UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549


Form 10-KSB




þ
            
            ANNUAL
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE
      ACT OF 1934


For the fiscal year ended December 31, 2007


or


o
            
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE
      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
            
            (I.R.S.
      Employerincorporation
      or organization)
            
            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. YesþNo o





Check
if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of Registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB.þ





Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes oNo
þ





Registrant’s
revenues for its most recent fiscal year: $39,000





The
aggregate market value of voting and non-voting common equity held by
non-affiliates of the Registrant was approximately $43,800,893 as of March 17,
2008, based upon the average of the high and low bid prices on the OTC Bulletin
Board reported for such date. This calculation does not reflect a determination
that certain persons are affiliates of the Registrant for any other
purpose.





The
number of shares of the Registrant’s Common Stock outstanding as of March 17,
2008 was 54,751,117 shares.





DOCUMENTS
INCORPORATED BY REFERENCE





Transitional
Small Business Disclosure Format (Check one): Yes oNo
þ











SAVE
THE WORLD AIR, INC.


FORM 10-KSB


INDEX




PagePART I
            
            3Item 1
            Business
            
            3Item 2
            Properties
            
            27Item 3
            Legal Proceedings
            
            27Item 4
            Submission of Matters to a Vote of Security
      Holders
            
            28PART II
            
            29Item 5
            Market for Common Equity and Related Stockholder
      Matters
            
            29Item 6
            Management’s Discussion and Analysis or Plan of
      Operation
            
            30Item 7
            Financial Statements
            
            37Item 8
            Changes in and Disagreements With Accountants on
      Accounting and Financial Disclosure
            
            37Item 8A
            Controls and Procedures
            
            37Item 8B
            Other Information
            
            38PART III
            
            39Item 9
            Directors and Executive Officers of
      Registrant
            
            39Item 10
            Executive Compensation
            
            43Item 11
            Security Ownership of Certain Beneficial Owners
      and Management and Related Stockholder Matters
            
            47Item 12
            Certain Relationships and Related
      Transactions
            
            48Item 13
            Exhibits
            
            50Item 14
            Principal Accountant Fees and
      Services
            
            52SIGNATURES
            
            53





i


PART I





Forward-Looking
Statements





This
Annual Report on Form 10-KSB 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 below under the heading “Risk Factors.” 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.





Item 1.Business





The
discussion of our business is as of the date of filing this report, unless
otherwise indicated.





Overview





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.





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.  On the other hand, because our ECO ChargR and MAG ChargR
products are customized to specific brands, models and engine sizes, these
products ultimately will require hundreds of 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 second quarter of 2008. We also plan on
commencing  initial sales of our MAG ChargR product in Asia and the
United States in the automobile and motorcycle industry in the second quarter of
2008.  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.




3


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.




At this
time, we do not intend to devote significant effort to the commercialization of
products incorporating our CAT-MATE technology.  However, we are
considering various possible ways to take advantage of opportunities that may
become available to us.  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.  See “Competition”, “Government
Regulation and Environmental Matters”and “Intellectual
Property” below.




There are significant risks associated
with our business, our company and our stock.  See “Risk Factors”
below.




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 2007 and will need to raise
substantial additional capital in 2008, and possibly beyond, to fund our sales
and marketing efforts, continuing research and development, and certain other
expenses, until our revenue base grows sufficiently.  See
“Management’s Discussion and Analysis” below.




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”.





Recent
Developments




During 2005 and 2006, we began to focus
on the initial marketing of our products. We entered into the first agreements
for the distribution of our products in late 2005 and early 2006. Our first two
U.S. distributorship agreements were with Team Phantom of Alaska and Motorcycle
Products Consulting Incorporated (“MPCI”) of California.  These
agreements provide for the sale of our product lines in the North American OEM
and specialty consumer accessories market for motorcycles, to certain named
prospective purchasers.  We are awaiting the successful conclusion of
certification testing of MPCI’s client’s motor to begin shipping to MCPI ECO
ChargR’s in small quantities commencing in the second quarter of
2008.  Team Phantom has gone out of business without performing on its
contract.




In
January 2006, we entered into our first international distributorship
agreement, with Golden Allied Enterprises (Group) Co., Ltd., (“GAE”). This
distributorship agreement (the “GAE Agreement”) provides that GAE will serve as
our exclusive distributor for our ZEFS and CAT-MATE products in the People’s
Republic of China. The agreement with GAE was conditioned upon our ZEFS-based
products achieving EURO2 standards in tests to be conducted in Shanghai. These
tests were successfully completed in April 2006, during which tests of a
device incorporating our ZEFS technology achieved EURO2 standards and devices
incorporating a combination of our ZEFS and CAT-MATE technologies achieved EURO3
standards. In April of 2007 we successfully passed EPA and CARB emissions
standards and certified GAE’s client Shanghai Yide’s ATV and scooter
products.  See “Independent Laboratory and Scientific Testing” and
“Sales and Marketing” below.




In
April 2006, we entered into a product development agreement with Kwong Kee
(Qing Xin) Environmental Exhaust Systems Company, Ltd. (“Kwong Kee”) in China.
Under this agreement, Kwong Kee, a manufacturer of mufflers and catalytic
converters, collaborates with us on product development for certain markets,
primarily in Asia, and makes available to us its research and development
facilities, testing equipment and product design and development support
team.  See “Sales and Marketing” and “Manufacturing”
below.




In
July 2006, we entered into an agreement with Quadrant Technology L.P.
(“Quadrant”), pursuant to which Quadrant provides product development services.
Under this agreement, we also granted Quadrant a right of first refusal to
manufacture certain of our products.  See “Sales and Marketing” and
“Manufacturing” below.




In July
2006.we entered into a separate agreement with SS Sales and Marketing Group (“SS
Sales”), to provide marketing and promotional services in the western United
States and western Canada for our products.  SS Sales will be paid a
commission equal to 5% of the gross amount actually collected on contracts we
enter into during the contract term for existing or future customers introduced
by SS Sales in the territory covered by the agreement. SS Sales is owned by
Nathan Shelton, one of the directors of the Company.  We also have an
agreement pending with Scafidi-Bolio & Associates to be our sales agents in
a defined territory in the eastern United States and eastern Canada. (See “Sales
and Marketing” below and “Item 12. Certain Relationships and Related
Transactions”).




In
October 2006, we entered into a distributorship agreement with PT Citra Cahaya
Indonesia (“PTCC”), who will serve as the exclusive distributor for our products
in Indonesia.  We began delivering some of our products under this
agreement (the “PTCC Agreement”) in the first quarter of 2007. Although we have
shipped to and received payment from this distributor, we have not received any
re-orders and we are not confident we will receive any future
orders.  See “Sales and Marketing” below.




In
December 2006, we entered into a distributorship agreement with T&C Adtech
Co., Ltd. “Adtech”), who will serve as the exclusive distributor for our ECO
ChargR, MAG ChargR and CAT-MATE products in Vietnam. The agreement (the “Adtech
Agreement”) is for one year and will be renewed automatically for successive
periods if certain minimum firm orders are placed by Adtech in twelve-month
periods ending on September 30th.  We did not receive any orders in
2007 and we now consider this agreement to be null and void (See “Sales and
Marketing” below).




In
February 2007, we entered into two license agreements with Temple University,
one covering Temple University’s current patent application concerning certain
electric field effects on gasoline, kerosene and diesel fuel particle size
distribution (in fuel injection engines), and the other covering Temple
University’s current patent application concerning electric field effects on
crude oil. We also entered into a research and development agreement, to conduct
further research on the ELEKTRA technology and magnetic technologies in
general. (See “Our Technology and Products”below).




4
 
  In April
2007, we received the final report of RAND Corporation (“RAND”), whom we had
retained in December 2002 to study the scientific validity and market potential
of our original ZEFS technology, help us develop a plan to assess the technical
basis for our ZEFS technology and understand the potential market for products
incorporating the ZEFS technology if a technical basis were
established.  (See “RAND Report” below).


In August
2007, we entered into a private labeling and distribution agreement with
Magnumforce Racecar Fabrication Inc. (Magnumforce) of California.  To
date we have not been able to perform on this agreement as we have lacked the
funding to commence production.  Magnumforce is still engaged and
currently awaiting our ability to move forward.





Our
Business Strategy




The Crisis of the Effect of Motor
Emissions on Air Pollution




The
incomplete and inefficient burning of fossil fuel in internal combustion engines
results in unburned gases, such as hydrocarbons (“THC”), carbon monoxide (“CO”)
and oxides of nitrogen (“NOx”) being expelled as harmful emission as a
by-product of the engine's exhaust. These emissions have contributed to
significant air pollution and depletion of the ozone layer that protects the
world’s atmosphere from harmful ultraviolet radiation. As a result, the world
has experienced significant deterioration to its air quality since the beginning
of the 20th century and the problem has gotten progressively worse with each
passing year. Forecasts published by the World Resources Institute indicate that
this trend will continue to accelerate.




According
to the Goddard Institute for Space Studies, in 2000, the world's roads were
supporting about 800 million vehicles, almost 500 million of which are cars and
the remainder of which are trucks, buses, motorcycles and scooters. The United
States, Japan and Europe account for the majority of motor vehicles, but future
growth is expected to be most rapid in Asia and Latin
America.  Vehicle population is projected to increase by 50-100% by
2030. As a result, vehicles will continue to apply pressure to the environment
and it is projected that emissions of all pollutants will be significantly
higher in 2030 than today, unless additional controls on emissions are
implemented.




In the
United States, California, through the California Air Resources Board (“CARB”),
continues to set the lowest emission standards for the country and the United
State Environmental Protection Agency (“EPA”) has indicated it may adopt lower
emission standards, which would be applicable throughout the United States.
California Governor Arnold Schwarzenegger has also announced his intent to seek
greenhouse gas (“GHG”) legislation and the United States Congress is also
considering GHG legislation.  (See “Government Regulation and
Environmental Matters” below).




Governments
internationally recognize the serious effects caused by air pollution and many
nations have enacted legislation to mandate that engine manufacturers be
required to reduce exhaust emissions caused by their products. As evidenced by
the overwhelming participation in the establishment of the Kyoto Accord, many
nations are moving towards tighter GHG emissions control as well. The European
Union (“EU”) currently requires all member nations to adopt EURO 3 emissions
standards for motorcycles and EURO 4 emissions standards for automobiles and
trucks. SomeEastern European
countries contemplating EU admission, and certain Asian countries, have also
announced gradual phase-in of EURO standards, including China, Indonesia,
Vietnam, Thailand and India. See “Government Regulation and Environmental
Matters” below.




Among
recent developments:





●
              The
      EU has tightened standards on light duty vehicle emissions and fuel
      quality for 2000 and 2005, broadened coverage (e.g., cold temperature),
      and imposed low sulfur requirements for diesel fuel and gasoline; Euro 3,
      4 and 5 standards for heavy duty trucks and buses, will require advanced
      NOx and particulate matter post-combustion pollution control systems. The
      auto industry has agreed to a voluntary commitment to reduce carbon
      dioxide (“CO2“)
      emissions per kilometer driven by 25% by
2008.





●
              CARB
      tightened CO, HC, NOx and PM requirements and established principles of
      fuel neutrality (diesel vehicles meet the same standards as gasoline
      vehicles) and usage neutrality (light trucks and sport utility vehicles
      used primarily as passenger cars must meet the same standards as cars);
      CARB decided that diesel PM is a toxic air contaminant leading to an
      effort to further reduce PM emissions from existing diesel
      vehicles.





●
              EPA,
      in conjunction with CARB, imposed the largest enforcement action in
      history on the heavy engine industry; EPA adopted stringent national PM
      and NOx standards for heavy duty trucks and buses and mandated low sulfur
      diesel fuel to enable the advanced technologies necessary to achieve these
      requirements.





●
              China
      and India adopted the Euro 1 auto and truck emissions standards and are
      phasing out the use of unleaded
gasoline.




Notwithstanding
initiatives such as these, much more needs to be done to reverse the harmful
effects of decades of pollutants contributed by motor emissions.  Yet,
the cost of adding emissions control devices to engines or vehicles has always
been a challenge, since manufacturers shift the cost of such devices to the
consumer.  In developing nations, where incomes are extremely low,
economics and the lack of government resources have hampered
progress.  Nonetheless, we believe that the social and political
realities of protecting our environment may result in further government
mandates that manufacturers adopt solutions to reduce harmful motor
emissions.


5


As we
have worked with various companies to develop our technology, we have uncovered
other potential applications that were not evident to us as recently as one year
ago.  For example, we have determined that potential applications
exist in lowering the viscosity of edible food oils when moving them as a liquid
through pipelines is required.  We are also looking into application
of the Elektra technology in burning fossil fuels for purposes other than
powering motor vehicles.  We believe that there are many potential
applications for our technology which have yet to be explored, but the primary
appeal of our products currently are for the purpose of increasing fuel
efficiency and performance enhancement.




Our Technologies
and Products




ZEFS and MK
IV.  Our principal business focus currently rests with
development and distribution of products designed to solve the complex problems
caused by pollution from motorcycles, automobiles and other equipment driven by
internal combustion engines and to improve the performance of those engines. We
have introduced the ECO ChargR, which incorporated our MK IV technology, and the
MAG ChargR, which incorporates either our ZEFS or MK IV technologies, depending
upon the application.  We have designed and tested various versions of
our ECO ChargR and MAG ChargR products for use on 2- and 4-stroke carbureted and
fuel injection gasoline engines and are in the process of designing versions of
the ECO ChargR and MAG ChargR products for application on various types of
engines that use diesel fuels.




Historically,
manufacturers of vehicles, motorcycles, power sports equipment, boats and small
utility motors have had very few technological options to reduce emissions to
the strictest levels of current and future government standards. The
approach used by engine manufacturers to address this mandate has thus far
generally taken the form of installing catalytic converters, which work on the
principle of super heating gases within the exhaust manifold after the damaging
gases have been created through internal combustion.




These
traditional devices are expensive and sensitive to the poor quality and
adulterated fuel that is commonly found in developing nations. Bad fuel can
permanently damage a catalytic converter with the first tank full, whereas ECO
ChargR and MAG ChargR are unaffected by the problem of bad fuel. Catalytic
converters also do not share the benefits of our ECO ChargR and MAG ChargR of
increased fuel efficiency and performance. In fact, in many cases catalytic
converters are detrimental to mileage and power.




ECO
ChargR and MAG ChargR contain permanent rare-earth magnets, which produce a very
strong magnetic field. This field, when arranged in specific manner of shape and
strength, causes a molecular change in the fuel as it passes through the field.
As fuel passes through the magnetic field, a molecular change in the fuel occurs
facilitating a decline in both viscosity and surface tension. This allows for
finer atomization, resulting in a more optimized mixture and therefore more
efficient combustion, lower emissions, more horsepower and torque and improved
fuel economy.  The scientific theory behind the ZEFS technology is
described in certain scientific papers and published articles.  See
“RAND Report” below.




ECO
ChargR and MAG ChargR have been developed for one-, two- and four- barrel
carbureted and fuel injection engines. These products are easily fitted to the
base plates of carburetors and fuel injection systems; the devices are compact,
there are no moving parts. They are also inexpensive to produce, extremely
durable and unaffected by poor quality fuel.




We
differentiate our 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.  The ECO ChargR is intended to
reduce exhaust emissions in vehicle and small utility motors.  ECO
ChargR products will be marketed primarily to OEMs as well as to pilot and
government-mandated emissions programs.  The MAG ChargR is intended to
increase power and improve mileage. MAG ChargR products will be marketed
primarily to the specialty consumer accessories market for many types of
vehicles, including but not limited to cars, trucks, motorcycles, scooters,
ATVs, snowmobiles, personal watercraft and small utility motors.  On
the other hand, because our ECO ChargR and MAG ChargR products are customized to
specific brands, models and engine sizes, these products ultimately will require
hundreds of individually developed parts, which can be expensive and
time-consuming.




Testing
by the Company, as well as by independent third-party laboratories, has
demonstrated that both ECO ChargR and MAG ChargR generate significant reductions
in THC and CO emissions and, in the case of MAG ChargR, also improves fuel
efficiency by lowering gas consumption and increases engine
performance.  For RAND’s conclusions about some of our testing
regarding emissions reductions, see “RAND Report” below.  See also
“Independent Laboratory and Scientific Testing” below.




ELEKTRA.  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
entered into two license agreements with Temple University, one covering Temple
University’s current patent application concerning certain electric field
effects on gasoline, kerosene and diesel fuel particle size distribution, and
the other covering Temple University’s current patent application concerning
electric field effects on crude oil and edible oil viscosity, and any and all
United States and foreign patents issuing in respect of the technologies
described in such applications (individually, a “License Agreement” and
collectively, the “License Agreements”). 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 $250,000, payable in three
installments of $100,000, the first installment of which was paid in March 2007,
and $75,000 on each of February 2, 2008, which has not been paid, and
February 2, 2009, respectively; and (ii) annual maintenance fees of
$125,000 annually commencing January 1, 2008, which has not been paid. 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 two
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 is in default in connection with its payment obligations under the
License Agreements.  Nonetheless, the Company has not received any
written notice from Temple University of a material breach relating to required
payments under the License Agreements.  Any such notice must provide
the Company with 60 days’ notice to cure the material breach.  Should
the Company receive such notice, the Company’s failure to cure could result in a
termination of the License Agreements. Under the License Agreements the Company
must pay a penalty equal to 1% per month of the amounts due and unpaid under the
License Agreements.




6


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, 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. Pursuant to the R&D Agreement, we
will make payments to Temple University in the aggregate amount of $500,000,
payable in eight non-refundable installments commencing with $123,750, which was
paid in March 2007, and seven payments of $53,750 every three months
thereafter until paid in full. The payments of $53,750 due in June, September
and December 2007 have not been paid. The Company is in default under the
R&D Agreement, however, the Company has not received any notice of default
from Temple University. 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.




Dr.
Rongjia Tao, of Temple University, is the principal investigator of the ELEKTRA
technology and we intend that he will work with us in research and development
and product development, seeking to produce two commercial products: (i) a
product utilizing an electric field to improve the fuel injection in engines for
diesel, kerosene, and gasoline; and (ii) a product utilizing electric or
magnetic fields to reduce crude oil viscosity and improve crude oil and edible
oil flow in pipelines.  We are in the early stages of developing
ELEKTRA products that, based on preliminary testing, is intended to improve fuel
economy and change fuel viscosity, and may improve performance and reduce
emissions, depending upon the specific application.Dr. Tao’s published
articles in The International
Journal of Physics have reported how uniform electrical field technology
affects fuels.  We believe that this effect is identical, or
substantially similar, to that of our own magnetic technology; therefore, we
expect to achieve similar results with ELEKTRA as Dr. Tao reported with respect
to uniform electrical field technology generally. When it is developed, we
intend to market ELEKTRA products primarily to the transportation industry, oil
refineries and pipelines, and OEMs.  Our ability to make progress with
Temple University is dependent, in part, on our ability to finance our
obligations and devote adequate financial resources to the commercialization of
the ELEKTRA technology.  (See “Management’s Discussion and Analysis or
Plan of Operations – Liquidity and Capital Resources”).




Unlike
ECO ChargR and MAG ChargR, ELEKTRA is essentially universal, with only a handful
of versions required to cover most applications.  The ELEKTRA
technology is designed to be installed in the fuel supply lines of vehicles and,
because there are very few variations in the size and type of those lines, we
anticipate that a relatively small number of variable capacity devices and a
selection of installation adapters will cover most vehicle
installations.




We
believe that the applications for products incorporating the ELEKTRA technology
will include gas, diesel and bio-fuel injected motor vehicles, as well as
applications in aviation, marine, oil pipeline and refining industries.Subject to our
cash flow and liquidity limitations,we are currently
developing motor vehicle applications and our present intention, subject to
change, is to seek joint venture partners to commercialize the ELEKTRA
technology in various applications.  Subject to adequate financing, we
currently believe that we will commence sales of ELEKTRA products by the third
quarter of 2008.  (See “Management’s Discussion and Analysis or Plan
of Operations – Liquidity and Capital Resources”).




CAT-MATE.  Our
CAT-MATE technology is designed to work in conjunction with, and enhance the
function of, common catalytic converters, when incorporated into their
design.  Our CAT-MATE technology allows a converter to ignite more
quickly and more easily on small displacement motors. Our CAT-MATE technology
also helps retain heat in the converter, allowing it to stay lit under idling
and low RPM operation.  Small motors, especially 2-stroke versions,
are subject to low exhaust velocity and heat during idling, which causes most
converters to extinguish and then become fouled with oil and contaminants
eventually rendering them difficult to relight or useless.  We believe
that our CAT-MATE technology can be used on 2- and 4-stroke motorcycles,
off-road and marine vehicles, generators, lawn mowers, on stationary implements
and on carbureted and fuel injection motor vehicles.  At this time, we
do not intend to devote significant effort to the commercialization of products
incorporating our CAT-MATE technology.  However, we are considering
various possible ways to take advantage of opportunities that may become
available to us.




Research and
Development




On
May 14, 2004, we filed a patent application in Australia with respect to
certain technology   (Method and Apparatus for a Treatment of a
Fluid).  Following discussions with Temple University about a number
of matters, including intellectual property rights, in July 2004, we
entered into a license agreement with Temple University (the “2004 License
Agreement”), for a research project with Dr. Rongjia Tao as principal
investigator. That project and the related products involve the development and
commercialization of underwater and cold temperature applications for improving
oil flow under different temperature and pressure conditions. In connection with
the 2004 License Agreement, we assigned the original patent application for this
technology to Temple University and agreed to assign all subsequent patent
applications for this technology to Temple University.  Under the 2004
License Agreement, we have the right to file additional patent applications, at
our sole expense but for the benefit of Temple University, in various
countries.  We have exclusive rights to this technology only in
countries where we file patent applications.  In 2005, 2006 and 2007,
we filed several additional patent applications in various
countries.  As a result of Dr. Tao’s recently announced progress in
reducing viscosity of crude oil with magnetic pulses, we believe that this
technology may have commercial viability. We are maintaining the patent
applications in the countries in which we have filed them, while we continue to
explore the commercial benefits of pursuing this opportunity in these and
possibly other countries.  (See “Intellectual Property”
below).




We are
actively continuing our development of products incorporating our ZEFS and MK IV
technologies for use on gasoline and diesel powered engines and have taken steps
to finalize devices to fit on carbureted, throttle body and multi-port fuel
injection systems. We have used prototype ECO ChargR and MAG ChargR products as
demonstration units, during presentations before manufacturers.  It is
our intention to continue to develop products incorporating these
technologies.  Because of the complexity and enormity of the task of
designing multiple variations of our ECO CharG and MAG ChargR products to fit
the numerous makes and models of engines, we intend to seek the cooperation of
manufacturers to assist us in engineering, marketing and installing our ECO
ChargR and MAG ChargR products.




We are
also engaged in early research and development of products incorporating our
ELEKTRA technology for use on diesel engines, such as those used on trucks,
buses, heavy equipment and generators. Because these types of vehicles use
engines provided from a relatively few manufacturers, the number of product
variations utilizing our ELEKTRA technology needed to service these fleets is
considerably less than the number of variations required by our ECO ChargR and
MAG ChargR products.




7


In
conjunction with Temple, we have been engaged by several oil production and
pipeline companies to demonstrate the potential of this technology as applied to
various oil production applications.  One major oil producer has
funded the construction of a very large iteration of this device for field
testing on a working pipeline.  This test is expected to be executed
later this year.  We are also, along with Temple, working with a
company which specializes in custom manufacturing equipment and process design
to develop applications of Electra and our magnetic technologies for improving
the performance and efficiency of manufacturing and facilities.




We have
tested products incorporating our ZEFS, MK IV and CAT-MATE technologies for
multiple makes and models of automobiles, motorcycles and ATVs, and the results
of tests of devices incorporating our ZEFS technology were provided to RAND for
evaluation




In late
2005, we established a state-of-the-art research and product development
facility in Morgan Hill, California.  In connection with the
establishment of our Morgan Hill facility, we transitioned the primary site of
our research and development from Queensland to Morgan Hill.  We no
longer use our Queensland facility.  RAND also assisted us in setting
up our testing protocols at Morgan Hill.  In addition, we are engaged
in research and development of additional prototypes and products, including
ELEKTRA and other magnetic technologies and products, at our Morgan Hill
facility.




In
April 2006, we entered into a product development agreement with Kwong Kee.
Under this agreement, Kwong Kee, a manufacturer of mufflers and catalytic
converters, collaborates with us on product development for certain markets,
primarily in Asia, and makes available to us its research and development
facilities, testing equipment and product design and development support team in
China.




We spent
$600,816 in 2007 and $401,827 in 2006 on research and development.(See
“Management's Discussion and Analysis of Financial Condition and Results of
Operation-Results of Operations” and Note 11 - Notes to Consolidated Financial
Statements” for a more complete understanding of our research and development
expenses).




Independent
Laboratory and Scientific Testing




The four
internationally recognized emissions standards testing agencies for the
certification of motor vehicles, parts, systems and aftermarket devices are the
EPA, CARB, United Kingdom Vehicle Certification Agency (“VCA”) and
Technischer Überwachungs-Verein (TUV-Germany/EU).




Independent
third-party laboratories have conducted tests of devices incorporating our ZEFS,
MK IV and CAT-MATE technologies, which tests we have sought in order to gain
better market acceptance by manufacturers and governmental regulatory officials.
Research and testing using government-standard testing equipment in the United
States, Thailand, China and Hong Kong has demonstrated that the tested devices
incorporating our ZEFS technology reduce engine emissions, such as THC and CO,
and, for the most part, NOx, while also improving fuel consumption and
performance. Research and testing using government standard test equipment in
Thailand has demonstrated that the tested devices incorporating our ZEFS
technology improves performance.  Research and testing using
government standard test equipment in the United States and Hong Kong has
demonstrated that the tested devices incorporating our CAT-MATE technology
reduce engine emissions, such as THC, CO and NOx.  For RAND’s
conclusions about some of our testing regarding emissions reductions, see “RAND
Report” below.




With
respect to third-party test results reported for NOx, some tests have shown that
NOx on tested devices incorporating our technologies has
increased.  Based on informal discussions we have had with
manufacturers of the tested vehicles and/or engineers at the testing
laboratories, and other anecdotal evidence, we believe that such increases, when
reported, are due to the vehicle, such as problems with the vehicle’s exhaust
system, rather than problems with the tested device incorporating our
technologies.




In
December 2002, we retained RAND to study the scientific validity and market
potential of our original ZEFS technology, help us develop a plan to assess the
technical basis for our ZEFS technology and understand the potential market for
products incorporating the ZEFS technology if a technical basis were
established.  RAND outlined a research and evaluation program for the
Company to examine the theoretical basis of the ZEFS device and to test the
impact of the device when installed on vehicles.




In early
2003, RAND determined that a comprehensive product-testing program was
warranted. As a result, in May 2003, we entered into an arrangement under
which RAND coordinated and supervised both a theoretical scientific study of the
concepts underlying our ZEFS technology, as well as an empirical
study.   In response to a request for proposal (“RFP”) that RAND
sent to 14 universities in the United States, January 2005.Temple University was chosen to research the ZEFS technology. Temple
University’s research of the ZEFS technology concluded in early
2005.




Most of
RAND's work on our behalf concluded in December 2005, while further
development of our technologies continued.  In 2006, our MK IV
technology was first developed and enhancements have continued into early
2007.  We submitted to RAND additional test results from the MK
technology conducted in January 2007 at Olson Ecologic Labs (“Olson Labs”) in
Fullerton, California, on three separate motorcycles of differing displacements
to demonstrate the effectiveness of more current versions of our
technology.  The conclusions of RAND’s final report, which was
published on April 27, 2007, are summarized under “RAND Report”
below.




Tests of
our devices using our CAT-MATE technology on a Honda 2-stroke NSR 150 motorcycle
and a Warrior 2-stroke 63cc generator conducted by Hong Kong Exhaust Emissions
Laboratory (“HKEEL”) in July and August 2004 showed that the tested
devices incorporating our CAT-MATE technology significantly reduce emissions of
CO, THC and NOx. These results were certified by VCA in




Emissions
and fuel economy tests conducted in 2004 and 2005 at Automotive Testing and
Development Services, Inc. in Ontario California, and in 2005 at Northern
California Diagnostics Laboratory in Napa, California, both EPA and CARB
approved testing laboratories, on a devices incorporating our CAT-MATE
technology within the OEM exhaust system of a 1995 Mexican fuel injected
Volkswagen Beetle taxi, showed significant reductions of THC, CO and NOx
emissions, compared to the in-place original OEM exhaust system. In 2006,
testing on a device incorporating our MK IV technology for Harley-Davidson style
motors was conducted at the EPA and CARB certified testing facility Olson Labs.
These tests yielded results that would allow these motors to meet current and
future EPA and CARB emissions standards without expensive fuel injection and
catalytic converters.




Further
testing on a used 4-stroke motorcycle incorporating our ZEFS technology was
conducted in December 2005 in Bangkok, Thailand at Automotive Emission
Laboratory, Pollution Control Department, Ministry of Natural Resources and
Environment of Thailand, and was performed jointly with S.P. Suzuki of Thailand,
the authorized distributor of Suzuki products in Thailand. These certified mean
test results surpassed “hot start” EURO 2 standards in all three of the harmful
exhaust emissions, THC, CO and NOx, by the following amounts:




8




THC
            
            NOx
            
            COEURO2
      Standard
            
            1.20
            g/km
            
            0.30
            g/km
            
            5.50
            g/kmWith
      ZEFS Device
            
            0.52
            g/km
            
            0.10
            g/km
            
            1.42
            g/km%
      Better than EURO2
            
            
            56
            %
            
            
            65
            %
            
            
            74
            %




In
addition, during the testing horsepower increased at all ranges, peaking at
18.8% at 50km/h and fuel economy increased 33% over the baseline
tests.




Additional
testing was conducted in early March 2006 on a new Chinese-manufactured
carbureted 4-stroke Suyijia SZK125 motorcycle incorporating our ZEFS
technologies at HKEEL. These certified best test results surpassed “cold start”
EURO 3 standards for motorcycles of 150cc or less in all three of the harmful
exhaust emissions, THC, CO and NOx, by the following amounts:




THC
            
            NOx
            
            COEURO3
      Standard
            
            0.80
            g/km
            
            0.15
            g/km
            
            2.0
            g/kmWith
      ZEFS Device
            
            0.33
            g/km
            
            0.108
            g/km
            
            1.86
            g/km%
      Better than EURO3
            
            
            59
            %
            
            
            28
            %
            
            
            7
            %




In
addition, during the testing fuel economy increased 7% over the baseline
tests.




Of
further note regarding the HKEEL testing is the fact that it is generally
difficult for anyone to meet EURO 3 guidelines because the testing includes a
“cold start” phase. The “cold start” phase includes exhaust emissions created
when a motor is started after an eight-hour cold soak. It is during this warm-up
time that engines produce their highest level of emissions. This is also where
many catalytic converters fail because they must be heated to about 300 degrees
Fahrenheit to begin working effectively.





In May
2006, Shanghai Motor Vehicle Test Center conducted tests of devices
incorporating our ZEFS and CAT-MATE technologies as required by our distribution
agreement required with GAE.  See “Sales and Marketing” below. The
results of these tests are summarized below:




Technical
    Targets
            
            
            
            CO
              g/km
            
            
            
            HC
              g/km
            
            
            
            NOx
              g/kmEURO3
      Standard
            
            
            £2.0
            
            
            
            £0.8
            
            
            
            £0.15Measured
      Values
            ZEFS
      Device (“hot start”)(a)
            
            
            0.90
            
            
            
            0.20
            
            
            
            0.13ZEFS/CAT-MATE
      Device (“cold start”)(b)
            
            
            1.04
            
            
            
            0.18
            
            
            
            0.12


___________


(a)  A
“hot start” test is run for EURO2 compliance, which standard was
achieved.


(b)  A
“cold start” test is run for EURO3 compliance, which standard was
achieved.




Also in
May 2006, at the request of the office of the Minister of Energy for the
Kingdom of Thailand, we participated in a “hot start” test at the testing
laboratories of the Thai petroleum company, the PTT Public Company Limited, of
products incorporating our MK IV technology for fuel efficiency. In this test,
the Thai distributor for Suzuki Motorcycles, SP Suzuki, supplied a new 125cc
4-stroke Best motor scooter to be tested without our preparing or participating
in the installation of a device incorporating our MK IV technology. The mean
test results showed an average 5.13% improvement in fuel efficiency, as
follows:




Run 1
            
            Run 2
            
            Run 3(l/km)
            
            (l/km)
            
            (l/km)
            
            AverageBaseline
      FC Test Runs without MK IV Device
            
            
            0.0196
            
            
            
            0.0195
            
            
            
            0.0193
            
            
            
            0.0195FC
      Test Runs with MK IV Device
            
            
            0.0186
            
            
            
            0.0184
            
            
            
            0.0185
            
            
            
            0.0185Difference
            
            
            0.0010
            
            
            
            0.0011
            
            
            
            0.0008
            
            
            
            0.0010Improvement
            
            
            5.10
            %
            
            
            5.64
            %
            
            
            4.15
            %
            
            
            5.13
            %





In
February 2007, tests were performed at Olson Labs for the purpose of evaluating
the emissions reduction and fuel efficiency improvement benefits of our ECO
ChargR product.  The mean test results were as follows:





Total
      Hydrocarbon (THC) Emissions (gms/km)Suzuki
      110
            
            RevTech
      100
            
            Merch
      125AVERAGE
      BASELINE
            
            
            0.124
            
            
            
            1.821
            
            
            
            1.372AVERAGE
      ECO CHARGR
            
            
            0.098
            
            
            
            1.685
            
            
            
            1.302%
      Improvement
            
            
            21.0
            %
            
            
            7.5
            %
            
            
            5.1
            %




9




Carbon
      Monoxide (CO) Emissions (gms/km)Suzuki
      110
            
            RevTech
      100
            
            Merch
      125AVERAGE
      BASELINE
            
            
            1.729
            
            
            
            29.086
            
            
            
            21.201AVERAGE
      ECO CHARGR
            
            
            1.231
            
            
            
            18.160
            
            
            
            15.805%
      Improvement
            
            
            28.8
            %
            
            
            37.6
            %
            
            
            25.5
            %




Oxides
      of Nitrogen (NOx) Emissions (gms/km)Suzuki
      110
            
            RevTech
      100
            
            Merch
      125AVERAGE
      BASELINE
            
            
            0.066
            
            
            
            0.136
            
            
            
            0.287AVERAGE
      ECO CHARGR
            
            
            0.063
            
            
            
            0.196
            
            
            
            0.268%
      Improvement
            
            
            4.5
            %
            
            
            -44.0
            %
            
            
            6.4
            %




Fuel
      Economy (miles per gallon)Suzuki
      110
            
            RevTech
      100
            
            Merch
      125AVERAGE
      BASELINE
            
            
            241.97
            
            
            
            39.68
            
            
            
            34.83AVERAGE
      ECO CHARGR
            
            
            253.16
            
            
            
            41.08
            
            
            
            34.82%
      Improvement
            
            
            4.6
            %
            
            
            3.5
            %
            
            
            0.0
            %





These
results from Olson Labs were submitted to RAND (see “RAND Report” below) and to
the EPA for consideration for the “EPA 511 Program”.  (See “Government
Regulation and Environmental Matters” below).





