, 2009 was $202,148
which includes a 10% default penalty.  The Company is currently
negotiating an extension of these outstanding notes.
 
 2009
Winter Offering II
 
 From
February 4, 2009, through March 11, 2009, the Company conducted and concluded a
private offering (the “Winter 2009 Offering II”) of up to $250,000 aggregate
face amount of its convertible notes (the “Winter 2009  #2 Notes”)
with 17 accredited investors. A total of $247,302 aggregate face amount of the
Winter 2009 #2 Notes were sold for an aggregate purchase price of
$224,820.  While the stated interest rate on the Winter 2009#2 Notes
is 0%, the actual interest rate on the Winter 2009 #2 Notes is 10% per annum.
The Winter 2009 #2 Notes mature on the first anniversary of their date of
issuance. The Winter 2009 #2 Notes are convertible, at the option of the
noteholder, into shares of common stock of the Company (the “Conversion Shares”)
at an initial conversion price equal to the average of the closing bid price of
the Company’s common stock for the five trading days preceding the closing dates
of the Winter 2009 #2 Offering (the “Conversion Price”). Up to 772,818
Conversion Shares are initially issuable at a Conversion Price of $0.32 per
share.
 
 Each of
the investors in the Winter 2009 #2 Offering received, for no additional
consideration, a warrant (the “Winter 2009 #2 Warrants”), entitling the holder
to purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Winter 2009 #2 Notes are
convertible (the “Warrant Shares”). Each Winter 2009 #2 Warrant is exercisable
on a cash basis only at an initial price of $0.50 per share, and is exercisable
immediately upon issuance and for a period of two (2) years from the date of
issuance. Up to 386,409 Warrant Shares are initially issuable on exercise of the
Winter 2009 #2Warrants.
   22
 
 The
Company received $224,820 in net proceeds in the Winter 2009 #2 Offering which
will be used for general corporate purposes and working capital. The aggregate
value of the Winter 2009 #2 Offering Warrants issued in connection with the
January 26, 2009 closing were valued at $62,028 using the Black-Scholes option
valuation model with the following assumptions; risk-free interest rate of
1.03%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 156%; and an expected life of two years (statutory term) and
vest immediately upon issuance.  The Company also determined that the
notes contained a beneficial conversion feature of $161,791.  The
value of the Winter 2009 #2 Offering Warrants, the beneficial conversion
feature, and the transaction fees of $22,482 are considered as debt discount and
are being amortized over the life of the Note.
 
 As of
September 30, 2009, investors have converted $85,800 of the Convertible Notes
into 268,124 shares of the Company’s common stock. The outstanding balance at
September 30, 2009 was $161,502.
 
 2009
Spring Offering
 
 From
March 17, 2009, through April 30, 2009, the Company conducted and concluded a
private offering (the “Spring 2009 Offering”) of up to $300,000 aggregate face
amount of its convertible notes (the “Spring 2009 Notes”) with 11 accredited
investors. A total of $181,500 aggregate face amount of the Spring 2009 Notes
were sold for an aggregate purchase price of $165,000.  The Spring
2009 Notes mature on the first anniversary of their date of issuance, are
convertible, at the option of the noteholder, into up to 672,222 shares of
common stock of the Company at a conversion price of $0.27 per
share.
 
 Each of
the investors in the Spring 2009 Offering received, for no additional
consideration, a warrant (the “Spring 2009 Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Spring 2009 Notes are
convertible (the “Warrant Shares”).  Each Spring 2009 Warrant is
exercisable on a cash basis only at an initial price of $0.50 per share, and is
exercisable for a period of two years.  Up to 336,111 Warrant Shares
are initially issuable on exercise of the Spring 2009 Warrants.
 
 The
Company received $165,000 in net proceeds in the Spring 2009 Offering which will
be used for general corporate purposes and working capital. The aggregate value
of the Spring 2009 Offering Warrants issued in connection with the April 30,
2009 closing were valued at $39,994 using the Black-Scholes option valuation
model with the following assumptions; risk-free interest rate of 0.94%; dividend
yield of 0%; volatility factors of the expected market price of common stock of
156.39%; and an expected life of two years (statutory term) and vest immediately
upon issuance.  The Company also determined that the notes contained a
beneficial conversion feature of $96,827.  The value of the Spring
2009 Offering Warrants, the beneficial conversion feature, and the transaction
fees of $16,500 are considered as debt discount and are being amortized over the
life of the Note.
 
 As of
September 30, 2009, investors have converted $38,500 of the Convertible Notes
into 142,590 shares of the Company’s common stock. The outstanding balance at
September 30, 2009 was $143,000.
 
 2009
Summer Offering
 
 From June
9, 2009, through September 28, 2009, the Company conducted and concluded a
private offering (the “Summer 2009 Offering”) of up to $500,000 aggregate face
amount of our convertible notes (the “Summer 2009 Notes”) with interest
compounded quarterly at the annual rate of seven percent (7%) payable at
maturity. A total of $467,500 Spring 2000 Notes were sold to 17 accredited
investors. The Summer 2009 Notes mature on the third anniversary of the closing
of this offering and will be convertible, at the option of the noteholder, into
up to 1,870,000 shares of common stock of the Company at a conversion price of
$0.25 per share.
 
 Each of
the investors in the Summer 2009 Offering will receive, for no additional
consideration, a warrant (the “Summer 2009 Warrants”), entitling the holder to
purchase a number of shares of our common stock equal to 100% of the number of
shares of common stock into which the Summer 2009 Notes are convertible (the
“Warrant Shares”).  Each Summer 2009 Warrant is exercisable on a cash
basis only at an initial price of $0.30 per share, and is exercisable for a
period of thirty six months.  Up to 1,870,000 Warrant Shares are
initially issuable on exercise of the Summer 2009 Warrants.
 
 The
Company received $467,500 in net proceeds in the Summer 2009 Offering which will
be used for general corporate purposes and working capital. The aggregate value
of the Summer 2009 Offering Warrants issued in connection with the September 28,
2009 closing were valued at $269,543 using the Black-Scholes option valuation
model with the following assumptions; risk-free interest rate of 1.00; dividend
yield of 0%; volatility factors of the expected market price of common stock of
147.21%; and an expected life of three years (statutory term) and vest
immediately upon issuance.  The Company also determined that the notes
contained a beneficial conversion feature of $197,957.  The value of
the Summer 2009 Offering Warrants and the beneficial conversion feature are
considered as debt discount and are being amortized over the life of the
Note.
 
 The
outstanding balance as of September 30, 2009 was $467,500
 
 23
 
 6.
Capital stock
 
 During
the nine months ended September 30, 2009, the Company issued 2,165,026 shares of
common stock in exchange for conversion of $460,129 of Convertible
Notes.
 
 During
the nine months ended September 30, 2009, the Company granted 340,000 shares of
common stock in exchange for consulting services in the amount of
$137,500.
 
 During
the nine months ended September 30, 2009, the Company granted 430,370 shares of
common stock in settlement of accounts payable of $104,414.
 
 During
the nine months ended September 30, 2009, the Company issued 83,333 shares of
common stock upon exercise of stock options at $0.27 per share and valued at
$22,500
 
 7.  Stock
options and warrants
 
 The
Company periodically issues stock options and warrants to employees and
non-employees in capital raising transactions, for services and for financing
costs.  Stock-based compensation is measured at the grant date, based
on the fair value of the award, and is recognized as expense over the requisite
service period.  Options vest and expire according to terms
established at the grant date.
  Options
 
 The
Company currently issues stock options to employees, directors and consultants
under the 2004 Stock Option Plan (the Plan). The Company could issue options
under the Plan to acquire up to 5,000,000 shares of common stock. In
February 2006, the board approved an amendment to the Plan (approved by the
Shareholders in May 2006), increasing the authorized shares by
2,000,000 shares to 7,000,000 shares. At September 30, 2009, 2,398,775
were available to be granted under the Plan. Prior to 2004, the Company granted
3,250,000 options outside the Plan to officers of the Company of which 250,000
are still outstanding.
 
 Employee
options vest according to the terms of the specific grant and expire from 5 to
10 years from date of grant. Non-employee option grants to date are vested
upon issuance. The weighted-average, remaining contractual life of employee
options outstanding at September 30, 2009 was 7.6 years. Stock option
activity for the period January 1, 2009 to September 30, 2009, was as
follows:
 
 Weighted
      Avg.
                Options
              
              
              Weighted
      Avg.
                Exercise
      PriceOptions
      outstanding, January 1, 2009
              
              
              4,601,225
              
              
              $
              0.53Options
      granted
              
              
              333,333
              
              
              
              .30Options
      exercised
              
              
              (83,333
              )
              
              
              0.27Options
      forfeited
              
              
              —
              
              
              
              —Options
      cancelled
              
              
              —
              
              
              
              —Options
      outstanding, September 30, 2009
              
              
              4,851,225
              
              
              $
              0.52
 
 The
weighted average exercise prices, remaining contractual lives for options
granted, exercisable, and expected to vest under the Plan as of September 30,
2009 were as follows:
 
 Outstanding
      Options
              
              Exercisable
      OptionsWeighted
              
              
              
              WeightedOption
              
              
              
              
              Life
              
              Average
      Exercise
              
              
              
              Average
      ExerciseExercise
      Price Per Share
              
              Shares
              
              (Years)
              
              Exercise
      Price
              
              Shares
              
              Price$ 0.21 - $ 0.99
              
              4,463,679
              
              
              7.8
              
              $
              0.45
              
              
              
              4,130,346
              
              
              $
              0.46$ 1.00 - $ 1.99
              
              327,546
              
              
              5.6
              
              $
              1.41
              
              
              
              327,546
              
              
              $
              1.41$ 2.00 - $ 2.26
              
              60,000
              
              
              1.9
              
              $
              2.26
              
              
              
              60,000
              
              
              $
              2.264,851,225
              
              
              7.8
              
              $
              0.52
              
              
              
              4,517,892
              
              
              $
              0.54
 
 As of
September 30, 2009 the market price of the Company’s stock was $0.41 per
share. Future unamortized compensation expense on the outstanding
options at September 30, 2009 is $72,110.  At September 30, 2009,
the aggregate intrinsic value of the options outstanding and exercisable
was $339,333.
   24
 
 Black-Scholes
value of options
 
 During
the nine months ended September 30, 2009 and 2008, the Company valued options
for pro-forma purposes at the grant date using the Black-Scholes pricing model
with the following average assumptions:
 
 September
      30,2009
              
              2008Expected
      life (years)
              
              
              5.5
              
              
              
              5.5Risk
      free interest rate
              
              
              2.57
              %
              
              
              4.42
              %Volatility
              
              
              129
              %
              
              
              124.57
              %Expected
      dividend yield
              
              
              0.00
              %
              
              
              0.00
              %
 
 The
weighted average fair value for options granted in 2008 was
$0.24.  The weighted average for options granted during the nine
months ended September 30, 2009 was $0.27.
 
 Warrants
 
 The
following table summarizes certain information about the Company’s stock
purchase warrants from January 1, 2009 to September 30, 2009:
  Warrants
              
              
              Weighted
      Avg.
                Exercise
      PriceWarrants
      outstanding, January 1, 2009
              
              
              10,400,003
              
              
              $
              0.70Warrants
      granted
              
              
              2,949,743
              
              
              
              0.37Warrants
      exercised
              
              
              —
              
              
              
              —Warrants
      cancelled
              
              
              (1,502,310
              )
              
              
              —Warrants
      outstanding, June 30, 2009
              
              
              11,847,436
              
              
              $
              0.55
 
 
 Outstanding
      Warrants
              
              
              Exercisable
      WarrantsWarrantExercise
      PricePer Share
              
              Shares
              
              Life(Years)
              
              WeightedAverage
      ExercisePrice
              
              
              Shares
              
              
              WeightedAverage
      ExercisePrice$
      0.30 - $ 0.99
              
              
              9,702,168
              
              2.0
              
              $
              0.44
              
              
              
              9,702,168
              
              
              $
              0.48$
      1.00 - $ 1.99
              
              
              2,057,966
              
              2.4
              
              $
              1.00
              
              
              
              2,057,966
              
              
              $
              1.00$
      2.00 - $ 2.70
              
              
              87,302
              
              1.9
              
              $
              2.70
              
              
              
              87,302
              
              
              $
              2.7011,847,436
              
              2.0
              
              $
              0.55
              
              
              
              11,847,436
              
              
              $
              0.60
 
 As of
September 30, 2009 the market value of the Company's stock was $0.41 per share,
and the aggregate intrinsic value of the warrants outstanding was
$-0-.
  25
  8.  Research
and development
 
 
 The
Company has research and development facilities in Morgan Hill, California. The
Company has tested products incorporating our ZEFS, MK IV and ELEKTRA
technologies for multiple makes and models diesel engines, motorbikes, boats,
generators, lawnmowers and other small engines.  The Company has
purchased test vehicles, test engines and testing equipment. The Company
incurred $274,577 and $432,184 for the nine months ended September 30, 2009 and
2008, respectively, on its research and development activities.
 
 Temple
University License Agreements
 
 The
Company has entered into a research and development agreement (R&D
Agreement) with Temple University to conduct further research on the
ELEKTRA technology. Under the R&D Agreement Temple University will conduct a
24-month research project towards expanding the scope of, and developing
products utilizing, the technologies covered under the License Agreements,
including design and manufacture of prototypes utilizing electric fields to
improve diesel, gasoline and kerosene fuel injection in engines using such fuels
and a device utilizing a magnetic field to reduce crude oil viscosity for crude
oil (paraffin and mixed base) and edible oil flow in pipelines. If the research
project yields results within the scope of the technologies licensed pursuant to
the License Agreements, those results will be deemed included as rights licensed
to the Company pursuant to the License Agreements. If the research project
yields results outside of the scope of the technologies covered by the License
Agreements, the Company has a six-month right of first negotiation to enter into
a new worldwide, exclusive license agreement with Temple University for the
intellectual property covered by those results.
 
 The
Company has entered into three License Agreements with
Temple University covering Temple University’s current patent
applications concerning certain electric field effects on gasoline, kerosene and
diesel fuel particle size distribution, and concerning electric field effects on
crude oil and edible oil viscosity. Initially, the License Agreements are
exclusive and the territory licensed to the Company is worldwide. Pursuant to
the License Agreements, the Company will pay to Temple University
(i) license fees in the aggregate amount of $300,000.  A payment
of $50,000 was due on November 1, 2006; a payment of $100,000 was due on March
2, 2007; a payment of $75, 000 was due on February 2, 2008 and the final payment
was due on February 2, 2009.  Annual maintenance fees of $25,000 for the
first license were due on November 1, 2007 and November 1,
2008.  Annual maintenance payments of $125,000 for two of the licenses
were due January 1, 2008.  In addition, each License Agreement
separately provides that the Company will pay royalties to Temple University on
net sales of products incorporating the technology licensed under that License
Agreement in an amount equal to 7% of the first $20 million of net sales,
6% of the next $20 million of net sales and 5% of net sales in excess of
$40 million. Sales under the three License Agreements are not aggregated
for purposes of calculating the royalties payable to Temple University. In
addition, the Company has agreed to bear all costs of obtaining and maintaining
patents in any jurisdiction where the Company directs Temple University to
pursue a patent for either of the licensed technologies. Should the Company not
wish to pursue a patent in a particular jurisdiction, that jurisdiction would
not be included in the territory licensed to the Company.
 
 The
Company has also entered into a research and development agreement (R&D
Agreement) with Temple University to conduct further research on the
ELEKTRA technology. Under the R&D Agreement Temple University will conduct a
24-month research project towards expanding the scope of, and developing
products utilizing, the technologies covered under the License Agreements,
including design and manufacture of prototypes utilizing electric fields to
improve diesel, gasoline and kerosene fuel injection in engines using such fuels
and a device utilizing a magnetic field to reduce crude oil viscosity for crude
oil (paraffin and mixed base) and edible oil flow in pipelines. If the research
project yields results within the scope of the technologies licensed pursuant to
the License Agreements, those results will be deemed included as rights licensed
to the Company pursuant to the License Agreements. If the research project
yields results outside of the scope of the technologies covered by the License
Agreements, the Company has a six-month right of first negotiation to enter into
a new worldwide, exclusive license agreement with Temple University for the
intellectual property covered by those results.  Pursuant to the R&D
Agreement, the Company will make payments to Temple University in the
aggregate amount of $500,000
 
 At
December 31, 2008, the Company was in default in the amount of $300,000 in
connection with its payment obligations under the License Agreements and
maintenance payments.  On November 10, 2008, the Company received written
notice from Temple University of a material breach relating to required
payments under the License Agreements.  The notice provides the
Company with 60 days’ notice to cure the material breach.  The
Company’s failure to cure could result in a termination of the License
Agreements. If the termination occurs, the Company estimates this would have a
material adverse impact on the Company’s financial condition and
operations.  Under the License Agreements the Company is subject to a
penalty of 1% per month of the amounts due and unpaid under the License
Agreements.
 
 
 26
 
 At
December 31, 2008, the Company was in default in the amount of $376,250 under
the R&D Agreement.  On November 10, 2008, the Company received
written notice of default from Temple University. The notice provides the
Company with 60 days to cure the material breach.  The Company’s
failure to cure the breach could result in the termination of the R&D
Agreement.  If the termination occurs, the Company estimates this
would have a material adverse impact on the Company’s financial condition and
operations.
 
 On
January 9, 2009, the Company entered into a Letter Agreement with
Temple University wherein Temple University granted to the Company an
extension of time to cure the above-referenced breaches until March 31,
2009.  The Letter Agreement provides for payments of $100,000 on each
of January 31, 2009, February 28, 2009 and March 31, 2009. The Company made the
January 31, 2009 payment but did not make the payment due on February 28, 2009.
On March 26, 2009, the Company received a written extension for both the
February 28, 2009 payment and the March 31, 2009 payment until April 30,
2009.  All additional amounts past due as of December 31, 2008 and
additional License and Maintenance Fees of $200,000 which became due the first
quarter of 2009  were to be re-negotiated on or before April, 2009,
however, this has now been extended to December 31, 2009. (See Note
10)
 
 At
September 30, 2009, the Company owed to Temple University $400,000 for the
License Agreements and Maintenance Fees; $376,250 for the R&D Agreement and
$76,500 in penalties for a total of $852,750. A penalty equal to 1% of the
amount due and unpaid on the first day of each calendar month will be added to
the outstanding amount due Temple University.
 
 The
Company has provided for all past due amounts in the financial statements at
September 30, 2009 and December 31, 2008.  Fees due
Temple University as of September 30, 2009 and December 31, 2008 were
$852,750 and $716,500, respectively, and are included in accounts payable to
Temple University in the accompanying condensed consolidated financial
statements.  During the nine months ended September 30, 2009 and 2008,
the Company recorded $236,250 and $376,500, respectively, of fees and penalties
due to Temple University.
 
 9.  Commitments
and contingencies
 
 Legal
matters
 
 On
December 19, 2001, the SEC filed civil charges in the United States Federal
District Court, Southern District of New York, against the Company, the
Company’s former President and then sole director Jeffrey A. Muller, and others,
alleging that the Company and the other defendants were engaged in a fraudulent
scheme to promote the Company’s stock. The SEC complaint alleged the existence
of a promotional campaign using press releases, Internet postings, an elaborate
website, and televised media events to disseminate false and materially
misleading information as part of a fraudulent scheme to manipulate the market
for stock in the Company which was then controlled by Mr. Muller. On
March 22, 2002, the Company signed Consent to Final Judgment of Permanent
Injunction and Other Relief in settlement of this action as against the
corporation only, which the Court approved on July 2, 2002. Under this
settlement, the Company was not required to admit fault and did not pay any
fines or restitution.
 
 On
July 2, 2002, after an investigation by the Company’s newly constituted
board of directors, the Company filed a cross-complaint in the SEC action
against Mr. Muller and others seeking injunctive relief, disgorgement of
monies and stock and financial restitution for a variety of acts and omissions
in connection with sales of the Company’s stock and other transactions occurring
between 1998 and 2002.  Among other things, the Company alleged that
Mr. Muller and certain others sold Company stock without providing adequate
consideration to the Company; sold insider shares without making proper
disclosures and failed to make necessary filing required under federal
securities laws; engaged in self-dealing and entered into various
undisclosed  related-party transactions; misappropriated for their own
use proceeds from sales of the Company’ stock; and entered into various
undisclosed arrangement regarding the control, voting and disposition of their
stock.
 