In April
of 2007, Olson Labs conducted successful EPA and CARB testing of a 300cc ATV for
Chinese vehicle manufacturer Shanghai Yide (“Yide”), a client of GAE, which
certified their ATVs, motorcycles and scooters for sale in all 50 US
states,  Yide is now producing a full line of vehicles based on this
certification for export to the US and are expected to begin purchasing ECO
ChargR and CAT-MATE products through GAE sometime this year.  These
test results surpassed EPA and CARB standards by the following
amounts:




Shanghai
      Yide 300cc ATV Certification Test ResultsTHC
            
            
            NOx
            
            
            CO
            
            
            THC+NOxEPA
      Standard
            
            
            
            
            
            
            
            
            35
            
            
            
            1.5CARB
      Standard
            
            
            1.2
            
            
            
            
            
            
            15ECO
      ChargR and CAT-MATE
            
            
            0.187
            
            
            
            0.092
            
            
            
            9.1985
            
            
            
            0.279%
      Below EPA
            
            
            
            
            
            
            
            
            
            
            74
            %
            
            
            81
            %%
      Below CARB
            
            
            84
            %
            
            
            
            
            
            
            39
            %




RAND
Report





In
December 2002, we retained the RAND to study the scientific validity and
market potential of our original ZEFS technology, help us develop a plan to
assess the technical basis for our ZEFS technology and understand the potential
market for products incorporating the ZEFS technology if a technical basis were
established.  RAND outlined a research and evaluation program for the
Company to examine the theoretical basis of the ZEFS device and to test the
impact of the device when installed on vehicles.




In early
2003, RAND determined that a comprehensive product-testing program was
warranted. As a result, in May 2003, we entered into an arrangement under
which RAND coordinated and supervised both a theoretical scientific study of the
concepts underlying our ZEFS technology, as well as an empirical
study.  The scope of RAND’s work was limited to testing the ZEFS
technology as to its effect on emissions reductions
and did not evaluate the effect of the ZEFS technology on performance
enhancement or fuel economy.  In response to an RFP that RAND sent to
14 universities in the United States, Temple University was chosen to research
the ZEFS technology. Temple University’s research of the ZEFS technology
concluded in early 2005.




10
 
  RAND's
other activities on our behalf concluded in December 2005, while further
development of our technologies continued.  In 2006, our MK IV
technology was first developed and enhancements have continued into early
2007.  We submitted to RAND additional test results from the MK
technology conducted in January 2007 at Olson Labs, on three separate
motorcycles of differing displacements to demonstrate the effectiveness of more
current versions of our technology.
 
 On April
27, 2007, RAND issued its final report, entitled “An Approach to Assessing the
Technical Feasibility and Market Potential of a New Automotive
Device.”  RAND opined that the application of magnetic fields has not
been shown in scientific literature to lower the viscosity of automotive
fuels.  RAND concluded, among other things, that we would need to
conduct further laboratory studies and in-use testing to determine the
effectiveness of the ZEFS technology in reducing pollutants and increasing fuel
efficiency in gasoline and diesel-powered vehicles.
  RAND’s
analysis of the laboratory testing data that we had previously had undertaken
found at best mixed results from these tests, and therefore RAND could not
confirm the effectiveness of the ZEFS technology in actual use.  For
purposes of its report, RAND did not review certain additional tests that were
conducted for us, including the tests by Olson Labs in early 2007, after RAND’s
fieldwork was completed.
  The RAND
report said the existing technical literature does not contain credible reports
that the application of magnetic fields to either gasoline or diesel fuel oil
will reduce the viscosities of these automotive fuels. Researchers at Temple
University, who were funded by us as a result of the competitive grants process
administered by RAND, have reported findings indicating a potential connection
between magnetic fields and fuel viscosity. However, RAND reported that such
laboratory work has not yet been independently reviewed and published by the
Temple University research team, and it does not settle the issue of how
magnetic fields might affect actual engine performance.
  RAND
concluded that the market potential for products incorporating our ZEFS
technology will depend significantly on demonstrating positive results from our
technology, competition posed by other technologies, and regulatory policies and
cost-effectiveness to other alternatives.
  It should
be noted that RAND tested our original ZEFS technology as to its effect on
emissions reduction only and not performance enhancement or fuel
economy.  Versions of the ZEFS technology studied by RAND are not
being marketed by us as emissions reduction products.  We believe that
a reassessment and redesign of our products intended to improve the consistency
of third-party test results led to the development and evolution of products
incorporating our MK IV technology intended to reduce emissions, which has taken
place since the completion of RAND’s fieldwork.  We further believe
that these newer iterations of our Company’s technologies have performed more
consistently in testing at independent third-party labs since the completion of
RAND’s fieldwork.  The MK IV technology has also undergone independent
third-party testing, which we believe shows significant improvement when
compared to our original ZEFS technology.
  Sales
and Marketing
  In
October 2004, we commenced initial marketing efforts for products
incorporating our ZEFS and CAT-MATE technologies, and these efforts are
continuing with respect to ZEFS-based products. Subsequently, we commenced
initial marketing efforts for products incorporating our MK IV technology, and
these efforts are also continuing. We are focused on selling or licensing our
technologies and products domestically and internationally to motorcycle,
automobile, carburetor, fuel-injection and diesel engine manufacturers as well
as exhaust and muffler OEMs and the consumer specialty accessories market. We
have made presentations of our ZEFS, MK IV and CAT-MATE technologies and our
products to OEMs in the United States, Asia and Europe.
  United
States.  We entered into the first agreements for the
distribution of our products in late 2005 and early 2006. Our first two U.S.
distributorship agreements were with Team Phantom and MPCI.  These
agreements provide for the sale of our product lines in the North American OEM
and specialty consumer accessories market for motorcycles, to certain named
prospective purchasers. Our timing to ship product under a purchase order from
MPCI depends upon our financing and ability to pay for the manufacture of
products from our outsourced manufacturer.  See “Management’s
Discussions and Analysis or Plan of Operations – Liquidity and Capital
Resources”. We currently do not believe that we will be receiving any orders
from Team Phantom for our products because they have ceased business
operations.
  China.  In
January 2006, we entered into our first international distributorship
agreement, with GAE. The GAE Agreement provides that GAE will serve as our
exclusive distributor for our ZEFS and CAT-MATE products in the People’s
Republic of China. The GAE Agreement was conditioned upon our ZEFS-based
products achieving EURO2 standards in tests to be conducted in Shanghai. These
tests were successfully completed in May 2006, during which tests of a
device incorporating our ZEFS technology achieved EURO2 standards and devices
incorporating a combination of our ZEFS and CAT-MATE technologies achieved EURO3
standards.  (See “Independent Scientific and Laboratory Testing”
above).
  The
initial term of the GAE agreement is for sixteen months from March 2006 and will
be renewed automatically for successive periods of 12 months each if certain
minimum firm orders are placed, as follows:
  500,000
units in the first year
 1,000,000
units in the second year
 2,000,000
units in the third year
 3,000,000
units in the fourth year; and
 5,000,000
units in the fifth year.
  If GAE
purchases 11,500,000 or more units during the first five years, the term of the
GAE Agreement shall be extended for an additional period of five years. If GAE
sells 15,000,000 or more units during the second five years, the term of the GAE
Agreement shall be extended for a second additional period of five
years.  Upon each such renewal a mutually agreeable schedule of prices
and number of units to be purchased by GAE shall be determined. The agreement is
terminable by either party upon 10 days’ written notice following a material
breach which is not cured within 20 days by the party receiving written notice
of a breach.  We have also given GAE rights of first refusal to
distribute in the People’s Republic of China new products which we may
create.
  11
 Pursuant
to the GAE Agreement, in order to retain exclusivity as our distributor in
China, GAE was required to place its initial order on or before July 31, 2006
for 100,000 units. Of this amount, 10,000 units were scheduled for delivery by
September 30, 2006; 30,000 units were scheduled for delivery in March 2007;
30,000 units were scheduled for delivery in June 2007; and 30,000 units were
scheduled for delivery in July 2007.  GAE was also required to have
issued in our favor an irrevocable stand-by letter of credit in the sum of
$60,000 equal to the purchase price of 10,000 units comprising the first
shipment.  After the first shipment and no later than January 31,
2007, GAE was required to have issued in our favor an additional letter of
credit in an amount equal to $540,000, which is the purchase price of the
remaining 90,000 units comprising the initial order.
  In
July 2006, GAE placed its initial order under the GAE Agreement, for
100,000 units, to be shipped in installments through
July 2007.  In November 2006, we shipped the first installment of
5,000 units to GAE.  However, GAE has not requested additional
shipments against this initial order, nor posted additional letters of credit as
required by the GAE Agreement.  GAE did not meet their target of
ordering 500,000 units by July 31, 2007.  We are currently in
discussions with GAE regarding a revised shipment schedule and changing GAE’s
distributorship status to a non-exclusive arrangement, but we cannot give any
assurances as to what, if any, shipping schedule will result from such
discussions.
  Additionally,
under the GAE Agreement, we agreed to issue warrants to GAE to purchase up to
1,000,000 shares of our common stock at a purchase price of $1.00 per share to
GAE.  Warrants to purchase 200,000 shares of our common stock are
issuable upon delivery of the $60,000 and $540,000 letters of credit. Warrants
to purchase an additional 300,000 shares of our common stock are issuable upon
full payment for 500,000 units.  Warrants to purchase 500,000 shares
of our common stock are issuable upon full payment for 10,000,000 units. The
Warrants shall be exercisable for two years from their respective dates of
issuance. Because GAE has not placed the orders required under the GAE Agreement
nor supplied the required letters of credit, we have not yet issued the warrants
provided for in the GAE Agreement.
  Under the
GAE Agreement, we are required to provide technical support to GAE at our cost
and expense, as GAE shall reasonably request. We are responsible for the costs
of shipping and insurance relating to shipment to the port of Shanghai, People’s
Republic of China. GAE is responsible for the payment of all taxes, duties and
imposts assessed on the products. We are responsible for any CIF mandated
charges relating to the shipment of the products.
  We do not
feel the current agreement with GAE is valid as they have not lived up to the
purchase terms.  However, we feel this is a viable company and
opportunity and we are currently renegotiating our agreement and expect to
conclude in the second quarter of 2008.
  In recent months, we have also begun
working with and assisting manufacturers of vehicles and engines to obtain EPA
and CARB certification in the United States for the sale of their
products.  We assisted Shanghai Yide, a Chinese manufacturer of ATVs,
in certification testing.  At the request of Shanghai Yide, Olson Labs
conducted vehicle certification tests in February and March 2007 on an ATV
manufactured by Shanghai Yide, which was fitted with a combination of our ECO
ChargR and CAT-MATE products. These tests were conducted as part of the
application process by Shanghai Yide to obtain EPA and CARB approval for the
sale of certain of its vehicles in the United States.
  Indonesia. In October
2006, we entered into the PTCC Agreement with PTCC, who will serve as the
exclusive distributor for our ECO ChargR, MAG ChargR and CAT-MATE products in
Indonesia.
  The PTCC
Agreement is for an initial term one year and will be renewed automatically for
successive periods if certain minimum firm orders as placed, for years ending
September 30, as follows:
 
 50,000
units in the first year
 50,000
units in the second year
 100,000
units in the third year
 150,000
units in the fourth year; and
 250,000
units in the fifth year.
  If PTCC
sells 600,000 or more units during the first five years, the term of the PTCC
Agreement shall be extended for an additional period of five years. If PTCC
sells 2,000,000 or more units during the second five years, the term of the PTCC
Agreement shall be extended for a second additional period of five years. Upon
each such renewal a mutually agreeable schedule of prices and number of units to
be purchased by PTCC shall be determined.  The PTCC Agreement is
terminable by either party upon 10 days’ written notice following a
material breach which is not cured within 20 days by the party receiving written
notice of a breach. We have also given PTCC rights of first refusal to
distribute in Indonesia new products which we may create.
  Pursuant
to the PTCC Agreement, in order to retain exclusivity as our distributor in
Indonesia, PTCC was required to place its initial order on or before October 31,
2006 for 10,000 units.  Of this amount, 2,000 units were originally
scheduled for delivery in January 2007, and 2000 units were scheduled for
delivery in each of March, April, May and June 2007.  PTCC was also
required to have issued in our favor an irrevocable stand-by letter of credit in
the sum of $95,000 equal to the purchase price of 10,000 units composing
the first order.  After the first shipment, at the time of placement
of an order PTCC is required to have issued in our favor additional letters of
credit in an amount equal to the purchase price of the total number of units
covered by such order.
  We
began delivering some of our products under this agreement in the first quarter
of 2007, with the first shipped installment of 2,000 units against an initial
order of 10,000 units, and the remainder of the order due to ship at various
times under a revised schedule from June through October 2007.  We
have received partial payment for the first installment. We have not yet
received firm orders for the subsequent shipments covered by the initial
order.
  Under the
PTCC Agreement, we are required to provide technical support to PTCC at our cost
and expense, as PTCC shall reasonably request. We are responsible for the costs
of shipping and insurance relating to shipment to the port of Medan, North
Sumatra, Indonesia. PTCC is responsible for the payment of all taxes,
duties and imposts assessed on the products. We are responsible for any CIF
mandated charges relating to the shipment of the products.
  12
 During
2007, we did not receive any re-orders from PTCC and we no longer consider the
agreement to be valid.
  Vietnam.  In
December 2006, we entered into the Adtech Agreement with Adtech, who will serve
as the exclusive distributor for our ECO ChargR, MAG ChargR and CAT-MATE
products in Vietnam.
  The
agreement is for an initial term of one year and will be renewed automatically
for successive periods if certain minimum firm orders as placed, for years
ending September 30, as follows:
 
 50,000
units in the first year
 50,000
units in the second year
 100,000
units in the third year
 150,000
units in the fourth year; and
 250,000
units in the fifth year.
  If Adtech
sells 600,000 or more units during the first five years, the term of the Adtech
Agreement shall be extended for an additional period of five years. If Adtech
sells 2,000,000 or more units during the second five years, the term of the
Adtech Agreement shall be extended for a second additional period of five years.
Upon each such renewal a mutually agreeable schedule of prices and number of
units to be purchased by Adtech shall be determined.  The Adtech
Agreement is terminable by either party upon 10 days’ written notice following a
material breach which is not cured within 20 days by the party receiving written
notice of a breach. We have also given Adtech rights of first refusal to
distribute in Vietnam new products which we may create.
 
 Pursuant
to the Adtech Agreement, in order to retain exclusivity as our distributor in
Vietnam, Adtech was required to place its initial order on or before October 31,
2006 for 10,000 units. 2,000 units of which were scheduled for delivery in
January 2007, 2000 units of which were scheduled for delivery in March 2007 and
the remaining 6,000 units of which were scheduled for delivery in May
2007.  Adtech was also required to have issued in our favor an
irrevocable stand-by letter of credit in the sum of $22,000 equal to the
purchase price of the 2,000 units scheduled for delivery in January
2007.  After the first shipment, at the time of placement of an order
Adtech is required to have issued in our favor additional letters of credit in
an amount equal to the purchase price of the total number of units covered by
such order.
  We began
delivering some of our products under this agreement in the first quarter of
2007, with the first shipped installment of 2,000 units against an initial order
of 10,000 units, originally due to ship at various times through May
2007.  We have received payment for the first installment and intend
to ship subsequent installments against payment, which we have not yet
received.  We currently expect that additional shipments against the
initial order will be delivered, at the request of Adtech, in installments at
various times through 2007, which is subject to change.   Based
upon the anticipated modified order rate, we do not expect Adtech to place
orders totaling at least 50,000 units by September 30, 2007.
 
 Under the Adtech Agreement, we are
required to provide technical support to Adtech at our cost and expense, as
Adtech shall reasonably request. We are responsible for the costs of shipping
and insurance relating to shipment to the port of Ho Chi Minh City, Vietnam.
Adtech is responsible for the payment of all taxes, duties and imposts assessed
on the products. We are responsible for any CIF mandated charges relating to the
shipment of the products.
 
 At the close of 2007, Adtech had not
placed any re-orders and is in default of the agreement.
 
 Europe.  We
also intend to seek distribution opportunities for products incorporating our
ZEFS, MK IV and ELEKTRA technologies in Europe, in addition to our marketing
efforts in the United States and Asia.  See “Independent Laboratory
and Scientific Testing” and “RAND Report” above.  At this time, no
such distribution agreements are in place.
  Other
Countries.  We also intend to pursue marketing of our products
in developing nations of the world. Harmful exhaust emissions from motorcycles
and automobiles in developing countries are at the highest levels because of the
continued widespread use of older models with either no or malfunctioning
catalytic converters. We intend to continue to work with governments worldwide
at all levels, together with industry, to capitalize on our technology to
achieve what we know to be common global environmental objectives.
  Other
Efforts.  In April 2006, we entered into a product
development agreement with Kwong Kee. Under this agreement, Kwong Kee, a
manufacturer of mufflers and catalytic converters, collaborates with us on
product development for certain markets, primarily in Asia, and makes available
to us its research and development facilities, testing equipment and product
design and development support team in China.
  In
July 2006, we entered into an agreement with Quadrant, pursuant to which
Quadrant provides product development services. Under this agreement, we also
granted Quadrant a right of first refusal to manufacture certain of our
products.
  In July
2006, we entered into a separate agreement with SS Sales, to provide exclusive
marketing and promotional services in the western United States and western
Canada (the “Territory”) for our products.  SS Sales will also provide
advice, assistance and information on marketing our products in the automotive
after-market, and will seek to recruit and establish a market with distributors,
wholesalers and others.  SS Sales will be paid a commission equal to 5% of
the gross amount actually collected on contracts we enter into during the
contract term for existing or future customers introduced by SS Sales in the
Territory. The contact 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, one of the
directors of the Company since February 12, 2007.  We also have an
agreement pending with Scaffidi-Bolio & Associates to be our sales agents in
a defined territory in the eastern United States and eastern
Canada.
  In
October 2006, we introduced our ECO ChargR and MAG ChargR products for use in
motorcycles at the INERMOT motorcycle trade show in Cologne,
Germany.  In November 2006, we introduced our ECO ChargR and MAG
ChargR products for use in automobiles and trucks at the SEMA convention in Las
Vegas, Nevada.
  13
 Manufacturing
  Subject
to a right of refusal that Quadrant has to manufacture certain of our products,
we intend to outsource the manufacture of all our products incorporating our
ZEFS and MK IV technologies, as well as the magnets and housings used as
components in those products.  We believe that we will have a number
of choices available for third-party manufacturers of our products.
  The
manufacture of the magnets used in products incorporating our ZEFS or MK IV
technologies requires a rare-earth metal, neodymium. Neodymium is readily
available in China, at relatively stable prices.
  Although
products incorporating the ELEKTRA technology remain in development, we
currently intend to outsource the manufacture of any such products, as well as
the components used in those products.
 
 Competition
 
 The
automotive and motor engine industry is highly competitive. We have many
competitors in the United States and throughout the world developing
technologies to make engines more environmentally friendly and fuel-efficient.
Many of our competitors have greater financial, research, marketing and staff
resources than we do. For instance, automobile manufacturers have already
developed catalytic converters on automobiles in order to reduce emissions, but,
as discussed above, this creates greenhouse gases and makes controlling
emissions costly and complex. The industry has also proposed high-pressure fuel
injection systems for gas and diesel applications but these modifications are
extremely expensive. While we believe that our technologies have greater
benefits, they may be unable to gain market acceptance. Furthermore, research
and development throughout the world is constantly uncovering new
technologies.
 
 Although
we are unaware of any technologies that compete directly with our technologies,
there can be no assurance that any unknown existing is, or future technology
will be, superior to products incorporating our ZEFS and MK IV technologies, as
well as any products we may produce incorporating the ELEKTRA technology.
 Our ZEFS and MK IV technologies provide, and we believe that the ELEKTRA
technology may provide, the benefits of all of emission reductions, fuel
efficiency and engine performance enhancement. There are competing products
which provide one or more of the beneficial attributes of our ZEFS, MK IV and
ELEKTRA technologies, but not all three benefits. Additionally, we believe that
those competing products that show benefit in more than one area demonstrate
greater benefit in only one area and provide only minimal improvements in other
areas. This contrasts with the independent third-party testing of devices
incorporating our ZEFS and MK IV technologies, which shows greater improvement
in multiple areas. See “Independent Laboratory and Scientific Testing” and “RAND
Report” above.
  Competing
emissions reduction products are largely comprised of catalytic converters and
alternative fuels. Catalytic converters are much more expensive than products
incorporating our ZEFS and MK IV technologies, and are sensitive and subject to
damage caused by the poor quality or adulteration of fuel commonly used in
developing nations. In addition, while catalytic converters reduce emissions,
they do not improve fuel efficiency or engine performance. Domestically, there
are a large number of manufacturers and distributors of catalytic converters,
such as Engelhart Inc., Dow Corning Inc., Delphi Corporation and Car Sound
Exhaust System, Inc., among others. Internationally, most catalytic converters
are manufactured and distributed by Engelhart Inc., Delphi Corporation and a
large number of smaller businesses in a fragmented industry.
  Alternative
fuels, such as hydrogen, electricity, liquid natural gas and ethanol, generally
require more costly conversions and the fuels are not readily available, if at
all, in most of the world.
  We are
not aware of any other technology using magnetic, uniform electrical field fuel
treatments or products based on such technology which has been proven to
significantly improve fuel mileage. There are many products currently on the
market that claim to increase fuel efficiency. We believe that the majority of
these products have not undergone or provided independent scientific validation
from a recognized third party, or testing at a certified laboratory. Fuel
injection does improve fuel efficiency and performance, but is extremely
expensive from the perspective of the developing nations of the world. Major
domestic and international manufacturers and distributors of fuel injection
systems include Delphi Corporation, Robert Bosch Corporation, Siemens
Corporation, and a large number of smaller businesses in a fragmented
industry.
  We are
not aware of any other technology using magnetic, uniform electrical field fuel
treatments or products based on such technology which has been proven to
significantly improve performance. There are many products which a consumer can
purchase to increase overall performance. All of the most effective such
products, including forced induction, nitrous oxide injection and exotic
exhaust, are very expensive, increase emissions, reduce fuel efficiency and
shorter the life of the engine. Major domestic and international manufacturers
and distributors of performance-enhancing systems include Holley Performance
Products, Inc., Nitrous Express Inc., Paxton Automotive Corporation, Eaton
Corporation, Vortec Engineering LLC, Flowermaster, Inc., Hedman Manufacturing,
Inc., Gibson Performance, Inc. and a large number of smaller businesses in a
fragmented industry.
  Nonetheless,
many of our competitors have greater financial, research, marketing and staff
resources than we do. While we believe that our technology has greater benefits,
it may be unable to gain market acceptance. Furthermore, research and
development throughout the world is constantly uncovering new technologies.
Although we are unaware of any technologies that compete directly with ours,
there can be no assurance that any existing or future technology is or will be
superior to products incorporating our ZEFS, MK IV or CAT-MATE technologies, or
any products we may produce incorporating our ELEKTRA technology.
 
 Government Regulation and
Environmental Matters
 
 Our
research and development activities are not subject to any governmental
regulations that would have a significant impact on our business and we believe
that we are in compliance with all applicable regulations that apply to our
business as it is presently conducted. Our products, as such, are not subject to
certification or approval by the EPA or other governmental agencies domestically
or internationally. Instead, such agencies test and certify a sample engine
fitted with our products.  Depending upon whether we manufacture or
license our products in the future and in which countries such products are
manufactured or sold, we may be subject to regulations, including environmental
regulations, at such time.
  14
 U.S.
Government Regulation
 
 We are
currently pursuing EPA and CARB executive order exemptions for our products.
These exemptions would signify that our products do not adversely affect
vehicles emissions and would allow our products to be used on emissions control
equipped on and off-road vehicles. We are also submitting our technologies
to the EPA under the “511 Program” which was established in 1970 to evaluate new
emissions and fuel saving technologies for cars and trucks. In April 2007, we
made a formal request that the EPA consider our carbureted 4-stroke engine
device as part of this program, even though there are few carbureted cars and
trucks left on the road, because the EPA is tightening emissions regulation on
motorcycle, utility and non-road vehicles. We believe that these applications
are well suited for our technologies.  We are unable to estimate the
time it may take for the EPA to act upon our application or predict whether or
not such application will be favorably received, especially considering that we
are asking the EPA to amend its existing program.
  EU Regulation
  The
current EU emissions standard for motorcycles is EURO 3, and for automobiles and
trucks the emissions standard is EURO 4. Although there is not a EURO 4 standard
for motorcycles currently, the current trend appears to be for stricter
regulation. On the other hand, the automobile standard is currently moving
towards adopting EURO 5 standards by 2009 and EURO 6 by 2014. These standards
are difficult to attain and the automotive industry is spending billions of
Euros to engineer solutions. European auto manufacturers are becoming
increasingly at odds with the European Commission (“EC”), the body which
evaluates the industry and makes regulatory standards recommendations to the EU,
over CO2 emissions
regulations.
  The
CO2
emissions limits are currently a voluntary agreement between the EU and the auto
manufacturers. The EU target is to reach an average CO2
emissionof
120 g/km for all new passenger cars by 2012. However it has become
increasingly clear that the voluntary agreement will not succeed. The average
CO2
emissions per car have dropped only to 160 g/km in 2005, whereas the
average was 186 g/km in 1995.  Because of this, lawmakers have
started considering regulation.  In late 2005, the European Parliament
passed a resolution in support of mandatory CO2 emissions
standards to replace the current voluntary agreement. In late 2006, the EC
announced that it was working on a proposal for a legally-binding limit CO2 emissions
from cars. The EC is also proposing the doubling of the fuel efficiency of new
cars by 2020.
  Currently
the only accepted method for reducing a vehicle’s CO, THC and NOx emissions is
catalytic converters, but this system converts these gases into largely CO2 and N2O,
both GHGs. Therefore the lower the CO, THC and NOx output, the higher the
CO2
production. The only remedy is increasing fuel efficiency and the automakers
argue this is costly and results in small low-power vehicles which consumers
will not want to buy.
  Intellectual
Property
  In
December 1998, we acquired all of the marketing and manufacturing rights to
the ZEFS technologies from the purported inventor of the technology in exchange
for 5,000,000 shares of our common stock, $500,000 and $10 royalty for each unit
sold. In November 2002, under our settlement with the bankruptcy trustee
for the estate of the purported inventor and his wife, the trustee transferred
all ownership and legal rights to an existing international patent application
for the ZEFS MK I technology to us. In exchange for these rights, we issued to
the bankruptcy trustee a warrant to purchase 500,000 shares of our common stock
at $1.00 share and granted a $0.20 royalty on each device we sell.
  In
May 2002, we settled a dispute with Kevin “Pro” Hart, who claimed
proprietary rights to the ZEFS technologies. In November 2002, under our
settlement with the bankruptcy trustee for the estate of Mr. Hart, the trustee
assigned all ownership and legal rights to the international patent application
for the ZEFS technology to us, in exchange for an option to purchase 500,000
shares of our common stock at $1.00 share and a $0.20 royalty on each device we
sell. Mr. Hart died in March 2006. See “Part I, Item 3. Legal
Proceedings” and Note 1 to Notes to Consolidated Financial Statements”
below.
  The
CAT-MATE technology was created by Adrian Menzell, a member of our research team
in Australia. On August 20, 2003, Mr. Menzell filed preliminary
Australian patent application #2004900192 for the CAT-FLAP device, a version of
the CAT-MATE technology.  This technology was enhanced and on
June 4, 2004, Mr. Menzell filed preliminary Australian patent
application #2004903000 for the CAT-MATE. On September 1, 2003, we had
entered into an Assignment Agreement with Mr. Menzell, pursuant to which
this technology was assigned to us in exchange for 20,000 shares of our common
stock and a royalty of $.25 for each CAT-MATE device sold. On June 26,
2004, we received a deed of assignment from Mr. Menzell and each pending
patent application was transferred to our name. Mr. Menzell previously served as
a consultant to our company.
  ZEFS Patent
Applications
  We
obtained the patent application for the ZEFS MK1 device [PCT/AU01/00585]
originally filed in Australia on May 19, 2000. The International Filing
Application for our ZEFS MK1 technology was filed on May 21, 2001 (Official
No. 10/275946) [PCT/AU01/00585] and modified as ZEFS MK2 on July 9,
2003. On November 4, 2003 we filed for our ZEFS MK3 (#2003906094). The
United States Patent and Trademark Office issued a Notice of Allowance of Patent
dated January 24, 2005 and the patent issued on 7 June 2005 for the ZEFS
MK1 device. The duration of the patent is 20 years from the date the
original application was filed. Prior to the issuance of such patent, we relied
solely on trade secrets, proprietary know-how and technological innovation
to develop our technology and the designs and specifications for the ZEFS
technology. Overall, we have applied for a patent on an international basis in
approximately 64 countries worldwide.
  ZEFS
MK1—Device For Saving
Fuel and Reducing
Emissions.Thisfuel saving
device has a disk- like nonmagnetic body provided with a central opening and a
number of permanent magnets having opposed polarities positioned about the
central opening to provide multidirectional magnetic fields. The device is
positioned in a fuel air mixture to reduce emissions.
  15
 The
following table summarizes the status of the ZEFS MK1 patent application in the
following countries:
 
 Country
                
                Number
                
                Filing
      date
                
                StatusAustralia
                
                2001258057
                
                21
      May 2001
                
                GRANTEDBosnia
      & Herzegovina
                
                BAP
      021290A
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsBrazil
                
                0111365-8
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsBulgaria
                
                107391
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsCanada
      (small
                  entity
      status)
                
                2409195
                
                21
      May 2001
                
                Examination
      requested April 2006China
                
                01809802.9
                
                21
      May 2001
                
                Under
      examination – response filedColumbia
                
                02115018
                
                21
      May 2001
                
                Examination
      requested 23 July 2004.Croatia
                
                P20020982A
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsCzech
      Republic
                
                PV
      2002-4092
                
                21
      May 2001
                
                Accepted  -
      awaiting Deed of Letters PatentEurasian
      +++
                
                200201237
                
                21
      May 2001
                
                GRANTED.
      Renewed in Russia only.Europe  ++
                
                019331222.2
                
                21
      May 2001
                
                Awaiting
      examinationGeorgia
                
                4098/01-2002
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsHong
      Kong
                
                04100327.0
                
                21
      May 2001
                
                Automatic
      grant upon grant of the Chinese applicationHungary
                
                P
      03 01796
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsIndia*
                
                IN/PCT/2002/01523
                
                21
      May 2001
                
                Under
      Examination – response filedIndonesia
                
                WO0200202844
                
                21
      May 2001
                
                Accepted
      – awaiting Deed of Letters PatentIsrael
                
                152902
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsKorea
      [South]
                
                2002-7015531
                
                21
      May 2001
                
                Under
      examination – response filed.Japan
                
                586731/2001
                
                21
      May 2001
                
                Examination
      to be requested by 21 May 2008Mexico
                
                PA/A/2002/011365
                
                21
      May 2001
                
                GRANTEDMorocco
                
                PV/26.964
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsNew
      Zealand
                
                523113
                
                21
      May 2001
                
                GRANTEDNorway
                
                20025531
                
                21
      May 2001
                
                Awaiting
      examinationPoland
                
                P358837
                
                21
      May 2001
                
                Awaiting
      examinationSerbia
                
                P-870/02
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsSingapore
                
                93310
                  [WO
      01/90562]
                
                21
      May 2001
                
                GRANTEDSouth
      Africa
                
                2002/10013
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsSri
      Lanka
                
                12918
                
                21
      May 2001
                
                GRANTEDTrinidad
      & Tobago
                
                TT/A/2002/00213
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsUkraine
                
                20021210144
                
                21
      May 2001
                
                ABANDONED
      on client’s instructionsUnited
      States
                
                6901917
                
                21
      May 2001
                
                GRANTEDVietnam
                
                1-2002-01168
                
                21
      May 2001
                
                GRANTED
 
 ++European
patent application covers Austria Belgium Switzerland Liechtenstein Cyprus
Germany Denmark Spain Finland France Great Britain Greece Ireland Italy
Luxembourg Netherlands Portugal Sweden Turkey Lithuania Latvia Slovenia Romania
Macedonia.
  +++ The
Eurasian Patent Convention was signed on September 9, 1994 in Moscow by the
Heads of the Governments of the Republic of Azerbaijan, the Republic of Armenia,
the Republic of Belarus, Georgia, the Republic of Kazahkstan, the Kyrgyz
Republic, the Republic of Moldova, the Russian Federation, the Republic of
Tajikistan and Ukraine .
  ZEFS
MK2—Device for Saving
Fuel and Reducing Emissions. This fuel saving device similar to that of
the MK1 except that a central magnet can be provided in the opening and the
peripheral magnets extend only partially through the depth of the body and stop
short of the top wall to provide the option of moving the magnetic field further
away from the base of the carburetor to increase the area of magnetic influence
between the point of fuel atomization and the point of cessation of magnetic
influence.
  The
priority date is July 19, 2003 from Australian patent application
2003903626.
 
 The
following table summarizes the status of the ZEFS MK2 patent application in the
following countries:
 
 Country
                
                Number
                
                Filing
      date
                
                StatusTaiwan
                
                1236519
                
                19
      July 2003
                
                ABANDONED
      on Client’s InstructionsChina
                
                200480025660.X
                
                15
      July 2004
                
                ABANDONED
      on Client’s InstructionsEurope
                
                04737571.2
                
                15
      July 2004
                
                ABANDONED
      on Client’s InstructionsIndia
                
                300/KOL
      NP/06
                
                15
      July 2004
                
                ABANDONED
      on Client’s InstructionsIndonesia
                
                WO0200600441
                
                15
      July 2004
                
                ABANDONED
      on Client’s InstructionsJapan
                
                Awaiting
                
                15
      July 2004
                
                ABANDONED
      on Client’s InstructionsUnited
      States
                
                10/564747
                
                15
      July 2004
                
                ABANDONED
      on Client’s Instructions
 
 16
 
 NO
FURTHER ACTION TO BE TAKEN ON THIS PORTFOLIO.  APPLICATIONS ARE TO BE
ALLOWED TO LAPSE AS ACTIONS ARISE.
  ZEFS
MK3—Emission Control
Devices.This emission control device is particularly suited for fuel
injection systems which have an elongate body formed with one or more channels
and a number of permanent magnets are positioned in the channels. The device
sits on a fuel rail.
  The
priority date is November 4, 2003 from Australia patent application
2003906094.
  The
following table summarizes the status of the ZEFS MK3 patent application in the
following countries:
 
 Country
                
                Number
                
                Filing
      date
                
                StatusThailand
                
                095155
                
                3
      November 2004
                
                ABANDONED
      on Client’s InstructionsChina
                
                200480039739.8
                
                4
      November 2004
                
                ABANDONED
      on Client’s InstructionsJapan
                
                Awaiting
      Number
                
                4
      November 2004
                
                ABANDONED
      on Client’s InstructionsUnited
      States
                
                10/578311
                
                4
      November 2004
                
                Application
      filed – awaiting examinationEurope
                
                04796967.0
                
                4
      November 2006
                
                ABANDONED
      on Client’s Instructions
  The US
national patent application will be processed according to the requirements of
the US Patent Office. Therefore, it is not possible to provide an accurate and
complete summary of the next action and cost as in many cases, the deadline for
the next action depends on the backlog with the US Patent
Office.  There are no renewal fees payable until after
grant.
  NO
FURTHER ACTION TO BE TAKEN ON THIS PORTFOLIO.  APPLICATIONS ARE TO BE
ALLOWED TO LAPSE AS ACTIONS ARISE.
  MK IV Patent
Applications
 
 Device for Saving
Fuel and Reducing Emissions.This device is
similar to the Mark 1 device but uses stacked magnets.
 
 The
following table summarizes the status of the MK IV patent application in the
following countries:
 
 Country
                
                Number
                
                Filing
      date
                
                StatusChina
                
                NA
                
                20
      June 2006
                
                Application
      sent to AgentJapan
                
                NA
                
                20
      June 2006
                
                Application
      sent to AgentKorea
      [South]
                
                NA
                
                20
      June 2006
                
                Application
      sent to AgentMalaysia
                
                PI
      20062013
                
                2
      May 2006
                
                Examination
      due by 2 May 2008PCT
                
                PCT/AU2006/000861
                
                20
      June 2006
                
                Demand
      for IPE filed – IPRP favorable.Taiwan
                
                95115220
                
                28
      April 2006
                
                Examination
      due by 29 April 2009Thailand
                
                0601001997
                
                2
      May 2006
                
                Application
      filed - awaiting examinationUnited
      States
                
                NA
                
                20
      June 2006
                
                Application
      sent to Agent
  National
patent applications are due byJanuary
21 2008.
 