 On
July 30, 2002, the U.S. Federal District Court, Southern District of New
York, granted the Company’s application for a preliminary injunction against
Mr. Muller and others, which prevented Mr. Muller and other
cross-defendants from selling, transferring, or encumbering any assets and
property previously acquired from the Company, from selling or transferring any
of the Company’s stock that they may have owned or controlled, or from taking
any action to injure the Company or the Company’s business and from having any
direct contact with the Company’s shareholders. The injunctive order also
prevented Mr. Muller or his nominees from engaging in any effort to
exercise control over the Company’s corporation and from serving as an officer
or director of the Company.  In the course of the litigation, the
Company has obtained ownership control over all patent rights to the ZEFS
device.
 
 
 27
 
 On
January 4, 2007, the Court entered a final judgment against Jeffrey Muller which
barred Mr. Muller from serving as an officer or director of a public
company for a period of 20 years, ordered Mr. Muller to disgorge any
shares of the Company’s stock that he still owns and directed the Company to
cancel any issued and outstanding shares of the Company’s stock still owned by
Mr. Muller. Mr. Muller was also ordered to disgorge unlawful profits
in the amount of $7.5 million and to pay a civil penalty in the amount of
$100,000.  Acting in accordance with the ruling and decision of the
Court, the Company has canceled (i) 8,047,403 shares of common stock that
had been held by Mr. Muller and/or his affiliates, (ii) options to
acquire an additional 10,000,000 shares of the Company’s common stock held by
Mr. Muller personally and (iii) $1,017,208 of debt which Mr. Muller
claimed was owed to him by the Company.  After an appeal filed by Mr.
Muller was dismissed the Judgment against him is considered final.
 
 On
February 8, 2007, Federal Magistrate Judge Maas issued a post-judgment order, at
the Company’s request, which further concluded that all of the shares of the
Company’s stock held by Mr. Muller or any of his nominees directly or indirectly
owned or controlled were to be recaptured by the Company and were subject to
disgorgement and forfeiture.  The ruling provided that all shares,
options and any other obligations allegedly owed by the Company to Mr. Muller
were to be disgorged in our favor and confirmed the earlier judgment holding
Mr. Muller liable for $7.5 million in actual damages, imposing a
$100,000 fine and barring Mr. Muller from any involvement with a publicly traded
company for 20 years.  With prejudgment interest, this ruling
brings the actual damages against Muller to over
$11 million.  Additionally, the Court clarified that the order
required the disgorgement of any shares of the Company’s stock that
Mr. Muller or any of his nominees directly or indirectly owned or
controlled.  In furtherance of this order, the Company has taken
action to cancel over 3.6 million shares which had been issued to offshore
companies.  The Order also confirmed the appropriateness of actions
previously taken by the Company to acquire the patent rights and to consolidate
the manufacturing, marketing and distribution rights with its ownership of all
rights to the existing patents. On February 11, 2009, Judge Maas confirmed that
his previous decision was modified and Save the World Air’s Motion for Summary
Judgment was granted in favor of Save the World Air as set forth in his order of
February 8, 2007.  A proposed Final Judgment in favor of Save the
World air is pending before the United States District Court, Southern District
of New York
 
 Dispute
with Former Corporate Officer
 
 The
Company has been involved in a dispute with its former Corporate Officer
concerning claims in connection with his departure from the
Company.  Although the matter is ongoing, the Company has consulted
with legal counsel concerning its rights and obligations in responding to the
claims.
 
 
 10.  Subsequent
events
 
 The Company has evaluated subsequent
events occurring between the end of our fiscal quarter, September 30, 2009 and
November 12, 2009.
 
 On
November 11, 2009, the Company received from Temple University a written
extension of the January 9, 2009 Letter Agreement.  The agreement
provides an extension of the $100,000 due to Temple on February 28, 2009 and
$100,000 due March 30, 2009 to December 31, 2009.  The Company expects
that all payments regarding past due amounts will be renegotiated on or before
December 31, 2009.
 
 From
October 1, through November 12, 2009, the Company issued 3,667,977 shares of
common stock in exchange for the conversion of $847,497 Convertible
Notes.
 
 
 28
 
 Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations
 
 This
Quarterly Report on Form 10-Q contains forward-looking statements. These
forward-looking statements include predictions regarding our
future:
 
 ●
              revenues
      and profits;●
              customers;●
              research
      and development expenses and efforts;●
              scientific
      and other third-party test results;●
              sales
      and marketing expenses and efforts;●
              liquidity
      and sufficiency of existing cash;●
              technology
      and products;●
              the
      outcome of pending or threatened litigation; and●
              the
      effect of recent accounting pronouncements on our financial condition and
      results of operations
 
 You can
identify these and other forward-looking statements by the use of words such as
“may,” “will,” “expects,” “anticipates,” “believes,” “estimates,” “continues,”
or the negative of such terms, or other comparable terminology.
 
 Forward-looking
statements also include the assumptions underlying or relating to any of the
foregoing statements.
 
 Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth under the heading “Risk Factors” in our Annual Report on Form 10-K for the
year ended December 31, 2008. All forward-looking statements included in
this document are based on information available to us on the date hereof. We
assume no obligation to update any forward-looking statements.
 
 Overview
 
 The
following discussion and analysis of our condensed consolidated financial
condition and condensed consolidated results of operations should be read in
conjunction with the condensed consolidated financial statements and notes
thereto included in Part I, Item 1 of this Form 10-Q and the condensed
consolidated financial statements and notes thereto contained in our Annual
Report on Form 10-K for the fiscal year ended December 31,
2008.
 
 We are a
green technology company that leverages a suite of patented, patent-pending and
licensed intellectual properties related to the treatment of fuels. Technologies
patented by, or licensed to, us utilize either magnetic or uniform electrical
fields to alter physical characteristics of fuels and are designed to create a
cleaner combustion. Cleaner combustion has been shown to improve performance,
enhance fuel economy and/or reduce harmful emissions in laboratory
testing.
 
 
 29
 
 Our ECO
ChargRTM and MAG ChargRTM products use fixed magnetic fields to alter some
physical properties of fuel, by incorporating our patented and patent-pending
ZEFS and MK IV technologies.  We differentiate ECO ChargR and MAG
ChargR products based on their differing attributes and marketing focus. ECO
ChargR products are primarily designed to reduce harmful emissions and MAG
ChargR products are primarily designed to enhance performance and fuel economy.
Our ECO ChargR product is intended to reduce exhaust emissions in vehicle and
small utility motors.  ECO ChargR will be marketed primarily to
original equipment manufacturers (“OEMs”) as well as to pilot and
government-mandated emissions programs.  Our MAG ChargR product is
intended to increase power and improve mileage. MAG ChargR will be marketed
primarily to the specialty consumer accessories market for many types of
vehicles, including but not limited to cars, trucks, motorcycles, scooters, all
terrain vehicles (“ATVs”), snowmobiles, personal watercraft and small utility
motors.  Because our ECO ChargR and MAG ChargR products are customized to
specific brands, models and engine sizes, these products ultimately will require
individually developed parts, which can be expensive and time-consuming to
produce.  See “Our Technologies and Products” below.
 
 Our first
revenues have come from initial sales in Asia for our ECO ChargR product in the
motorcycle industry. We plan on commencing sales of ECO ChargR to customers in
the United States in the motorcycle industry in the fourth quarter of 2009. We
also plan on commencing initial sales of our MAG ChargR product in the
United States in the automobile and motorcycle industry in the fourth quarter of
2009.  See “Recent Developments” and “Sales and Marketing”
below.
 
 We have
obtained a license from Temple University for their patent-pending uniform
electric field technology, tentatively called ELEKTRATM. The ELEKTRA technology
consists of passing fuel through a specific strong electrical
field.  Although ELEKTRA has a similar effect on fuels as our ZEFS and
MK IV technologies, ELEKTRA incorporates a uniform electrical field
principle.  Based on our early research and product development, we
believe that ELEKTRA carries certain advantages over our ZEFS and MK IV
technologies, primarily not requiring as many variations for products
incorporating the ELEKTRA technology compared to products incorporating the ZEFS
or MK IV technologies. Preliminary testing conducted in Europe by an
outside research and development facility indicates that ELEKTRA causes a
significant change in some of the physical characteristics of the fuel,
resulting in better atomization of the fuel and improved
combustion.
 
 We have
also entered into a research and development agreement with Temple University to
conduct further research on the ELEKTRA technology and magnetic technologies in
general.  Together with Temple University, we have developed prototype
products using the ELEKTRA technology and we are continuing testing, and
research and development. We are in the early stages of developing ELEKTRA
products that, based on the previously mentioned preliminary testing, is
intended to improve fuel economy and change fuel viscosity, and may improve
performance and reduce emissions, depending upon the specific application. We
are also working with Temple and several domestic and international corporations
investigating applications of this technology to the transportation industry,
oil refineries and pipelines, and OEMs. See “Our Technologies and Products”
below.
 
 We
operate in a highly competitive industry.  Many of our activities may
be subject to governmental regulation.  We have taken aggressive steps
to protect our intellectual property.
 
 There are
significant risks associated with our business, our company and our
stock.
 
 We are a
development stage company that generated its first initial revenues in the
fourth quarter of 2006. Our expenses to date have been funded primarily through
the sale of stock and convertible debt, as well as proceeds from the exercise of
stock purchase warrants. We raised capital in 2008 and the first nine months of
2009 and will need to raise substantial additional capital in the balance of
2009, and possibly beyond, to fund our sales and marketing efforts, continuing
research and development, and certain other expenses, until our revenue base
grows sufficiently.
 
 Our
company was incorporated on February 18, 1998, as a Nevada corporation,
under the name Mandalay Capital Corporation. We changed our name to Save the
World Air, Inc. on February 11, 1999, following the acquisition of
marketing and manufacturing rights of the ZEFS technologies. Our mailing address
is 235 Tennant Avenue, Morgan Hill, California 95037. Our telephone number is
(408)-778-0101. Our corporate website is www.stwa.com.  Information
contained on the website is not deemed part of this Annual Report.
 