 The
priority date is June 21, 2005 from Australian patent application
2005903248.
 
 Under the
terms of the Paris Convention, the Australian patent application provided “cover
note” type protection for 12 months (i.e. until June 21, 2006) in all countries
that are party to the Paris Convention, including all the major
economies.  An International Patent Application (“PCT Application”)
was filed to continue the protection in a number of countries which are
signatories to the Patent Co-operation Treaty (the “PCT”).  The PCT is
an international agreement which provides for a single filing to have
simultaneous effect in a number of member countries. A single search is
conducted and the results of the search as well as a copy of the description and
the claims are communicated to each of the countries in which a patent is
sought. The national patent offices in each of the countries concerned
subsequently process the PCT Application as a national patent application,
making use of the PCT search results.  The filing of the PCT Application by
the Company extends the protection in all 133 signatory countries of the PCT
until at least December 21, 2008.
 
 Additional
national patent applications are due by December 21, 2007.   The
Company’s ability to make these filings in a timely manner is dependent, in
part, on its financial resources.  See “Management’s Discussion and
Analysis or Plan of Operations – Liquidity and Capital Resources”.
 
 CAT-MATE Patent
Applications
  CAT-FLAP
(Afterburner)–Improvementsin
or Relating to Emission Control Systems.A catalytic converter is
provided in an engine exhaust flow to reduce emissions. A valve is provided
downstream from the catalytic converter. The valve is in a closed position when
the exhaust flow volume is low to keep the hot exhaust gas around the catalytic
converter to keep the catalytic converter within its operational temperatures.
When the exhaust flow volume is high (e.g. the engine is revving) the catalyst
is kept at its operational temperature by normal gas flow and valve is
opened to not impede exhaust flow. A simple hinge flap is one method by which
this can be achieved.
  17
  Country
                
                Number
                
                Filing
      date
                
                StatusAustralia
                
                2004312099
                
                23
      December 2004
                
                Examination
      to be requested  by December 2009Canada
                
                2559287
                
                23
      December 2004
                
                Examination
      to be requested by December 2009China
                
                200480042295.3
                
                23
      December 2004
                
                Examination
      requested December 2006Europe
                
                04802122.4
                
                23
      December 2004
                
                Application
      filed - awaiting examinationIndonesia
                
                WO0200602208
                
                23
      December 2004
                
                ABANDONED
      on client’s instructionsJapan
                
                2006-548033
                
                23
      December 2004
                
                ABANDONED
      on client’s instructionsKorea
                
                2006-7016017
                
                23
      December 2004
                
                Examination
      Due by 23 December 2009Mexico
                
                PA/a/2006/007863
                
                23
      December 2004
                
                Application
      filed – awaiting examinationMalaysia
                
                PI20050041
                
                6
      January 2005
                
                Examination
      to be requested by January 2010.New
      Zealand
                
                548993
                
                23
      December 2004
                
                Application
      filed – awaiting examination.Thailand
                
                096762
                
                4
      January 2005
                
                Examination
      to be requested by January 2010Taiwan
                
                93140533
                
                24
      December 2004
                
                Examination
      to be requested by December 2007.United
      States
                
                10/581637
                
                23
      December 2004
                
                Application
      filed – awaiting examination.
 
 The priority date is January 16,
2004 from Australian patent application 2004900192
 
 Each
national patent application will be processed according to the peculiar
requirements of the national Patent Office. Therefore, it is not possible to
provide an accurate and complete summary of the next action and cost as in many
cases, the deadline for the next action depends on the backlog with the national
Patent Office.
 
 However,
generally, a renewal fee is payable in some countries each year on 23 December
and we expect the cost for December 2007 to be approximately US$2000.
 
 Additionally,
for the above cases that have not yet been granted (e.g. pending patent
applications), it will be necessary to pay fees from time to time such as
examination fees, processing fees, grant fees etc. Again, we are not able to
specify exactly when these fees will occur but as a rule of thumb, you should
budget for US$1500 per pending application per year.
 
 NO
FURTHER ACTION TO BE TAKEN ON THIS PORTFOLIO.  APPLICATIONS ARE TO BE
ALLOWED TO LAPSE AS ACTIONS ARISE.
  CAT-MATE—Inline Exhaust
Device to Improve Efficiency of a
Catalytic Converter.A set of rings is placed downstream from the catalytic converter to
re-radiate heat to the catalytic converter to keep the converter working at a
warmer temperature and therefore greater efficiency.
  The
priority date is June 4, 2004 from Australian patent application
2004903000.
  This
invention was incorporated into the specifications filed pursuant to the
CAT-FLAP invention.
  Method and Apparatus for
Treatment of a Fluid
 Cullen
& Co Reference: 040540
 Applicant:  Temple
University of the Commonwealth System of Higher Education
 
 Method and
Apparatus for Treatment of a Fluid (Temple University).This is an
apparatus for the magnetic treatment of oils to improve
viscosity.  Under the 2004 License Agreement with Temple University,
we have filed the following patent applications, at our sole expense and for the
benefit of Temple University, in order to secure rights to license this
technology in these countries
 
 Summary
of Invention
 Treating
oils with magnetic fields to improve viscosity.
 
 Claim
1 (PCT Application)
 
 An
apparatus for the magnetic treatment of a fluid which produces at least one
magnetic field for a period of time, Tc at or
above a critical magnetic field strength, Hc, the
period Tc and the
field strength Hc determined
relative to one another and dependant upon the properties of the fluid. (All
clear ISR)
 
 Priority
Date
  The
priority date is 14 May 2004 from Australian patent application 2004902563. (The
GCC application was refilled and therefore the priority date for that
application will be set at the actual filing date of the refilled
application).
  18
  Country
                
                Number
                
                Filing
      date
                
                StatusGCC
      *
                
                GCC/P/2005/5066
                
                22
      August 2005
                
                Application
      filed – awaiting examination.Brazil
                
                0510871-3
                
                13
      May 2005
                
                Examination
      to be requested by May 2008Canada
                
                2566739
                
                13
      May 2005
                
                Examination
      to be requested by May 2010China
                
                200580023369.3
                
                13
      May 2005
                
                Examination
      requested April 2007Algeria
                
                060593
                
                13
      May 2005
                
                Application
      filed – awaiting examinationEurasia
      **
                
                200602114
                
                13
      May 2005
                
                Under
      examination – response filed.Egypt
                
                PCT
      1087/2006
                
                13
      May 2005
                
                Application
      filed – awaiting examinationUnited
      Kingdom
                
                0624025.3
                
                13
      May 2005
                
                Under
      examination – response filedIndonesia
                
                WO0200603429
                
                13
      May 2005
                
                Application
      filed – examination to be requested by 13 May 2008Libya
                
                To
      be advised
                
                
                
                Application
      sent to agentMexico
                
                PA/a/2006/013206
                
                13
      May 2005
                
                Application
      filed – awaiting examinationNorway
                
                20065632
                
                13
      May 2005
                
                Application
      filed – awaiting examinationUnited
      States
                
                11/519168
                
                13
      May 2005
                
                Application
      filed – awaiting examination
  * Covers
Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and
Bahrain.
 
 ** The
Eurasian Patent Convention was signed on September 9, 1994 in Moscow by the
Heads of the Governments of the Republic of Azerbaijan, the Republic of Armenia,
the Republic of Belarus, Georgia, the Republic of Kazakstan, the Kyrgyz
Republic, the Republic of Moldova, the Russian Federation, the Republic of
Tajikistan, Ukraine and came into force on August 12, 1995 after Turkmenistan,
Belarus and Tajikistan deposited their instruments of accession to the
Convention to the WIPO Director General, on March 1, 1995, May 8, 1995 and May
12, 1995 respectively. To date, the Convention is also ratified by the Russian
Federation, the Republic of Kazakhstan, Republic of Azerbaijan, the Kyrgyz
Republic, the Republic of Moldova and the Republic of Armenia
 
 NO
FURTHER ACTION TO BE TAKEN ON THIS PORTFOLIO.  APPLICATIONS ARE TO BE
ALLOWED TO LAPSE AS ACTIONS ARISE.
  Trademarks
  CAT-MATE
 Cullen
& Co Reference: 040695
 
 Class:
7Devices to
reduce noxious exhaust emissions from combustion engines; devices positioned in
the exhaust flow of an exhaust of a combustion engine and to reduce pollutants
in the exhaust; devices to radiate or transmit heat to a catalytic converter in
an exhaust system; devices to radiate or transmit heat to a catalytic converter
in an exhaust system and which absorbs the heat from the exhaust gasses and
reradiates the heat to the catalytic converter in the exhaust system; all the
foregoing being for petrol or diesel engines
  Country
                
                Number
                
                Filing
      Date
                
                StatusAustralia
                
                1008291
                
                25
      June 2004
                
                RegisteredMadrid*
                
                858359
                
                21
      December 2004
                
                Registered
 
 * The
Madrid Protocol application designated the following countries:
 ●
                  China;
 ●
                  European
      Community;
 ●
                  Japan;
 ●
                  Korea;
      - abandoned
 ●
                  Singapore;
      and
 ●
                  United
      States of
America.  abandoned
  NO
FURTHER ACTION TO BE TAKEN ON THIS PORTFOLIO.  APPLICATIONS ARE TO BE
ALLOWED TO LAPSE AS ACTIONS ARISE
 ECO
ChargR
 Cullen
& Co. Reference: 061047
 
 Class: 7Devices to treat fuel in
combustion engines; devices positioned in the fuel train of a combustion engine
to reduce pollutants in the exhaust and maximize efficiency of combustion;
magnetic fuel treatment devices including in-line treatment devices; fuel
treatment devices utilizing magnets; all the foregoing being for petrol or
diesel engines.
 
 Country
                
                Number
                
                Filing
      Date
                
                StatusAustralia
                
                1121860
                
                4
      July 2006
                
                GRANTEDMadrid
      *
                
                1121860
                
                4
      January 2007
                
                GRANTEDCanada
                
                1330199
                
                4
      January 2007
                
                Accepted
      – awaiting Registration CertificateIndonesia
                
                D00
      2007 000330
                
                4
      January 2007
                
                Application
      filed – awaiting examinationMalaysia
                
                2007/00156
                
                4
      January 2007
                
                Application
      filed – awaiting examinationThailand
                
                649741
                
                4
      January 2007
                
                Application
      filed – awaiting examinationTaiwan
                
                96000462
                
                4
      January 2007
                
                Under
      examination – response filed.
  19
  * Madrid
Protocol application designates the following countries:
 
 ●
                  China
 ●
                  European
      Community
 ●
                  United
      States
 ●
                  Japan
 ●
                  Korea
 ●
                  Singapore
 ●
                  Vietnam
 
 MAG
ChargR
 Cullen
& Co. Reference:  061048
 
 Class: 7Devices to treat fuel in
combustion engines; devices positioned in the fuel train of a combustion engine
to reduce pollutants in the exhaust and maximize efficiency of combustion;
magnetic fuel treatment devices including in-line treatment devices; fuel
treatment devices utilizing magnets; all the foregoing being for petrol or
diesel engines.
 
 Country
                
                Number
                
                Filing
      Date
                
                StatusAustralia
                
                1121864
                
                4
      July 2006
                
                Registered
      Co-Existence Agreement with Mag InstrumentsMadrid
                
                1121864
                
                4
      January 2007
                
                GRANTEDCanada
                
                1330200
                
                4
      January 2007
                
                Under
      examination – response filedIndonesia
                
                D00
      2007 000331
                
                4
      January 2007
                
                Application
      filed – awaiting examinationMalaysia
                
                2007/00157
                
                4
      January 2007
                
                Application
      filed – awaiting examinationThailand
                
                649742
                
                4
      January 2007
                
                Application
      filed – awaiting examinationTaiwan
                
                96000465
                
                4
      January 2007
                
                Allowed/Accepted.
 
 Madrid
Protocol application designates the following countries:
 ●
                    China
 ●
                    European
      Community
 ●
                    United
      States
 ●
                    Japan
 ●
                    Korea
 ●
                    Singapore
 ●
                    Vietnam
 STWA
PERFORMANCE
 Cullen
& CO. Reference:  061794
 
 Class 7:  Devices to
reduce noxious exhaust emissions from combustion engines, namely inline valves,
inline throttling valves, inline baffles and catalytic converter heaters;
devices positioned in the exhaust flow of a combustion engine and to reduce
pollutants in the exhaust, namely inline valves, inline throttling valves,
inline baffles and catalytic converter heaters; devices to radiate or transmit
heat to a catalytic converter in an exhaust system, namely inline valves, inline
throttling valves, inline baffles and catalytic converter heaters; devices to
radiate or transmit heat to a catalytic converter in an exhaust system and which
absorbs the heat from the exhaust gases and reradiates the heat to the catalytic
converter in the exhaust system, namely inline valves, inline throttling valves,
inline baffles and catalytic converter heaters; all the foregoing being for
petrol or diesel engines; devices to treat fuel in combustion engines; devices
positioned in the fuel train of a combustion engine to reduce pollutants in the
exhaust and maximize efficiency of combustion; magnetic fuel treatment devices
including in-line treatment devices; fuel treatment devices utilizing magnets;
all the foregoing being for petrol or diesel engines.
  Country
                  
                  Number
                  
                  Filing
      Date
                  
                  StatusAustralia
                  
                  1140033
                  
                  11
      July 2006
                  
                  GRANTEDMadrid
                  
                  1140033
                  
                  10
      July 2007
                  
                  GRANTED
 NO
FURTHER ACTION TO BE TAKEN ON THIS PORTFOLIO.  APPLICATIONS ARE TO BE
ALLOWED TO LAPSE AS ACTIONS ARISE.
 
 20
  Non-Disclosure
Agreements
  To
further protect our intellectual property, we have entered into agreements with
certain employees and consultants, which limit access to, and disclosure or use
of, our technology. There can be no assurance, however, that the steps we have
taken to deter misappropriation of our intellectual property or third party
development of our technology and/or processes will be adequate, that others
will not independently develop similar technologies and/or processes or that
secrecy will not be breached. In addition, although management believes that our
technology has been independently developed and does not infringe on the
proprietary rights of others, there can be no assurance that our technology does
not and will not so infringe or that third parties will not assert infringement
claims against us in the future. Management believes that the steps they have
taken to date will provide some degree of protection; however, no assurance can
be given that this will be the case.
 
 Employees
  As of
December 31, 2007, we had seven full-time employees. As of such date, we
also utilized the services of four part-time consultants to assist us with
various matters, including accounting and marketing. We intend to hire
additional personnel to provide services when they are needed on a full-time
basis. We recognize that our efficiency largely depends, in part, on our ability
to hire and retain additional qualified personnel as and when needed and we have
adopted procedures to assure our ability to do so.
  Risk Factors We have just
begun to generate revenues, we have a history of losses, and we cannot assure
you that we will ever become or remain profitable. As a result, you may lose
your entire investment.
  We
generated our first revenues from operations in late 2006 and, accordingly, we
have incurred net losses every year since our inception in 1998. For the fiscal
years ended December 31, 2007 and 2006, we had net losses of $6,262,743 and
$10,181,523, respectively.  To date, we have dedicated most of our
financial resources to research and development, general and administrative
expenses and initial sales and marketing activities. We have funded all of our
activities through sales of our securities, including equity and debt. Although
we generated our first revenues in late 2006, we anticipate net losses and
negative cash flow to continue for the foreseeable future until such time as our
products are brought to market in sufficient amounts to offset operating losses.
As planned, we have significantly expanded both our research and development
efforts, and our sales and marketing efforts, during the past year.
Consequently, we will need to generate substantial additional funds, from a
combination of revenue and external financing activities, to fund our
operations. Our ability to achieve profitability is dependent upon our
continuing research and development, product development, and sales and
marketing efforts, to deliver viable products and the company’s ability to
successfully bring them to market. Although our management is optimistic that we
will succeed in marketing products incorporating our ZEFS, MK IV and CAT-MATE
technologies, there can be no assurance that we will ever generate significant
revenues or that any revenues that may be generated will be sufficient for us to
become profitable or thereafter maintain profitability. If we cannot generate
sufficient revenues or become or remain profitable, we may have to cease our
operations and liquidate our business.
  Our independent
auditors have expressed doubt about our ability to continue as a going concern,
which may hinder our ability to obtain future
financing.
  In their
report dated March 24, 2008, our independent auditors stated that our
consolidated financial statements for the year ended December 31, 2007 were
prepared assuming that we would continue as a going concern. Our ability to
continue as a going concern is an issue raised as a result of our recurring
negative cash flows from operations and accumulated deficit. We had an
accumulated deficit of  $36,690,340 as of December 31,
2007. Our ability to continue as a going concern is subject to our ability
to obtain significant additional capital to fund our operations and to generate
revenue from sales, of which there is no assurance. The going concern
qualification in the auditor’s report could materially limit our ability to
raise additional capital. If we fail to raise sufficient capital, we may have to
liquidate our business and you may lose your investment.
  Since we have not
yet begun to generate positive cash flow from operations, our ability to
continue operations is dependent on our ability to either begin to generate
positive cash flow from operations or our ability to raise capital from outside
sources.
  We have
not generated positive cash flow from operations and have relied on external
sources of capital to fund operations. We had $47,660 in cash at December 31,
2007 and negative cash flow from operations of $3,172,816 for the year ended
December 31, 2007.
  We
currently do not have credit facilities available with financial institutions or
other third parties, and historically have relied upon best efforts third-party
funding. Though we have been successful at raising capital on a best efforts
basis in the past, we can provide no assurance that we will be successful in any
future best-efforts financing endeavors. We will need to continue to rely upon
financing from external sources to fund our operations for the foreseeable
future. If we are unable to raise sufficient capital from external sources to
fund our operations, we may need to curtail operations.
  We will need
substantial additional capital to meet our operating needs, and we cannot be
sure that additional
financing will be available.
  As of
December 31, 2007 and thereafter, our expenses ran, and are expected to
continue to run, at a “burn rate” of approximately $200,000 per month, which
amount could increase during 2008. We are not currently able to fund operations
on a current basis, and we will require substantial additional capital in order
to operate.  In order to fund some our capital needs, we
conductedprivate
offerings of our securities in early 2007 and in early 2008 We also
established what is generally referred to as an equity line of credit of up to
$10,000,000 with Dutchess Private Equity Fund, LLP (“Dutchess”), under which we
may put shares of our common stock to Dutchess for sale into the marketplace and
receive the proceeds of these sales.  From November 6, 2006
through December 31, 2006, we raised $380,095 gross proceeds from such puts, and
between January 1, 2007 and June 12, 2007, we raised an additional
$992,055 gross proceeds from such puts. We may need to rely substantially
on additional puts from the equity line of credit unless and until we can
arrange additional interim or permanent financings.  Reliance on the
equity line of credit could create downward pressure on the price of our common
stock and is dilutive to our existing shareholders.  While discussion
regarding additional interim and permanent financings are being actively
conducted, management cannot predict with certainty that the equity line of
credit will be available to provide adequate funds, or any funds at all, or
whether any additional interim or permanent financings will be available at all
or, if it is available, if it will be available on favorable terms. If we cannot
obtain needed capital, our research and development, and sales and marketing
plans, business and financial condition and our ability to reduce losses and
generate profits will be materially and adversely
affected.  Additionally risks specifically relating to our equity line
of credit with Dutchess are set forth at the end of this
section.
  21
 We
will need additional capital to repay certain short-term debt as it
matures.
  We have
$1,057,100 remaining principal amount of convertible subordinated notes due June
2008, September 2008 and December 2008 to certain investors.  In
February 2008, we issued $521,400 convertible notes in our 2008 Winter Offering
to certain investors, which will be due in February 2009.
  Due to
the Company’s limited capital resources, management cannot predict with
certainty that there will be cash available to repay these obligations, and
other obligations, on their respective maturity dates.  If we do not
raise adequate funds, we would be unable to repay these obligations as they
mature during the next twelve months and we could default on such
obligations.
  As a company with
an unproven business strategy, our limited history of operations makes
evaluation of our business and prospects difficult.
  Our
business prospects are difficult to predict because of our limited operating
history, early stage of development and unproven business strategy. Since our
incorporation in 1998, we have been and continue to be involved in development
of products using our technology, establishing manufacturing and marketing of
these products to consumers and industry partners. Although we believe our
technology and products in development have significant profit potential, we may
not attain profitable operations and our management may not succeed in realizing
our business objectives.
  If we are
not
able to devote adequate resources to product development and commercialization,
we may not be able to develop our products.
  Our
business strategy is to develop, manufacture and market products incorporating
our ZEFS and MK IV technologies, and, to a lesser extent, our CAT-MATE
technology.  We also intend to develop, manufacture and market
products incorporating the ELEKTRA technology. We believe that our revenue
growth and profitability, if any, will substantially depend upon our ability
to:
 
 •
                raise
      additional needed capital for research and development;•
                complete
      development of our products in development; and•
                successfully
      introduce and commercialize our new
products.
 
 Certain
of our products are still under various stages of development. Because we have
limited resources to devote to product development and commercialization, any
delay in the development of one product or reallocation of resources to product
development efforts that prove unsuccessful may delay or jeopardize the
development of other product candidates. Although our management believes that
it can finance our product development through private placements and other
capital sources, if we do not develop new products and bring them to market, our
ability to generate revenues will be adversely affected.
  The commercial
viability of the ZEFS and CAT-MATE technologies remains largely unproven and we
may not be able to attract customers.
  Despite
the fact that have entered into various distribution agreements and made some
initial sales of our products to distributors, to the best of our knowledge, no
consumer or automobile manufacturer has used the products incorporating the ZEFS
or CAT-MATE technologies to reduce motor vehicle emissions to date. Accordingly,
the commercial viability of our devices is not known at this time. If commercial
opportunities are not realized from the use of products incorporating the ZEFS
and CAT-MATE technologies, our ability to generate revenue would be adversely
affected.  There can be no assurances that we will be successful in
marketing our products, or that customers will ultimately purchase our products.
Failure to have commercial success from the sale of our products will
significantly and negatively impact our financial condition.
  RAND
Corporation has raised questions about the scientific basis and testing results
of the ZEFS and CAT-MATE technologies.
  On April
27, 2007, RAND issued its final report on our ZEFS and CAT-MATE
technologies.  In that report, RAND opined that the application of
magnetic fields has not been shown in scientific literature to lower the
viscosity of automotive fuels.  RAND concluded, among other things,
that we would need to conduct further laboratory studies and in-use testing to
determine the effectiveness of our ZEFS technology in reducing pollutants and
increasing fuel efficiency in gasoline and diesel-powered vehicles.
  Additionally,
RAND’s analysis of the third-party laboratory testing we previously had
undertaken found at best mixed results from these tests, and therefore RAND
could not confirm the effectiveness of our ZEFS technology in actual
use.  The RAND report said the existing technical literature does not
contain credible reports that the application of magnetic fields to either
gasoline or diesel fuel oil will reduce the viscosities of these automotive
fuels.
  The
impact of the RAND report on our ability to continue to sell our products is
unknown at this time.  However, if distributors or purchasers of our
products, or governments, develop reservations about the effectiveness of our
products as a result of the RAND report, or otherwise, it would likely have a
material adverse impact on our ability to sell our products and generate
revenue.
  22
 The commercial
viability of the
ELEKTRA technology remains largely unproven and we may not be able to attract
customers.
  To the
best of our knowledge, no consumer or automobile manufacturer has used the
products incorporating the ELEKTRA technology to reduce motor vehicle emissions
to date. Accordingly, the commercial viability of our devices are not known at
this time. If commercial opportunities are not realized from the use of products
incorporating the ELEKTRA technology, our ability to generate revenue would be
adversely affected.  There can be no assurances that we will be
successful in marketing our products, or that customers will ultimately purchase
our products. Failure to have commercial success from the sale of our products
will significantly and negatively impact our financial condition.
  If our products
and services do not gain market acceptance, it is unlikely that we will become
profitable.
  The
market for products that reduce harmful motor vehicle emissions is evolving and
we have many successful competitors. Automobile manufacturers have historically
used various technologies, including catalytic converters, to reduce exhaust
emissions caused by their products. At this time, our technology is unproven,
and the use of our technology by others is limited. The commercial success of
our products will depend upon the adoption of our technology by auto
manufacturers and consumers as an approach to reduce motor vehicle emissions.
Market acceptance will depend on many factors, including:
  •
                  the
      willingness and ability of consumers and industry partners to adopt new
      technologies;•
                  the
      willingness and ability of consumers and industry partners to adopt new
      technologies;•
                  the
      willingness of governments to mandate reduction of motor vehicle
      emissions;•
                  our
      ability to convince potential industry partners and consumers that our
      technology is an attractive alternative to other technologies for
      reduction of motor vehicle emissions;•
                  our
      ability to manufacture products and provide services in sufficient
      quantities with acceptable quality and at an acceptable cost;
      and•
                  our
      ability to place and service sufficient quantities of our
      products.
 If
our products do not achieve a significant level of market acceptance, demand for
our products will not develop as expected and it is unlikely that we will become
profitable.
  We need to
outsource and rely on third parties for the manufacture, sales and marketing of
our products, and our future success will be dependent on the timeliness and
effectiveness of the efforts of these third parties.
  We do not
have the required financial and human resources or capability to manufacture
market and sell our products. Our business model calls for the outsourcing of
the manufacture, and sales and marketing of our products in order to reduce our
capital and infrastructure costs as a means of potentially improving our
financial position and the profitability of our business. Accordingly, we must
enter into agreements with other companies that can assist us and provide
certain capabilities that we do not possess. We have entered into certain
distribution agreements, but we may not be successful in entering into
additional such alliances on favorable terms or at all. Even if we do succeed in
securing additional distribution agreements, we may not be able to maintain
them. Furthermore, any delay in entering into agreements could delay the
development and commercialization of our products and reduce their
competitiveness even if they reach the market. Any such delay related to our
existing or future agreements could adversely affect our business.
  We do not
currently have an agreement in place for the manufacture of products
incorporating our ZEFS or MK IV technologies, although Quadrant has a right of
first refusal for the manufacture of such products. Although we presently intend
to have products incorporating our CAT-MATE technology manufactured by Kwong Kee
in China, we do not yet have an agreement in place for the manufacture of
products incorporating our CAT-MATE technology.
  If any party to
which we have outsourced certain functions fails to perform its obligations
under agreements with us, the development and commercialization of our products
could be delayed or curtailed.
  To the
extent that we rely on other companies to manufacture, sell or market our
products, we will be dependent on the timeliness and effectiveness of their
efforts. If any of these parties do not perform its obligations in a timely and
effective manner, the commercialization of our products could be delayed or
curtailed because we may not have sufficient financial resources or capabilities
to continue such development and commercialization on our own.
  Any revenues that
we may earn in the future are unpredictable, and our operating results are
likely to fluctuate from
quarter to quarter.
  We
believe that our future operating results will fluctuate due to a variety of
factors, including:
 
 •
              delays
      in product development;•
              market
      acceptance of our new products;•
              changes
      in the demand for, and pricing, of our products;•
              competition
      and pricing pressure from competitive products;•
              manufacturing
      delays; and•
              expenses
      related to, and the results of, proceedings relating to our intellectual
      property.
  23
 A large portion
of our expenses, including expenses for our facilities, equipment and personnel,
is relatively fixed and not subject to further significant reduction. In
addition, we expect our operating expenses will increase in 2008 as
we continue our research and development and increase our production and
marketing activities, among other activities. Although we expect to generate
revenues from sales of our products in future periods, revenues may decline or
not grow as anticipated and our operating results could be substantially harmed
for a particular fiscal period. Moreover, our operating results in some quarters
may not meet the expectations of stock market analysts and investors. In that
case, our stock price most likely would decline.
  Nondisclosure
agreements with employees and others may not adequately prevent disclosure of
trade secrets and other proprietary information.
  In order
to protect our proprietary technology and processes, we rely in part on
nondisclosure agreements with our employees, licensing partners, consultants,
agents and other organizations to which we disclose our proprietary information.
These agreements may not effectively prevent disclosure of confidential
information and may not provide an adequate remedy in the event of unauthorized
disclosure of confidential information. In addition, others may independently
discover trade secrets and proprietary information, and in such cases we could
not assert any trade secret rights against such parties. Costly and
time-consuming litigation could be necessary to enforce and determine the scope
of our proprietary rights, and failure to obtain or maintain trade secret
protection could adversely affect our competitive business position. Since we
rely on trade secrets and nondisclosure agreements, in addition to patents, to
protect some of our intellectual property, there is a risk that third parties
may obtain and improperly utilize our proprietary information to our competitive
disadvantage. We may not be able to detect unauthorized use or take appropriate
and timely steps to enforce our intellectual property rights.
  The manufacture,
use or sale of our current and proposed products may infringe on the patent
rights of others, and we may be forced to litigate if an intellectual property
dispute arises.
  If we
infringe or are alleged to have infringed another party’s patent rights, we may
be required to seek a license, defend an infringement action or challenge the
validity of the patents in court. Patent litigation is costly and time
consuming. We may not have sufficient resources to bring these actions to a
successful conclusion. In addition, if we do not obtain a license, do not
successfully defend an infringement action or are unable to have infringed
patents declared invalid, we may:
 •
                  incur
      substantial monetary damages;•
                  encounter
      significant delays in marketing our current and proposed product
      candidates;•
                  be
      unable to conduct or participate in the manufacture, use or sale of
      product•
                  candidates
      or methods of treatment requiring licenses;•
                  lose
      patent protection for our inventions and products; or•
                  find
      our patents are unenforceable, invalid, or have a reduced scope of
      protection.
 Parties
making such claims may be able to obtain injunctive relief that could
effectively block our ability to further develop or commercialize our current
and proposed product candidates in the United States and abroad and could result
in the award of substantial damages. Defense of any lawsuit or failure to obtain
any such license could substantially harm the company. Litigation, regardless of
outcome, could result in substantial cost to and a diversion of efforts by the
Company to operate its business.
  We may face
costly intellectual property disputes.
  Our
ability to compete effectively will depend in part on our ability to develop and
maintain proprietary aspects of our technologies and either to operate without
infringing the proprietary rights of others or to obtain rights to technology
owned by third parties. Our pending patent applications, specifically patent
rights of the MK IV and CAT-MATE technologies, may not result in the issuance of
any patents or any issued patents that will offer protection against competitors
with similar technology. Patents we have received for our ZEFS technologies, and
which we may receive, may be challenged, invalidated or circumvented in the
future or the rights created by those patents may not provide a competitive
advantage. We also rely on trade secrets, technical know-how and continuing
invention to develop and maintain our competitive position. Others may
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to our trade secrets.
  We are involved
in a patent infringement suit brought by our former sole director and executive
officer.
  In
April 2005, Jeffrey A. Muller, the Company’s former sole director and
executive officer, filed a complaint against us seeking declaratory and
injunctive relief and alleging unfair competition in connection with a claimed
prior patent interest in the ZEFS technologies. Mr. Muller is seeking to
have the patent rights in the ZEFS technologies that were previously transferred
to us by Mr. Muller’s bankruptcy trustee declared null and void. This is
but one of several claims that have been litigated over a number of years
between Mr. Muller and us. While we believe that we have valid claims and
defenses, there can be no assurance that an adverse result or outcome in the
pending litigation would not have a material adverse effect on our business
prospects, financial position and cash flow.
  We may not be
able to attract or retain qualified senior personnel.
  We
believe we are currently able to manage our current business with our existing
management team. However, as we expand the scope of our operations, we will need
to obtain the full-time services of additional senior management and other
personnel. Competition for highly-skilled personnel is intense, and there can be
no assurance that we will be able to attract or retain qualified senior
personnel. Our failure to do so could have an adverse effect on our ability to
implement our business plan. As we add full-time senior personnel, our overhead
expenses for salaries and related items will increase compensation packages,
these increases could be substantial.
  24
 If we lose our
key personnel or are unableto attract and
retain additional personnel, we may be
unable to achieve profitability.
  Our
future success is substantially dependent on the efforts of our senior
management, particularly Charles R. Blum, our President and Chief Executive
Officer, and Eugene E. Eichler, our Chief Financial Officer. The loss of the
services of members of our senior management may significantly delay or prevent
the achievement of product development and other business objectives. Because of
the scientific nature of our business, we depend substantially on our ability to
attract and retain qualified marketing, scientific and technical personnel,
including consultants. There is intense competition among specialized automotive
companies for qualified personnel in the areas of our activities. If we lose the
services of, or do not successfully recruit key marketing, scientific and
technical personnel, the growth of our business could be substantially impaired.
We do not maintain key man insurance for any of these individuals.
  We expect to
incur increased costs under the Sarbanes-Oxley Act of 2002.
  As a
public company, we incur significant legal, accounting and other expenses. In
addition, the Sarbanes-Oxley Act of 2002, as well as related rules adopted by
the SEC, has imposed substantial requirements on public companies, including
certain corporate governance practices and requirements relating to internal
control over financial reporting under Section 404 of the Sarbanes-Oxley
Act. We expect these rules and regulations to increase our legal and financial
compliance costs and to make some activities more time-consuming and costly.
Effective disclosure of controls and procedures and internal controls are
necessary for us to produce reliable financial reports and are important in
helping prevent financial fraud generally. In order to accomplish this, we have
retained an outside consulting firm to assist us in implementing proper
procedures. We will incur significant up-front expenses to do so. If we are
unable to achieve and maintain adequate disclosure controls and procedures and
internal controls, our business and operating results could be
harmed.
  Changes in stock
option accounting rules may adversely affect our reported operating results, our
stock price, and our ability to attract and retain
employees.
  In
December 2004, the Financial Accounting Standards Board (“FASB”) published
new rules that will require companies such as us to record all stock-based
employee compensation as an expense. The new rules apply to stock options
grants, as well as a wide range of other share-based compensation arrangements
including restricted share plans, performance-based awards, share appreciation
rights and employee share purchase plans. As required by FASB, we adopted these
rules effective January 1, 2006.  As a small company with limited
financial resources, we have depended upon compensating our officers, directors,
employees and consultants with such stock based compensation awards in the past
in order to limit our cash expenditures and to attract and retain officers,
directors, employees and consultants. Accordingly, if we continue to grant stock
options or other stock based compensation awards to our officers, directors,
employees, and consultants, our future earnings, if any, will be reduced (or our
future losses will be increased) by the expenses recorded for those grants.
These compensation expenses may be larger than the compensation expense that we
would be required to record were we able to compensate these persons with cash
in lieu of securities. Since we are a small company, the expenses we may have to
record as a result of future options grants may be significant and may
materially negatively affect our reported financial results...
  Currently,
there is only very limited trading in our stock, so you may be unable to sell
your shares at or near the quoted bid prices if you need to sell your
shares.
  The
shares of our common stock are thinly-traded on the OTC Bulletin Board, meaning
that the number of persons interested in purchasing our common shares at or near
bid prices at any given time may be relatively small or non-existent. This
situation is attributable to a number of factors, including the fact that we are
a small company engaged in a high risk business which is relatively unknown to
stock analysts, stock brokers, institutional investors and others in the
investment community that can generate or influence daily trading volume and
valuation. Should we even come to the attention of such persons, they tend to be
risk-averse and would be reluctant to follow an unproven, early stage company
such as ours or purchase or recommend the purchase of our shares until such time
as we became more seasoned and viable. As a consequence, there may be periods of
several days or more when trading activity in our shares is minimal or
non-existent, as compared to a seasoned issuer which has a large and steady
volume of trading activity that will generally support continuous trading
without negatively impacting our share price. We cannot provide any assurance
that a broader or more active public trading market for shares of our common
stock will develop or be sustained.  Due to these conditions, we
cannot give any assurance that shareholders will be able to sell their shares at
or near bid prices or at all.
  On
February 6, 2008, the Company was reinstated to the OTC Bulletin
Board.
  The market price
of our stock is volatile.
  The
market price for our common stock has been volatile during the last year,
ranging from a closing bid price of $1.10on January 12,
2007 to a closing bid price of $0.29 on June 5, 2007, and a closing bid price of
$0.80 on March 17, 2008. Additionally, the bid price of our stock has been both
higher and lower than those amounts on an intra-day basis in the last year.
Because our stock is thinly traded, its price can change dramatically over short
periods, even in a single day. The market price of our common stock could
fluctuate widely in response to many factors, including:
  •
                    developments
      with respect to patents or proprietary
      rights;•
                    announcements
      of technological innovations by us or our
      competitors;
  25
 •
                    announcements
      of new products or new contracts by us or our
      competitors;•
                    actual
      or anticipated variations in our operating results due to the level of
      development expenses and other factors;•
                    changes
      in financial estimates by securities analysts and whether any future
      earnings of ours meet or exceed such
  estimates;
 •
                    conditions
      and trends in our industry;•
                    new
      accounting standards;•
                    general
      economic, political and market conditions and other factors;
      and•
                    the
      occurrence of any of the risks described in this
      Memorandum.
  Substantial sales
of common stock could cause our stock price to fall.
  In the
past year, there have been times when average daily trading volume of our common
stock has been extremely low, and there have been many days in which no shares
were traded at all. At other times, the average daily trading volume of our
common stock has been high. If all of the shares we registered with the SEC are
issued by us under the equity line of credit, an additional 7,000,000 shares of
our common stock will be able to be freely sold on the market. Because of the
limited trading volume, the sudden release of up to 7,000,000 additional freely
trading shares onto the market, or the perception that such shares will or could
come onto the market, could have an adverse affect on the trading price of our
stock. No prediction can be made as to the effect, if any, that sales of the
shares that we may issue under the equity line of credit, or the availability of
such shares for sale, will have on the market prices prevailing from time to
time.  Nevertheless, the possibility that substantial amounts of
common stock may be sold in the public market may adversely affect prevailing
market prices for our common stock and could impair our ability to raise capital
through the sale of our equity securities.
  Potential
issuance of additional shares of our common stock could dilute existing
stockholders.
  We are
authorized to issue up to 200,000,000 shares of common stock. To the extent of
such authorization, our Board of Directors has the ability, without seeking
stockholder approval, to issue additional shares of common stock in the future
for such consideration as the Board of Directors may consider sufficient. The
issuance of additional common stock in the future will reduce the proportionate
ownership and voting power of the common stock offered hereby.
  There are
7,000,000 shares underlying our equity line of credit, which shares we have
registered with the SEC, and the sale of these shares could depress the market
price of our common stock.
  The sale
by Dutchess into the public market of up to 7,000,000 shares we have registered
under our equity line of credit with Dutchess could depress the market price of
our common stock. As of September 20, 2006, shortly before we filed a
registration statement (the “Dutchess Registration Statement”) with the SEC, we
had 39,317,619 shares of common stock issued and outstanding and the closing bid
price of our common stock on the OTC Bulletin Board was $1.46. From November 6,
2006 through March 17, 2008, Dutchess sold, at our request, an aggregate
2,367,905 shares of our common stock under the equity line of
credit.  The last put by the Company was on June 12, 2007 for $3,880
and 12,500 shares.  As of March 17, 2008, we had 54,751,117 shares of
common stock issued and outstanding and the closing bid price of our common
stock on the OTC Bulletin Board was $0.80. Our stock price is
influenced by many factors other than sales of our stock by
Dutchess.
  Assuming we
utilize the maximum amount available under the equity line of credit, existing
shareholders could experience substantial dilution upon the issuance of shares
to Dutchess.
  Our
equity line of credit with Dutchess contemplates the potential future issuance
and sale of up to $10,000,000 of our common stock to Dutchess subject to certain
restrictions and obligations. The following is an example of the number of
shares that could be issued at various prices assuming we utilize the maximum
amount available under the equity line of credit. These examples assume issuance
at a market price of $1.46 per share, which was the closing bid price of our
common stock on September 20, 2006 and at 10%, 25% and 50% below $1.46 per
share.  However, the closing bid price of our common stock on March
17, 2008 was $0.80, meaning that based on current stock prices even more shares
of our common stock would now have to be issued to Dutchess for the same dollar
amount we draw down under the equity line of credit than in the examples given
in the below table.
  The
following table should be read in conjunction with the text above and the
footnotes immediately following the table:
  Percent
      below
              