 Our
common stock is quoted on the Over-the-Counter Bulletin Board under the symbol
“ZERO.OB”.
 
 Results
of Operations
 
 We did
not generate any revenue for the three-month period and nine month periods ended
September 30, 2009 and 2008.
 
 Operating
expenses were $488,281 for the three-month period ended September 30, 2009,
compared to $1,148,887 for the three-month period ended September 30, 2008,
a decrease of $660,606. This decrease is attributable to decreases in non-cash
expenses of $533,238 and cash expenses of $127,368. Specifically, the decrease
in non-cash expense is attributable to decreases in valuation of options given
as compensation $532,814 and depreciation $424. Specifically, the cash expense
decrease is attributable to decreases in consulting and professional fees
$107,787, corporate expenses $17,711 and travel expenses $5,608, offset by
increases in salaries and benefits $3,335 and miscellaneous office expenses
$403.
   30
  Operating
expenses were $1,923,703 for the nine-month period ended September 30,
2009, compared to $2,428,889 for the nine-month period ended September 30,
2008, a decrease of $505,186. This decrease is attributable to a decrease in
non-cash expenses of $634,751, offset by an increase in cash expenses of
$129,565.  The increase in cash expenses is attributable to increases
in salaries and benefits $66,235, consulting and professional fees $56,673 and
office and other expenses $31,527, offset by decreases in travel expense $18,437
and corporate expense $6,433.
 
 Research
and development expenses were $12,517 for the three-month period ended
September 30, 2009, compared to $109,822 for the three-month period ended
September 30, 2008, a decrease of $97,305. This decrease is mainly
attributable to decreases in product testing, research and supplies $49,555 and
contract fees $47,750.
 
 Research
and development expenses were $274,577 for the nine-month period ended
September 30, 2009, compared to $432,184 for the nine-month period ended
September 30, 2008, a decrease of $157,607. This decrease is attributable
to decreases in contract fees $140,250 and product testing, research and
supplies $17,357.
 
 Other
expense for the three-month period ended September 30, 2009 were $250,616,
compared to $220,430 for the three-month period ended September 30, 2008,
an increase of $30,186. This increase is attributable to an increase in non-cash
interest expense $22,466 and cash interest expense $7,720.
 
 Other
expense for the nine-month period ended September 30, 2009 were $1,084,896,
compared to $1,593,940 for the nine-month period ended September 30, 2008,
a decrease of $509,044. This decrease is attributable to decreases in
non-cash interest expense $559,662 and loss on sale of equipment $9,683, offset
by an increase in cash interest expense $7,695 and a   decrease
in other income $52,606.
 
 We had a
net loss of $751,414, or $0.01 per share, for the three-month period ended
September 30, 2009, compared to a net loss of $1,479,139, or $0.03 per
share, for the three-month period ended September 30, 2008. We had a net
loss of $3,283,176, or $0.05 per share, for the nine-month period ended
September 30, 2009, compared to a net loss of $4,455,013, or $0.10 per
share, for the nine-month period ended September 30, 2008. We expect to
incur additional net loss in the fiscal year ending December 31, 2009,
primarily attributable to continued operating and marketing-related expenditures
without the benefit of any significant revenue for the remainder of the
year.
 
 Liquidity and Capital
Resources
 
 General
 
 Since its
inception, the Company has been primarily engaged in organizational and
pre-operating activities. The Company has generated insignificant revenues and
has incurred accumulated losses of $46,026,240 from February 18, 1998
(Inception) through September 30, 2009. As reflected in the accompanying
condensed consolidated financial statements, the Company had a net loss of
$3,283,176 and a negative cash flow from operations of $1,137,284 for the nine
months ended September 30, 2009, and had a working capital deficiency of
$4,139,319 and a stockholders' deficiency of $4,021,286 at September 30,
2009.   The Company is currently unable to meet its cash obligations
and is in default of certain of its convertible note agreements and its
obligations under its license agreements with Temple University.   As
a result, the Company's independent registered public accounting firm, in their
report on the Company's 2008 consolidated financial statements, raised
substantial doubt about the Company's ability to continue as a going
concern.
 
 Our
operations to date have been funded through issuances of our common stock and
convertible notes whereby we raised an aggregate $18,355,017 from February 18,
1998 (inception) through September 30, 2009. Based on our current operating
plan, we believe that we do not have sufficient cash and cash equivalents to
implement our operating plan. We will need to obtain additional financing in
addition to the funds already raised through the sale of equity securities to
fund our cash needs and continue our operations. Additional financing, whether
through public or private equity or debt financing, arrangements with
stockholders or other sources to fund operations, may not be available, or if
available, may be on terms unacceptable to us. Our ability to maintain
sufficient liquidity is dependent on our ability to raise additional capital. If
we issue additional equity securities to raise funds, the ownership percentage
of our existing stockholders would be reduced. New investors may demand rights,
preferences or privileges senior to those of existing holders of our common
stock. Debt incurred by us would be senior to equity in the ability of debt
holders to make claims on our assets. The terms of any debt issued could impose
restrictions on our operations. If adequate funds are not available to satisfy
either medium or long-term capital requirements, our operations and liquidity
could be materially adversely affected and we could be forced to cut back our
operations.
 
 
 31
 
 Details
of Recent Financing Transactions
 
 Morale
Orchards, LLC and Leodis Matthews
 
 Leodis
Matthews, through his law firm, Matthews & Partners, (“Matthews”) serves as
outside legal counsel to the Company.  Morale Orchards, LLC (“Morale”)
is owned by Jacqueline Alexander, the wife of Leodis
Matthews.
 
 In 2006
and 2007, Morale purchased two convertible promissory notes totaling
$1,225,000.  The notes were unsecured; convertible into 1,595,588
shares of common stock, due one year from the date issued, and had an implied
interest rate of 22.5%.  Warrants to purchase 797,794 shares of common
stock were issued with the notes.  As of January 31, 2008, the notes
were in default, and the total amount due for the notes was $1,362,212,
including penalties and interest.  In addition to the two notes, we
borrowed $20,000 from Morale on October 30, 2007.  At January 31,
2008, we were also indebted to Matthews $472,762 for past legal
fee.
 
 Effective
January 31, 2008, the Company, Morale, and Matthews agreed to a settlement of
our loans due Morale and fees due Matthews.   Morale agreed to
waive all accrued interest on the notes after January 31, 2008, and Morale and
Matthews agreed to accept 7,421,896 shares of common stock of the Company as
payment of the notes payable and fees.
 
 On March
10, 2008, we issued 5,530,848 shares of the Company’s common stock valued at
$2,101,722 to Morale for the conversion of the notes totaling $1,362,212 and
cancellation of $20,000 Note.   Also on March 10, 2008, the we
issued 1,891,048 shares of the Company’s common stock valued at $718,598 to
Matthews in exchange for settlement of the legal fees due Matthews of
$472,762.
 
 The fair
value of the shares of common stock issued was determined to be $0.38 per share,
based on the closing price of the Company’s common stock on January 31, 2008,
for a total settlement of $2,820,320.  As a result of the issuance of
shares of common stock, the we incurred additional non-cash costs of $927,903
that have been reflected as costs to settle outstanding debt in the accompanying
condensed consolidated statement of operations.
  2007 Winter
Offering.  From December 27, 2007 to February 29, 2008 we
conducted an offering (the “2007 Winter Offering”) of up to $1,000,000 aggregate
face amount of its convertible notes (the “ 2008 Winter Notes”) with a small
number of accredited investors.  Of this amount, $521,400 aggregate
face amount of the 2007 Winter Notes were sold for an aggregate purchase price
of $474,000 net proceeds.  Therefore, while the stated interest rate
on the 2007 Winter Notes is 0%, the implied interest rate on the 2007 Winter
Notes is 10%.  The 2007 Winter Notes mature on the first anniversary
of their date of issuance.  The 2007 Winter Notes are convertible, at
the option of the noteholder, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2007 Winter Offering (the “Conversion Price”).  Up
to $1,042,800 Conversion Shares are issuable at a Conversion Price of $0.50 per
share.
 
 Each of
the investors in the 2007 Winter Offering received, for no additional
consideration, a warrant (the “ 2007 Winter Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the (2007 Winter Notes) are
convertible (the “2007 Warrant Shares”)  Each  2007 Winter
Warrant is exercisable on a cash basis only at a Price of $0.50 per share, and
is exercisable for a period of two years from the date of
issuance.  Up to 521,400 2008 Warrant Shares are initially issuable on
exercise of the 2007 Winter Warrants.
 
 As of
September 30, 2009, investors have converted $521,400 of the Convertible Notes
into 1,042,800 shares of the Company’s common stock.  There was no
outstanding balance at September 30, 2009.
 
 2008 Spring
Offering. On May
27, 2008,  we made an offering (the “2008 Spring Offering”) with a
certain investor of which, $66,000 face amount of the 2008 Spring Note was
sold for $60,000 net proceeds.  Therefore, while the stated interest
rate on the 2008 Spring Note is 0%, the implied interest rate on the 2008 Spring
Note is 10%. The 2008 Spring Note will mature on the first anniversary of
the date of issuance.  The 2008 Spring Note is convertible, at the
option of the noteholder, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Spring Offering (the “Conversion
Price”).  The 132,000 Conversion Shares are issuable at a Conversion
Price of $0.50 per share.
 
 The
investor in the 2008 Spring Offering received, for no additional consideration,
a warrant (the “ 2008 Spring Warrants”), entitling the holder to purchase a
number of shares of the Company’s common stock equal to 50% of the number of
shares of common stock into which the ( 2008 Spring Notes) are convertible (the
“2008 Spring Warrant Shares”).  The 2008 Spring Warrant Shares is
exercisable on a cash basis only at a Price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  The
66,000 2008 Spring Warrant Shares are initially issuable upon exercise of the
2008 Spring Warrants.
 