              
              
              
              
              
              
              
              
              
              
              
              
              Percent
      ofcurrent
      market
              
              Price
      per share
              
              Number
      of shares
              
              Shares
              
              outstandingprice
              
              (1)
              
              issuable
      (2)
              
              outstanding
      (3)
              
              shares
      (4)0
              %
              
              $
              1.4162
              
              
              
              7,061,150
              
              
              
              46,378,769
              
              
              
              15.22
              %10
              %
              
              $
              1.2746
              
              
              
              7,845,599
              
              
              
              47,163,218
              
              
              
              16.63
              %25
              %
              
              $
              1.0622
              
              
              
              9,414,423
              
              
              
              48,732,042
              
              
              
              19.32
              %50
              %
              
              $
              0.7081
              
              
              
              14,122,299
              
              
              
              53,439,918
              
              
              
              26.43
              %
  (1)
              
              Represents
      purchase prices equal to 97% of $1.46 and potential reductions of 10%, 25%
      and 50%.(2)
              
              Represents
      the number of shares issuable if the entire $10,000,000 remaining
      commitment under the equity line of credit was drawn down at the indicated
      purchase prices.Since only 7,000,000 shares of our common stock are being
      registered by us at this time, we would have to file another registration
      statement and have it declared effective by the SEC in order to make
      additional drawdown’s resulting in the issuance of more than the 7,000,000
      shares of common stock being registered hereunder.(3)
              
              Based
      on 39,317,619 shares of common stock issued and outstanding as of
      September 20, 2006.(4)
              
              Percentage
      of the total outstanding common stock after the issuance of the shares
      indicated, without considering the 4.99% contractual restriction on the
      number of shares that Dutchess may own at any point in time or other
      restrictions on the number of shares we may
  issue.
  26
 
  The lower the
stock price, the greater the number of shares issuable under the equity line of
credit, which could contribute to the future decline of our stock price and
dilute existing shareholders’ equity and voting rights.
 The
number of shares that Dutchess will receive under its agreement with us is
calculated based upon the market price of our common stock prevailing at the
time of each drawdown request, or put. The lower the market price, the greater
the number of shares that are issuable under the agreement. Upon issuance of the
shares, to the extent that Dutchess will attempt to sell the shares into the
market, these sales could further reduce the market price of our common stock.
This in turn will increase the number of shares issuable under the agreement.
This could lead to lower market prices and a greater number of shares to be
issued. A larger number of shares issuable at a discount in a declining market
could expose our shareholders to greater dilution and a reduction of the value
of their investment.  As of March 17, 2008, we had issued 2,367,905
shares of our common stock to Dutchess under the equity line of credit and had
received $1,372,150 gross proceeds from Dutchess under the equity line of
credit.
  Our common stock
is subject to penny stock regulation, which may make it more difficult for us to
raise capital.
  Our
common stock is considered penny stock under SEC regulations. It is subject to
rules that impose additional sales practice requirements on broker-dealers who
sell our securities. For example, broker-dealers must make a suitability
determination for the purchaser, receive the purchaser’s written consent to the
transaction prior to sale, and make special disclosures regarding sales
commissions, current stock price quotations, recent price information and
information on the limited market in penny stock. Because of these additional
obligations, some broker-dealers may not effect transactions in penny stocks,
which may adversely affect the liquidity of our common stock and shareholders’
ability to sell our common stock in the secondary market. This lack of liquidity
may make it difficult for us to raise capital in the future.
 
 Item 2.Properties
 
 Our Executive Offices and our
engineering, production and testing facility is located at 235
Tennant Avenue,Morgan
Hill, California,
95037.In September 2005, the Company
entered into a lease for
the termSeptember 1, 2005 through August 31, 2007 and
carriedan option to renew
for two additional years at the then prevailing market rate. Monthly rent
was$2,240 per month
under this lease. The lease was amended in February 2006 for additional
space.Monthly rate under
the amended lease was$4,160 per month.  The
Company renewed this lease on August 9, 2007 for an additional two-year
term.  The rent is $4,640 per monthfor the first six months of the new
term of the lease and $5,480 per month for the remaining eighteen months of the
new term of the lease.  We believe that this space is adequate for our
current and planned needs.
 
 Item 3.Legal
Proceedings
 
 On
December 19, 2001, the SEC filed civil charges in the United States Federal
District Court, Southern District of New York, against us, our former President
and then sole director Jeffrey A. Muller, and others, alleging that we and the
other defendants were engaged in a fraudulent scheme to promote our 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 our corporation, which was then
controlled by Mr. Muller. On March 22, 2002, we 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, we were not required to admit fault and did not pay
any fines or restitution.
  On
July 2, 2002, after an investigation by our newly constituted board of
directors, we 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 our stock and other transactions occurring between 1998 and
2002.  Among other things, we alleged that Mr. Muller and certain
others sold Company stock without providing adequate consideration to us; 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 our 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 our 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 us, from selling or transferring any of our
stock that they may have owned or controlled, or from taking any action to
injure us or our business and from having any direct contact with our
shareholders. The injunctive order also prevented Mr. Muller or his nominees
from engaging in any effort to exercise control over our corporation and from
serving as an officer or director of our company.
  In the
course of the litigation, we have 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 our stock that he still owns and directed the Company to cancel any
issued and outstanding shares of our 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, we have 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 our 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
our 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.
  27
 Patent
Infringement Claims by Jeffrey A. Muller
 
 In April 2005, Jeffrey A. Muller, the Company’s former sole director and
executive officer, filed a complaint against us in the Federal District Court
for the Central District of California, seeking declaratory and injunctive
relief and alleging unfair competition in connection with a claimed prior patent
interest in the ZEFS device and stock option rights. In seeking declaratory
relief, Mr. Muller is seeking to have the patent rights in the ZEFS device
that were previously transferred to us by Mr. Muller’s bankruptcy trustee
declared null and void.
  This
lawsuit brought by Mr. Muller arose out of the same claims that were the
subject of  litigation in the Federal District Court for the Southern
District of New York, in which the Court entered judgment against Mr.
Muller.  Those claims are pending further
proceedings.  While we believe that we have valid claims and defenses,
there can be no assurance that an adverse result or outcome on the pending
motions or a trial of this case would not have a material adverse effect on our
financial position or cash flow.
  Litigation Involving Scottish Glen Golf Company
  We are
involved in litigation with Scottish Glen Golf Company, Inc. (SGGC) doing
business as KZ Golf, Inc., the Company’s previous landlord on claims in the
aggregate amount of $104,413.   STWA does not dispute the fact
that certain amounts of unpaid past rent are due but does dispute that it owes
the aggregate of $104,413 demanded by SGGC; more than half of which are
purported “late fees” which was assessed at the rate of $100 per
day.  It is the company’s position that the late fees are void and
unenforceable and that STWA is entitled to a set-off for office space that
reverted back to SGGC.
  While the
Company believes that it has valid claims and defenses, given the inherent
uncertainties of litigation, the Company cannot predict the outcome of this
matter.  Accordingly, there can be no assurance that an adverse result
or outcome of this matter would not have a material adverse effect on the
Company’s financial position or cash flow.  The Company believes that
these claims arose from acts of a related party involving a former officer and
director and his wife as a beneficial owners of SGGC.
 
 Item 4.Submission of
Matters to a Vote of Security Holders.
 
 Not
Applicable
 
 28
 
  PART
II
 
 Item 5.Market
for Common
Equity and Related Stockholder Matters
 
 Through
May 21, 2007, our common stock was traded on the Over the Counter Bulletin Board
(the “OTCBBJ under
the symbol “ZERO”. Effective May 22, 2007, our common stock was removed from the
OTCBB and placed on the “Pink Sheets”. Effective February 8, 2008, our
common stock was reinstated and currently trades on the OTCBB. The following
table sets forth the high and low bid prices of the Company’s common stock for
the quarters indicated as quoted on the Pink Sheets or the OTCBB, as applicable,
as reported by Yahoo Finance.These quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not represent actual transactions.
  2006
                  
                  
                  2007High
                  
                  
                  Low
                  
                  
                  High
                  
                  
                  LowFirst Quarter
                  
                  $
                  5.00
                  
                  
                  $
                  0.56
                  
                  
                  $
                  1.17
                  
                  
                  $
                  0.60Second Quarter
                  
                  $
                  3.13
                  
                  
                  $
                  1.45
                  
                  
                  $
                  0.80
                  
                  
                  $
                  0.25Third Quarter
                  
                  $
                  2.74
                  
                  
                  $
                  1.11
                  
                  
                  $
                  0.60
                  
                  
                  $
                  0.17Fourth h Quarter
                  
                  $
                  1.65
                  
                  
                  $
                  0.55
                  
                  
                  $
                  0.48
                  
                  
                  $
                  0.15
 
 According
to the records of our transfer agent, we had 1,012 stockholders of record of
ourcommon
stock at March 17, 2008. The Company believes that the number of beneficial
owners is substantially higher than this amount.
  We do not
pay a dividend on our common stock and we currently intend to retain future cash
flows to finance our operations and fund the growth of our business. Any payment
of future dividends will be at the discretion of our Board of Directors and will
depend upon, among other things, our earnings, financial condition, capital
requirements, level of indebtedness, contractual restrictions in respect to the
payment of dividends and other factors that our Board of Directors deems
relevant.
 
 Issuances
of Unregistered Securities in Last Fiscal Year
  Morale
OrchardsTransaction
  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 Item 12. Certain Relationships and Related
Transactions)
  2007
PIPE Offering.
  From
January 13 through April 27, 2007, the Company conducted an offering
(the “2007 PIPE Offering”), through Spencer Clarke, as exclusive placement
agent. The Company raised $400,000 gross proceeds and $352,000 net
proceeds.    Interest on the 2007 PIPE Notes, at a rate of
10% per annum, is payable quarterly. The Notes are due nine months from date of
issuance. The Notes are convertible into 571,429 shares of the Company’ Common
Stock and investors received warrants entitling the holders to purchase up to
857,144 shares of the Company’s Common Stock.
  The terms
of the 2007 PIPE Offering were modified on August 29, 2007 and again on December
17, 2007.  See (“Details of Recent Financing
Transactions”)
  2007
Spring Offering.
  From
June 13, 2007 through June 26, 2007, the Company conducted a private
offering (the “2007 Spring Offering”) and issued Convertible Notes in the
aggregate face amount of $451,000.  These notes were sold for an
aggregate purchase price of $410,000.  The Notes are convertible into
1,210,489 shares of the Company’s common stock and in addition, investors
received warrants entitling the holders to purchase up to 605,242 shares of the
Company’s common stock. (See “Details of Recent Financial
Transactions”)
  29
 
  2007
Summer Offering.
  From
August 8, 2007 through September 27, 2007, the Company conducted a private
offering (the "2007 Summer Offering") and issued Convertible Notes in the
aggregate face amount $309,980.  These Notes were sold for an
aggregate purchase price of $281,800. The Notes are convertible into 837,784
shares of Company’s common stock and in addition, investors received warrants
entitling the holders to purchase up to 418,892 shares of the Company’s common
stock. (See “Details of Recent Financial Transactions”).
 2007
Fall Offering.
 
 From
November 14, 2007 through December 17, 2007 the Company conducted  a
private offering (the “ 2007 Fall Offering”) and issued Convertible Notes in the
aggregate face amount of $622,600.  These Notes were sold for an
aggregate purchase price of $566,000.  The Notes are convertible into
1,596,410 shares of the Company’s common stock and in addition, investors
received warrants entitling the holders to purchase up to 798,205 shares of the
Company’s common stock. (See “Details of Recent Financing
Transactions”).
  Other
Issuances.
  During
the year ended December 31, 2007, convertible notes in the amount of $526,480 of
our previously issued and outstanding Investor Notes were converted to 1,910,711
shares of common stock.
  Item 6.Management’s Discussion and
Analysis or Plan of Operation
 
 The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and supplementary data referred to in Item 7 of this Form
10-KSB.
  This
discussion contains forward-looking statements that involve risks and
uncertainties. Such statements, which include statements concerning future
revenue sources and concentration, selling, general and administrative expenses,
research and development expenses, capital resources, additional financings and
additional losses, are subject to risks and uncertainties, including, but not
limited to, those discussed above in Item 1 and elsewhere in this Form
10-KSB, particularly in “Risk Factors,” that could cause actual results to
differ materially from those projected. Unless otherwise expressly indicated,
the information set forth in this Form 10-KSB is as of December 31, 2007,
and we undertake no duty to update this information.
 
 Overview
 
 We are a
development stage company that generated its first initial revenues in the
fourth quarter of 2006. Our focus is on research and development, and initial
sales and marketing, of products incorporating our proprietary and patented
technology, which is designed to reduce harmful emissions, and/or improve fuel
efficiency and engine performance on equipment and vehicles driven by internal
combustion engines. We have devoted the bulk of our efforts to the completion of
the design, the development of our production models, testing of devices and the
promotion of our products in the marketplace. We anticipate that these efforts
will continue during 2008.
  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 2007 and will need to raise substantial
additional capital in 2008, and possibly beyond, to fund our sales and marketing
efforts, continuing research and development, and certain other expenses, until
our revenue base grows sufficiently.
 
 Results
of Operation
 
 Revenues
were $39,000 for the fiscal year ended December 31, 2007, compared to $30,000 a
year ago, an increase of $9,000. Cost of goods sold were $10,720 for the fiscal
year ended December 31, 2007, compared to $13,400 a year ago. We realized a
gross profit of $28,280 for the fiscal year ended December 31, 2007, compared to
$16,600 a year ago, an increase of $11,680 due to increase in
revenues.
  Operating
expenses were $3,956,345 for the fiscal year ended December 31, 2007,
compared to $7,412,227 for the fiscal year ended December 31, 2006, a
decrease of $3,455,882. The decrease is attributable to a decrease in non-cash
expenses of $2,632,375 and a decrease in cash expenses of $823,507.
Specifically, the decrease in non-cash expenses is attributable to decreases in
options and warrants given to employees and consultants ($2,645,298), offset by
an increase in depreciation expense ($12,923). The decrease in cash
expenses is attributable to   decreases in salaries and benefits
expenses ($569,684); travel ($161,758); corporate expenses ($80,680); exhibit
and trade shows ($75,661); office and other expenses ($30,073); offset by
an increase in consulting and professional fees ($94,349).
  Research
and development expenses were $600,816 for the fiscal year ended December 31,
2007, compared to $401,827 for the fiscal year ended December 31, 2006, an
increase of $198,989. Our research and development expenses include
contracts with RAND and Temple University, consultant’s fees, travel, cost of
services and supplies. The increase in research and development expenses is
primarily attributable to an increase in contracts with RAND Corporation and
Temple University of $446,780. This increase was offset by decreases in
consultant’s fees ($110,701); testing tools and supplies ($73,571); and travel
expenses ($63,519).
  30
  Interest
and other income was $3,475 for the fiscal year ended December 31, 2007,
compared to $15,422 for the fiscal year ended December 31, 2006, a decrease
of $11,947. This decrease is attributable to a decrease in interest earned on
money market accounts.  Interest expense was $1,736,537 for the fiscal
year ended December 31, 2007, compared to $2,398,691 for the fiscal year ended
December 31, 2006.  This decrease of $662,154 is attributable to a
decrease in non-cash interest expense and financing fees of $778,771; offset by
an increase in cash interest expense and financing fees of
$116,617.
  We had a
net loss of $6,262,743 or $0.16 per share for the fiscal year ended December 31,
2007 compared to a net loss of $10,181,523, or $0.28 per share for the fiscal
year ended December 31, 2006.
 Liquidity
and Capital Resources
 
 General
 
 We have
incurred negative cash flow from operations in the developmental stage since our
inception in 1998. As of December 31, 2007, we had cash of $47,660 and an
accumulated deficit of $36,690,340. Our negative operating cash flow in 2007 was
funded primarily through the sale convertible notes as well as sale of our stock
by Dutchess Private Equity Fund, LLC (“Dutchess”) under our equity line of
credit.
 
 The
accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in
the accompanying consolidated financial statements, the Company had a net loss
of $6,262,743 and a negative cash flow from operations of $3,172,816 for the
year ended December 31, 2007, and had a working capital deficiency of $4,565,344
and a stockholders’ deficiency of $4,359,786 at December 31,
2007.  These factors raise substantial doubt about its ability to
continue as a going concern. The ability of the Company to continue as a going
concern is dependent upon the Company’s ability to raise additional funds and
implement its business plan. The consolidated financial statements do not
include any adjustments that might be necessary if the Company is unable to
continue as a going concern
 
 During
2007, we raised an aggregate of $3,148,855 gross proceeds ($3,022,491 net
proceeds) from the sale of our stock and the issuance of debt, as
follows:
  ●
                    Gross
      proceeds of $400,000 (net proceeds of $352,000) from the issuance of
      convertible notes and warrants in a PIPE offering conducted by Spencer
      Clarke, LLC of New York in March and April
2007.
 ●
                    Gross
      and net proceeds of $500,000 from the issuance of a convertible note and
      related warrants in a private offering to Morale Orchards on January 10,
      2007. The face amount of the note is $612,500 due January 10,
      2008.
 ●
                    Gross
      proceeds of $992,055 (net proceeds of $912,691) from the issuance of stock
      under our equity line of credit from
Dutchess.
 ●
                    Gross
      and net proceeds of $410,000 from the issuance of convertible notes and
      warrants in a Spring 2007 offering.  The face amount of the
      notes is $451,000.
 ●
                    Gross
      and proceeds of $281,800 from the issuance of convertible notes in a
      Summer 2007 offering.  The face amount  of the notes
      is $309,980.
 ●
                    Gross
      and net proceeds of $566,000 from the issuance of convertible notes in a
      Fall 2007 offering.  The face amount of the notes is
      $622,600.
  Subsequent
to fiscal year ended December 31, 2007 and through March 17, 2008, we raised an
aggregate of $474,000 gross and net proceeds from the sale of our stock and
the issuance of debt in our 2008 Winter Offering.
 
 Details
of Recent Financing Transactions
  Equity Line of
Credit.  In
September 2006, to address our longer-term capital needs, we entered into
what is sometimes referred to as an equity line of credit arrangement with
Dutchess.  See “Risk Factors”.
  Specifically,
we entered into an investment agreement, pursuant to which Dutchess is committed
to purchase up to $10,000,000 of our common stock over the 36-month term of the
investment agreement. We are not obligated to request any portion of the
$10,000,000.
  In
connection with the equity line of credit, we filed the Dutchess Registration
Statement with the SEC on October 6, 2006 to register 7,000,000 shares of Common
Stock that we may issue under the equity line of credit and the Dutchess
Registration Statement was declared effective by the SEC on October 30,
2006.
  Under
the line of credit we may, but are not obligated to, put shares of our stock to
Dutchess from time to time over a 36-month period, at a purchase price
calculated at 97% of the lowest best closing bid for our common stock for the
five trading days following our put notice to Dutchess. Because the price of our
common stock fluctuates and the number of shares of our common stock, if any,
that we may issue, should we exercise our put rights under the equity line of
credit, will vary, we do not know how many shares, if any, we will actually
issue under the equity line of credit. If we put more than the amount that would
require us to issue the 7,000,000 shares that we have registered with the SEC,
we would be required to file a new registration statement with regard to the
excess number of shares and have it declared effective by the SEC, before we
could make further puts under the equity line of credit.
  The
actual number of shares that we may issue pursuant to the equity line of credit
is not determinable as it is based on the market price of our common stock from
time to time and the number of shares we desire to put to Dutchess. Under the
terms of the equity line of credit, Dutchess may not own more than 4.99% of our
issued and outstanding stock at any one time.
  As we draw down on the equity line of
credit, more shares will be sold into the market by Dutchess. These additional
shares could cause our stock price to drop. In turn, if the stock price drops
and we make more drawdown’s on the equity line of credit, more shares will come
into the market, which could cause a further drop in the stock price. You should
be aware that there is an inverse relationship between our stock price and the
number of shares to be issued pursuant to the equity line of credit. If our
stock price declines, we will be required to issue a greater number of shares
under the equity line of credit. We have no obligation to utilize the full
amount available under the equity line of credit.
 
 31
  Because
of the drop of our stock price since the establishment of the equity line of
credit, we have not used the maximum amount of the equity line of credit that we
could have used.  As of March 17, 2008, we have issued 2,367,905
shares of our common stock to Dutchess under the equity line of credit and have
received $1,372,170 gross proceeds from Dutchess under the equity line of
credit.
 Morale
Transaction.  On December 5, 2006, we entered into a Note
Purchase Agreement (the “Note Purchase Agreement”) with Morale. The entire
equity interest in Morale is beneficially owned by Leodis Matthews, who is the
Company’s litigator through his law firm. 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. 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.
  Each of
the Morale Notes is convertible into shares of our Common Stock at a per share
conversion price initially equal to the closing price of a share of our Common
Stock on the trading day prior to the date of issuance of such Morale Note. The
conversion right is exercisable during the period commencing 90 days prior
to the maturity of each Morale Note. Concurrently with the issuance of a Morale
Note, for no additional consideration, Morale will acquire Morale Warrants to
purchase a number of shares of our Common Stock equal to 50% of the number of
shares of our Common Stock initially issuable on conversion of the associated
Morale Note. The Morale Warrants become exercisable 180 days after the date
of their issuance.
  The
Morale Note purchased by Morale on December 5, 2006 is convertible at the
rate of $0.85 per share into 720,588 shares of our Common Stock and the Morale
Warrants are exercisable at $0.85 per share for 360,294 shares of our Common
Stock.    The Morale Note purchased by Morale on January 10,
2007 is convertible at the rate of $0.70 per share into 875,000 shares of our
Common Stock and the Morale Warrants are exercisable at $0.70 per share for
437,500 shares of our Common Stock.
  Repayment
of each Morale Note is to be made monthly, at an amount equal to at least $3,750
for each Morale Note. Additional payments may be made prior to maturity with no
prepayment penalties. In the event the Company has not repaid each Morale Note
in full by the anniversary date of its issuance, the remaining balance shall be
increased by 10% as an initial penalty, and the Company shall pay additional
interest of 2.5% per month, compounded daily, for each month until such Morale
Note is paid in full.
  Morale
has piggyback registration rights pursuant to which Morale may require the
Company to include the shares of our Common Stock issuable upon conversion of
the Morale Notes and exercise of the Morale Warrants in certain future
registration statements we may elect to file, subject to the right of the
Company and/or its underwriters to reduce the number of shares to be included in
such a registration in good faith based on market or other
conditions.
  As of
December 31, 2007, the Company was in default on the December 5, 2006
Convertible Note. On January 31, 2008, the Company, Morale Orchards, LLP and
Matthews & Partners entered into a Modification Satisfaction
Agreement.  (See Item 12. “Certain Relationships and Related
Transactions”).
  2007 PIPE
Offering. From January 13 through April 27, 2007, the Company
conducted an offering (the “2007 PIPE Offering”), through Spencer Clarke, as
exclusive placement agent, of up to $2,000,000 principal amount of its 10%
convertible notes (the “2007 PIPE Notes”). Interest on the 2007 PIPE Notes, at a
rate of 10% per annum, is payable quarterly. The Notes are due nine months from
date of issuance. The Notes are convertible into shares of Common Stock at an
initial conversion price of $0.70 per share (the “Conversion Shares”). The
Company raised $400,000 gross proceeds ($352,000 net proceeds) in the 2007 PIPE
Offering.  The per share price of the Company’s common stock on the
Pink Sheets during this period ranged from a low bid price (intraday) of $0.58
to a high bid price (intraday) of $1.03.
  The
Company has the right to redeem any or all of the outstanding 2007 PIPE Notes in
its sole discretion anytime after the termination of the 2007 PIPE Offering and
prior to the maturity date of the 2007 PIPE Notes. The redemption price shall be
the face amount of the redeemed Notes plus accrued and unpaid interest thereon.
Subject to the following sentence, at any time prior to the maturity date of the
2007 PIPE Notes, for each additional $1,000,000 of gross proceeds raised from
one or more offerings of the Company’s equity or quasi-equity securities, the
Company shall redeem 2007 PIPE Notes with a minimum face value of $500,000
together with accrued and unpaid interest, until the entire outstanding 2007
PIPE Note is redeemed. Certain financings that the Company may conduct outside
of North America and only up to a maximum of UK £15,000,000 in the aggregate,
are exempt from this provision to redeem the 2007 PIPE Notes in whole or in
part.
  Investors
in the 2007 PIPE Offering received, for no additional consideration, a warrant
(the “2007 PIPE Warrant”), entitling the holder to purchase a number of shares
of the Company’s common stock equal to 150% of the number of shares of common
stock into which the 2007 PIPE Notes are convertible (the “Warrant Shares”). The
2007 PIPE Warrant will be exercisable on a cash basis only and will have
registration rights. The 2007 PIPE Warrant is exercisable at an initial price of
$1.00 per share, and is exercisable immediately upon issuance and for a period
of three years from the date of issuance.
  Promptly,
but no later than 90 days following the closing date of the PIPE Offering, the
Company was required to file a registration statement with the SEC to register
the Conversion Shares and the Warrant Shares. The Company was further required
to use its best efforts to ensure that the Registration Statement was declared
effective within 120 days after filing.
  Pursuant
to the terms of the PIPE Notes, on the 91st day following the closing date, (i)
the interest rate on the PIPE Notes increased from 10% to 18% per annum until
the event of default is cured and (ii) the holders of the PIPE Notes became
entitled to receive additional warrants in an amount equal to 25% of the PIPE
Warrants originally issued, for each 60-day period that the Company remains in
default.
  The
Company was unable to meet its obligations to file the Registration Statement
required under the terms of the 2007 PIPE Offering in a timely manner. In early
July 2007, the Company began discussions with Spencer Clarke, acting on behalf
of the holders of the PIPE Notes and PIPE Warrants, for an extension of time to
file the Registration Statement. Notwithstanding such discussions, Spencer
Clarke issued a Notice of Default dated August 1, 2007 (the "Notice") to the
Company for its failure to file the Registration Statement in a timely
manner.
  32
 
  On August
29, 2007, the Company entered into a modification agreement with the 2007 PIPE
note holders. The Modification Agreement was entered into as a result of
negotiations between the Company and Spencer Clarke, LLC ("Spencer Clarke"), the
Company's exclusive placement agent for the 2007 PIPE Offering, after the
Company failed to file with the Securities and Exchange Commission (the "SEC")
in a timely manner a registration statement (the "Registration Statement") to
register the shares of the Company's common stock into which the PIPE Notes are
convertible (the "Conversion Shares") and for which the PIPE Warrants may be
exercised (the "Warrant Shares").
 Pursuant
to the Modification Agreement, the parties have agreed as follows:
  ●
                    Promptly,
      but no later than November 30, 2007 (instead of on or before July 2,
      2007), the Company shall file the Registration Statement with the SEC to
      register the Conversion Shares and the Warrant
  Shares.
 ●
                    Effective
      August 1, 2007, the interest rate on the PIPE Notes shall be increased
      from 10% per annum to 18% per annum until such time as the Registration
      Statement is declared effective by the
SEC.
 ●
                    The
      price at which the PIPE Notes may be converted into Conversion Shares (the
      "Conversion Price") shall be reduced from $0.70 to $0.45 per
      share.
 ●
                    Each
      Investor shall receive, for no additional consideration, additional
      warrants ("Additional Warrants") in an amount equal to an additional 50%
      of the PIPE Warrants originally issued pursuant to the terms of the 2007
      PIPE Offering. The Additional Warrants shall have the same registration
      rights as are described in the Private Placement Memorandum dated January
      12, 2007 (the "Offering Memorandum") used in connection with the 2007 PIPE
      Offering applicable to the PIPE Warrants; shall be exercisable immediately
      upon issuance; shall remain exercisable for a period of five years from
      the date of the Modification Agreement, on a cash basis only, at an
      initial exercise price of $0.45 per share; and shall, in all other
      respects, have the same terms and conditions, and be in the same form, as
      the PIPE Warrants.
 ●
                    If
      the Company does not file the Registration Statement with the SEC by
      November 30, 2007, each Investor shall receive, for no additional
      consideration, warrants ("Delay Warrants") in an amount equal to an
      additional 50% of the PIPE Warrants originally issued pursuant to the
      terms of the Offering Memorandum. The Delay Warrants shall have the same
      registration rights as are described in the Offering Memorandum applicable
      to the PIPE Warrants; shall be exercisable immediately upon issuance;
      shall remain exercisable for a period of five years from the date of this
      Agreement, on a cash basis only, at an initial exercise price of $0.45 per
      share; and shall, in all other respects, have the same terms and
      conditions, and be in the same form, as the PIPE
  Warrants.
 
 The terms
and conditions of the Offering Memorandum, the PIPE Notes and the PIPE Warrants,
to the extent not expressly amended in the Modification Agreement, remain in
full force and effect.
  The
issuance of the Additional Warrants (“Delay Warrants”), if any, and the
reduction of the Conversion Price of the PIPE Notes, has the potential to dilute
the percentage ownership interest of the Company's existing
shareholders.
  On
November 30, 2007, the Company and the Investors entered into the Second
Modification Agreement and pursuant to this agreement have agreed as
follows:
 
 ●
                    The
      Investors have agreed to forgive all accrued interest on their PIPE Notes,
      from the date of issuance thereof through December 14,
    2007.
 ●
                    On
      December 14, 2007, the Company agreed to pay all Investors 50% of the
      principal amount of their original PIPE Notes which equals a total cash
      repayment of $200,000.  Additionally, in repayment of the other
      50% of the principal amount of the original PIPE Notes, the Company, on
      December 14, 2007, agreed to issue to Investors a total of 1,060,000
      shares of the Company’s common stock (the “Conversion
      Shares”).
 ●
                    Concurrently
      with the cash payment and the issuance of the Conversion Shares as noted
      in paragraph 2 above, the Investors agreed to deliver to the Company the
      original of the PIPE Notes, which will be marked and deemed cancelled and
      of no further force or
effect.
 ●
                    In
      further consideration of the above terms and conditions, the Investors
      have agreed that the Company shall not be required to, and shall not, file
      a Registration Statement with the Securities and Exchange Commission or
      any state securities agency to register or qualify the PIPE Notes, the
      Conversion Shares, the PIPE Warrants, or any shares issuable pursuant to
      the PIPE Warrants (the Warrant Shares”).  The Conversion Shares
      and Warrant Shares when issued will be deemed restricted securities and
      bear appropriate legends.
 ●
                    The
      terms and conditions of the PIPE Warrants, to the extent not expressly
      amended in the Second Modification Agreement, shall remain in full force
      and effect in furtherance of the terms and conditions set forth in the
      Modification Agreement.
 
 Payment
of $200,000 was made by the Company in accordance with the Second Modification
Agreement, the Original Notes were surrendered by the Investors and Common Stock
in the amount of 1,060,000 shares was issued to the investors on December 27,
2007.
  2007 Spring
Offering.From
June 13, 2007 through June 26, 2007, the Company conducted a private
offering (the “Spring 2007 Offering”) of up to $550,000 aggregate face amount of
its convertible notes (the “Spring 2007 Notes”) with a small number of
accredited investors. Of this amount, $451,000 aggregate face amount of the
Spring 2007 Notes were sold for an aggregate purchase price of $410,000 net
proceeds... Therefore, while the stated interest rate on the Spring 2007 Notes
is 0%, the actual interest rate on the Spring 2007 Notes is 10%. The Spring 2007
Notes mature on the first anniversary of their date of issuance. The Spring 2007
Notes are convertible, at the option of the noteholders, 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 Spring 2007 Offering
(the “Conversion Prices”). Up to 1,210,489 Conversion Shares are initially
issuable at Conversion Prices of either $0.34 or $0.53 per share, depending upon
which of the two closing dates of the Spring 2007 Offering the Spring 2007 Notes
were sold.  The per share price of the Company’s common stock on the
Pink Sheets during this period ranged from a low bid price (intraday) of $0.35
to a high bid price (intraday) of $0.59.
  Each of
the investors in the Spring 2007 Offering received, for no additional
consideration, a warrant (the “Spring 2007 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 2007 Notes are
convertible (the “Warrant Shares”). Each Spring 2007 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 years from the date of
issuance. Up to 605,242 Warrant Shares are initially issuable on exercise of the
Spring 2007 Warrants.
  In
October and November 2007, Investors converted $110,000 of the Convertible Notes
into 265,538 shares of the Company’s Common Stock.
  33
 2007 Summer
Offering.From August 8, 2007
through September 27, 2007, the Company conducted a private offering (the
"Summer 2007 Offering") of up to $330,000 aggregate face amount of its
convertible notes (the "Summer 2007 Notes") with a small number of accredited
investors. Of this amount, $309,980 aggregate face amount of the Summer 2007
Notes were sold for an aggregate purchase price of $281,800 net proceeds. While
the stated interest rate on the Summer 2007 Notes is 0%, the actual interest
rate on the Summer 2007 Notes is 10%. The Summer 2007 Notes mature on the first
anniversary of their date of issuance... The Summer 2007 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 Summer 2007 Offering (the "Conversion Prices"). Up to
837,784 Conversion Shares are issuable at a Conversion Price of $0.37 per
share.
  Each of
the investors in the Summer 2007 Offering received, for no additional
consideration, a warrant (the "Summer 2007 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 Summer 2007 Notes are
convertible (the "Warrant Shares"). Each Summer 2007 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 418,892 Warrant Shares are
initially issuable on exercise of the Summer 2007 Warrants.
  In
November 2007, Investors converted $326,480 of the Convertible Notes into
850,711 shares of the Company’s Common Stock.
  2007 Fall
Offering.From November 14, 2007
through December 17, 2007, the Company conducted a private offering (the "Fall
2007 Offering") of up to $1,100,000 aggregate face amount of its convertible
notes (the "Fall 2007 Notes") with a small number of accredited investors. Of
this amount, $622,600 aggregate face amount of the Fall 2007 Notes were sold for
an aggregate purchase price of $566,000 net proceeds. While the stated interest
rate on the Fall 2007 Notes is 0%, the actual interest rate on the Fall 2007
Notes is 10%. The Fall 2007 Notes mature on the first anniversary of their date
of issuance... The Fall 2007 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 Fall 2007 Offering (the "Conversion Prices"). Up to 1,596,410 Conversion
Shares are issuable at a Conversion Price of $0.39 per share.
  Each of
the investors in the Fall 2007 Offering received, for no additional
consideration, a warrant (the "Fall 2007 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 (Fall 2007 Notes) are
convertible (the "Warrant Shares"). Each Fall 2007 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 796,205 Warrant Shares are
initially issuable on exercise of the Fall 2007 Warrants.
  Summary
  We have
cash on hand to meet expenses only for a short period of time.  In
order to fund the repayment of our outstanding notes, we must raise additional
funds. At December 31, 2007, these notes included the Spring 2007 Notes due in
June 2008, the Summer 2007 Notes due in September 2008 and the Fall Notes due in
December 2008.  In addition to the funds required to continue to
operate our business, including without limitation the expenses we will incur in
connection with the license and research and development agreements with Temple
University, costs associated with product development and commercialization of
the ELEKTRA technology, costs to manufacture and ship our products, costs to
design and implement an effective system of internal controls and disclosure
controls and procedures, costs of maintaining our status as a public company by
filing periodic reports with the SEC, and costs required to protect our
intellectual property. In addition, as discussed below, we have substantial
contractual commitments, including without limitation salaries to our executive
officers pursuant to employment agreements, certain severance payments to a
former officer and consulting fees, during the remainder of 2008 and
beyond.
  In light
of the Company’s financial commitments over the next several months and its
liquidity constraints, we have implemented cost reduction measures in all areas
of operations, including but not limited to personnel lay-offs, marketing and
advertising, deferral of placing orders to manufacturers of our ECO ChargR and
MAG ChargR products for sale to our existing distributors, research and
development and product development of ELEKTRA products, and certain other
expenses.  We intend to review these measures on an ongoing basis and
make additional decisions as may be required.
  We may
continue to use our equity line of credit for some of our additional
requirements for 2008.  However, even if we continued to use our
equity line of credit, it will not be sufficient to meet all of our current
liabilities and other obligations in 2008. Among other things, the thin trading
of our common stock may limit our ability to use the equity line of credit
without adversely affecting the price of our common stock. Therefore, in
addition to the completed 2007 Spring Offering, the 2007 Summer Offering
and  the 2007 Fall Offering, the Company is actively pursuing
additional financing alternatives  On December 27, 2008, the Company
began the 2008 Winter Offering (See “Item 8B., Other
Information”).  No assurance can be given that any future financing
will be available or, if available, that it will be on terms that are
satisfactory to the Company. At present, we have relatively few financing
options available to us.
  Contractual
Obligations
  The
following table discloses our contractual commitments for future periods.
Long-term commitments are comprised operating leases and minimum guaranteed
compensation payments under employment and other agreements.  See Note
12 to Notes to Consolidated Financial Statements, “Commitments and
Contingencies”.
 
 Year ending December
      31,
                  
                  Operating Leases (1)
                  
                  
                  Guaranteed Payments2008
                  
                  $
                  65,280
                  
                  
                  $
                  535,683
                  (2)2009
                  
                  
                  44,800
                  
                  
                  
                  200,000
                  (3)2010
                  
                  
                  0
                  
                  
                  
                  125,000
                  (4)Total
                  
                  $
                  110,080
                  
                  
                  $
                  860,683
  34
 (1)    Consists
of rent for our Morgan Hill Facility expiring on August 31, 2009. (For
description of this property, see Part 1, Item 2, “Property”.
 (2)  
Consists of an aggregate $120,683 in total compensation, including base salary
and certain contractually-provided benefits, to   one executive
officer, pursuant to employment agreement that expire on July 25, 2008; $415,000
in licensing and maintenance fees to Temple University.
 (3)  
Consists of license and maintenance fees due to Temple
University;
 (4)  
Consists of maintenance fees due to Temple University.
   Licensing Fees to
Temple University.For details of the licensing agreements
with Temple University, see Part I, Item 1, “Business - Our Business Strategy -
Our Technologies and Products”.
  Critical Accounting Policies and
Estimates
  Our
discussion and analysis of financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these 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 results that we report in our
consolidated 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 the Notes to the Consolidated
Financial Statements, “Summary of Significant Accounting Policies”.
  We
believe the following critical accounting policies, among others, require
significant judgments and estimates used in the preparation of our consolidated
financial statements.
  The
preparation of consolidated 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 consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Certain significant estimates were made in connection with
preparing our consolidated financial statements as described in Note 1 to Notes
to Consolidated Financial Statements. See Item 7, “Financial Statements”.
Actual results could differ from those estimates.
  Revenue
Recognition
  The
Company has adopted Staff Accounting Bulletin 104, “Revenue Recognition” and
therefore recognizes revenue based upon meeting four criteria:
 
 ●
                    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.
 
 The
Company contract manufactures fixed magnetic field products and sells them to
various original equipment manufacturers in the motor vehicle and small utility
motor markets. The Company negotiates 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, the Company recognizes the
revenue associated with the sale of the products to the
customer.  Freight charges pertaining to shipments are recorded as
General and Administrative Expense.
  Accounts
Receivable Allowance Policy
  The
Company reports accounts receivable in relation to sales of
product.  The Company performs an analysis of the receivable balances
in order to determine if an allowance for doubtful accounts is
necessary.  As of December 31, 2007, no allowance is
necessary.
  Property
and equipment and depreciation
  Property
and equipment are stated at cost. Depreciation is computed using the
straight-line method based on the estimated useful lives of the assets,
generally ranging from three to ten years. Expenditures for major renewals and
improvements that extend the useful lives of property and equipment are
capitalized. Expenditures for repairs and maintenance are charged to expense as
incurred. Leasehold improvements are amortized using the straight-line method
over the shorter of the estimated useful life of the asset or the lease
term.
 
 35
  Long-lived
assets
  The
Company accounts for the impairment and disposition of long-lived assets in
accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” In accordance with SFAS No. 144,
long-lived assets to be held are reviewed for events or changes in circumstances
that indicate that their carrying value may not be recoverable. The Company
periodically reviews the carrying values of long-lived assets to determine
whether or not impairment to such value has occurred. No impairments were
recorded for the year ended December 31, 2007.  The Company recorded
an impairment of approximately $505,000 during the period from inception
(February 18, 1998) through December 31, 2007.
  Stock-Based
Compensation
  On
January 1, 2006, the Company adopted Statements of Financial Accounting
Standards No. 123R (revised 2004), “Share-Based Payment,”
(“SFAS 123R”) which requires the measurement and recognition of
compensation expense for all share-based payment awards made to employees and
directors based on estimated fair values. SFAS 123R supersedes the
Company’s previous accounting under APB 25 for periods beginning in fiscal
2006.  In March 2005, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 107 (“SAB 107”) relating to
SFAS 123R. The Company has applied the provisions of SAB 107 in its
adoption of SFAS 123R.
  The
Company adopted SFAS 123R using the modified prospective transition method,
which requires the application of the accounting standard as of January 1,
2006, the first day of the Company’s fiscal year 2006. The Company’s
consolidated financial statements as of and for the years ended December 31,
2007 and 2006 reflect the impact of SFAS 123R. In accordance with the
modified prospective transition method, the Company’s consolidated financial
statements for prior periods have not been restated to reflect, and do not
include, the impact of SFAS 123R.  Stock-based compensation
expense recognized under SFAS 123R for employee and directors for the year ended
December 31, 2007 was $67,592.
  SFAS 123R
requires companies to estimate the fair value of share-based payment awards to
employees and directors on the date of grant using an option-pricing model. The
value of the portion of the award that is ultimately expected to vest is
recognized as expense over the requisite service periods in the Company’s
Statements of Operations. Stock-based compensation expense recognized in the
Statements of Operations for the year ended December 31, 2006 included
compensation expense for share-based payment awards granted prior to, but not
yet vested as of January 1, 2006 based on the grant date fair value estimated in
accordance with the pro-forma provisions of SFAS 123 and compensation expense
for the share-based payment awards granted subsequent to January 1, 2006 based
on the grant date fair value estimated in accordance with the provisions of SFAS
123R. For stock-based awards issued to employees and directors, stock-based
compensation is attributed to expense using the straight-line single option
method, which is consistent with how the prior-period pro formas were provided.
As stock-based compensation expense recognized in the Statements of Operations
for the second quarter of fiscal 2006 is based on awards ultimately expected to
vest, it has been reduced for estimated forfeitures. SFAS 123R requires
forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those estimates. In our
pro-forma information required under SFAS 123 for the periods prior to fiscal
2006, the Company accounted for forfeitures as they occurred.
  The
Company’s determination of fair value of share-based payment awards to employees
and directors on the date of grant using the Black-Scholes model, which is
affected by the Company’s stock price as well as assumptions regarding a number
of highly complex and subjective variables. These variables include, but are not
limited to our expected stock price volatility over the term of the awards, and
actual and projected employee stock option exercise behaviors.
  The
Company has elected to adopt the detailed method provided in SFAS 123R for
calculating the beginning balance of the additional paid-in capital pool (“APIC
pool”) related to the tax effects of employee stock-based compensation, and to
determine the subsequent impact on the APIC pool and Statements of Cash Flows of
the tax effects of employee stock-based compensation awards that are outstanding
upon adoption of SFAS 123R.
  The
Company accounts for stock option and warrant grants issued to non-employees for
goods and services using the guidance of SFAS No. 123 and Emerging Issues Task
Force (EITF) No. 96-18: “Accounting for Equity Instruments that are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services,” whereby the fair value of such option and warrant grants is
determined using the Black-Scholes option pricing model at the earlier of the
date at which the non-employee’s performance is completed or a performance
commitment is reached.
 
 Recent
Accounting Pronouncements
 
 Statement
No. 157
 
 FASB
Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements, issued in September 2006, establishes a formal framework for
measuring fair value under GAAP.  It defines and codifies the many
definitions of fair value included among various other authoritative literature,
clarifies and, in some instances, expands on the guidance for implementing fair
value measurements, and increases the level of disclosure required for fair
value measurements.  Although SFAS No. 157 applies to and amends the
provisions of existing FASB and AICPA pronouncements, it does not, of itself,
require any new fair value measurements, nor does it establish valuation
standards.  SFAS No. 157 applies to all other accounting
pronouncements requiring or permitting fair value measurements, except for; SFAS
No. 123 (R), share-based payment and related pronouncements, the practicability
exceptions to fair value determinations allowed by various other authoritative
pronouncements, and AICPA Statements of Position 97-2 and 98-9 that deal with
software revenue recognition.  This statement is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years.  The Company is
currently evaluating the effect SFAS 157 will have on its consolidated financial
position, results of operations and cash flows.
 
 36
 
 Statement
No. 159
 
 In
February 2007, the Financial Accounting Standards Board (FASB) issued FASB
Statement No. 159, “The Fair Value Option for Financial Assets and
Financial Liabilities — including an amendment of FASB Statement
No. 115” (FAS 159).FAS 159, which becomes effective for the company on
January 1, 2008, permits companies to choose to measure many financial
instruments and certain other items at fair value and report unrealized gains
and losses in earnings. Such accounting is optional and is generally to be
applied instrument by instrument. The Company does not anticipate that election,
if any, of this fair-value option will have a material effect on its
consolidated financial position, results of operations and cash
flows.
  SFAS
No. 141 (R) and SFAS No. 160
  In
December 2007, the FASB issued SFAS No. 141 (R), Business Combinations, and SFAS
No. 160, Non-controlling Interests in Consolidated Financial Statements. SFAS
No. 141 (R) requires an acquirer to measure the identifiable assets acquired,
the liabilities assumed, and any non-controlling interest in the acquiree at
their fair values on the acquisition date, with goodwill being the excess value
over the net identifiable assets acquired. SFAS No. 160 clarifies that a
non-controlling interest in a subsidiary should be reported as equity in the
consolidated financial statement. The calculation of earnings per share will
continue to be based on income amounts attributable to the parent. SFAS No. 141
(R) and SFAS No. 160 are effective for financial statements issued for fiscal
years beginning after December 15, 2008. Early adoption is prohibited. We have
not yet determined the effect on our financial statements, if any, upon adoption
of SFAS No. 141 (R) or SFAS No. 160.
 
 Item 7.Financial
Statements
 
 Our
consolidated financial statements as of and for the years ended December 31,
2007 and 2006 are presented in a separate section of this report following Item
14 and begin with the index on page F-1.
 
 Item 8.Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure
 
 None.
  Item 8A.Controls and
Procedures
 
 Evaluation
of Disclosure Controls and Procedures
 
 Our
management evaluated, with the participation of our Chief Executive Officer and
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-KSB. Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures (as
defined in Rules 13a-15(b) under the Securities Exchange Act of 1934 (the
“Exchange Act”)  are not adequate to ensure that information required
to be disclosed by us in reports that we file or submit under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified in SEC rules and forms.
 
 Management’s
Annual Report on Internal Control over Financial Reporting.
 
 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
management is responsible for establishing and maintaining adequate internal
control over financial reporting as required in Rule 13a-15(b).  In
December 2006 our Controller retired and in January 2007 our Chief Financial
Officer retired, although our former Controller still provides certain financial
consulting services for us.  We have hired an Interim Chief Financial
Officer and a full-time Controller.  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
this review during 2008 to comply with the requirements of the
SEC.  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.
  
 37
 Our
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting and
management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the SEC that permit us to provide
only Management’s report in this annual report.
  Other
than as described above, there were no changes in our internal control over
financial reporting that occurred during the period covered by this Annual
Report on Form 10-KSB that has materially affected, or is reasonably likely to
materially affect, our internal control over financial
reporting.
 
 Item 8B. Other
Information
 
 On January 30, 2008, a Company Director, Cecil B. Kyte advanced $10,000 for
operating expenses and was repaid on February 27, 2008
 
 A
Modification and Satisfaction Agreement was entered into effective as of January
31, 2008, by and among Save the World Air, Inc., Morale Orchards, LLC and
Matthews & Partners, a law firm. (See “Item 12., Certain Relationships and
Related Transactions”).
  2008
Fall Offering Note Conversions
  On March
10, 2008, 442,820 shares of the Company’s Common Stock were issued to
noteholders in the 2008 Fall Offering who converted and cancelled Convertible
Notes in the amount of $172,700 at a conversion price of $0.39 per
share.
  Stock Issued to
Consultants
  On March
10, 2008, 17,738 shares of the Company’s Common Stock were issued to Consultants
as partial payment of consulting fees.
  2008
Winter Offering
  From
December 27, 2007 to February 29, 2008  the Company conducted an
offering (the “2008 Winter Offering”) of up to $1,000,000 aggregate face amount
of its convertible notes (the “Winter 2008 Notes”) with a small number of
accredited investors.  Of this amount, $521,400 aggregate face amount
of the 2008 Winter Notes were sold for an aggregate purchase price of $474,000
net proceeds.  Therefore, while the stated interest rate on the 2008
Winter Notes is 0%, the actual interest rate on the Winter 2008 Notes is
10%.  The Winter 2008 Notes mature on the first anniversary of their
date of issuance.  The 2008 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 2008 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 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 “Warrant Shares”)  Each 2008 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 Warrant Shares are initially issuable on
exercise of the 2008 Winter Warrants.
  Resignation of
Director
  On
February 21, 2008, Joseph Helleis resigned as a Director.  Cecil B.
Kyte was appointed Chairman of the Audit Committee and Nathan Shelton was
appointed to serve on the Audit Committee to replace Mr. Helleis.
  38
 Termination
of Employment of Officer
  Effective
March 21, 2008, the employment relationship between the Company and John
Bautista, Chief Operating Officer, was terminated.
  PART III
  Item 9.
Directors and Executive Officers of Registrant
 
 ELECTION OF
DIRECTORS
 Composition of Board of
Directors
 Our
bylaws provide that the Board shall consist of between one and eight directors,
as determined by the Board from time to time. At December 31, 2007, the Board
consists of six (6) members elected by the holders of the common stock at the
Company’s Meeting of Shareholders on December 13, 2007.  Our directors
are elected by our stockholders at each annual meeting of stockholders and will
serve until their successors are elected and qualified, or until their earlier
resignation or removal. There are no family relationships among any of our
current directors or our executive officers.
  Directors
 
 The following constitute the Board of
Directors as of December 31, 2007:
   Name
                  
                  Age
                  
                  Position
                  Director
                    SinceCharles R.
      Blum
                  
                  69
                  
                  President, Chief
      Executive Officer, Director
                  2007Steven
      Bolio
                  
                  62
                  
                  Director
                  2007Joseph Helleis (1)
      (2)
                  
                  69
                  
                  Director
                  2002Cecil B. Kyte (1)
      (3)
                  
                  36
                  
                  Chairman,
      Director
                  2006John F. Price PhD
      (1) (2) (3)
                  
                  63
                  
                  Director
                  2002Nathan
      Shelton
                  
                  60
                  
                  Director
                  2007
 
 (1)   Member
of the Audit Committee
 (2)   Member
of the Compensation Committee
 (3)   Member
of the Nominating and Corporate Governance Committee
 
 Biographical Information Regarding
Directors
 
 Charles R.
Blum was appointed on July 25, 2007 to the Board of directors and engaged
as the President and Chief Executive Officer of the Company. Mr. Blum spent 22
years as the President/CEO of the Specialty Equipment Market Association
(SEMA).  SEMA is a trade group representing 6500 business members who
are actively engaged in the manufacture and distribution of automotive parts and
accessories. SEMA produces the world’s largest automotive aftermarket Trade Show
which is held annually in Las Vegas, Nevada. Mr. Blum led the association as its
members grew from a handful of small entrepreneurial companies into an industry
membership that sells over 31 billion dollars of product at the retail level
annually. Mr. Blum has a proven record of accomplishment as a senior executive
and brings a broad knowledge of the automotive aftermarket to the
Company.  Mr. Blum attended Rutgers University.
  Steven
Bolio was appointed to the Board of Directors on February 12,
2007.  Mr. Bolio has held prominent positions with a number of
businesses in the automotive specialty equipment industry spanning a forty-five
year successful career with experience in retail, wholesale, product development
and manufacturing.  For the past 18 years, Mr. Bolio is a partner in
the firm of Scafidi-Bolio & Associates, a manufacturing representative group
serving the automotive aftermarket industry. He served 6 years on the
Specialty Equipment Market Association (SEMA) Board of Directors as well as on
multiple SEMA committees.  In 2006 he was elected to the SEMA “Hall of
Fame.”  Mr. Bolio attended Bentley College.
  Joseph
Helleishas
served as a director since May 2002 and as our Chairman of the Board since
December 2005, succeeding the late Edward L. Masry. Since 2002, he has been
operating his own financial services consulting firm, Joseph Helleis and
Associates. From 2000 to 2002, he was President/ Chief Executive Officer with
Bank of Whittier, California. From 1981 to 2000, he served in senior executive
capacities as Chairman/ CEO, President/ CEO, and Chief Credit Officer with a
number of financial institutions in the southern California region. After his
honorable discharge from the United States Navy in 1960, Mr. Helleis served
with Citibank in New York City until 1981 where his last position was Vice
President/ Senior Credit Officer for the New York State Business Banking Region.
Mr. Helleis has an AA degree from the National  Institute of
Credit.  Mr. Helleis resigned as a Director on February 22,
2008.
  Cecil Bond
Kyte,recently
appointed in December 2007 and currently serving as Chairman of the Board, has
served as a director since February 21, 2006. For the past twenty years Mr. Kyte
has been a pilot in various capacities and flight academy
instructor.  From February 2000 to November 2002, Mr. Kyte was
employed by United States regional carrier, Chautauqua Airways, including
service as an airline Captain.  After retiring in December 2002, Mr.
Kyte has been an investor in a number of businesses, including oil and gas and
financial business consulting services.  He is a co-founder of
SwissGuard International, GmbH, a financial consulting firm based in Zurich,
Switzerland.  A recent auto-racing achievement, Mr. Kyte won the 2006
SCCA ITA Regional Championship and also “Rookie of the Year”
award.  Mr., Kyte received a B.S. Degree in Accounting from Long Beach
State University.
  39
 John F. Price,
Ph.D.,has
served as a director since May 2002. He co-founded and has served as Chairman of
the Board of Conscious Investing Pty Ltd., located in Sydney, Australia, a
software company, since May 2001. In June 1998, Mr. Price founded Price
Value, Inc., located in Sydney, Australia, a software company to market software
that he developed. He has served as Chairman of the Board of Price Value, Inc.,
located in Sydney, Australia since 1998. Since October 1997, Mr. Price has
held various teaching positions in mathematics and physics at University of New
South Wales, located in Sydney, Australia. From 1990 to 1998, he was professor
and head of the Mathematics Department at Maharishi University of Management
located in Sydney, Australia. Mr. Price received a B.Sc. and M.Sc. from the
University of Melbourne and a Ph.D. from the Australian National
University.
  Nathan
Shelton has served as our director since February 12, 2007. Mr. Shelton
has a long and distinguished career with a number of diverse successful
companies primarily related to the automotive industry, holding prominent
positions.  In 1987 he joined K&N Engineering as President and
part owner and built the company into an industry leader.  In 2002 he
sold his interest in K&N Engineering and founded S&S Marketing, which is
engaged in the automotive aftermarket parts rep business, which he currently
operates. Mr. Shelton is the recipient of numerous industry related prestigious
awards and in 1992, Specialty Equipment Market Association (SEMA) invited him to
join its board of directors, which includes serving in capacity as its Chairman
from 2002 to 2004.  In 2007 he was elected to the SEMA “Hall of
Fame”.  Mr. Shelton served honorably in the United States Seabees from
1968 to 1972.  He attended Chaffey Junior College.
 
 Executive
Officers
 The
following table sets forth certain information regarding our executive officers
as of December 31, 2007:
 Name
                    
                    Age
                    
                    PositionCharles R.
      Blum
                    
                    69
                    
                    President and Chief
      Executive OfficerJohn Bautista
      (1)
                    
                    48
                    
                    Executive Vice
      President and Chief Operating OfficerEugene E. Eichler
      (2)
                    
                    81
                    
                    Interim Chief
      Financial Officer
 (1)     Mr.
Bautista’s employment relationship with the company was terminated on March 31,
2008.
  (2)     Mr.
Charles Dargan resigned as the Company’s Chief Financial Officer effective
November 5, 2007.  Mr. Eichler will continue to serve as Interim Chief
Financial Officer until a replacement is appointed.
  For
the biography of Charles R. Blum, please see above under “Biographical
Information Regarding Directors.”
  John
Bautista has served as our Executive Vice President and Chief Operating
Officer since February 2006 and served as our Vice President of Operations from
July 2005 through February 2006. He previously served as a consultant to our
company from April 2005 to June 2005. From June 2003 to June 2005, Mr., Bautista
was President and CEO of JDAK Enterprise, Inc., a company engaged in
international importing, distribution and brokerage of motorcycle parts, as well
as the production and assembly of custom motorcycles. From January 1999 through
May 2003, Mr. Bautista was Mechanical Service and Calibration Department Manager
for Mechanical Environmental Systems Analysis and Adjustment Agency. Mr.
Bautista has technical knowledge and experience with ISO certified programs
under Department of Defense, Department of Energy and Environmental Protection
Agency regulations.
  Eugene E.
Eichler, CPA, is currently our Interim Chief Financial
Officer.   The Company intends to obtain a Chief Financial
Officer on a permanent basis to replace Mr. Eichler once a suitable replacement
is available. He served as our Chief Executive Officer from October 2005 until
November 2006, at which time he separated from the company due to medical
disability. He served as our Chief Financial Officer since May 2002 until
November 2006 and has been a director since May 2002. Mr. Eichler served as our
President from March 2004 to October 2005 and as our Chief Operating Officer
from October 2001 to March 2004. Mr. Eichler was the Chief Financial Officer and
Firm Administrator of the law firm Masry & Vititoe from 1982 to October
2001. From 1974 to 1982, Mr. Eichler provided financial consulting services to
Foundation for HMO’s, Acne Care Medical Clinics and Earth Foods, Inc. From 1960
to 1974, Mr. Eichler headed financial consulting services for Milburn Industries
and Brown, Eichler & Company. From 1953 to 1960, he held the position of
Chief Budgets and Forecasts at North American Aviation. From 1951 to 1953, Mr.
Eichler held various audit positions at the Atomic Energy Commission. Mr.
Eichler received a B.A. from University of Montana.
  Charles K.
Dargan, II became our Chief Financial Officer in January
2007.  As noted above, Mr. Dargan resigned as the Company’s Chief
Financial Officer effective November 5, 2007.  Since January 2003, he
served as founder and principal of CFO911, a provider of operational and
managerial expertise, specifically in accounting and finance, to middle market
companies.  From March 2000 to January 2003, Mr. Dargan was the Chief
Financial Officer of Semotus Solutions, Inc., an American Stock Exchange-listed
wireless mobility software company.  Mr. Dargan also serves as
director of 411 Web Directory, Inc., InterSearch Group, Inc. and Anchor Audio,
Inc.  He received his B.A. degree in Government from Dartmouth
College, and his M.B.A. degree and M.S.B.A. degree in Finance from the
University of Southern California.
 
 40
 
 Code of Business
Conduct.
 
 CORPORATE
GOVERNANCE
 We
maintain a corporate governance page on our corporate website at www.stwa.com,
which includes information regarding the Company’s corporate governance
practices. Our codes of business conduct and ethics, Board committee charters
and certain other corporate governance documents and policies and code of
business conduct will be posted on our website. In addition, we will provide a
copy of any of these documents without charge to any stockholder upon written
request made to Corporate Secretary, Save the World Air, Inc., 235 Tennant
Avenue, Morgan Hill, California 95037.  The information on our website
is not, and shall not be deemed to be, a part of this proxy statement or
incorporated by reference into this or any other filing we make with the
Securities and Exchange Commission (the “SEC”).
 
 Board of
Directors
  Director
Independence
  Our Board
of Directors currently consists of six (5) members. The Board has affirmatively
determined that Messrs. Price, Kyte, Shelton and Bolio are independent
directors.  Mr. Blum, our President and Chief Executive Officer is not
considered independent.
  Meetings of the
Board
  The Board
held seven (7) meetings and acted by written consent one (1) time during 2007
and seven (7) meetings and acted by written consent three (3) times in 2006.
Each of the directorsattended 75% or more of
the aggregate number of meetings of the Board and Committees on which the
director served in 2007 and 2006.
  Each of
our directors is encouraged to attend the Company’s 2008 Annual Meeting and to
be available to answer any questions posed by stockholders to such director.
Because our Board holds one of its regular meetings in conjunction with our
Annual Meeting of stockholders, we anticipate that all of the members of the
Board will be present for the 2008 Annual Meeting.
  Communications with the
Board
  The
following procedures have been established by the Board in order to facilitate
communications between our stockholders and the Board:
  •
                  
                  Stockholders
      may send correspondence, which should indicate that the sender is a
      stockholder, to the Board or to any individual director, by mail to
      Corporate Secretary, Save the World Air, Inc., 235 Tennant Avenue, Morgan
      Hill, California 95037 or by e-mail to questions@stwa.com.•
                  
                  Our
      Secretary will be responsible for the first review and logging of this
      correspondence and will forward the communication to the director or
      directors to whom it is addressed unless it is a type of correspondence
      which the Board has identified as correspondence which may be retained in
      our files and not sent to directors. The Board has authorized the
      Secretary to retain and not send to directors communications that:
      (a) are advertising or promotional in nature (offering goods or
      services), (b) solely relate to complaints by customers with respect
      to ordinary course of business customer service and satisfaction issues or
      (c) clearly are unrelated to our business, industry, management or
      Board or committee matters. These types of communications will be logged
      and filed but not circulated to directors. Except as set forth in the
      preceding sentence, the Secretary will not screen communications sent to
      directors.•
                  
                  The
      log of stockholder correspondence will be available to members of the
      Board for inspection. At least once each year, the Secretary will provide
      to the Board a summary of the communications received from stockholders,
      including the communications not sent to directors in accordance with the
      procedures set forth above.
 Our
stockholders may also communicate directly with the non-management directors,
individually or as a group, by mail c/o Corporate Secretary, Save the World
Air, Inc., 235 Tennant Avenue, Morgan Hill, California 95037 or by e-mail to
questions@stwa.com.
  The Audit
Committee has established procedures, as outlined in the Company’s policy for
“Procedures for
Accounting and Auditing Matters”,for the receipt,
retention and treatment of complaints regarding questionable accounting,
internal controls, and financial improprieties or auditing matters. Any of the
Company’s employees may confidentially communicate concerns about any of these
matters by calling our toll-free number, (877) 487-0200. Upon receipt of a
complaint or concern, a determination will be made whether it pertains to
accounting, internal controls or auditing matters and if it does, it will be
handled in accordance with the procedures established by the Audit Committee.
 Committees of the
Board
 The Board
has a standing Audit Committee, Compensation Committee, and Nominating and
Corporate Governance Committee. Each of these committees operates under a
written charter. Copies of these charters, and other corporate governance
documents, are available on our website, www.stwa.com In
addition, we will provide a copy of any of these documents without charge to any
stockholder upon written request made to Corporate Secretary, Save the World
Air, Inc., 235 Tennant Avenue, Morgan Hill, California 95037.1.
  The
composition, functions and general responsibilities of each committee are
summarized below.
  41
 Audit Committee
  The Audit
Committee currently consists of Messrs. Kyte (chairperson), Price and
Shelton. The Board has determined that Mr. Kyte is an audit committee
financial expert, and is independent within the meaning of Item 407 of
Regulation S-B promulgated by the SEC.  The Board also believes that
Messrs. Price and Shelton meet the independence and knowledge requirements of
NASDAQ as currently in effect.  The Audit Committee held a total of
five (5) meetings during 2007 and a total of seven (7) meetings during
2006.
  The Audit
Committee operates under a written charter. The Audit Committee’s duties include
responsibility for reviewing our accounting practices and audit procedures. In
addition, the Audit Committee has responsibility for reviewing complaints about,
and investigating allegations of, financial impropriety or misconduct. The Audit
Committee works closely with management and our independent auditors. The Audit
Committee also meets with our independent auditors on a quarterly basis,
following completion of their quarterly reviews and annual audit, to review the
results of their work. The Audit Committee also meets with our independent
auditors to approve the annual scope of the audit services to be
performed.
  As part
of its responsibility, the Audit Committee is responsible for engaging our
independent auditor, as well as pre-approving audit and non-audit services
performed by our independent auditor in order to assure that the provision of
such services does not impair the independent auditor’s
independence.
  Please
see “Audit Committee Report” below, which provides further details of many of
the duties and responsibilities of the Audit Committee.
  Compensation Committee, Compensation
Committee Interlocks and Insider Participation
  The
Compensation Committee currently consists of Messrs. Price (chairperson)
and Shelton. The Board believes that Messrs. Price and Shelton meet the
independence requirements of NASDAQ as currently in effect. None of our
executive officers served on the compensation committee of another entity or on
any other committee of the board of directors of another entity performing
similar functions during 2007. The Compensation Committee held four (4) meetings
during 2007 and held three meetings during 2006.
  The
Compensation Committee operates under a written charter. The Compensation
Committee establishes the compensation and benefits of our executive officers.
The Compensation Committee also administers our employee benefit plans,
including our 2004 Plan.
  Please
see “Compensation Committee Report” below, which details the Compensation
Committee’s report on our executive compensation for 2007.
  Nominating and Corporate Governance
Committee
  The
Nominating and Corporate Governance Committee currently consists of
Messrs. Price (chairperson), Kyteand Bolio.The Board believes that
Messrs. Price, Kyte and Bolio meet the independence requirements of NASDAQ
as currently in effect. The Nominating and Corporate Governance Committee held
seven (7) meetings during 2007 and held seven (7) meetings during
2006.
  The
Nominating and Corporate Governance Committee operates under a written charter.
The Nominating and Corporate Governance Committee has the primary responsibility
for overseeing the Company’s corporate governance compliance practices, as well
as supervising the affairs of the Company as they relate to the nomination of
directors. The principal ongoing functions of the Nominating and Corporate
Governance Committee include developing criteria for selecting new directors,
establishing and monitoring procedures for the receipt and consideration of
director nominations by stockholders and others, considering and examining
director candidates, developing and recommending corporate governance principles
for the Company and monitoring the Company’s compliance with these principles
and establishing and monitoring procedures for the receipt of stockholder
communications directed to the Board.
  The
Nominating and Corporate Governance Committee is also responsible for conducting
an annual evaluation of the Board to determine whether the Board and its
committees are functioning effectively. In performing this evaluation, the
Nominating and Corporate Governance Committee receives comments from all
directors and reports annually to the Board with the results of this
evaluation.
 Director
Nominations
 The
Nominating and Corporate Governance Committee seeks out appropriate candidates
to serve as directors of the Company, and the Nominating and Corporate
Governance Committee interviews and examines director candidates and makes
recommendations to the Board regarding candidate selection. In considering
candidates to serve as director, the Nominating and Corporate Governance
Committee evaluates various minimum individual qualifications, including
strength of character, maturity of judgment, relevant technical skills or
financial acumen, diversity of viewpoint and industry knowledge, as well as the
extent to which the candidate would fill a present need on the
Board.
  The
Nominating and Corporate Governance Committee will consider, without commitment,
stockholder nominations for director. Nominations for director submitted to this
committee by stockholders are evaluated according to the Company’s overall needs
and the nominee’s knowledge, experience and background. A nominating stockholder
must give appropriate notice to the Company of the nomination not less than
90 days prior to the first anniversary of the preceding year’s annual
meeting. In the event that the date of the annual meeting is advanced by more
than 30 days or delayed by more than 60 days from the anniversary date
of the preceding year’s annual meeting, the notice by the stockholder must be
delivered not later than the close of business on the later of the 60th day
prior to such annual meeting or the tenth day following the day on which public
announcement of the date of such annual meeting is first made.
  The
stockholders’ notice shall set forth, as to:
 •
                      each
      person whom the stockholder proposes to nominate for election as a
      director:•
                      the
      name, age, business address and residence address of such
      person,•
                      the
      principal occupation or employment of the
  person,
  42
  •
                      the
      class and number of shares of the Company which are beneficially owned by
      such person, if any, and•
                      any
      other information relating to such person which is required to be
      disclosed in solicitations for proxies for election of directors pursuant
      to Regulation 14A under the Exchange Act and the rules
      hereunder; and the stockholder giving the
  notice•
                      the
      name and record address of the stockholder and the class and number of
      shares of the Company which are beneficially owned by the
      stockholder,•
                      a
      description of all arrangements or understandings between such stockholder
      and each proposed nominee and any other person or persons (including their
      names) pursuant to which nomination(s) are to be made by such
      stockholder,•
                      a
      representation that such stockholder intends to appear in person or by
      proxy at the meeting to nominate the persons named in its
      notice,•
                      any
      other information relating to such person which is required to be
      disclosed in solicitations for proxies for election of directors pursuant
      to Regulation 14A under the Exchange Act and the rules
      thereunder.
 The
notice must be accompanied by a written consent of the proposed nominee to be
named as a director.
  We have
adopted codes of business conduct and ethics for our directors, officers and
employees which also meet the requirements of a code of ethics under Item 406 of
Regulation S-B.  You can access the Company’s Code of Business Conduct
and Ethics and our Code of Ethics for Senior Executives and Financial Officers
on the Corporate Governance page of the Company’s website at www.stwa.com.  Any
shareholder who so requests may obtain a printed copy of the Code of Conduct by
submitting a request to the Company’s Corporate Secretary.
 Item 10.Executive
Compensation
  EXECUTIVE
COMPENSATION
  fiscal
years by the Named Executive Officers:
  Summary
Compensation Table
   Long-Term
      Compensation AwardsSecurities
                  