 As of
September 30, 2009, the investor converted $66,000 of the Convertible Notes into
132,000 shares of the Company’s common stock.  There was no
outstanding balance at September 30, 2009.
   32
 
 2008 Summer
Offering.  From July 17,
2008 to August 31, 2008,  we conducted an offering (the “2008 Summer
Offering”) of up to $600,000 aggregate face amount of its convertible notes
“the”2008 Summer Offering) with a small number of accredited investors. Of this
amount $484,000 aggregate face amount of the 2008 Summer Notes were sold for an
aggregate purchase price of $440,000 net proceeds.  Therefore, while
the stated interest rate on the 2008 Summer Notes is 0%, the implied interest
rate on the 2008 Summer Notes is 10%.  The 2008 Summer Notes will mature on
the first anniversary of the date of issuance.  The 2008 Summer Notes
are convertible, at the option of the noteholders, into shares of common stock
of the Company (the “Conversion Shares”) at a conversion price equal to the
average of the closing bid price of the Company’s common stock for the five
trading days preceding the closing date of the 2008 Summer Offering (the
“Conversion Price”).  Up to 1,423,530 Conversion Shares are issuable
at a Conversion Price of $0.34 per share.
 
 Each of
the investors in the 2008 Summer Offering received, for no additional
consideration, a warrant (the “ 2008 Summer Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Summer Notes) are
convertible (the “2008 Summer Warrant Shares”). Each 2008 Summer Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 711,764, 2008 Summer Warrant Shares are initially issuable upon exercise of
the 2008 Summer Warrants.  As of September 30, 2009, investors have
converted $143,000 of the Convertible Notes into 420,589 shares of the
Company’s common stock.  On September 2, 2009, the Company was in
default on the outstanding notes of $341,000. The balance at September was
$375,100 which includes the 10% default penalty
 
 2008 Fall
Offering.  From September 8, 2008 to October 31, 2008, we
conducted an offering (the “2008 Fall Offering”) of up to $500,000 aggregate
face amount of its Convertible Notes.  A total of $198,220 aggregate
face amount of the 2008 Fall Notes were sold for an aggregate purchase price of
$180,200 net proceeds.  Therefore, while the stated interest on the
2008 Fall Notes is 0%, the implied interest rate on the 2008 Fall Notes is
10%.  The 2008 fall notes will mature on the first anniversary of the
date of issuance.  The 2008 Fall Notes are convertible, at the option
of the noteholders, into shares of common stock of the Company (the “Conversion
Shares”) at a conversion price equal to the average of the closing bid price of
the Company’s common stock for the five trading days preceding the closing date
of the 2008 Fall Offering (the “Conversion Price”).  Up to 1,321,466
Conversion Shares are issuable at a Conversion Price of $0.15 per
share.
 
 Each of
the investors in the 2008 Fall Offering received, for no additional
consideration, a warrant (the “ 2008 Fall Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Fall Notes) are
convertible (the “2008 Fall Warrant Shares”). Each 2008 Fall Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 660,734 2008 Fall Warrant Shares are initially issuable upon exercise of the
2008 Fall Warrants.
 
 As of
September 30, 2009, investors have converted $70,400 of the Convertible Notes
into 469,333 shares of the Company’s common stock.  The outstanding
Convertible Note balance at September 30, 2009 was $127,820.
 
 2008 Winter
Offering.  From November 24, 2008 to December 5, 2008, we
conducted an offering (the “2008 Winter Offering”) of up to $500,000 aggregate
face amount of its Convertible Notes.  A total of $524,700 aggregate
face amount of the 2008 Winter Notes were sold for an aggregate purchase price
of $477,000 net proceeds.  Therefore, while the stated interest on the
2008 Winter Notes is 0%, the implied interest rate on the 2008 Winter Notes is
10%.  The 2008 Winter Notes will mature on the first anniversary of
the date of issuance.  The 2008 Winter Notes are convertible, at the
option of the noteholders, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Winter Offering (the “Conversion Price”).  Up
to 3,086,470 Conversion Shares are issuable at a Conversion Price of $0.17 per
share.
 
 Each of
the investors in the 2008 Winter Offering received, for no additional
consideration, a warrant (the “ 2008 Winter Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Winter Notes) are
convertible (the “2008 Winter Warrant Shares”). Each 2008 Winter Warrant is
exercisable on a cash basis only at a price of $0.30 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 1,543,235 2008 Winter Warrant Shares are initially issuable upon exercise of
the 2008 Winter Warrants.
 
 As of
September 30, 2009, investors have converted $407,000 of the Convertible
Notes into 2,394,117 shares of the Company’s common stock.  The
outstanding Convertible Note balance at September 30, 2009 was
$117,700.
 
 2009 Winter
Offering #1.  From January 13, 2009, through January 26, 2009,
we conducted and concluded a private offering (the “Winter 2009 Offering”) of up
to $250,000 aggregate face amount of its convertible notes (the “Winter 2009
Notes”) with 8 accredited investors. A total of $250,000 aggregate face amount
of the Winter 2009 Notes were sold for an aggregate purchase price of
$250,000.  The Winter 2009 Notes bear interest at 10% per annum,
payable at maturity. The Winter 2009 Notes mature three months from their date
of issuance. The Winter 2009 Notes are convertible, at the option of the
noteholder, into shares of common stock of the Company (the “Conversion Shares”)
at an initial conversion price equal to the average of the closing bid price of
the Company’s common stock for the five trading days preceding the closing dates
of the Winter 2009 Offering (the “Conversion Price”). Up to 694,444 Conversion
Shares are initially issuable at a Conversion Price of $0.36 per
share.
   33
 
 Each of
the investors in the Winter 2009 Offering received, for no additional
consideration, a warrant (the “Winter 2009 Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Winter 2009 Notes are
convertible (the “Warrant Shares”).  Each Winter 2009 Warrant is
exercisable on a cash basis only at an initial price of $0.50 per share, and is
exercisable immediately upon issuance and for a period of two (2) years from the
date of issuance. Up to 347,722 Warrant Shares are initially issuable on
exercise of the Winter 2009 Warrants.
 
 The
aggregate value of the Winter 2009 Offering Warrants issued in connection with
the January 26, 2009 closing were valued at $66,178 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of 0.85%; dividend yield of 0%; volatility factors of the expected market price
of common stock of 151.42%; and an expected life of two
years  (statutory term) and vest immediately upon
issuance.  The Company also determined that the notes contained a
beneficial conversion feature of $183,822.  The value of the Winter
2009 Offering Warrants and the beneficial conversion feature are considered as
debt discount and were amortized over the life of the notes.
 
 As of
September 30, 2009, investors have converted $25,000 of the Convertible Notes
into 69,444 shares of the Company’s common stock. As of April 26, 2009, the
Company was in default in the amount of $225,000.  The Company has
paid $45,352 as a partial redemption of the defaulted convertible
notes.  The outstanding balance at September 30, 2009 was $202,148
which includes a 10% default penalty.  The Company is currently
negotiating an extension of these outstanding notes.
 
 2009 Winter
Offering #2.  From February 4, 2009, through March 11, 2009, we
conducted and concluded a private offering (the “Winter 2009 #2 Offering”) of up
to $250,000 aggregate face amount of its convertible notes (the “Winter
2009  #2 Notes”) with 17 accredited investors. A total of $247,302
aggregate face amount of the Winter 2009 #2 Notes were sold for an aggregate
purchase price of $224,820.  While the stated interest rate on the
Winter 2009#2 Notes is 0%, the actual interest rate on the Winter 2009 #2 Notes
is 10% per annum. The Winter 2009 #2 Notes mature on the first anniversary of
their date of issuance. The Winter 2009 #2 Notes are convertible, at the option
of the noteholder, into shares of common stock of the Company (the “Conversion
Shares”) at an initial conversion price equal to the average of the closing bid
price of the Company’s common stock for the five trading days preceding the
closing dates of the Winter 2009 #2 Offering (the “Conversion Price”). Up to
772,818 Conversion Shares are initially issuable at a Conversion Price of $0.32
per share.
 
 Each of
the investors in the Winter 2009 #2 Offering received, for no additional
consideration, a warrant (the “Winter 2009 #2 Warrants”), entitling the holder
to purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Winter 2009 #2 Notes are
convertible (the “Warrant Shares”). Each Winter 2009 #2 Warrant is exercisable
on a cash basis only at an initial price of $0.50 per share, and is exercisable
immediately upon issuance and for a period of two (2) years from the date of
issuance. Up to 386,409 Warrant Shares are initially issuable on exercise of the
Winter 2009 #2Warrants.
 
 We
received $224,820 in net proceeds in the Winter 2009 #2 Offering which will be
used for general corporate purposes and working capital.  The
aggregate value of the Winter 2009 #2 Offering Warrants issued in connection
with the January 26, 2009 closing were valued at $62,028 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of 1.03%; dividend yield of 0%; volatility factors of the expected market price
of common stock of 156%; and an expected life of two years (statutory term) and
vest immediately upon issuance.  We also determined that the notes
contained a beneficial conversion feature of $161,792.  The value of
the Winter 2009 Offering Warrants, the beneficial conversion feature, and the
transaction fees of $22,482 are considered as debt discount and are being
amortized over the life of the Note.
 
 As of
September 30, 2009, investors have converted $85,800 of the Convertible Notes
into 268,125 shares of the Company’s common stock. The outstanding Convertible
Note balance at September 30, 2009 was $161,502.
 
 2009 Spring
Offering.  From March 17, 2009 through April 30, 2009, we
conducted and concluded a private offering (the “Spring 2009 Offering”) of up to
$300,000 aggregate face amount of its convertible notes (the “Spring 2009
Notes”) with 11 accredited investors. A total of $181,500 aggregate face amount
of the Spring 2009 Notes were sold for an aggregate purchase price of
$165,000.  The Spring 2009 Notes mature on the first anniversary of
their date of issuance, are convertible, at the option of the noteholder, into
up to 672,222 shares of common stock of the Company at a conversion price of
$0.27 per share.
 
 Each of
the investors in the Spring 2009 Offering received, for no additional
consideration, a warrant (the “Spring 2009 Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Spring 2009 Notes are
convertible (the “Warrant Shares”).  Each Spring 2009 Warrant is
exercisable on a cash basis only at an initial price of $0.50 per share, and is
exercisable for a period of two years.  Up to 336,111 Warrant Shares
are initially issuable on exercise of the Spring 2009 Warrants.
   34
 
 We
received $165,000 in net proceeds in the Spring 2009 Offering which will be used
for general corporate purposes and working capital. The aggregate value of the
Spring 2009 Offering Warrants issued in connection with the April 30, 2009
closing were valued at $39,994 using the Black-Scholes option valuation model
with the following assumptions; risk-free interest rate of 0.94%; dividend yield
of 0%; volatility factors of the expected market price of common stock of
156.39%; and an expected life of two years (statutory term) and vest immediately
upon issuance.  We also determined that the notes contained a
beneficial conversion feature of $96,827.  The value of the Spring
2009 Offering Warrants, the beneficial conversion feature, and the transaction
fees of $16,500 are considered as debt discount and are being amortized over the
life of the Note.
 