                  
                  AllFiscal
                  
                  AnnualCompensation
                  
                  
                  RestrictedStock
      Awards
                  
                  
                  Underlying
                    Options
                  
                  
                  Other
      CompensationName and Principal Position
                  Year
                  
                  Salary ($)
                  
                  
                  ($)
                  
                  
                  (#)
                  
                  
                  ($)Blum,
      Charles, R. (1) Chief Executive Officer
                  2007
                  
                  $
                  200,000
                  
                  
                  $
                  0
                  
                  
                  
                  188,679
                  
                  
                  $
                  0Eugene
      E. Eichler (2) Chief Executive Officer and
                  2007
                  
                  $
                  0
                  
                  
                  $
                  0
                  
                  
                  
                  0
                  
                  
                  $
                  0Chief
      Financial Officer
                  2006
                  
                  $
                  300,000
                  
                  
                  $
                  0
                  
                  
                  
                  409,171
                  
                  
                  $
                  02005
                  
                  $
                  240,000
                  
                  
                  $
                  0
                  
                  
                  
                  424,000
                  
                  
                  $
                  0Bruce
      H. McKinnon (3) Chief Executive Officer and
                  2007
                  
                  $
                  240,000
                  
                  
                  $
                  0
                  
                  
                  
                  0
                  
                  
                  $
                  0Chief
      Operating Officer
                  2006
                  
                  $
                  240,000
                  
                  
                  $
                  0
                  
                  
                  
                  409,171
                  
                  
                  $
                  02005
                  
                  $
                  192,000
                  
                  
                  $
                  0
                  
                  
                  
                  350,000
                  
                  
                  $
                  0John
      Bautista (4)
                  2007
                  
                  $
                  175,000
                  
                  
                  $
                  0
                  
                  
                  
                  0
                  
                  
                  $
                  0Chief
      Operating Officer
                  2006
                  
                  $
                  170,833
                  
                  
                  $
                  0
                  
                  
                  
                  209,171
                  
                  
                  $
                  0
  (1)
                  Mr.
      Blum was appointed Chief Executive Officer in July 2007.  See
      “Employment Agreements” below.(2)
                  Mr. Eichler
      was appointed Chief Operating Officer, Chief Financial Officer and
      Treasurer in October 2001. In March 2004, Mr. Eichler relinquished
      his position as Chief Operating Officer, and was appointed President of
      the Company, a position he held until November 2005, when he assumed the
      position of Chief Executive Officer, and he continued to serve as Chief
      Financial Officer.  On November 20, 2006, Mr. Eichler resigned,
      due to disability, the position of Chief Executive Officer and on January
      5, 2007 he resigned as Chief Financial Officer.  On October 18,
      2007, Mr. Eichler was appointed Interim Chief Financial
      Officer.  Mr. Eichler has been working full time for the Company
      since June 15, 2007 without cash compensation.  In lieu of cash
      compensation for his past and future services as Interim Chief Financial
      Officer, the Board extended the expiration date of Mr. Eichler’s options
      to November 20, 2008. (See “Employment Agreements”
      below).(3)
                  Mr. McKinnon
      was appointed Executive Vice President of Business Development in October
      2001. In March 2004, Mr. McKinnon was appointed Chief Operating
      Officer of the Company, a position he held until October 2005, when he
      assumed the position of President.   On November 20, 2006,
      Mr. McKinnon was appointed Chief Executive Officer and he continued to
      serve as President. On July 18, 2007, Mr. McKinnon was removed as Chief
      Executive Officer and President.  See “Employment Agreements”
      below.
  43
  (4)
                  Mr.
      Bautista was appointed Vice President of Operations in July
      2005.  In February 2006, Mr. Bautista was appointed Executive
      Vice President and Chief Operating Officer. Mr. Bautista agreed to reduce
      his salary to half on October 1, 2007. (See “Employment Agreements”
      below).(5)
                  The
      number and value of vested restricted stock based upon the closing market
      price of the common stock at December 30, 20067 ($0.31) were as
      follows: Mr. Eichler, 571,429 vested shares valued at $177,143;
      Mr. McKinnon, 435,714 vested shares valued at $135,071and Mr.
      Bautista 85,714 vested shares
  valued  $26,571.
  A
substantial portion of the salaries identified above have been deferred and will
be paid subject to the Company’s future financial and cash
position.
  OPTION
GRANTS IN LAST FISCAL YEAR
 The following table sets forth
information concerning the stock option grants made to each of the Named
Executive Officers during the 2007 fiscal year. No stock appreciation rights
were granted to any of the Named Executive Officers during the 2007 fiscal
year.
 
 Individual
      GrantsNumber
      of
                  
                  
                  Percent
      ofSecurities
                  
                  
                  Total
      OptionsUnderlying
                  
                  
                  Granted
      to
                  
                  Exercise
      orOptions
                  
                  
                  Employees
      in
                  
                  Base
      Price
                  
                  ExpirationName
                  
                  Granted
                  
                  
                  Fiscal 2007
                  
                  Per Share
                  
                  DateCharles
      R. Blum
                  
                  
                  188,679
                  
                  
                  
                  100%
                  
                  $
      .53
                  
                  
                  07/18/17
 AGGREGATED OPTION EXERCISES IN LAST
FISCAL YEAR
 AND YEAR-END OPTION
VALUES
 No
options were exercised by any of the Named Executive Officers during the 2007
fiscal year... The following table sets forth the number of shares of our common
stock subject to exercisable and unexercisable stock options which the Named
Executive Officers held at the end of the 2007 fiscal year.
 
 Number
      of SecuritiesUnderlying
      UnexercisedOptions
      at
                  
                  
                  Value
      of UnexercisedShares
                  
                  
                  Value
                  
                  Fiscal
      Year-End (#)
                  
                  
                  In-the-Money
      Options ($)(1)Acquired
      on
                  
                  
                  RealizedName
                  
                  Exercise
      (#)
                  
                  
                  ($)
                  
                  Exercisable
                  
                  
                  Unexercisable
                  
                  
                  Exercisable
                  
                  
                  UnexercisableCharles
      R. Blum
                  
                  
                  
                  
                  
                  $
                  ---
                  
                  
                  
                  0
                  
                  
                  
                  188,679Eugene
      E. Eichler
                  
                  
                  ---
                  
                  
                  $
                  ---
                  
                  
                  
                  1,371,127
                  
                  
                  
                  0
                  
                  
                  $
                  0
                  
                  
                  $
                  0John
      Bautista
                  
                  
                  
                  
                  
                  $
                  ---
                  
                  
                  
                  309,171
                  
                  
                  
                  0
                  
                  
                  $
                  0
                  
                  
                  $
                  0
 
 (1)
                  Market
      value of our common stock at fiscal year-end minus the exercise price. The
      closing price of our common stock on December 31, 2007 the last
      trading day of the year was $0.31 per
  share.
  44




EQUITY COMPENSATION PLAN INFORMATION
FOR 2007
 The following table sets forth information regarding outstanding options and
shares reserved for future issuance under our equity compensation plans as of
December 31, 2007:
 Number
      of SecuritiesRemaining
      Availablefor
      Future IssuanceNumber
      of Securities
              
              
              
              
              Under
      Equityto
      be Issued upon
              
              
              Weighted-Average
              
              
              Compensation
      PlansExercise
      of
              
              
              Exercise
      Price of
              
              
              (Excluding
      SecuritiesOutstanding
      Options,
              
              
              Outstanding
      Options,
              
              
              Reflected
      in thePlan
      Category
              
              Warrants
      and Rights
              
              
              Warrants
      and Rights
              
              
              First
      Column)Equity
      compensation plans approved by security holders
              
              
              3,938,455
              
              
              $
              .97
              
              
              
              3,061,545Equity
      compensation plans not approved by security holders
              
              
              250,000
              
              
              $
              .40
              
              
              
              N/ATotal
              
              
              4,188,455
              
              
              $
              .95
              
              
              
              N/A
 
 EMPLOYMENT
AGREEMENTS
 Agreement with
Eugene E. Eichler. On December 1, 2003,
the Company entered into an employment agreement with Eugene E. Eichler,
pursuant to which he originally served as our Chief Operating Officer. Effective
March 2, 2004, Mr. Eichler has served as our President and Chief
Financial Officer and his employment agreement was amended accordingly. The
initial term of the agreement expires on December 31, 2007 and renews
automatically for additional one-year terms unless either party has given notice
of non-extension prior to the end of a term. Under the agreement, as amended,
Mr. Eichler was paid base compensation of $192,000 per annum through
March 1, 2004 and $240,000 per annum effective March 2,
2004.  On October 5, 2005, Mr. Eichler resigned as President and was
appointed Chief Executive Officer at a base compensation of $300,000 per annum
through December 2007.The base compensation is reviewable by the Board in
subsequent years of the term. Mr. Eichler is also eligible to participate
in the Company’s incentive and benefit plans, including eligibility to receive
grants of stock options under the 2004 Plan.
 If
Mr. Eichler’s employment is terminated by us without cause or as a result
of his disability or death, he or his estate, as the case may be, will be
entitled to receive an amount equal to the greater of (i) his highest base
compensation paid to him with respect to one of the two years immediately
preceding the year in which the termination occurs or (ii) his base
compensation in effect immediately prior to the date of termination, for a
period of one year beginning on the date of termination. In addition, he will be
entitled to receive an amount equal to the greater of the aggregate bonus(es),
if any, paid to him with respect to one of the two years immediately preceding
the year in which the termination occurs. Mr. Eichler and his dependents
will be entitled to continue to participate at the same levels in the Company’s
benefit plans for a period of one year.
  On
November 9, 2006, Mr. Eichler and the Company executed a Separation Agreement
whereby on November 20, 2006 Mr. Eichler resigned as Chief Executive Officer and
as Chief Financial Officer effective upon the appointment of his successor, but
in no event later than January 31, 2007.  His resignations were due to
medical disability. Under the terms of the Separation Agreement, Mr. Eichler
shall be paid cash compensation at the rate of Three Hundred Thousand Dollars
($300,000) per annum, for the period commencing November 20, 2006 and continuing
thereafter to and including December 31, 2007.  All stock options
heretofore granted to Mr. Eichler for services rendered shall be accelerated and
shall become fully vested on November 20, 2006 and may be exercised at any time
until November 20, 2007, after which time any unexercised options shall be
cancelled.  Mr. Eichler is also eligible to participate in the
Company’s incentive and benefit plans, including eligibility to receive grants
of stock options under the 2004 Plan.  Mr. Eichler received cash
payments through January 2007 and no further payments after that
date.
  Mr.
Eichler has been working full time for the Company since June 15, 2007 without
cash compensation.  Mr. Eichler was appointed Interim Chief Financial
Officer to replace Charles Dargan who resigned on November 5,
2007.  In lieu of cash compensation for his past and future services
as Interim Chief Financial Officer, the Board extended the expiration date of
Mr. Eichler’s options to November 20, 2008.
  Agreement with
Bruce H. McKinnon. On December 1, 2003, the Company entered into an
employment agreement with Bruce H. McKinnon, pursuant to which he originally
served as our Executive Vice President of Business Development. Effective
March 2, 2004, Mr. McKinnon has served as our Chief Operating Officer
and his employment agreement was amended accordingly. The initial term of the
agreement expires on December 31, 2007 and renews automatically for
additional one-year terms unless either party has given notice of non-extension
prior to the end of a term. Under the agreement, as amended, Mr. McKinnon
was paid base compensation of $153,600 per annum through March 1, 2004
and $192,000 per annum effective March 2, 2004. On October 5, 2005,
Mr. McKinnon resigned as Chief Operating Officer and was appointed President at
a base compensation of $240,000 per annum.  The base compensation is
reviewable by the Board in subsequent years of the term. Mr. McKinnon is
also eligible to participate in the Company’s incentive and benefit plans,
including eligibility to receive grants of stock options under the 2004
Plan.
  45
 If
Mr. McKinnon’s employment is terminated by us without cause or as a result
of his disability or death, he, or his estate as the case may be, will be
entitled to receive an amount equal to the greater of (i) his highest base
compensation paid to him with respect to one of the two years immediately
preceding the year in which the termination occurs or (ii) his base
compensation in effect immediately prior to the date of termination, for a
period of one year beginning on the date of termination. In addition, he will be
entitled to receive an amount equal to the greater of the aggregate bonus(es),
if any, paid to him with respect to one of the two years immediately preceding
the year in which the termination occurs. Mr. McKinnon and his dependents
will be entitled to continue to participate at the same levels in the Company’s
benefit plans for a period of one year.
  On
November 20, 2006, Mr. McKinnon was appointed Chief Executive Officer at no
change in salary for the remaining term of his employment contract.
  On June
14, 2007, the Company and Mr. McKinnon agreed that Mr. McKinnon would resign as
Chief Executive Officer of the Company effective upon the appointment of a new
Chief Executive Officer which occurred on July 25, 2007.  Mr. McKinnon
will continue to serve as President of the Company and receive the compensation
provided for in accordance with the provisions of the Employment Agreement
between Mr. McKinnon and the Company dated October 5, 2005 through December 31,
2007. Mr. McKinnon’s compensation shall remain unchanged for the period
commencing hereof and continuing thereafter to and including December 31,
2007.  All compensation under the Employment Agreement that has been
accrued but is, as of the data of this Agreement unpaid, shall be paid to
McKinnon as soon as reasonably practicable, but in no event shall such sums be
paid later than August 31, 2007.  Mr. McKinnon will continue to serve
as a Director of the Company until he is replaced at the Company’s 2007 Annual
Meeting.  Mr. McKinnon has not been paid any compensation since
January 2007.
  On July
18, 2007, Mr. McKinnon was removed as President of the Company.
  Agreement with
John Bautista. On July 1, 2005, the Company entered into an
employment agreement with John Bautista. pursuant to which he originally served
as our Vice President of Operations.  The term of his agreement
expires on June 30, 2006 and renews automatically for additional one-year terms
unless either party has given notice of non-extension prior to the end of a
term.  The agreement provides for base compensation of
$120,000.  On February 1, 2006, Mr. Bautista was appointed Executive
Vice President and Chief Operating Officer at a base compensation of
$200,000.  The base compensation is reviewable by the Board in
subsequent years of the term.  Mr. Bautista is also eligible to
participate in the Company’s incentive and benefit plans, including eligibility
to receive grants of stock options under the 2004 Plan.
  If
Mr. Bautista’s employment is terminated by us without cause or as a result
of his disability or death, he, or his estate as the case may be, will be
entitled to receive an amount equal to the greater of (i) his highest base
compensation paid to him with respect to one of the two years immediately
preceding the year in which the termination occurs or (ii) his base
compensation in effect immediately prior to the date of termination, for a
period of one year beginning on the date of termination. In addition, he will be
entitled to receive an amount equal to the greater of the aggregate bonus(as),
if any, paid to him with respect to one of the two years immediately preceding
the year in which the termination occurs. Mr. Bautista and his dependents
will be entitled to continue to participate at the same levels in the Company’s
benefit plans for a period of one year.
  On
December 28, 2007, Mr. Bautista notified the Company that he did not wish to
renew his contract beyond December 31, 2007 and he would continue his employment
without a contract.  Effective March 21, 2008, the employment
relationship between the Company and Mr. Bautista, Chief Operating Officer, was
terminated.
  Agreement with
Charles R. Blum.On July 18, 2007, the Company entered into an employment
agreement with Charles R. Blum, pursuant to which se serves as our President and
Chief Executive Officer.  The initial term of the agreement became
effective on July 25, 2007 and expires on July 25, 2008 and renews automatically
for addition one-year periods unless either party has given notice of
non-extension prior to April 30, 2008.  The agreement provides for a
base compensation of $200,000 per year.  Mr. Blum is eligible to
participate in the Company’s incentive and benefit plans, including eligibility
to receive grants of stock options under the 2004 plan.
  Mr. Blum
shall be eligible to receive an annual cash bonus in an amount equal to 2% of
the Company’s net profit, if any, for its most recently completed fiscal year,
computed in accordance with generally accepted accounting principles applied
consistently with prior periods.  The Bonus shall be payable, if at
all, on the anniversary date of employment each year of the term; provided that
no bonus shall be paid if the Executive is not, on such payment date, in the
employ of the Company.
  Mr. Blum
shall also receive (i) an option (the “Initial Option”) to purchase 188,679
shares (the “Initial Option Shares”) of the Company’s common
stock.  The Initial Option shall be an incentive stock option, shall
be exercisable at $0.53 per share, shall be exercisable for ten years from the
date of grant and shall vest on the first anniversary of the Effective Date; and
(ii) an option (the “Supplemental Option”) to purchase a number of shares (the
“Supplemental Option Shares”) of the Company’s common stock equal to the result
of (A) 100,000 divided by (B) the closing price per share of the Company’s
Common Stock on the first anniversary of the Effective Date.  The
Supplemental Option shall be an incentive stock option, shall be exercisable at
the closing price per share on the first anniversary of the Effective Date,
shall be exercisable for ten years from the date of grant and shall vest on the
second anniversary of the Effective Date.
 
 Termination
of Mr. Blum’s contract will terminate upon his death or disability and may be
terminated by the Company with or without cause and may be voluntarily
terminated by Mr. Blum.  Termination of Mr. Blum’s employment for any
reason shall be effective upon the Date of Termination and he shall only be
entitled to receive the compensation accrued through the Date of
Termination.  In the event of Involuntary Termination, involving
merger, consolidation or sale or disposition of all of the Company’s assets, Mr.
Blum shall be entitled to receive (i) all compensation that has accrued through
the date of termination, plus, (ii) a severance payment equal to one year’s
compensation, plus he shall be entitled to continue to participate in the
Company’s employee benefit programs offered to other senior management employees
of the Company for a period of 12 months following the date of termination,
provided that if at any time while the Company is required to pay severance to
Mr. Blum, his death or disability would cause the severance payments to
terminate.
 
 46
 
 Item 11.Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
 
 SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
 The
following table sets forth certain information regarding the beneficial
ownership of our common stock as of December 31, 2007 by:
 •
              each
      person, or group of affiliated persons, known by us to be the beneficial
      owner of more than 5% of the outstanding shares of our common
      stock;•
              each
      of our directors;•
              our
      Chief Executive Officer and each of our two other most highly-compensated
      executive officers serving as such as of December 31, 2007 whose
      total annual salary and bonus exceeded $100,000, for services rendered in
      all capacities to the Company (such individuals are hereafter referred to
      as the “Named Executive Officers”); and•
              all
      of our directors and executive officers as a
  group.
  Number of Shares
      of
              
              
              Percentage
      ofCommon
      Stock
              
              
              Shares
      BeneficiallyName and Address of
      Beneficial Owner (1)
              
              Beneficially Owned
      (2)
              
              
              Owned
      (2)Named Executive
      Officers and DirectorBlum, Charles R. -
      Chief Executive Officer (3)
              
              
              0
              
              
              
              *Eichler, Eugene E. –
      Chief Financial Officer (4)
              
              
              2,049,699
              
              
              
              4.2
              %Bautista, John -
      Chief Operating Officer (5)
              
              
              487,585
              
              
              
              1.0
              %Cecil B. Kyte –
      Chairman, Director (6)
              
              
              2,179,410
              
              
              
              4.5
              %Price, John F. –
      Director (7)
              
              
              621,000
              
              
              
              1.3
              %Helleis, Joseph –
      Director (8)
              
              
              555,000
              
              
              
              1.2
              %Shelton, Nathan –
      Director (9)
              
              
              154,585
              
              
              
              *Bolio, Steven –
      Director
              
              
              0
              
              
              
              *All directors and
      executive officers as a group
              
              
              6,047,279
              
              
              
              11.5
              %Five Percent
      StockholdersJoseph R. and Joette
      M. Dell (10)
              
              
              3,750,352
              
              
              
              7.5
              %Leodis C. Matthews
      (11)
              
              
              3,107,668
              
              
              
              6.3
              %
    *
              Represents
      less than 1%.(1)
              Unless
      otherwise indicated, the address of each listed person is c/o Save
      the World Air, Inc., 235 Tennant Avenue, Morgan Hill, California
      95037(2)
              Percentage
      of beneficial ownership is based upon 46,470,413 shares of our common
      stock outstanding as of December 31, 2007. Beneficial ownership is
      determined in accordance with the rules of the SEC and generally includes
      voting or investment power with respect to securities. Shares of common
      stock subject to options and warrants currently exercisable or
      convertible, or exercisable or convertible within 60 days, are deemed
      outstanding for determining the number of shares beneficially owned and
      for computing the percentage ownership of the person holding such options,
      but are not deemed outstanding for computing the percentage ownership of
      any other person. Except as indicated by footnote, and subject to
      community property laws where applicable, the persons named in the table
      have sole voting and investment power with respect to all shares of common
      stock shown as beneficially owned by them.(3)
              Has
      options to purchase 188,679 shares of our common stock which will not vest
      until July 28, 2008.(4)
              Includes
      warrants to purchase 107,143 shares of our common stock exercisable
      currently and options to purchase 1,371,127 shares
      of our common stock exercisable currently.(5)
              Includes
      warrants to purchase 25, 000 shares of our common stock exercisable
      currently and options to purchase 309,171 shares
      of our common stock exercisable currently.(6)
              Includes
      warrants to purchase 942,051 shares of our common stock exercisable
      currently and options to purchase 30,000 shares
      of our common stock exercisable currently.(7)
              Includes
      options to purchase 180,000 shares of our common stock exercisable
      currently.
  47
  (8)
              Includes
      options to purchase 305,000 shares of our common stock exercisable
      currently.(9)
              Includes
      options to purchase 104,585 shares of our common stock exercisable
      currently.(10)
              Includes
      warrants to purchase 621,765 shares of our common stock exercisable
      currently and Notes convertible into 2,393,382
      shares of our common stock exercisable
currently.(11)
              Includes
      warrants owned by Morales, LLC to purchase 797,794 shares of our common
      stock exercisable currently and Notes
      owned by Morale Orchards, LLC convertible into 1,595,588 shares of our
      common stock exercisable currently.Morale
      Orchards, LLC is beneficially owned by Leodis C. Matthews, who serves as
      the Company’s outside litigationthrough
      his law firm, Matthews &
  Partners.
 
 The
information required by this section is incorporated by reference from the
information in the section entitled “Security Ownership of Certain Beneficial
Owners and Management” in the Proxy Statement.
 
 Item 12. Certain
Relationships and Related Transactions
 
 Litigation Involving Sublessor of
Former Corporate Offices
  We are
involved in litigation with Scottish Glen Golf Company, Inc. (SGGC) doing
business as KZ Golf, Inc., the Company’s previous landlord on claims in the
aggregate amount of $104,413.   STWA does not dispute the fact
that certain amounts of unpaid past rent are due but does dispute that it owes
the aggregate of $104,413 demanded by SGGC; more than half of which are
purported “late fees” which was assessed at the rate of $100 per
day.  It is the company’s position that the late fees are void and
unenforceable and that STWA is entitled to a set-off for office space that
reverted back to SGGC.
  While the
Company believes that it has valid claims and defenses, given the inherent
uncertainties of litigation, the Company cannot predict the outcome of this
matter.  Accordingly, there can be no assurance that an adverse result
or outcome of this matter would not have a material adverse effect on the
Company’s financial position or cash flow.  The Company believes that
these claims arose from acts of a related party involving a former officer and
director and his wife as a beneficial owners of SGGC.
  Loans From
Related Parties
  In May
and August 2007, a Company Director, Eugene E. Eichler made loans to the Company
totaling $81,404.  These loans are repayable at such time as the
Company’s cash flow permits.
  On
October 30, 2007, Morale Orchards, LLP made a loan to the Company in the amount
of $20,000 due on demand.
  On
January 30, 2008, a Company Director, Cecil B. Kyte advanced $10,000 for
operating expenses and was repaid on February 27, 2008.
  Modificationand
SatisfactionAgreement With
Related Party
  A
Modification and Satisfaction Agreement was entered into effective as of January
31, 2008, by and among Save the World Air, Inc. (the “Company”), Morale
Orchards, LLC (“Morale”) and Matthews & Partners, a law firm (the “Matthews
Law Firm”).
  On
December 5, 2006, the Company entered into a Note Purchase Agreement (the “Note
Purchase Agreement”) with Morale, pursuant to which Morale purchased from the
Company two (2) Convertible Promissory Notes, one dated December 5, 2006 (the
“2006 Morale Note”), in the principal face amount of $612,500, and another,
dated January 10, 2007 (the “2007 Morale Note”), also in the principal face
amount of $612,500 (collectively, the “Morale Notes”), and two (2) warrants, one
accompanying the 2006 Morale Note, and the other accompanying the 2007 Morale
Note.  Each warrant provides Morale the right to purchase shares of
common stock of the Company (each either the “2006 Warrant or 2007 Warrant, or
collectively the Morale Warrants”).  The aggregate purchase price for
the Morale Notes and Morale Warrants was $1,000,000, of which $500,000 was paid
by Morale and received by the Company on or about December 5, 2006, and of which
$500,000 was paid by Morale and received by the Company on or about January 10,
2007.
  The 2006
Morale Note is convertible at the rate of $0.85 per share into 720,588 shares of
the Company’s common stock, and the 2007 Morale Note is convertible at the rate
of $0.70 per share into 875,000 shares of the Company’s common
stock;
  The 2006
Morale Warrant is exercisable at $0.85 per share for 360,294 shares of the
Company’s common stock, and the 2007 Morale Warrant is exercisable at $.70 per
share for 437,500 shares of the Company’s common stock;
  The Note
Purchase Agreement provides, in pertinent part, that in the event the Company
has not repaid each of the Morale Notes in full by the anniversary date of their
issuances, the principal balances of each note shall be increased by ten percent
(10%) and the Company shall pay interest at two and one-half percent (21⁄2%) per
month, compounded daily, for each month until each of the Morale Notes is paid
in full;
  As of
January 31, 2008, both the 2006 and 2007 Morale Notes were unpaid, and neither
of the Morale Notes nor the Morale Warrants have been converted into shares of
common stock of the Company.
  48
 Morale
also has piggy-back registration rights pursuant to which Morale may require the
Company to include the shares of the Company’s common stock issuable upon
conversion of the Morale Notes and exercise of the Morale Warrants in certain
future registration statements the Company may elect to file.
  The
amount due and owing as of January 31, 2008, under the 2006 Morale Note is
$689,327. The amount due and owing as of January 31, 2008, under the 2007 Morale
Note is $672,885.
  The
Company borrowed the principal sum of $20,000 from Morale on October 30, 2007,
at an interest rate of ten percent (10%) per annum. Principal and accrued
interest under the Morale Note is due on demand, and no payments there under
have been made by the Company.
  Morale is
beneficially owned by Jacqueline Alexander, who is the wife of Leodis Matthews
of the Matthews Law Firm. Mr. Matthews disclaims any beneficial ownership in
Morale.  The Company is indebted to the Matthews Law Firm for unpaid
legal fees and costs through January 31, 2008, in the aggregate amount of
$472,762.
  The
Company, Morale and the Matthews Law Firm now desire to modify the terms and
provisions of, and to provide for the satisfaction of the Company’s obligations
under, the Morale Notes, the Additional Morale Note and the Matthews Law Firm
Debt, pursuant to the terms and conditions set forth in this Modification and
Satisfaction Agreement.
  The
Company, Morale and the Matthew Law Firm agree to the following:
  1. Waiver of
Interest.
  (i)
                Morale
      agrees to forgive and waive any and all accrued interest on the Morale
      Notes from and after January 31,
2008;
  (ii)
                Morale
      agrees to forgive and waive any and all accrued interest due on the
      Additional Morale Note from the date of its issuance;
  and
  (iii)
                The
      Matthews Law Firm agrees to forgive any and all interest which may have
      accrued on the Matthews Law Firm
Debt.
  2. Cancellation
of Notes, Debt and Obligations.  Upon the
execution of this Modification and Satisfaction Agreement, the 2006 Morale Note,
the 2007 Morale Note, the Additional Morale Note, the Unpaid 2006 Morale Note
Debt, the Unpaid 2007 Morale Note Debt, the Unpaid Additional Morale Note Debt
and the Matthews Law Firm Debt, shall all be cancelled, be deemed satisfied in
full and be of no further force or effect, effective January 31,
2008.
  3. No
Registration Rights.  Upon execution
hereof, the Morale Registration Rights shall be cancelled and be of no further
force or effect.
  4. Issuance
of Shares.  In consideration
of this Modification and Satisfaction Agreement, including the waivers and
cancellations as set forth in paragraphs 1 and 2, above, upon execution hereof,
and concurrently with the waivers and cancellations provided hereunder, the
Company shall issue a total of 7,421,896 shares of its common stock to Morale
and the Matthews Law Firm, allocable as follows:  (i) 2,759,308 shares
shall be issued to Morale arising out of and in exchange for cancellation of the
2006 Morale Note and the Unpaid 2006 Morale Note Debt; (ii) 2,691,540 shares
shall be issued to Morale arising out of and in exchange for cancellation of the
2007 Morale Note and the Unpaid 2007 Morale Note Debt; (iii) 80,000 shares shall
be issued to Morale arising out of and in exchange for cancellation of the
Additional Morale Note and the Unpaid Additional Morale Note Debt; and (iv)
1,891,048 shares shall be issued to the Matthews Law Firm arising out of and in
exchange for cancellation of the Matthews Law Firm Debt.  The Company
shall not be required to, and shall not, file a Registration Statement with the
Securities and Exchange Commission or any state securities agency to register or
qualify the shares of common stock of the Company issuable to Morale and the
Matthews Law Firm hereunder, and all such shares when issued shall be deemed
restrictive securities and bear appropriate legends.
  5. Morale
Warrants.  The terms and
conditions of the Morale Warrants, to the extent not expressly amended in this
Modification and Satisfaction Agreement, shall remain in full force and
effect.
  On March
10, 2008, 80,000 shares of the Company’s Common Stock was issued to Morale
Orchards, LLP, in cancellation of a note payable in the amount of $20,000 as
part of the Modification Agreement entered into on January 31, 2008 between the
Company and Morale Orchards, LLP and Matthews & Partners.
  On March
10, 2008, 5,450,848 shares of the Company’s Common Stock was issued to Morale
Orchards, LLP, in conversion and cancellation of the Convertible Notes issued
December 5, 2006 and January 11, 2007 in the amount of $1,362,712 as part of the
Modification Agreement entered into on January 31, 2008  between the
Company and Morale Orchards, LLP and Matthews & Partners.
  On March
10, 2008, 1,891,048 shares of the Company’s Common Stock was issued to Leodis C.
Matthews, APC, in cancellation of accrued professional fees in the amount of
$472,762 as part of the Modification Agreement entered into on January 31, 2008
between the Company and Morale Orchards, LLP and Matthews &
Partners.
 
 49
 
 Item 13.Exhibits
 
 (a)
              The
      following documents are filed as part of this Form
  10-KSB.
 
 Financial Statements:
 
 Reference
is made to the contents to the consolidated financial statements of Save the
World Air, Inc. under Item 7 of this Form 10-KSB.
 
 (b)
              Exhibits:
 
 The exhibits listed below are required by Item 601 of
Regulation S-B.
  Exhibit
      No.
              
              Description3.1(1)
              
              Articles
      of Incorporation, as amended, of the Registrant.3.2(1)
              
              Bylaws
      of the Registrant.10.1(2)
              
              Commercial
      Sublease dated October 16, 2003 between the Registrant and KZ Golf,
      Inc.10.2(9)
              
              Amendment
      dated June 15, 2004 to Exhibit 10.110.3
      (10)
              
              Amendment
      dated August 14, 2005 to Exhibit 10.110.4(10)
              
              General
      Tenancy Agreement dated March 14, 2006 between the Registrant and Autumlee
      Pty Ltd.10.5(3)
              
              Agreement
      dated December 13, 2002 between the Registrant and
    RAND.10.6(2)**
              
              Agreement
      dated May 7, 2003 between the Registrant and RAND.10.7(5)
              
              Modification
      No. 1 dated as of August 21, 2003 to
      Exhibit 10.510.8(5)
              
              Modification
      No. 2 dated as of October 17, 2003 to
      Exhibit 10.510.9(5)
              
              Modification
      No. 3 dated as of January 20, 2004 to
      Exhibit 10.510.10(4)
              
              Deed
      and Document Conveyance between the Trustee of the Property of Jeffrey Ann
      Muller and Lynette Anne Muller (Bankrupts).10.11(4)
              
              Assignment
      and Bill of Sale dated May 28, 2002 between the Registrant and Kevin
      Charles Hart.10.12(11)†
              
              Amended
      and Restated Employment Agreement dated October 5, 2005 between the
      Registrant and Eugene E. Eichler.10.13(15)†
              
              Severance
      Agreement dated November 8, 2006 between the Registrant and Eugene E.
      Eichler10.14(11)†
              
              Amended
      and Restated Employment Agreement dated October 5, 2005 between the
      Registrant and Bruce H. McKinnon.10.15(6)
              
              Save
      the World Air, Inc. 2004 Stock Option Plan10.16(8)
              
              Form
      of Incentive Stock Option Agreement under 2004 Stock Option
      Plan10.17(8)
              
              Form
      of Non-Qualified Stock Option Agreement under 2004 Stock Option
      Plan10.18(8)
              
              Consulting
      Agreement dated as of October 1, 2004 between the Registrant and John
      Fawcett10.19(7)
              
              License
      Agreement dated as of July 1, 2004 between the Registrant and Temple
      University – The Commonwealth System of Higher Education10.20(8)
              
              Consulting
      Agreement dated as of November 19, 2004 between the Registrant and London
      Aussie Marketing, Ltd.10.21(13)
              
              Amendment
      dated September 14, 2006 to Exhibit 10.2010.22(8)†
              
              Employment
      Agreement dated September 1, 2004 with Erin Brockovich10.23(15)†
              
              Amendment
      dated as of July 31, 2006 to Exhibit 10.2210.24(8)
              
              Assignment
      of Patent Rights dated as of September 1, 2003 between the Registrant
      and Adrian Menzell10.25(8)
              
              Global
      Deed of Assignment dated June 26, 2004 between the Registrant and
      Adrian Menzell10.26(11)†
              
              Amended
      and Restated Employment Agreement dated as of March 1, 2006 between the
      Registrant and John Richard Bautista III10.27(9)
              
              Lease
      dated August 15, 2005 between the Registrant and Thomas L.
      Jackson10.28(10)
              
              Amendment
      dated February 1, 2006 to Exhibit 10.2710.29(10)
              
              Form
      of 9% Convertible Note issued in the 2005 Interim
Financing10.30(10)
              
              Form
      of Stock Purchase Warrant issued in the 2005 Interim
    Financing10.31(10)
              
              Form
      of Stock Purchase Warrant issued in the 2005 Bridge
    Financing10.32(11)
              
              Form
      of Stock Purchase Warrant issued in 2006 Regulation S
      financing10.33(11)
              
              Form
      of Stock Purchase Warrant issued in 2006 PIPE financing10.34(12)
              
              Commercial
      Sublease between the Registrant and KZG Golf dated January 1,
      200610.35(12)
              
              Investment
      Agreement dated September 15, 2006 between the Registrant and Dutchess
      Private Equities Fund10.36(12)
              
              Registration
      Rights Agreement dated September 15, 2006 between the registrant and
      Dutchess Private Equities Fund, LLP10.37(17)
              
              License
      Agreement between the Registrant and Temple University dated February 2,
      200710.38(17)
              
              License
      Agreement between the Registrant and Temple University dated February 2,
      200710.39(17)
              
              R&D
      Agreement between the Registrant and Temple University dated February 2,
      200710.40(14)
              
              Note
      Purchase Agreement dated December 5, 2006 between the registrant and
      Morale Orchards LLC10.41(14)
              
              Form
      of Stock Purchase Warrant issued to Morale Orchards LLC10.42(14)
              
              Form
      of Convertible Note issued to Morale Orchards LLC10.43(16)
              
              Consulting
      Agreement dated January 4, 2007 between the Registrant and Spencer Clarke
      LLC10.44(15)
              
              Agreement
      dated as of July 15, 2006 between the Company and SS Sales and Marketing
      Group10.45(15)
              
              Engagement
      Agreement between the Registrant and Charles K. Dargan II10.46(15)
              
              Form
      of 10% Convertible Note issued in 2007 PIPE Offering
  50
  10.47(15)
              
              Form
      of Stock Purchase Warrant issued in 2007 PIPE Offering10.48(18)
                10.49(19)
                10.50(20)
                10.51(21)
                10.52(22)
                10.53(23)
                10.54(23)
                10.55(24)
                10.56(25)
                10.57(26)
                10.58(26)
                10.59(27)
                10.60(28)
                10.61(29)
                10.62(30)
                10.63(31)
                10.64(32)
                10.65(32)
                10.66(33)
                10.67(34)
                10.68(34)
                10.69(34)
              
              Appointment
      of New Directors, Nathan Shelton, Steven Bolio and Dennis
      Kenneally
                Issuance
      of RAND Final Report
                Delisting
      from OTCBB to OTC Pink Sheets
                Resignation
      of Director, Dennis Kenneally
                Resignation
      of Officer, Bruce H. McKinnon
                Form
      of 9% Convertible Note issued in 2007 Spring Offering
                Form
      of Stock Purchase Warrant issued in 2007 Spring Offering
                Termination
      of North Hollywood Lease
                Modification
      Agreement of 10% 2007 PIPE Convertible Notes
                Form
      of 9% Convertible Note issued in 2007 Summer Offering
                Form
      of Stock Purchase Warrant issued in 2007 Summer Offering
                Resignation
      of Director, J. Joseph Brown
                Resignation
      of Chief Financial Officer and Appointment of Interim Chief Financial
      Officer
                Severance
      Agreement dated June 15, 2007 between Registrant and Bruce H.
      McKinnon
                Resignation
      of Director, Bruce H. McKinnon
                Second
      Modification Agreement of 10% 2007 PIPE Convertible Notes
                Form
      of 9% Convertible Note issued in 2007 Fall Offering
                Form
      of Stock Purchase Warrant issued in 2007 Fall Offering
                Resignation
      of Director, Joseph Helleis
                Form
      of 9% Convertible Note issued in 2008 Winter Offering
                Form
      of Stock Purchase Warrant issued in 2008 Winter Offering
                Modification
      and Satisfaction Agreement of Convertible Notes with Morale Orchards, LLP
      and Matthews & Partners21*
              
              List
      of Subsidiaries24*
              
              Power
      of Attorney (included on Signature Page)31.1*
              
              Certification
      of Chief Executive Officer of Annual Report Pursuant to
      Rule 13(a)—15(e) or Rule 15(d)—15(e).31.2*
              
              Certification
      of Chief Financial Officer of Annual Report Pursuant to 18 U.S.C.
      Section 1350.32.1*
              
              Certification
      of Chief Executive Officer and Chief Financial Officer of Annual Report
      pursuant to Rule 13(a)—15(e) or
Rule 15(d)—15(e).
 
 
 *
              
              Filed
      herewith.**
              
              Confidential
      treatment previously requested.†
              
              Management
      contract or compensatory plan or arrangement.(1)
              
              Incorporated
      by reference from Registrant’s Registration Statement on Form 10-SB
      (Registration Number 000-29185), as amended, filed on March 2,
      2000.(2)
              
              Incorporated
      by reference from Registrant’s Form 10-KSB for the fiscal year ended
      December 31, 2002.(3)
              
              Incorporated
      by reference from Registrant’s Form 8-K filed on December 30,
      2002.(4)
              
              Incorporated
      by reference from Registrant’s Form 8-K filed on November 12,
      2002.(5)
              
              Incorporated
      by reference from Registrant’s Form 10-QSB for the quarter ended
      March 31, 2004.(6)
              
              Incorporated
      by reference from Appendix C of Registrant’s Schedule 14A filed
      on April 30, 2004, in connection with its Annual Meeting of
      Stockholders held on May 24, 2004.(7)
              
              Incorporated
      by reference from Registrant Form 8-K filed on July 12,
      2004.(8)
              
              Incorporated
      by reference from registrant’s Form 10-KSB for the fiscal year ended
      December 31, 2004.(9)
              
              Incorporated
      by reference from Registrant’s Form 10-QSB for the quarter ended September
      30, 2005(10)
              
              Incorporated
      by reference from Registrant’s Form 10-KSB for the fiscal year ended
      December 31, 2005(11)
              
              Incorporated
      by reference from Registrant’s Form SB-2 filed on June 28, 2006 (SEC File
      No. 333- 333-135415)(12)
              
              Incorporated
      by reference from Registrant’s Form 8-K filed on September 21,
      2006(13)
              
              Incorporated
      by reference from Registrant’s Form SB-2 filed on October 6, 2006 (SEC
      File No. 333-137855)(14)
              
              Incorporated
      by reference from Registrant’s Form 8-K filed on December 11,
      2006(15)
              
              Incorporated
      by reference from Registrant’s Form 10KSB for the fiscal year ended
      December 31, 2006(16)
              
              Incorporated
      by reference from Registrant’s form 8-K filed on January 10,
      2007(17)
              
              Incorporated
      by reference from Registrant’s form 8K filed on February 8,
      2007(18)
              
              Incorporated
      by reference from Registrant’s form 8K filed on February 16,
      2007(19)
              
              Incorporated
      by reference from Registrant’s form 8K filed on May 3,
  2007(20)
              
              Incorporated
      by reference from Registrant’s form 8K filed on May 22
  2007(21)
              
              Incorporated
      by reference from Registrant’s form 8K filed on June 8,
    2007(22)
              
              Incorporated
      by reference from Registrant’s form 8K filed on June 15,
    2007(23)
              
              Incorporated
      by reference from Registrant’s form 8K filed on July 2,
    2007(24)
              
              Incorporated
      by reference from Registrant’s form 8K filed on July 18,
    2007(25)
              
              Incorporated
      by reference from Registrant’s form 8K filed on August 30,
      2007(26)
              
              Incorporated
      by reference from Registrant’s form 8K filed on October 9,
      2007(27)
              
              Incorporated
      by reference from Registrant’s form 8K filed on October 23,
      2007(28)
              
              Incorporated
      by reference from Registrant’s form 8K filed on November 9,
      2007(29)
              
              Incorporated
      by reference form Registrant’s Form 10QSB for the nine months ended
      September 30, 2007(30)
              
              Incorporated
      by reference from Registrant’s form 8K filed on November 15,
      2007(31)
              
              Incorporated
      by reference from Registrant’s form 8K filed on December 11,
      2007(32)
              
              Incorporated
      by reference from Registrant’s form 8K filed on December 20,
      2007(33)
              
              Incorporated
      by reference from Registrant’s form 8K filed on February 25,
      2008(34)
              
              Incorporated
      by reference from Registrant’s form 8K filed on March 11,
    2008
 
 51
  Item 14.Principal
Accountant Fees and Services
 
 RATIFICATION
OF APPOINTMENT OF INDEPNEDENT AUDITORS
 The
Audit Committee has selected Weinberg & Company, P.A. to audit our
financial statements for the fiscal year ending December 31, 2007. Although
ratification by stockholders is not required by law, the Board has determined
that it is desirable to request ratification of this selection by the
stockholders. Notwithstanding its selection, the Audit Committee, in its
discretion, may appoint new independent auditors at any time during the year if
the Audit Committee believes that such a change would be in the best interest of
the Company and its stockholders. If the stockholders do not ratify the
appointment of Weinberg & Company, P.A. the Audit Committee may
reconsider its selection.
 Weinberg &
Company, P.A. was first appointed in fiscal year 2003, and has audited our
financial statements for fiscal years 2002 through 2007.
 Audit and Other
Fees
 The
following table summarizes the fees charged by Weinberg & Company, P.A.
for certain services rendered to the Company during 2006 and 2007.
  AmountType of
      Fee
              
              Fiscal
                Year 2007
              
              
              Fiscal
                Year 2006Audit(1)
              
              $
              193,186
              
              
              $
              161,455Audit
      Related(2)
              
              
              0
              
              
              
              0Taxes
      (3)
              
              
              0
              
              
              
              0All
      Other (4)
              
              
              0
              
              
              
              0Total
              
              $
              193,186
              
              
              $
              161,455
 
 (1)
              This
      category consists of fees for the audit of our annual financial statements
      included in the Company’s annual report on Form 10-KSB and review of
      the financial statements included in the Company’s quarterly reports on
      Form 10-QSB. This category also includes advice on audit and
      accounting matters that arose during, or as a result of, the audit or the
      review of interim financial statements, statutory audits required by
      non-U.S. jurisdictions and the preparation of an annual “management
      letter” on internal control matters.(2)
              Represents
      services that are normally provided by the independent auditors in
      connection with statutory and regulatory filings or engagements for those
      fiscal years, aggregate fees charged for assurance and related services
      that are reasonably related to the performance of the audit and are not
      reported as audit fees. These services include consultations regarding
      Sarbanes-Oxley Act requirements, various SEC filings and the
      implementation of new accounting requirements.(3)
              Represents
      aggregate fees charged for professional services for tax compliance and
      preparation, tax consulting and advice, and tax
  planning.(4)
              Represents
      aggregate fees charged for products and services other than those services
      previously reported.
 
  52
  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.By:
                /s/ Charles
      R. BlumCharles R. BlumChief Executive
      OfficerDate:
      March 31, 2008
  POWER OF ATTORNEY
 
 KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints, jointly and severally, Charles R. Blum and Eugene E.
Eichler, and each of them, as his or her true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for him or her and
in his or her name, place and stead, in any and all capacities, to sign any and
all amendments to this Annual Report on Form 10-KSB, and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as he or she might or could do in person,
hereby ratifying and confirming all that said attorneys-in-fact and agents, or
any of them, or their or his or her substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.
  Pursuant
to the requirements of the Securities Exchange Act of 1934 this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
 
 NAME
              
              TITLE
              
              DATE/s/
      CHARLES R. BLUM
              
              President,
      Chief Executive Officer and
                Director
              
              March
      31, 2008Charles
      R. Blum/s/
      EUGENE E. EICHLER
              
              Interim
      Chief Financial Officer
              
              March
      31, 2008Eugene
      E. Eichler/s/
      CECIL B. KYTE
              
              Chairman
      of the Board
              
              March
      31, 2008Cecil
      B. Kyte/s/
      STEVEN BOLIO
              
              Director
              
              March
      31, 2008Steven
      Bolio/s/
      NATHAN SHELTON
              
              Director
              
              March
      31, 2008Nathan
      Shelton/s/
      JOHN PRICE
              
              Director
              
              March
      31, 2008John
      Price




53




INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 PageReport
      of Independent Registered Public Accounting
      Firm
              F-2Consolidated
      balance
      sheets
              F-3Consolidated
      statements of
      operations
              F-4Consolidated
      statements of stockholders’
      deficiency
              F-5
      - F-14Consolidated
      statements of cash
      flows
              F-15Notes
      to consolidated financial
      statements
              F-16
    F-1
  REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
   To the
Board of Directors and Stockholders of: Save The World Air, Inc. and
Subsidiary
  We have
audited the accompanying consolidated balance sheets of Save The World Air, Inc.
and Subsidiary, a development stage enterprise (the "Company") as of December
31, 2007 and 2006, and the related consolidated statements of operations,
stockholders' deficiency and cash flows and for the years then ended, and for
the period from February 18, 1998 (inception) to December 31, 2007. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
  We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated fmancial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
  We were
not engaged to examine management's assertion about the effectiveness of Save
The World Air, Inc. and Subsidiary's internal control over financial reporting
as of December 31, 2007 included in the Company's Item 8A "Controls and
Procedures" in the Annual report on Form 10-KSB and, accordingly, we do not
express an opinion thereon.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Save The World Air, Inc. and
Subsidiary as of December 31, 2007 and 2006, and the related consolidated
statements of operations, stockholders' deficiency and cash flows and for the
years then ended, and for the period from February 18, 1998 (inception) to
December 31, 2007 in conformity with accounting principles generally accepted in
the United States of America.
  The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company had a net loss of $6,262,743 and
a negative cash flow from operations of $3,172,816 for the year ended December
31, 2007, and had a working capital deficiency of $4,565,344 and a stockholders'
deficiency of $4,359,786 as of December 31, 2007. These factors raise
substantial doubt about its ability to continue as a going concern. Management's
plans concerning this matter are also described in Note 2. The accompanying
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
  Weinberg
& Company, P.A.
  Los
Angeles, California March 24, 2008
  
 F-2
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
BALANCE SHEETS
 
 December 31,2007
              
              
              2006ASSETSCurrent
      assetsCash
              
              $
              47,660
              
              
              $
              244,228Accounts
      receivable
              
              
              1,380
              
              
              
              —Inventories
              
              
              30,256
              
              
              
              21,314Other
      current
      assets
              
              
              20,552
              
              
              
              81,232Total
      current
      assets
              
              
              99,848
              
              
              
              346,774Equipment,net
              
              
              201,058
              
              
              
              322,023Other
      assets
              
              
              4,500
              
              
              
              4,500Total assets
              
              $
              305,406
              
              
              $
              673,297LIABILITIES
      AND STOCKHOLDERS’ DEFICIENCYCurrent
      liabilitiesAccounts
      payable- related
      parties
              
              $
              323,413
              
              
              $
              21,252Accounts
      payable-
      other
              
              
              716,986
              
              
              
              212,455Accrued
      expenses
              
              
              742,719
              
              
              
              468,413Accrued
      research and development
      fees
              
              
              53,347
              
              
              
              95,000Accrued
      professional
      fees
              
              
              747,261
              
              
              
              594,945Loan
      payable- related
      party
              
              
              83,596
              
              
              
              —Loan
      payable-
      other
              
              
              20,334
              
              
              
              —Convertible
      debentures, net- related
      parties
              
              
              227,136
              
              
              
              —Convertible
      debentures, net-
      others
              
              
              1,078,408
              
              
              
              177,926Convertible
      debenture, net- other
      default
              
              
              671,992
              
              
              
              —Total
      current liabilities
              
              
              4,665,192
              
              
              
              1,569,991Commitments
      and contingenciesStockholders’
      deficiencyCommon
      stock, $.001 par value: 200,000,000 shares authorized,
      46,470,413 and 40,081,757, shares issued and outstanding at
                December 31,
      2007 and 2006, respectively
              
              
              46,471
              
              
              
              40,082Common
      stock to be issued
              
              
              4,000
              
              
              
              60,000Additional
      paid-in
      capital
              
              
              32,280,083
              
              
              
              29,430,821Deficit
      accumulated during the development
      stage
              
              
              (36,690,340
              )
              
              
              (30,427,597
              )Total
      stockholders’
      deficiency
              
              
              (4,359,786
              )
              
              
              (896,694
              )Total liabilities and stockholder’sdeficiency
              
              $
              305,406
              
              
              $
              673,297
 
 See notes
to consolidated financial statements.
 F-3
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
  CONSOLIDATED
STATEMENTS OF OPERATIONS
 
 Inception(February18,
      1998) toYears Ended
    December 31,
              
              
              December
      31,2007
              
              
              2006
              
              
              2007Net
      sales
              
              $
              39,000
              
              
              $
              30,000
              
              
              $
              69,000Cost
      of goods sold
              
              
              10,720
              
              
              
              13,400
              
              
              
              24,120Gross
      profit
              
              
              28,280
              
              
              
              16,600
              
              
              
              44,880Operating
      expenses
              
              
              3,956,345
              
              
              
              7,412,227
              
              
              
              26,859,321Research
      and development expenses
              
              
              600,816
              
              
              
              401,827
              
              
              
              4,806,230Non-cash
      patent settlement cost
              
              
              —
              
              
              
              —
              
              
              
              1,610,066Loss
      before other income
              
              
              (4,528,881
              )
              
              
              (7,797,454
              )
              
              
              (33,230,737
              )Other
      expenseOther
      income
              
              
              3,384
              
              
              
              —
              
              
              
              3,509Interest
      income
              
              
              91
              
              
              
              15,422
              
              
              
              16,342Interest
      expense
              
              
              (1,736,537
              )
              
              
              (2,398,691
              )
              
              
              (4,492,380
              )Settlement
      of litigation and
      debt
              
              
              —
              
              
              
              —
              
              
              
              1,017,208Loss
      before provision for income taxes
              
              
              (6,261,943
              )
              
              
              (10,180,723
              )
              
              
              (36,686,058
              )Provision
      for income taxes
              
              
              800
              
              
              
              800
              
              
              
              4,282Net
      loss
              
              $
              (6,262,743
              )
              
              $
              (10,181,523
              )
              
              $
              (36,690,340
              )Net
      loss per common share, basic and diluted
              
              $
              (0.16
              )
              
              $
              (0.28
              )Weighted
      average common shares outstanding, basic and diluted
              
              
              38,378,845
              
              
              
              35,946,022
 
 See notes
to consolidated financial statements.
 F-4
 
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
  DeficitAccumulatedPrice
      per
              
              
              Common Stock
              
              
              Common
      Stock
              
              
              AdditionalPaid-in
              
              
              Deferred
              
              
              During
      the
                Development
              
              
              TotalStockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be 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
              )Stock
      issued for employee compensation on February 8, 2000
              
              
              1.03
              
              
              
              20,000
              
              
              
              20
              
              
              
              —
              
              
              
              20,580
              
              
              
              —
              
              
              
              —
              
              
              
              20,600Stock
      issued for consulting services on February 8, 2000
              
              
              1.03
              
              
              
              100,000
              
              
              
              100
              
              
              
              —
              
              
              
              102,900
              
              
              
              —
              
              
              
              —
              
              
              
              103,000Stock
      issued for professional services on April 18, 2000
              
              
              3.38
              
              
              
              27,000
              
              
              
              27
              
              
              
              —
              
              
              
              91,233
              
              
              
              —
              
              
              
              —
              
              
              
              91,260Stock
      issued for directors fees on April 18, 2000
              
              
              3.38
              
              
              
              50,000
              
              
              
              50
              
              
              
              —
              
              
              
              168,950
              
              
              
              —
              
              
              
              —
              
              
              
              169,000Stock
      issued for professional services on May 19, 2000
              
              
              4.06
              
              
              
              5,000
              
              
              
              5
              
              
              
              —
              
              
              
              20,295
              
              
              
              —
              
              
              
              —
              
              
              
              20,300Stock
      issued for directors fees on June 20, 2000
              
              
              4.44
              
              
              
              6,000
              
              
              
              6
              
              
              
              —
              
              
              
              26,634
              
              
              
              —
              
              
              
              —
              
              
              
              26,640Stock
      issued for professional services on June 20, 2000
              
              
              4.44
              
              
              
              1,633
              
              
              
              2
              
              
              
              —
              
              
              
              7,249
              
              
              
              —
              
              
              
              —
              
              
              
              7,251Stock
      issued for professional services on June 26, 2000
              
              
              5.31
              
              
              
              1,257
              
              
              
              1
              
              
              
              —
              
              
              
              6,674
              
              
              
              —
              
              
              
              —
              
              
              
              6,675Stock
      issued for employee compensation on June 26, 2000
              
              
              5.31
              
              
              
              22,000
              
              
              
              22
              
              
              
              —
              
              
              
              116,798
              
              
              
              —
              
              
              
              —
              
              
              
              116,820Stock
      issued for consulting services on June 26, 2000
              
              
              5.31
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              52,203
              
              
              
              —
              
              
              
              —
              
              
              
              52,213Stock
      issued for promotional services on July 28, 2000
              
              
              4.88
              
              
              
              9,675
              
              
              
              9
              
              
              
              —
              
              
              
              47,205
              
              
              
              —
              
              
              
              —
              
              
              
              47,214Stock
      issued for consulting services on July 28, 2000
              
              
              4.88
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              47,975
              
              
              
              —
              
              
              
              —
              
              
              
              47,985Stock
      issued for consulting services on August 4, 2000
              
              
              2.13
              
              
              
              35,033
              
              
              
              35
              
              
              
              —
              
              
              
              74,585
              
              
              
              —
              
              
              
              —
              
              
              
              74,620Stock
      issued for promotional services on August 16, 2000
              
              
              2.25
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              56,225
              
              
              
              —
              
              
              
              —
              
              
              
              56,250Stock
      issued for consulting services on September 5, 2000
              
              
              2.25
              
              
              
              12,833
              
              
              
              13
              
              
              
              —
              
              
              
              28,861
              
              
              
              —
              
              
              
              —
              
              
              
              28,874
   F-5
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                AccumulatedPrice
      per
              
              
              Common Stock
              
              
              Common
      Stock
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              During
      the Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              DeficiencyStock
      issued for consulting services on September 10, 2000
              
              
              1.50
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              14,740
              
              
              
              —
              
              
              
              —
              
              
              
              14,750Stock
      issued for consulting services on November 2, 2000
              
              
              0.88
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              8,643
              
              
              
              —
              
              
              
              —
              
              
              
              8,653Stock
      issued for consulting services on November 4, 2000
              
              
              0.88
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              8,643
              
              
              
              —
              
              
              
              —
              
              
              
              8,653Stock
      issued for consulting services on December 20, 2000
              
              
              0.50
              
              
              
              19,082
              
              
              
              19
              
              
              
              —
              
              
              
              9,522
              
              
              
              —
              
              
              
              —
              
              
              
              9,541Stock
      issued for filing services on December 20, 2000
              
              
              0.50
              
              
              
              5,172
              
              
              
              5
              
              
              
              —
              
              
              
              2,581
              
              
              
              —
              
              
              
              —
              
              
              
              2,586Stock
      issued for professional services on December 26, 2000
              
              
              0.38
              
              
              
              12,960
              
              
              
              13
              
              
              
              —
              
              
              
              4,912
              
              
              
              —
              
              
              
              —
              
              
              
              4,925Other
      stock issuance on August 24, 2000
              
              
              2.13
              
              
              
              2,000
              
              
              
              2
              
              
              
              —
              
              
              
              4,258
              
              
              
              —
              
              
              
              —
              
              
              
              4,260Common
      shares 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
              )Stock
      issued for consulting services on January 8, 2001
              
              
              0.31
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              3,038
              
              
              
              —
              
              
              
              —
              
              
              
              3,048Stock
      issued for consulting services on February 1, 2001
              
              
              0.33
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              3,235
              
              
              
              —
              
              
              
              —
              
              
              
              3,245Stock
      issued for consulting services on March 1, 2001
              
              
              0.28
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              2,743
              
              
              
              —
              
              
              
              —
              
              
              
              2,753Stock
      issued for legal services on March 13, 2001
              
              
              0.32
              
              
              
              150,000
              
              
              
              150
              
              
              
              —
              
              
              
              47,850
              
              
              
              —
              
              
              
              —
              
              
              
              48,000Stock
      issued for consulting services on April 3, 2001
              
              
              0.25
              
              
              
              9,833
              
              
              
              10
              
              
              
              —
              
              
              
              2,448
              
              
              
              —
              
              
              
              —
              
              
              
              2,458Stock
      issued for legal services on April 4, 2001
              
              
              0.25
              
              
              
              30,918
              
              
              
              31
              
              
              
              —
              
              
              
              7,699
              
              
              
              —
              
              
              
              —
              
              
              
              7,730Stock
      issued for professional services on April 4, 2001
              
              
              0.25
              
              
              
              7,040
              
              
              
              7
              
              
              
              —
              
              
              
              1,753
              
              
              
              —
              
              
              
              —
              
              
              
              1,760Stock
      issued for consulting services on April 5, 2001
              
              
              0.25
              
              
              
              132,600
              
              
              
              132
              
              
              
              —
              
              
              
              33,018
              
              
              
              —
              
              
              
              —
              
              
              
              33,150Stock
      issued for filing fees on April 30, 2001
              
              
              1.65
              
              
              
              1,233
              
              
              
              1
              
              
              
              —
              
              
              
              2,033
              
              
              
              —
              
              
              
              —
              
              
              
              2,034Stock
      issued for filing fees on September 19, 2001
              
              
              0.85
              
              
              
              2,678
              
              
              
              2
              
              
              
              —
              
              
              
              2,274
              
              
              
              —
              
              
              
              —
              
              
              
              2,276Stock
      issued for professional services on September 28,
2001
              
              
              0.62
              
              
              
              150,000
              
              
              
              150
              
              
              
              —
              
              
              
              92,850
              
              
              
              —
              
              
              
              —
              
              
              
              93,000Stock
      issued for directors services on October 5, 2001
              
              
              0.60
              
              
              
              100,000
              
              
              
              100
              
              
              
              —
              
              
              
              59,900
              
              
              
              —
              
              
              
              —
              
              
              
              60,000Stock
      issued for legal services on October 17, 2001
              
              
              0.60
              
              
              
              11,111
              
              
              
              11
              
              
              
              —
              
              
              
              6,655
              
              
              
              —
              
              
              
              —
              
              
              
              6,666Stock
      issued for consulting services on October 18, 2001
              
              
              0.95
              
              
              
              400,000
              
              
              
              400
              
              
              
              —
              
              
              
              379,600
              
              
              
              —
              
              
              
              —
              
              
              
              380,000Stock
      issued for consulting services on October 19, 2001
              
              
              1.25
              
              
              
              150,000
              
              
              
              150
              
              
              
              —
              
              
              
              187,350
              
              
              
              —
              
              
              
              —
              
              
              
              187,500Stock
      issued for exhibit fees on October 22, 2001
              
              
              1.35
              
              
              
              5,000
              
              
              
              6
              
              
              
              —
              
              
              
              6,745
              
              
              
              —
              
              
              
              —
              
              
              
              6,751Stock
      issued for directors
              
              
              0.95
              
              
              
              1,000,000
              
              
              
              1,000
              
              
              
              —
              
              
              
              949,000
              
              
              
              —
              
              
              
              —
              
              
              
              950,000Stock
      issued for consulting services on November 7, 2001
              
              
              0.85
              
              
              
              20,000
              
              
              
              20
              
              
              
              —
              
              
              
              16,980
              
              
              
              —
              
              
              
              —
              
              
              
              17,000
   F-6
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 
 Deficit
                AccumulatedPrice
      per
              
              
              Common Stock
              
              
              Common
    Stock
              
              
              Additional
      Paid-in
              
              
              Deferred
              
              
              During the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              DeficiencyStock
      issued for consulting services on November 20, 2001
              
              
              0.98
              
              
              
              43,000
              
              
              
              43
              
              
              
              —
              
              
              
              42,097
              
              
              
              —
              
              
              
              —
              
              
              
              42,140Stock
      issued for consulting services on November 27, 2001
              
              
              0.98
              
              
              
              10,000
              
              
              
              10
              
              
              
              —
              
              
              
              9,790
              
              
              
              —
              
              
              
              —
              
              
              
              9,800Stock
      issued for consulting services on November 28, 2001
              
              
              0.98
              
              
              
              187,000
              
              
              
              187
              
              
              
              —
              
              
              
              183,073
              
              
              
              —
              
              
              
              —
              
              
              
              183,260Intrinsic
      value of options issued to employees
              
              
              
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,600,000
              
              
              
              (2,600,000
              )
              
              
              —
              
              
              
              —Fair
      value of options issued to non-employees for services
              
              
              
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              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
              )Stock
      issued for directors services on December 10, 2002
              
              
              0.40
              
              
              
              2,150,000
              
              
              
              2,150
              
              
              
              —
              
              
              
              857,850
              
              
              
              —
              
              
              
              —
              
              
              
              860,000Common
      stock paid for, but not issued (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 for the year ended December 31, 2002
              
              
              
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (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
              
              
              
              1,425,000
              
              
              
              1,425
              
              
              
              (213,750
              )
              
              
              212,325
              
              
              
              —
              
              
              
              —
              
              
              
              —Common
      stock issued, previously paid for
              
              
              0.25
              
              
              
              880,000
              
              
              
              880
              
              
              
              (220,000
              )
              
              
              219,120
              
              
              
              —
              
              
              
              —
              
              
              
              —Stock
      issued for cash on March 20, 2003
              
              
              0.25
              
              
              
              670,000
              
              
              
              670
              
              
              
              —
              
              
              
              166,830
              
              
              
              —
              
              
              
              —
              
              
              
              167,500Stock
      issued for cash on April 4, 2003
              
              
              0.25
              
              
              
              900,000
              
              
              
              900
              
              
              
              —
              
              
              
              224,062
              
              
              
              —
              
              
              
              —
              
              
              
              224,962Stock
      issued for cash on April 8, 2003
              
              
              0.25
              
              
              
              100,000
              
              
              
              100
              
              
              
              —
              
              
              
              24,900
              
              
              
              —
              
              
              
              —
              
              
              
              25,000Stock
      issued for cash on May 8, 2003
              
              
              0.25
              
              
              
              1,150,000
              
              
              
              1,150
              
              
              
              —
              
              
              
              286,330
              
              
              
              —
              
              
              
              —
              
              
              
              287,480Stock
      issued for cash on June 16, 2003
              
              
              0.25
              
              
              
              475,000
              
              
              
              475
              
              
              
              —
              
              
              
              118,275
              
              
              
              —
              
              
              
              —
              
              
              
              118,750Stock
      issued for legal services on June 27, 2003
              
              
              0.55
              
              
              
              83,414
              
              
              
              83
              
              
              
              —
              
              
              
              45,794
              
              
              
              —
              
              
              
              —
              
              
              
              45,877Debt
      converted to stock on June 27, 2003
              
              
              0.25
              
              
              
              2,000,000
              
              
              
              2,000
              
              
              
              —
              
              
              
              498,000
              
              
              
              —
              
              
              
              —
              
              
              
              500,000Stock
      and warrants issued for cash on July 11, 2003
              
              
              0.25
              
              
              
              519,000
              
              
              
              519
              
              
              
              —
              
              
              
              129,231
              
              
              
              —
              
              
              
              —
              
              
              
              129,750Stock
      and warrants issued for cash on September 29, 2003
              
              
              0.25
              
              
              
              1,775,000
              
              
              
              1,775
              
              
              
              —
              
              
              
              441,976
              
              
              
              —
              
              
              
              —
              
              
              
              443,751Stock
      and warrants issued for cash on October 21, 2003
              
              
              0.25
              
              
              
              1,845,000
              
              
              
              1,845
              
              
              
              —
              
              
              
              459,405
              
              
              
              —
              
              
              
              —
              
              
              
              461,250Stock
      and warrants issued for cash on October 28, 2003
              
              
              0.25
              
              
              
              1,570,000
              
              
              
              1,570
              
              
              
              —
              
              
              
              390,930
              
              
              
              —
              
              
              
              —
              
              
              
              392,500Stock
      and warrants issued for cash on November 19, 2003
              
              
              0.25
              
              
              
              500,000
              
              
              
              500
              
              
              
              —
              
              
              
              124,500
              
              
              
              —
              
              
              
              —
              
              
              
              125,000
   F-7
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                AccumulatedPrice
      per
              
              
              Common Stock
              
              
              Common
                Stock
              
              
              Additional
      Paid-in
              
              
              Deferred
              
              
              During the Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be
      Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              DeficiencyFinders’
      fees related to stock issuances
              
              
              
              
              
              
              —
              
              
              
              —
              
              
              
              43,875
              
              
              
              (312,582
              )
              
              
              —
              
              
              
              —
              
              
              
              (268,707
              )Common
      stock paid for, but not issued (25,000 shares)
              
              
              0.25
              
              
              
              —
              
              
              
              —
              
              
              
              6,250
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              6,250Amortization
      of deferred comp
              
              
              
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              863,727
              
              
              
              —
              
              
              
              863,727Net
      loss for year ended December 31, 2003
              
              
              
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (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
              )Common
      stock issued, previously paid for
              
              
              0.25
              
              
              
              25,000
              
              
              
              25
              
              
              
              (6,250
              )
              
              
              6,225
              
              
              
              —
              
              
              
              —
              
              
              
              —Stock
      issued for director services on March 31, 2004
              
              
              1.50
              
              
              
              50,000
              
              
              
              50
              
              
              
              —
              
              
              
              74,950
              
              
              
              —
              
              
              
              —
              
              
              
              75,000Stock
      issued for finders fees on March 31, 2004
              
              
              0.15
              
              
              
              82,500
              
              
              
              82
              
              
              
              —
              
              
              
              12,293
              
              
              
              —
              
              
              
              —
              
              
              
              12,375Stock
      issued for finders fees on March 31, 2004
              
              
              0.25
              
              
              
              406,060
              
              
              
              407
              
              
              
              —
              
              
              
              101,199
              
              
              
              —
              
              
              
              —
              
              
              
              101,606Stock
      issued for services on April 2, 2004
              
              
              1.53
              
              
              
              65,000
              
              
              
              65
              
              
              
              —
              
              
              
              99,385
              
              
              
              —
              
              
              
              —
              
              
              
              99,450Debt
      converted to stock on April 2, 2004
              
              
              1.53
              
              
              
              60,000
              
              
              
              60
              
              
              
              —
              
              
              
              91,740
              
              
              
              —
              
              
              
              —
              
              
              
              91,800Stock
      issued upon exercise of warrants on May 21, 2004
              
              
              0.20
              
              
              
              950,000
              
              
              
              950
              
              
              
              —
              
              
              
              189,050
              
              
              
              —
              
              
              
              —
              
              
              
              190,000Stock
      issued for directors services on June 8, 2004
              
              
              1.70
              
              
              
              600,000
              
              
              
              600
              
              
              
              —
              
              
              