 As of
September 30, 2009, investors have converted $38,500 of the Convertible Notes
into 142,590 shares of the Company’s common stock. The outstanding balance at
September 30, 2009 was $143,000.
 
 2009
Summer Offering
 
 From June
9, 2009, through September 28, 2009, we conducted and concluded a private
offering (the “Summer 2009 Offering”) of up to $500,000 aggregate face amount of
our convertible notes (the “Summer 2009 Notes”) with interest compounded
quarterly at the annual rate of seven percent (7%) payable at maturity. A
total of $467,500 Spring 2000 Notes were sold to 17 accredited investors. The
Summer 2009 Notes mature on the second anniversary of the closing of this
offering and will be convertible, at the option of the noteholder, into up to
1,870,000 shares of our common stock at a conversion price of $0.25 per
share.
 
 Each of
the investors in the Summer 2009 Offering will receive, for no additional
consideration, a warrant (the “Summer 2009 Warrants”), entitling the holder to
purchase a number of shares of our common stock equal to 100% of the number of
shares of common stock into which the Summer 2009 Notes are convertible (the
“Warrant Shares”).  Each Summer 2009 Warrant is exercisable on a cash
basis only at an initial price of $0.30 per share, and is exercisable for a
period of thirty six months.  Up to 1,870,000 Warrant Shares are
initially issuable on exercise of the Summer 2009 Warrants.
 
 The
Company received $467,500 in net proceeds in the Summer 2009 Offering which will
be used for general corporate purposes and working capital. The aggregate value
of the Summer 2009 Offering Warrants issued in connection with the September 28,
2009 closing were valued at $245,825 using the Black-Scholes option valuation
model with the following assumptions; risk-free interest rate of 1.00; dividend
yield of 0%; volatility factors of the expected market price of common stock of
147.21%; and an expected life of three years (statutory term) and vest
immediately upon issuance.  The Company also determined that the notes
contained a beneficial conversion feature of $221,675.  The value of
the Summer 2009 Offering Warrants and the beneficial conversion feature are
considered as debt discount and are being amortized over the life of the
Note.
 
 The
outstanding balance at September 30, 2009 was $467,500
 
 Contractual
Obligations
 
 The
following table discloses our contractual commitments for future periods.
Long-term commitments are comprised of operating leases and minimum guaranteed
compensation payments under employment and other agreements. (See Note 9 in
Notes to Condensed Consolidated Financial Statements).
  Year
      ending December 31,
              
              
              Operating
                Leases
      (1)
              
              
              
              Guaranteed
                Payments2009
              
              $
              10,560
              
              
              $
              80,400
              
              (2)2010
              
              $
              43,560
              
              
              $
              207,200
              
              (3)2011
              
              $
              —
              
              
              $
              —$
              54,120
              
              
              $
              287,600
 
 (1) Consists
of rent for our Santa Barbara office expiring on December 31, 2010
 (2) Consists
of total compensation, including base salary and certain contractually-provided
benefits, to   two executive officers, pursuant to employment
agreements that expire on July 25, 2009 and January 30, 2010.
 (3) Consists
of an aggregate of $82,200 in total compensation, including base salary and
certain contractually provided benefits to one executive officer, pursuant to
employment agreement that expires on January 30, 2010 and $125,000 of license
and maintenance fees due to Temple University.
 
  35
  License
agreements with Temple University
 
 In 2007,
we entered into three License Agreements with
Temple University covering Temple University’s current patent
applications concerning certain electric field effects on gasoline, kerosene and
diesel fuel particle size distribution, and concerning electric field effects on
crude oil and edible oil viscosity.  Initially, the License Agreements
are exclusive and the territory licensed to us is worldwide.  Pursuant
to the License Agreements, we agreed to pay Temple University license fees
in the aggregate amount of $300,000 as follows: $50,000 was due November 1,
2006, $100,000 was due on March 2, 2007, $75, 000 was due February 2, 2008 and
$75,000 was due on February 2, 2009.  Annual maintenance fees of $25,000
for the first license were due on November 1, 2007 and November 1,
2008.  Annual maintenance payments of $125,000 for two of the licenses
were due January 1, 2008.  In addition, each License Agreement
provides that we will pay royalties to Temple University on net sales of
products incorporating such licensed technology.
 
 We have
also entered into a research and development agreement (R&D Agreement) with
Temple University to conduct further research on the ELEKTRA
technology.  Under the R&D Agreement Temple University will
conduct a 24-month research project towards expanding the scope of, and
developing products utilizing, the technologies covered under the License
Agreements.  Pursuant to the R&D Agreement, we will make payments
to Temple University in the aggregate amount of $500,000.
 
 At
December 31, 2008, we were in default in the amount of $716,500 under the
License Agreements, maintenance fees, R & D Agreement and related
penalties.  On January 9, 2009, we entered into a Letter
Agreement with Temple University wherein Temple University granted to us an
extension of time to cure the above-referenced breaches until March 31,
2009.  The Letter Agreement provides for payments of $100,000 on
January 31, 2009, $100,000 on February 28, 2009 and $100,000 on March 31,
2009.  We made the January 31, 2009 payment but did not make the
payment due on February 28, 2009.  On March 26, 2009, we received a
written extension for both the February 28, 2009 payment and the March 31,
2009 payment until April 30, 2009. All additional amounts past due as of
November 10, 2008 were to be re-negotiated on or before March 31, 2009, however,
this was   been extended to April 30, 2009. All additional
amounts past due as of December 31, 2008 and additional License and Maintenance
Fees of $200,000 which became due in the first quarter of 2009 were to be
re-negotiated on or before April 30, 2009, however, this has now been extended
to December 31, 2009.  A penalty equal to 1% of the amount due and unpaid
on the first day of each calendar month will be added to the outstanding amount
due Temple University.
 
 Fees due
Temple University as of September 30, 2009 and 2008 were $852,750 and
$537,750, respectively, and include all past due amounts and related
penalties.  During the nine months ended September 30, 2009 and 2008,
the Company recorded $236,250, and $376,500, respectively, of fees due to
Temple University.
 
 Critical
Accounting Policies and Estimates
 
 Our
discussion and analysis of our condensed consolidated financial condition and
results of operations is based upon our financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these condensed consolidated
financial statements and related disclosures requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, expenses, and
related disclosure of contingent assets and liabilities. We evaluate, on an
on-going basis, our estimates and judgments, including those related to the
useful life of the assets. We base our estimates on historical experience and
assumptions that we believe 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.
 
 The
methods, estimates and judgments we use in applying our most critical accounting
policies have a significant impact on the condensed consolidated results that we
report in our financial statements. The SEC considers an entity’s most critical
accounting policies to be those policies that are both most important to the
portrayal of a company’s financial condition and results of operations and those
that require management’s most difficult, subjective or complex judgments, often
as a result of the need to make estimates about matters that are inherently
uncertain at the time of estimation.. For a more detailed discussion of the
accounting policies of the Company, see Note 2 of Notes to the condensed
consolidated financial statements.
 
 We
believe the following critical accounting policies, among others, require
significant judgments and estimates used in the preparation of our condensed
consolidated financial statements:
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing our
condensed consolidated financial statements as described in Note 1 to Notes to
condensed consolidated financial statements. Actual results could differ from
those estimates
 
 Revenue
Recognition
 
 The
Company recognizes revenue based upon meeting the four criteria pursuant to the
authoritative guidance issued by the FASB:
 
 ●
              Persuasive
      evidence of an arrangement exists;●
              Delivery
      has occurred or services rendered;●
              The
      seller’s price to the buyer is fixed or determinable;
  and●
              Collectability
      is reasonably assured.
 
 36
  We
contract with manufactures of fixed magnetic field products and sell them to
various original equipment manufacturers in the motor vehicle and small utility
motor markets. We negotiate an initial contract with the customer fixing the
terms of the sale and then receives a letter of credit or full payment in
advance of shipment. Upon shipment, we recognize the revenue associated with the
sale of the products to the customer.
 
 Estimates
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing the
Company’s financial statements. Actual results could differ from those
estimates.
 
 Impairment
of long-lived assets
 
 Our
long-lived assets, such as property and equipment, are reviewed for impairment
when events and circumstances indicate that depreciable or amortizable long
lived assets might be impaired and the undiscounted cash flows estimated to be
generated by those assets are less than the carrying amount of those assets.
When specific assets are determined to be unrecoverable, the cost basis of the
asset is reduced to reflect the current value.
 
 We use
various assumptions in determining the current fair value of these assets,
including future expected cash flows and discount rates, as well as other fair
value measures. Our impairment loss calculations require us to apply judgment in
estimating future cash flows, including forecasting useful lives of the assets
and selecting the discount rate that reflects the risk inherent in future cash
flows.
 
 If actual
results are not consistent with our assumptions and judgments used in estimating
future cash flows and asset fair values, we may be exposed to future impairment
losses that could be material to our results.  No impairments were
recorded for the nine months ended September 30, 2009.  We recorded an
impairment of approximately $505,000 during the period from inception (February
18, 1998) through September 30, 2009.
 
 Stock-Based
Compensation
 
 The
Company periodically issues stock options and warrants to employees and
non-employees in capital raising transactions, for services and for financing
costs.  Stock-based compensation is measured at the grant date, based
on the fair value of the award, and is recognized as expense over the requisite
service period.  Options vest and expire according to terms
established at the grant date.
 
 Recent
Accounting Pronouncements
 
 In June
2009, the FASB issued authoritative guidance on accounting standards
codification and the hierarchy of generally accepted accounting principles.” The
FASB Accounting Standards CodificationTM (“Codification”) has become the source
of authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
accordance with GAAP. All existing accounting standard documents are superseded
by the Codification and any accounting literature not included in the
Codification will not be authoritative. However, rules and interpretive releases
of the Securities Exchange Commission (“SEC”) issued under the authority of
federal securities laws will continue to be sources of authoritative GAAP for
SEC registrants. The FASB authoritative guidance is effective for interim and
annual reporting periods ending after September 15, 2009. Therefore, beginning
with our quarter ending September 30, 2009, all references made by it to GAAP in
its consolidated financial statements now use the new Codification numbering
system. The Codification does not change or alter existing GAAP and, therefore,
it does not have an impact on our financial position, results of operations and
cash flows.
  On July
1, 2009, the Company adopted authoritative guidance issued by the FASB on
business combinations. The guidance retains the fundamental requirements that
the acquisition method of accounting (previously referred to as the purchase
method of accounting) be used for all business combinations, but requires a
number of changes, including changes in the way assets and liabilities are
recognized and measured as a result of business combinations. It also requires
the capitalization of in-process research and development at fair value and
requires the expensing of acquisition-related costs as incurred. We have applied
this guidance to business combinations completed since July 1,
2009.  Adoption of the new guidance did not have a material impact on
our financial statements.
   37
  In
October 2009, the FASB issued authoritative guidance on revenue recognition that
will become effective for the Company beginning July 1, 2010, with earlier
adoption permitted.  Under the new guidance on arrangements that
include software elements, tangible products that have software components that
are essential to the functionality of the tangible product will no longer be
within the scope of the software revenue recognition guidance, and
software-enabled products will now be subject to other relevant revenue
recognition guidance.  We believe adoption of this new guidance will
not have a material impact on our financial statements.
  In May
2009, the FASB issued new requirements for reporting subsequent events. These
requirements set forth the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. Disclosure of the date through which an
entity has evaluated subsequent events and the basis for that date is also
required.
  Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the AICPA, and the SEC did not or are not believed by
management to have a material impact on the Company's present or future
consolidated financial statements.
 
 
 Item
3. Quantitative and Qualitative Disclosure about Market Risk
 
 The
Company is a smaller reporting company and is not required to provide the
information required by this.
   Item 4.
Controls and Procedures
 
 Evaluation
of Disclosure Controls and Procedures
 
 Our
management evaluated, with the participation of our Chief Executive Officer and
Interim Chief Financial Officer, the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this Annual Report on Form
10-Q. Based on this evaluation, our Chief Executive Officer and Interim Chief
Financial Officer have concluded that our disclosure controls and procedures (as
defined in Rules 13a-15(e) under the
Securities Exchange Act of 1934 (the “Exchange Act”)  were ineffective
as of September 30, 2009, due to the material weaknesses in our internal control
over financial reporting described below.
  Disclosure
controls are procedures that are designed with the objective of ensuring that
information required to be disclosed in our reports filed under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and
forms.  Disclosure controls are also designed with the objective of
ensuring that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Interim Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.  Internal control consists of procedures which are
designed with the objective of providing reasonable assurance that our
transactions are properly authorized, recorded and reported and our assets are
safeguarded against unauthorized or improper use, to permit the preparation of
our financial statements in conformity with generally accepted accounting
principles.
  We
identified certain matters that constitute material weakness (as defined under
the Public Company Accounting Oversight Board Auditing Standard No. 2) in our
internal control over financial reporting as discussed on Management’s Annual
Report on Internal Control Over Financial Reporting below.
  In light
of the material weaknesses in internal control over financial reporting
described below, we performed additional analysis and other post-closing
procedures to ensure that our financial statements were prepared in accordance
with generally accepted accounting principles.  Despite material
weaknesses in our internal control over financial reporting, we believe that the
financial statements included in our Form 10-Q for the period ended September
30, 2009 fairly present, in all material respects, our financial condition,
results of operations, changes in shareholder’s equity and cash flows for the
periods presented.
  Management’s
Annual Report on Internal Control over Financial Reporting.
   38
  Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles and includes those policies and procedures that
(i) pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transaction and dispositions of our assets; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorizations of our management and directors; and
(iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a
material effect on the financial statements.
  Because
of its inherent limitation, internal control over financial reporting cannot
provide absolute assurance of achieving financial reporting
objectives.
  Our Chief
Executive Officer, Interim Chief Financial Officer and Controller conducted an
assessment of the effectiveness of our internal control over financial reporting
as of September 30, 2009 based on the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”).  A material weakness is a deficiency or a
combination of deficiencies in internal control over financial reporting, such
that there is a reasonable possibility that a material misstatement of the
Company’s annual or interim financial statements will not be prevented or
detected on a timely basis.
  Based on
that assessment, we have identified the following material weaknesses and have
implemented the following remediation of material weaknesses in internal control
over financial reporting:
  Lack of
segregation of duties
  We have
limited staff in our corporate offices and, as such, there is a lack of
segregation of duties.  In December 2006 our Controller retired and in
January 2007 our Chief Financial officer retired due to medical
problems.  We have subsequently hired an Interim Chief Financial
Officer and a full-time Controller and our former Controller provides certain
financial consulting services.
  Lack
of documented and reviewed system of internal control
  We have
an internal control weakness due to the lack of a documented and reviewed system
of internal control.  We have determined that to perform the processes
and remediate this internal control deficiency, we will either need to engage an
internal control consultant or reassign existing personnel.  We have
started to enhance some of our key internal control systems surrounding
inventory purchasing and control, and to document those changes; however, this
process is on-going and the implementation of policies and procedures may take
several quarters.
  As a
result of the material weaknesses described above, management concluded that, as
of September 30, 2009, we did not maintain effective internal control over
financial reporting based on the criteria established in Internal Control – Integrated
Framework, issued by COSO.
  We have
retained a consulting firm and are conducting an evaluation to design and
implement adequate systems of accounting and financial statement disclosure
controls. We expect to complete areview
during 2009 to comply with the requirements of the SEC, which as required
by SEC rules, will include an opinion from our auditors regarding management’s
report on internal control over financial reporting for our fiscal year ending
2010.  We believe that the ultimate success of our plan to improve
our internal control over financial reporting will require a
combination of additional financial resources, outside consulting services,
legal advice, additional personnel, further reallocation of responsibility among
various persons, and substantial additional training of those of our officers,
personnel and others, including certain of our directors such as our Chairman of
the Board and committee chairs, who are charged with implementing and/or
carrying out our plan.  It should also be noted that the design of any
system of controls and procedures 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, regardless of how remote.
  In
addition, our management with the participation of our Chief Executive Officer
and Interim Chief Financial Officer have determined that no change in our
internal control over financial reporting (as that term is defined in Rules
13(a)-15(f) and 15(d)-15(f) of the Securities Exchange Act of 1934) occurred
during or subsequent to the quarter ended September 30, 2009 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
   39
 
 PART
II
 
 Item 1.
Legal Proceedings
 
 On
December 19, 2001, the SEC filed civil charges in the United States Federal
District Court, Southern District of New York, against the Company, the
Company’s former President and then sole director Jeffrey A. Muller, and others,
alleging that the Company and the other defendants were engaged in a fraudulent
scheme to promote the Company’s stock. The SEC complaint alleged the existence
of a promotional campaign using press releases, Internet postings, an elaborate
website, and televised media events to disseminate false and materially
misleading information as part of a fraudulent scheme to manipulate the market
for stock in the Company which was then controlled by Mr. Muller. On
March 22, 2002, the Company signed a Consent to Final Judgment of Permanent
Injunction and Other Relief in settlement of this action as against the
corporation only, which the Court approved on July 2, 2002. Under this
settlement, the Company was not required to admit fault and did not pay any
fines or restitution.
 
 On
July 2, 2002, after an investigation by the Company’s newly constituted
board of directors, the Company filed a cross-complaint in the SEC action
against Mr. Muller and others seeking injunctive relief, disgorgement of
monies and stock and financial restitution for a variety of acts and omissions
in connection with sales of the Company’s stock and other transactions occurring
between 1998 and 2002.  Among other things, the Company alleged that
Mr. Muller and certain others sold Company stock without providing adequate
consideration to the Company; sold insider shares without making proper
disclosures and failed to make necessary filing required under federal
securities laws; engaged in self-dealing and entered into various
undisclosed  related-party transactions; misappropriated for their own
use proceeds from sales of the Company’ stock; and entered into various
undisclosed arrangement regarding the control, voting and disposition of their
stock.
 
 On
July 30, 2002, the U.S. Federal District Court, Southern District of New
York, granted the Company’s application for a preliminary injunction against
Mr. Muller and others, which prevented Mr. Muller and other
cross-defendants from selling, transferring, or encumbering any assets and
property previously acquired from the Company, from selling or transferring any
of the Company’s stock that they may have owned or controlled, or from taking
any action to injure the Company or the Company’s business and from having any
direct contact with the Company’s shareholders. The injunctive order also
prevented Mr. Muller or his nominees from engaging in any effort to
exercise control over the Company’s corporation and from serving as an officer
or director of the Company.
 
 In the
course of the litigation, the Company has obtained ownership control over all
patent rights to the ZEFS device.
 
 On
January 4, 2007, the Court entered a final judgment against Jeffrey Muller which
barred Mr. Muller from serving as an officer or director of a public
company for a period of 20 years, ordered Mr. Muller to disgorge any
shares of the Company’s stock that he still owns and directed the Company to
cancel any issued and outstanding shares of the Company’s stock still owned by
Mr. Muller. Mr. Muller was also ordered to disgorge unlawful profits
in the amount of $7.5 million and to pay a civil penalty in the amount of
$100,000.  Acting in accordance with the ruling and decision of the
Court, the Company has canceled (i) 8,047,403 shares of common stock that
had been held by Mr. Muller and/or his affiliates, (ii) options to
acquire an additional 10,000,000 shares of the Company’s common stock held by
Mr. Muller personally and (iii) $1,017,208 of debt which Mr. Muller
claimed was owed to him by the Company.  After an appeal filed by Mr.
Muller was dismissed the Judgment against him is considered final.
 
 On
February 8, 2007, Federal Magistrate Judge Maas issued a post-judgment order, at
the Company’s request, which further concluded that all of the shares of the
Company’s stock held by Mr. Muller or any of his nominees directly or indirectly
owned or controlled were to be recaptured by the Company and were subject to
disgorgement and forfeiture.  The ruling provided that all shares,
options and any other obligations allegedly owed by the Company to Mr. Muller
were to be disgorged in our favor and confirmed the earlier judgment holding
Mr. Muller liable for $7.5 million in actual damages, imposing a
$100,000 fine and barring Mr. Muller from any involvement with a publicly traded
company for 20 years.  With prejudgment interest, this ruling
brings the actual damages against Muller to over
$11 million.  Additionally, the Court clarified that the order
required the disgorgement of any shares of the Company’s stock that
Mr. Muller or any of his nominees directly or indirectly owned or
controlled.  In furtherance of this order, the Company has taken
action to cancel over 3.6 million shares which had been issued to offshore
companies.  The Order also confirmed the appropriateness of actions
previously taken by the Company to acquire the patent rights and to consolidate
the manufacturing, marketing and distribution rights with its ownership of all
rights to the existing patents. On February 11, 2009, Judge Maas confirmed that
his previous decision was modified and Save the World Air’s Motion for Summary
Judgment was granted in favor of Save the World Air as set forth in his order of
February 8, 2007.  A proposed Final Judgment in favor of Save the
World air is pending before the United States District Court, Southern District
of New York
  Dispute
with Former Corporate Officer
 
 The
Company has been involved in a dispute with it’s former Corporate Officer
concerning claims in connection with his departure from the
Company.  Although the matter is ongoing, the Company has consulted
with legal counsel concerning its rights and obligations in responding to the
claims
 
 
 40
  Item
1A.  Risk Factors
 
 There
have been no material changes in the risk factors previously disclosed in Form
10-K for the period ended December 31, 2008, we filed with the SEC on March 31,
2009.
 
 Item 2.  Unregistered
Sales of Equity Securities and Use of Proceeds
 
 Morale
Orchards Transaction
 
 On
December 5, 2006, we entered into a Note Purchase Agreement (the “Note
Purchase Agreement”) with Morale Orchards, LLC (“Morale”). The Note Purchase
Agreement provides that Morale will purchase the Company’s one-year Convertible
Promissory Notes in the aggregate face amount of $1,225,000 (the “Morale
Notes”), and five-year Warrants (the “Morale Warrants”) to purchase shares of
our Common Stock at prices ranging from $0.70 to $0.85 per share. The aggregate
purchase price for the Morale Notes and Morale Warrants is $1,000,000.
Therefore, while the stated interest on the Morale Notes is 0%, the actual
interest rate is 22.5% because the Morale Notes are being purchased at a
discount from their face amount.
 
 Pursuant
to the terms of the Note Purchase Agreement, Morale purchased one Morale Note in
the principal amount of $612,500 on December 5, 2006, for which it paid
$500,000 and purchased the other Morale Note in the principal amount of $612,500
on January 10, 2007, for which it paid $500,000.  The December 5,
2006 Note is convertible into 720,588 shares of our common stock and 360,294
Warrants to purchase our common stock were issued.  The January 10,
2007 Note is convertible into 875,000 shares of our common stock and 437,500
Warrants to purchase our common stock were issued.  (See “Details of
Recent Financing Transactions”).
 
 On
January 31, 2008, a Modification and Satisfaction Agreement was entered into
between the Company, Morale Orchards, LLP and Matthews &
Partners.  (See “Details of Recent Financing
Transactions”).
 
 2007
Winter Offering
 
 From
December 27, 2008 through February 29, 2008, we conducted a private offering
(the “2007 Winter Offering”) and issued Convertible Notes in the aggregate face
amount of $521,400.  These Notes were sold for an aggregate purchase
price of $474,000 net proceeds.  The Notes are convertible into
1,042,800 shares of our common stock and in addition, investors received
warrants entitling the holders to purchase up to 521,400 shares of our common
stock.  (See “Details of Recent Financing Transactions”).
 
 2008
Spring Offering
 
 On May
27, 2008 we conducted a private offering (the “2008 Spring Offering”) and issued
a Convertible Note in the aggregate face amount of $66,000.  This note
was sold for an aggregate purchase price of $60,000 net proceeds.  The
Note is convertible in to 132,000 shares of our common stock and in addition,
the investor received warrants entitling the holder to purchase up to 66,000
shares of our common stock.  (See “Details of Recent Financing
Transactions”).
 
 2008
Summer Offering
 
 From July
17, 2008 through August 31, 2008, we conducted a private offering (the “2008
Summer Offering”) and issued Convertible Notes in the aggregate face amount of
$484,000.  These Notes were sold for an aggregate purchase price of
$440,000 net proceeds.  The Notes are convertible into 1,423,530
shares of our common stock and in addition, investors received warrants
entitling the holders to purchase up to 711,764 shares of our common
stock.  (See “Details of Recent Financing Transactions”).
 
 
 2008
Winter Offering
 
 From
November 24, 2008 through December 5, 2008, the we conducted a private offering
(the “2008 Winter Offering”) and issued Convertible Notes in the aggregate face
amount of $524,700.  These Notes were sold for an aggregate purchase price
of $477,000 net proceeds.  The Notes are convertible into 3,086,470
shares of our common stock and in addition, investors received warrants
entitling the holders to purchase up to 1,543,235 shares of our common
stock.  (See “Details of Recent Financing Transactions”
 
 2009
Winter Offering I
 
 From
January 13, 2009 through January 26, 2009, we conducted a private offering (the
“2009 Winter Offering I”) and issued Convertible Notes in the aggregate face
amount of $250,000.  These Notes were sold for an aggregate purchase price
of $250,000 net proceeds.  The Notes are convertible into 699,444
shares of our common stock and in addition, investors received warrants
entitling the holders to purchase up to 347,722 shares of our common
stock.  (See “Details of Recent Financing Transactions”).
   41
  2009
Winter Offering II
 
 From
February 4, 2009 through March 11, 2009, we conducted a private offering (the
“2009 Winter Offering  II”) and issued Convertible Notes in the
aggregate face amount of $247,302.  These Notes were sold for an aggregate
purchase price of $224,820 net proceeds.  The Notes are convertible
into 772,818 shares of our common stock and in addition, investors received
warrants entitling the holders to purchase up to 386,409 shares of our common
stock.  (See “Details of Recent Financing Transactions”).
 
 2009
Spring Offering
 
 From
March 17, 2009 through April 30, 2009, we conducted a private offering (the
“2009 Spring”) and issued Convertible Notes in the aggregate face amount of
$181,500.  These Notes were sold for an aggregate purchase price of
$165,000 net proceeds.  The Notes are convertible into 672,222 shares
of our common stock and in addition, investors received warrants entitling the
holders to purchase up to 336,111 shares of our common stock.  (See
“Details of Recent Financing Transactions”).
 
 2009
Summer Offering
 
 From June
9, 2009 through September 28, 2009, we conducted a private offering (the “2009
Summer”) and issued Convertible Notes in the aggregate face amount of $467,500.
 These Notes were sold for an aggregate purchase price of $467,500 net
proceeds.  The Notes are convertible into 1,870,000 shares of our
common stock and in addition, investors received warrants entitling the holders
to purchase up to 1,870,000 shares of our common stock.  (See “Details
of Recent Financing Transactions”).
 
 The sales
of the securities described above were made in reliance on the exemptions from
registration set forth in Section 4(2) of the Securities Act of 1933, as
amended (the “Act”), or Regulations D or S promulgated
thereunder.
 
 Other
Issuances.
 
 During
the nine months ended September 30, 2009, we issued 2,165,026 shares of common
stock in exchange for conversion of $460,129 of Convertible Notes.
 
 During
the nine months ended September 30, 2009, we granted 340,000 shares of common
stock in exchange for consulting services in the amount of
$137,500.
 
 During
the nine months ended September 30, 2009, we granted 430,370 shares of common
stock in settlement of accounts payable of $104,414.
 
 During
the nine months ended September 30, 2009, we issued 83,333 shares of common
stock upon exercise of options @ $0.27 per share and valued at
$22,500.
 
 
 Item 3.
Defaults Upon Senior Securities
 
 None
   Item 4.
Submission of Matters to a Vote of Security Holders
 
 None
   42
  Item 5.
Other Information
 
 We have evaluated subsequent events
occurring between the end of our fiscal quarter, September 30, 2009 and November
12, 2009.
 
 On
November 11, 2009, we received from Temple University a written extension of the
January 9, 2009 Letter Agreement.  The agreement provides an extension
of the $100,000 due to Temple on February 28, 2009 and $100,000 due March 30,
2009 to December 31, 2009.  We expect that all payments regarding past
due amounts will be renegotiated on or before December 31, 2009.
 
 From
October 1, through November 12, 2009, we issued 3,667,977 shares of common stock
in exchange for the conversion of $847,497 Convertible Notes.
 
 
 Item 6.
Exhibits
 Exhibit
      No.
              
              Description31.1
              
              Certification
      of Chief Executive Officer of Quarterly Report Pursuant to Rule
      13(a)-15(e) or Rule 15(d)-15(e)31.2
              
              Certification
      of Interim Chief Financial Officer of Quarterly Report pursuant to
      Rule 13(a)-15(e) or
Rule 15(d)-15(e)
  32
              
              Certification
      of Chief Executive Officer and Interim Chief Financial Officer of
      Quarterly Report Pursuant to 18 U.S.C.
  Section 1350
 
 43
 
 SIGNATURES
 
 In
accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has
caused this Report to be signed on its behalf by the undersigned, hereunto duly
authorized.
 
 
 SAVE
      THE WORLD AIR, INC.Date:
      November 14, 2009
              By:
              /s/
      EUGENE E. EICHLEREugene
      E. EichlerInterim
      Chief Financial Officer
 
 
 
 44
 
 
 EXHIBIT
INDEX
 
 
 Exhibit
      No.
              
              Description31.1
              
              Certification
      of Chief Executive Officer of Quarterly Report Pursuant to Rule
      13(a)-15(e) or Rule 15(d)-15(e)31.2
              
              Certification
      of Interim Chief Financial Officer of Quarterly Report Pursuant to Rule
      13(a)-15(e) or Rule 15(d)-15(e)32
              
              Certification
      of Chief Executive Officer and Interim Chief Financial Officer of
      Quarterly Report Pursuant to 18 U.S.C. Section
  1350