              1,019,400
              
              
              
              —
              
              
              
              —
              
              
              
              1,020,000Stock
      issued for cash on August 25, 2004
              
              
              1.00
              
              
              
              550,000
              
              
              
              550
              
              
              
              —
              
              
              
              549,450
              
              
              
              —
              
              
              
              —
              
              
              
              550,000Stock
      issued upon exercise of options on August 30, 2004
              
              
              0.40
              
              
              
              4,000
              
              
              
              4
              
              
              
              —
              
              
              
              1,596
              
              
              
              —
              
              
              
              —
              
              
              
              1,600Stock
      issued for cash on September 8, 2004
              
              
              1.00
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              24,975
              
              
              
              —
              
              
              
              —
              
              
              
              25,000Stock
      issued for consulting services on September 15, 2004
              
              
              1.31
              
              
              
              50,000
              
              
              
              49
              
              
              
              —
              
              
              
              65,451
              
              
              
              —
              
              
              
              —
              
              
              
              65,500Stock
      issued for patent settlement on September 22, 2004
              
              
              1.24
              
              
              
              20,000
              
              
              
              20
              
              
              
              —
              
              
              
              24,780
              
              
              
              —
              
              
              
              —
              
              
              
              24,800Stock
      issued for research and development on October 6,
2004
              
              
              1.40
              
              
              
              65,000
              
              
              
              65
              
              
              
              —
              
              
              
              90,935
              
              
              
              —
              
              
              
              —
              
              
              
              91,000Stock
      issued for cash on October 6, 2004
              
              
              1.00
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              24,975
              
              
              
              —
              
              
              
              —
              
              
              
              25,000Stock
      issued for cash on October 15, 2004
              
              
              1.00
              
              
              
              150,000
              
              
              
              150
              
              
              
              —
              
              
              
              149,850
              
              
              
              —
              
              
              
              —
              
              
              
              150,000Stock
      issued upon exercise of stock options on October 21,
    2004
              
              
              0.40
              
              
              
              6,500
              
              
              
              6
              
              
              
              —
              
              
              
              2,594
              
              
              
              —
              
              
              
              —
              
              
              
              2,600Stock
      issued for cash on November 3, 2004
              
              
              1.00
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              24,975
              
              
              
              —
              
              
              
              —
              
              
              
              25,000Stock
      issued for cash on November 18, 2004
              
              
              1.00
              
              
              
              172,500
              
              
              
              173
              
              
              
              —
              
              
              
              172,327
              
              
              
              —
              
              
              
              —
              
              
              
              172,500Stock
      issued for cash on December 9, 2004
              
              
              1.00
              
              
              
              75,000
              
              
              
              75
              
              
              
              —
              
              
              
              74,925
              
              
              
              —
              
              
              
              —
              
              
              
              75,000Stock
      issued for cash on December 23, 2004
              
              
              1.00
              
              
              
              250,000
              
              
              
              250
              
              
              
              —
              
              
              
              249,750
              
              
              
              —
              
              
              
              —
              
              
              
              250,000Finders
      fees related to stock issuances
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (88,384
              )
              
              
              —
              
              
              
              —
              
              
              
              (88,384
              )Common
      stock paid for, but not issued (119,000 shares)
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              119,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              119,000Intrinsic
      value of options issued to employees
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              248,891
              
              
              
              (248,891
              )
              
              
              —
              
              
              
              —
   F-8
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                  AccumulatedPrice
      per
                
                
                Common Stock
                
                
                Common
                  Stock
                
                
                Additional
      Paid-in
                
                
                Deferred
                
                
                During the Development
                
                
                Total
                  Stockholders’Share
                
                
                Shares
                
                
                Amount
                
                
                to be
      Issued
                
                
                Capital
                
                
                Compensation
                
                
                Stage
                
                
                Deficiency
 Fair
      value of options issued to non-employees for services
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              55,381
              
              
              
              (55,381
              )
              
              
              —
              
              
              
              —Fair
      value of warrants issued for settlement costs
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              
              
              
              
              1,585,266
              
              
              
              —
              
              
              
              —
              
              
              
              1,585,266Fair
      value of warrants issued to non-employees for services
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              28,872
              
              
              
              —
              
              
              
              —
              
              
              
              28,872Amortization
      of deferred compensation
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              936,537
              
              
              
              —
              
              
              
              936,537Net
      loss for year ended December 31, 2004
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (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
              )Common
      stock issued, previously paid for
              
              
              1.00
              
              
              
              69,000
              
              
              
              69
              
              
              
              (69,000
              )
              
              
              68,931
              
              
              
              —
              
              
              
              —
              
              
              
              —Stock
      issued upon exercise of warrants, previously paid for
              
              
              1.00
              
              
              
              50,000
              
              
              
              50
              
              
              
              (50,000
              )
              
              
              49,950
              
              
              
              —
              
              
              
              —
              
              
              
              —Stock
      issued for cash on January 20, 2005
              
              
              1.00
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              24,975
              
              
              
              —
              
              
              
              —
              
              
              
              25,000Stock
      issued upon exercise of warrants on January 31, 2005
              
              
              0.40
              
              
              
              500
              
              
              
              1
              
              
              
              —
              
              
              
              199
              
              
              
              —
              
              
              
              —
              
              
              
              200Stock
      issued for cash on February 17, 2005
              
              
              1.00
              
              
              
              325,000
              
              
              
              325
              
              
              
              —
              
              
              
              324,675
              
              
              
              —
              
              
              
              —
              
              
              
              325,000Stock
      issued for cash on March 31, 2005
              
              
              1.00
              
              
              
              215,000
              
              
              
              215
              
              
              
              —
              
              
              
              214,785
              
              
              
              —
              
              
              
              —
              
              
              
              215,000Stock
      issued for cash on May 17, 2005
              
              
              1.00
              
              
              
              5,000
              
              
              
              5
              
              
              
              —
              
              
              
              4,995
              
              
              
              —
              
              
              
              —
              
              
              
              5,000Stock
      issued for cash on June 7, 2005
              
              
              1.00
              
              
              
              300,000
              
              
              
              300
              
              
              
              —
              
              
              
              299,700
              
              
              
              —
              
              
              
              —
              
              
              
              300,000Stock
      issued for cash on August 5, 2005
              
              
              1.00
              
              
              
              480,500
              
              
              
              480
              
              
              
              —
              
              
              
              480,020
              
              
              
              —
              
              
              
              —
              
              
              
              480,500Stock
      issued for cash on August 9, 2005
              
              
              1.00
              
              
              
              100,000
              
              
              
              100
              
              
              
              —
              
              
              
              99,900
              
              
              
              —
              
              
              
              —
              
              
              
              100,000Stock
      issued for cash on October 27, 2005
              
              
              1.00
              
              
              
              80,000
              
              
              
              80
              
              
              
              —
              
              
              
              79,920
              
              
              
              —
              
              
              
              —
              
              
              
              80,000Common
      stock cancelled on December 7, 2005
              
              Various
              
              
              
              (8,047,403
              )
              
              
              (8,047
              )
              
              
              —
              
              
              
              8,047
              
              
              
              —
              
              
              
              —
              
              
              
              —Stock
      issued for settlement of payables on December 21,
2005
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              57,092
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              57,092Stock
      issued for settlement of payables on December 31,
2005
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              555,429
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              555,429Finders
      fees related to stock issuances
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (109,840
              )
              
              
              —
              
              
              
              —
              
              
              
              (109,840
              )Intrinsic
      value of options issued to employees
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              243,750
              
              
              
              (243,750
              )
              
              
              —
              
              
              
              —Fair
      value of options issued for settlement costs
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              31,500
              
              
              
              —
              
              
              
              —
              
              
              
              31,500Fair
      value of warrants issued for settlement costs
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4,957
              
              
              
              —
              
              
              
              —
              
              
              
              4,957Fair
      value of warrants issued to non-employees for services
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              13,505
              
              
              
              —
              
              
              
              —
              
              
              
              13,505Amortization
      of deferred compensation
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              177,631
              
              
              
              —
              
              
              
              177,631Warrants
      issued with convertible notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              696,413
              
              
              
              —
              
              
              
              —
              
              
              
              696,413Intrinsic
      value of beneficial conversion associated with convertible
      notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              756,768
              
              
              
              —
              
              
              
              —
              
              
              
              756,768
   F-9
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                  AccumulatedPrice
      per
                
                
                Common Stock
                
                
                Common
                  Stock
                
                
                Additional
      Paid-in
                
                
                Deferred
                
                
                During the Development
                
                
                Total
                  Stockholders’Share
                
                
                Shares
                
                
                Amount
                
                
                to be
      Issued
                
                
                Capital
                
                
                Compensation
                
                
                Stage
                
                
                Deficiency
 Net
      loss for year ended December 31, 2005
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (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
              )Stock
      issued, for previously settled payables
              
              
              —
              
              
              
              846,549
              
              
              
              847
              
              
              
              (612,521
              )
              
              
              611,674
              
              
              
              —
              
              
              
              —
              
              
              
              —Stock
      issued upon exercise of warrants on March 23, 2006
              
              
              1.50
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              37,475
              
              
              
              —
              
              
              
              —
              
              
              
              37,500Stock
      issued upon exercise of warrants on March 27, 2006
              
              
              1.50
              
              
              
              50,000
              
              
              
              50
              
              
              
              —
              
              
              
              74,950
              
              
              
              —
              
              
              
              —
              
              
              
              75,000Stock
      issued upon exercise of warrants on March 27, 2006
              
              
              0.50
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              12,475
              
              
              
              —
              
              
              
              —
              
              
              
              12,500Stock
      issued upon exercise of warrants on March 30, 2006
              
              
              1.00
              
              
              
              10,000
              
              
              
              10
              
              
              
              —
              
              
              
              9,990
              
              
              
              —
              
              
              
              —
              
              
              
              10,000Stock
      issued upon exercise of warrants on April 10, 2006
              
              
              0.50
              
              
              
              36,250
              
              
              
              36
              
              
              
              —
              
              
              
              18,089
              
              
              
              —
              
              
              
              —
              
              
              
              18,125Common
      stock issued for convertible debt on April 10, 2006
              
              
              0.70
              
              
              
              269,600
              
              
              
              270
              
              
              
              —
              
              
              
              188,450
              
              
              
              —
              
              
              
              —
              
              
              
              188,720Stock
      issued for cash on April 24, 2006
              
              
              1.56
              
              
              
              473,000
              
              
              
              473
              
              
              
              —
              
              
              
              737,408
              
              
              
              —
              
              
              
              —
              
              
              
              737,881Stock
      issued upon exercise of warrants on April 26, 2006
              
              
              0.50
              
              
              
              125,000
              
              
              
              125
              
              
              
              —
              
              
              
              62,375
              
              
              
              —
              
              
              
              —
              
              
              
              62,500Stock
      issued upon exercise of warrants on April 26, 2006
              
              
              1.50
              
              
              
              100,000
              
              
              
              100
              
              
              
              —
              
              
              
              149,900
              
              
              
              —
              
              
              
              —
              
              
              
              150,000Common
      stock issued for convertible debt on April 26, 2006
              
              
              0.70
              
              
              
              35,714
              
              
              
              36
              
              
              
              —
              
              
              
              24,964
              
              
              
              —
              
              
              
              —
              
              
              
              25,000Stock
      issued upon exercise of warrants on May 6, 2006
              
              
              0.50
              
              
              
              200,000
              
              
              
              200
              
              
              
              —
              
              
              
              99,800
              
              
              
              —
              
              
              
              —
              
              
              
              100,000Stock
      issued upon exercise of warrants on May 15, 2006
              
              
              1.50
              
              
              
              25,000
              
              
              
              25
              
              
              
              —
              
              
              
              37,475
              
              
              
              —
              
              
              
              —
              
              
              
              37,500Stock
      issued upon exercise of warrants on May 15, 2006
              
              
              0.50
              
              
              
              50,000
              
              
              
              50
              
              
              
              —
              
              
              
              24,950
              
              
              
              —
              
              
              
              —
              
              
              
              25,000Stock
      issued for cash on June 7, 2006
              
              
              1.89
              
              
              
              873,018
              
              
              
              872
              
              
              
              —
              
              
              
              1,649,136
              
              
              
              —
              
              
              
              —
              
              
              
              1,650,008Common
      stock issued for convertible debt on June 7, 2006
              
              
              0.70
              
              
              
              1,535,716
              
              
              
              1,536
              
              
              
              —
              
              
              
              1,073,464
              
              
              
              —
              
              
              
              —
              
              
              
              1,075,000Stock
      issued upon exercise of warrants on June 8, 2006
              
              
              0.50
              
              
              
              900,000
              
              
              
              900
              
              
              
              —
              
              
              
              449,100
              
              
              
              —
              
              
              
              —
              
              
              
              450,000Stock
      issued upon exercise of warrants on June 9, 2006
              
              
              0.50
              
              
              
              9,000
              
              
              
              9
              
              
              
              —
              
              
              
              4,491
              
              
              
              —
              
              
              
              —
              
              
              
              4,500Stock
      issued upon exercise of warrants on June 23, 2006
              
              
              0.50
              
              
              
              150,000
              
              
              
              150
              
              
              
              —
              
              
              
              74,850
              
              
              
              —
              
              
              
              —
              
              
              
              75,000Stock
      issued upon exercise of warrants on June 23, 2006
              
              
              1.50
              
              
              
              15,000
              
              
              
              15
              
              
              
              —
              
              
              
              22,485
              
              
              
              —
              
              
              
              —
              
              
              
              22,500Common
      stock issued for convertible debt on June 30, 2006
              
              
              0.70
              
              
              
              219,104
              
              
              
              219
              
              
              
              —
              
              
              
              153,155
              
              
              
              —
              
              
              
              —
              
              
              
              153,374Common
      stock issued for convertible debt on July 11, 2006
              
              
              0.70
              
              
              
              14,603
              
              
              
              15
              
              
              
              —
              
              
              
              10,207
              
              
              
              —
              
              
              
              —
              
              
              
              10,222Common
      stock issued for convertible debt on August 7, 2006
              
              
              0.70
              
              
              
              1,540,160
              
              
              
              1,540
              
              
              
              —
              
              
              
              1,076,572
              
              
              
              —
              
              
              
              —
              
              
              
              1,078,112
   F-10
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                AccumulatedPrice
      per
              
              
              Common
      Stock
              
              
              Common
                Stock
              
              
              Additional
      Paid-in
              
              
              Deferred
              
              
              During the Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be
      Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              DeficiencyCommon
      stock issued upon exercise of warrants on August 7, 2006
              
              
              1.50
              
              
              
              175,000
              
              
              
              175
              
              
              
              —
              
              
              
              262,325
              
              
              
              —
              
              
              
              —
              
              
              
              262,500Common
      stock issued upon exercise of warrants on August 21, 2006
              
              
              1.50
              
              
              
              50,000
              
              
              
              50
              
              
              
              —
              
              
              
              74,950
              
              
              
              —
              
              
              
              —
              
              
              
              75,000Common
      stock issued for cash on August 22, 2006
              
              
              1.00
              
              
              
              14,519
              
              
              
              15
              
              
              
              —
              
              
              
              14,504
              
              
              
              —
              
              
              
              —
              
              
              
              14,519Common
      stock issued upon exercise of warrants on August 23, 2006
              
              
              1.00
              
              
              
              3,683
              
              
              
              4
              
              
              
              —
              
              
              
              3679
              
              
              
              —
              
              
              
              —
              
              
              
              3,683Common
      stock issued upon exercise of warrants on August 28, 2006
              
              
              1.50
              
              
              
              5,000
              
              
              
              5
              
              
              
              —
              
              
              
              7,495
              
              
              
              —
              
              
              
              —
              
              
              
              7,500Common
      stock issued for convertible debt on September 13, 2006
              
              
              0.70
              
              
              
              4,286
              
              
              
              4
              
              
              
              —
              
              
              
              2,996
              
              
              
              —
              
              
              
              —
              
              
              
              3,000Common
      stock issued upon exercise of warrants on September 13,
    2006
              
              
              0.50
              
              
              
              150,000
              
              
              
              150
              
              
              
              —
              
              
              
              74,850
              
              
              
              —
              
              
              
              —
              
              
              
              75,000Common
      stock issued for convertible debt on October 16, 2006
              
              
              0.70
              
              
              
              66,654
              
              
              
              67
              
              
              
              —
              
              
              
              46,591
              
              
              
              —
              
              
              
              —
              
              
              
              46,658Common
      stock issued upon exercise of warrants on November 3, 2006
              
              
              0.50
              
              
              
              210,000
              
              
              
              210
              
              
              
              —
              
              
              
              104,790
              
              
              
              —
              
              
              
              —
              
              
              
              105,000Common
      stock issued for put on equity line of credit on November 7,
      2006
              
              
              1.22
              
              
              
              94,4700
              
              
              
              94
              
              
              
              —
              
              
              
              115,368
              
              
              
              —
              
              
              
              —
              
              
              
              115,462Common
      stock issued for put on equity line of credit on November 14,
      2006
              
              
              1.14
              
              
              
              7,300
              
              
              
              7
              
              
              
              —
              
              
              
              8,349
              
              
              
              —
              
              
              
              —
              
              
              
              8,356Common
      stock issued for put on equity line of credit on November 27,
      2006
              
              
              0.83
              
              
              
              27,500
              
              
              
              28
              
              
              
              —
              
              
              
              22,913
              
              
              
              —
              
              
              
              —
              
              
              
              22,941Common
      stock issued for put on equity line of credit on November 28,
      2006
              
              
              0.82
              
              
              
              36,500
              
              
              
              36
              
              
              
              —
              
              
              
              30,059
              
              
              
              —
              
              
              
              —
              
              
              
              30,095Common
      stock issued for put on equity line of credit on December 6,
      2006
              
              
              0.78
              
              
              
              73,863
              
              
              
              74
              
              
              
              —
              
              
              
              57,244
              
              
              
              —
              
              
              
              —
              
              
              
              57,318Common
      stock issued for put on equity line of credit on December 26,
      2006
              
              
              0.55
              
              
              
              18,800
              
              
              
              19
              
              
              
              —
              
              
              
              10,377
              
              
              
              —
              
              
              
              —
              
              
              
              10,396Common
      stock issued for put on equity line of credit on December 31,
      2006
              
              
              0.59
              
              
              
              229,050
              
              
              
              229
              
              
              
              —
              
              
              
              135,300
              
              
              
              —
              
              
              
              —
              
              
              
              135,529Common
      stock paid for, but not issued
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              60,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              60,000Fair
      value of options issued to employees and officers
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              2,253,263
              
              
              
              —
              
              
              
              —
              
              
              
              2,253,263Fair
      value of warrants issued for services
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              401,130
              
              
              
              —
              
              
              
              —
              
              
              
              401,130Write
      off of deferred compensation
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (142,187
              )
              
              
              142,187
              
              
              
              —
              
              
              
              —
   F-11
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                AccumulatedPrice
      per
              
              
              Common
      Stock
              
              
              Common
                Stock
              
              
              Additional
      Paid-in
              
              
              Deferred
              
              
              During the Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be
      Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              DeficiencyWarrants
      issued for consulting
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              62,497
              
              
              
              —
              
              
              
              —
              
              
              
              62,497Warrants
      issued with convertible notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              408,596
              
              
              
              —
              
              
              
              —
              
              
              
              408,596Intrinsic
      value of beneficial conversion associated with convertible
      notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              851,100
              
              
              
              —
              
              
              
              —
              
              
              
              851,100Finders
      fees related to stock issuances
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (284,579
              )
              
              
              —
              
              
              
              —
              
              
              
              (284,579
              )Fees
      paid on equity line of credit
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (30,402
              )
              
              
              —
              
              
              
              —
              
              
              
              (30,402
              )Net
      loss for year ended December 31, 2006
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (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
              )Common
      stock issued for put on equity line of credit on January 11,
      2007
              
              
              0.63
              
              
              
              63,000
              
              
              
              63
              
              
              
              —
              
              
              
              39,659
              
              
              
              —
              
              
              
              —
              
              
              
              39,722Common
      stock issued for put on equity line of credit on January 22,
      2007
              
              
              0.73
              
              
              
              58,150
              
              
              
              58
              
              
              
              —
              
              
              
              42,246
              
              
              
              —
              
              
              
              —
              
              
              
              42,304Common
      stock issued for put on equity line of credit on February 9,
      2007
              
              
              0.73
              
              
              
              35,800
              
              
              
              36
              
              
              
              —
              
              
              
              26,009
              
              
              
              —
              
              
              
              —
              
              
              
              26,045Common
      stock issued for put on equity line of credit on February 16,
      2007
              
              
              0.70
              
              
              
              162,000
              
              
              
              162
              
              
              
              —
              
              
              
              112,979
              
              
              
              —
              
              
              
              —
              
              
              
              113,141Common
      stock issued for put on equity line of credit on February 26,
      2007
              
              
              0.66
              
              
              
              71,000
              
              
              
              71
              
              
              
              —
              
              
              
              46,761
              
              
              
              —
              
              
              
              —
              
              
              
              46,832Common
      stock issued for put on equity line of credit on March 5,
    2007
              
              
              0.66
              
              
              
              42,600
              
              
              
              43
              
              
              
              —
              
              
              
              28,056
              
              
              
              —
              
              
              
              —
              
              
              
              28,099Common
      stock issued for put on equity line of credit on March 12,
      2007
              
              
              0.67
              
              
              
              92,900
              
              
              
              93
              
              
              
              —
              
              
              
              62,085
              
              
              
              —
              
              
              
              —
              
              
              
              62,178Common
      stock issued for put on equity line of credit on March 19,
      2007
              
              
              0.64
              
              
              
              47,500
              
              
              
              48
              
              
              
              —
              
              
              
              30,362
              
              
              
              —
              
              
              
              —
              
              
              
              30,410Common
      stock issued for put on equity line of credit on March 26,
      2007
              
              
              0.63
              
              
              
              7,500
              
              
              
              7
              
              
              
              —
              
              
              
              4,722
              
              
              
              —
              
              
              
              —
              
              
              
              4,729Common
      stock issued for put on equity line of credit on March 31,
      2007
              
              
              0.61
              
              
              
              25,500
              
              
              
              25
              
              
              
              —
              
              
              
              15,558
              
              
              
              —
              
              
              
              —
              
              
              
              15,583Fees
      paid on equity line of credit
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (32,723
              )
              
              
              —
              
              
              
              —
              
              
              
              (32,723
              )Warrants
      issued with convertible notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              291,936
              
              
              
              —
              
              
              
              —
              
              
              
              291,936Intrinsic
      value of beneficial conversion associated with convertible
      notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              274,312
              
              
              
              —
              
              
              
              —
              
              
              
              274,312Fair
      value of warrants issued to non-employee for services
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              35,340
              
              
              
              —
              
              
              
              —
              
              
              
              35,340Fair
      value of options issued to an officer
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              16,302
              
              
              
              —
              
              
              
              —
              
              
              
              16,302
   F-12
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                AccumulatedPrice
      per
              
              
              Common
      Stock
              
              
              Common
                Stock
              
              
              Additional
      Paid-in
              
              
              Deferred
              
              
              During the Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be
    Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              DeficiencyCommon
      stock issued for put on equity line of credit on April 9,
    2007
              
              
              0.63
              
              
              
              56,300
              
              
              
              56
              
              
              
              —
              
              
              
              35,441
              
              
              
              —
              
              
              
              —
              
              
              
              35,497Common
      stock issued for put on equity line of credit on April 17,
      2007
              
              
              0.56
              
              
              
              73,835
              
              
              
              74
              
              
              
              —
              
              
              
              41,466
              
              
              
              —
              
              
              
              —
              
              
              
              41,540Common
      stock issued for put on equity line of credit on April 24,
      2007
              
              
              0.56
              
              
              
              122,857
              
              
              
              123
              
              
              
              —
              
              
              
              68,996
              
              
              
              —
              
              
              
              —
              
              
              
              69,119Common
      stock issued for put on equity line of credit on May 1,
    2007
              
              
              0.55
              
              
              
              226,081
              
              
              
              226
              
              
              
              —
              
              
              
              124,774
              
              
              
              —
              
              
              
              —
              
              
              
              125,000Common
      stock issued for put on equity line of credit on May 8,
    2007
              
              
              0.66
              
              
              
              29,400
              
              
              
              29
              
              
              
              —
              
              
              
              19,363
              
              
              
              —
              
              
              
              —
              
              
              
              19,392Common
      stock issued for put on equity line of credit on May 15,
    2007
              
              
              0.43
              
              
              
              403,502
              
              
              
              404
              
              
              
              —
              
              
              
              171,811
              
              
              
              —
              
              
              
              —
              
              
              
              172,215Common
      stock issued for put on equity line of credit on May 22,
    2007
              
              
              0.39
              
              
              
              119,800
              
              
              
              120
              
              
              
              —
              
              
              
              46,362
              
              
              
              —
              
              
              
              —
              
              
              
              46,482Common
      stock issued for put on equity line of credit on May 30,
    2007
              
              
              0.33
              
              
              
              80,996
              
              
              
              81
              
              
              
              —
              
              
              
              26,631
              
              
              
              —
              
              
              
              —
              
              
              
              26,712Common
      stock issued for put on equity line of credit on June 6,
    2007
              
              
              0.32
              
              
              
              54,700
              
              
              
              55
              
              
              
              —
              
              
              
              17,454
              
              
              
              —
              
              
              
              —
              
              
              
              17,509Common
      stock issued for put on equity line of credit on June 15,
    2007
              
              
              0.27
              
              
              
              94,500
              
              
              
              95
              
              
              
              —
              
              
              
              25,571
              
              
              
              —
              
              
              
              —
              
              
              
              25,666Common
      stock issued for put on equity line of credit on June 21,
    2007
              
              
              0.31
              
              
              
              12,500
              
              
              
              12
              
              
              
              —
              
              
              
              3,868
              
              
              
              —
              
              
              
              —
              
              
              
              3,880Fees
      paid on equity line of credit
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (46,641
              )
              
              
              —
              
              
              
              —
              
              
              
              (46,641
              )Warrants
      issued with convertible notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              260,718
              
              
              
              —
              
              
              
              —
              
              
              
              260,718Fair
      value of options issued to an officer
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              8,898
              
              
              
              —
              
              
              
              —
              
              
              
              8,898Common
      stock issued, previously paid for
              
              
              —
              
              
              
              2,597,524
              
              
              
              2,597
              
              
              
              (60,000
              )
              
              
              57,403
              
              
              
              —
              
              
              
              —
              
              
              
              —Fair
      value of options issued to  officers
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              20,574
              
              
              
              —
              
              
              
              —
              
              
              
              20,574Warrants
      issued with convertible notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              267,930
              
              
              
              —
              
              
              
              —
              
              
              
              267,930Common
      stock issued for convertible debt on October 5, 2007
              
              
              0.53
              
              
              
              51,887
              
              
              
              52
              
              
              
              —
              
              
              
              27,448
              
              
              
              —
              
              
              
              —
              
              
              
              27,500Common
      stock issued for convertible debt on November 12, 2007
              
              
              0.37
              
              
              
              255,081
              
              
              
              255
              
              
              
              —
              
              
              
              94,125
              
              
              
              —
              
              
              
              —
              
              
              
              94,380Common
      stock issued for convertible debt on November 12, 2007
              
              
              0.53
              
              
              
              51,887
              
              
              
              52
              
              
              
              —
              
              
              
              27,448
              
              
              
              —
              
              
              
              —
              
              
              
              27,500Common
      stock issued for convertible debt on November 14, 2007
              
              
              0.34
              
              
              
              80,882
              
              
              
              81
              
              
              
              —
              
              
              
              27,419
              
              
              
              —
              
              
              
              —
              
              
              
              27,500Common
      stock issued for convertible debt on November 14, 2007
              
              
              0.37
              
              
              
              95,227
              
              
              
              95
              
              
              
              —
              
              
              
              35,105
              
              
              
              —
              
              
              
              —
              
              
              
              35,200Common
      stock issued for convertible debt on November 15, 2007
              
              
              0.37
              
              
              
              163,514
              
              
              
              164
              
              
              
              —
              
              
              
              60,336
              
              
              
              —
              
              
              
              —
              
              
              
              60,500Common
      stock issued for convertible debt on November 16, 2007
              
              
              0.37
              
              
              
              71,351
              
              
              
              71
              
              
              
              —
              
              
              
              26,329
              
              
              
              —
              
              
              
              —
              
              
              
              26,400Common
      stock issued for convertible debt on November 16, 2007
              
              
              0.34
              
              
              
              80,882
              
              
              
              81
              
              
              
              —
              
              
              
              27,419
              
              
              
              —
              
              
              
              —
              
              
              
              27,500Warrants
      issued with convertible notes
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              158,652
              
              
              
              —
              
              
              
              —
              
              
              
              158,652
   F-13
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2007
 Deficit
                AccumulatedPrice
      per
              
              
              Common
      Stock
              
              
              Common
                Stock
              
              
              Additional
      Paid-in
              
              
              Deferred
              
              
              During the Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              to be
    Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              DeficiencyCommon
      stock to be issued for consulting services
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4,000
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4,000Common
      stock issued for convertible debt on December 28, 2007
              
              
              0.17
              
              
              
              1,060,000
              
              
              
              1,060
              
              
              
              —
              
              
              
              198,940
              
              
              
              —
              
              
              
              —
              
              
              
              200,000Fair
      value of options issued to an officer
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              21,818
              
              
              
              —
              
              
              
              —
              
              
              
              21,818Net
      loss for year ended December 31, 2007
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (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
              )
  
  See notes
to consolidated financial statements.
 F-14
  SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 
 Inception
      (February 18, 1998)Years Ended
    December 31,
              
              
              to
      December 31,2007
              
              
              2006
              
              
              2007Cash
      flows from operating activitiesNet
      Loss
              
              $
              (6,262,743
              )
              
              $
              (10,181,523
              )
              
              $
              (36,690,340
              )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
              )Stock
      based compensation expense
              
              
              67,592
              
              
              
              2,716,889
              
              
              
              2,969,176Issuance
      of common stock for services
              
              
              4.000
              
              
              
              —
              
              
              
              4,672,102Issuance
      of options for legal settlement
              
              
              —
              
              
              
              —
              
              
              
              31,500Issuance
      of warrants for legal settlement
              
              
              —
              
              
              
              —
              
              
              
              4,957Issuance
      of warrants for financing fees
              
              
              35,340
              
              
              
              —
              
              
              
              35,340Patent
      acquisition cost
              
              
              —
              
              
              
              —
              
              
              
              1,610,066Amortization
      of issuance costs and original issue debt discounts
                including
      beneficial conversion feature-part of interest expense
              
              
              1,573,596
              
              
              
              2,284,742
              
              
              
              4,372,901Amortization
      of deferred compensation
              
              
              —
              
              
              
              —
              
              
              
              3,060,744Depreciation
      and amortization of leasehold improvements
              
              
              167,380
              
              
              
              154,457
              
              
              
              355,599Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              (1,380
              )
              
              
              —
              
              
              
              (1,380
              )Inventory
              
              
              (8,942
              )
              
              
              (21,314
              )
              
              
              (30,256
              )Prepaid
      expenses and other
              
              
              60,680
              
              
              
              (72,223
              )
              
              
              (20,552
              )Other
      assets
              
              
              —
              
              
              
              —
              
              
              
              (4,500
              )Accounts
      payable and accrued expenses
              
              
              1,191,661
              
              
              
              (78,615
              )
              
              
              3,423,775Net
      cash used in operating activities
              
              
              (3,172,816
              )
              
              
              (5,197,587
              )
              
              
              (16,723,076
              )Cash
      flows from investing activitiesPurchase
      of equipment
              
              
              (46,415
              )
              
              
              (181,106
              )
              
              
              (553,107
              )Net
      cash used in investing activities
              
              
              (46,415
              )
              
              
              (181,106
              )
              
              
              (553,107
              )Cash
      flows from financing activitiesNet
      proceeds under equity line of credit
              
              
              912,691
              
              
              
              349,695
              
              
              
              1,262,386(Decrease)
      increase in payables to related parties and stockholder
              
              
              103,930
              
              
              
              (158,733
              )
              
              
              615,380Increase
      in convertible notes
              
              
              74,492
              
              
              
              —
              
              
              
              74,492Advances
      from founding executive officer
              
              
              —
              
              
              
              —
              
              
              
              517,208Net
      proceeds from issuance of convertible notes and warrants
              
              
              2,157,800
              
              
              
              1,365,500
              
              
              
              4,825,678Repayment
      of convertible notes
              
              
              (226,250
              )
              
              
              —
              
              
              
              (226,250
              )Net
      proceeds from issuance of common stock and common stock
      issuable
              
              
              —
              
              
              
              3,786,638
              
              
              
              10,254,949Net
      cash provided by financing activities
              
              
              3,022,663
              
              
              
              5,343,100
              
              
              
              17,323,843Net
      (decrease) increase in
      cash
              
              
              (196,568
              )
              
              
              (35,593
              )
              
              
              47,660Cash, beginning of
      period
              
              
              244,228
              
              
              
              279,821
              
              
              
              —Cash, end of
      period
              
              $
              47,660
              
              
              $
              244,228
              
              
              $
              47,660Supplemental
      disclosures of cash flow informationCash
      paid during the year forInterest
              
              $
              1,239
              
              
              $
              128,634
              
              
              $
              135,044Income
      taxes
              
              $
              800
              
              
              $
              800
              
              
              $
              3,482Non-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
              
              
              —
              
              
              
              —
              
              
              
              113,981Cancellation
      of stock
              
              
              —
              
              
              
              —
              
              
              
              8,047Conversion
      of accounts payable and accrued expenses to common stock
              
              
              —
              
              
              
              —
              
              
              
              612,521Conversion
      of related party debt to convertible debentures
              
              
              —
              
              
              
              45,000
              
              
              
              45,000Conversion
      of convertible debentures to common stock
              
              
              526,480
              
              
              
              2,580,086
              
              
              
              2,973,434Write
      off of deferred compensation
              
              
              —
              
              
              
              142,187
              
              
              
              142,187Non-cash
      equity-warrant valuation and intrinsic value of beneficial
              
              
              1,253,548
              
              
              
              1,259,696
              
              
              
              3,966,425conversion
      associated with convertible notes`
 
 See notes
to consolidated financial statements.
 F-15
 
 SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
  1.    
Description of business
 
 Description of business
 
 Save the
World Air, Inc. (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, the Company
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.
  The
Company was incorporated in Nevada on February 18, 1998 under the name
Mandalay Capital Corp.  The Company changed its name to Save the World
Air, Inc. on February 11, 1999 following the purchase of the worldwide
exclusive manufacturing, marketing and distribution rights for the ZEFS
technologies.   The Company has been acquiring new technologies,
developing prototype products using the Company’s technologies and conducting
scientific tests regarding the technologies and prototype products. The
Company’s 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.  When fitted to an
internal combustion engine, they are expected to reduce carbon monoxide,
hydrocarbons and nitrous oxide emissions and to increase power and improve
mileage. The Company has also developed prototype products and named them
“CAT-MATE” technology.
  The
Company has entered into two License Agreements with Temple University, one
covering Temple University’s current patent application concerning certain
electric field effects on gasoline, kerosene and diesel fuel particle size
distribution, and the other covering Temple University’s current patent
application concerning electric field effects on crude oil and edible oil
viscosity, and any and all United States and foreign patents issuing in respect
of the technologies described in such applications. 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 $250,000, payable in three
installments of $100,000, the first installment of which was paid in March 2007,
and $75,000 on each of February 2, 2008, which has not been paid, and
February 2, 2009, respectively; and (ii) annual maintenance fees of
$125,000 annually commencing January 1, 2008, which has not been paid. 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 two
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 is in default in connection with its payment obligations under the
License Agreements.  Nonetheless, the Company has not received any
written notice from Temple University of a material breach relating to required
payments under the License Agreements.  Any such notice must provide
the Company with 60 days’ notice to cure the material breach.  Should
the Company receive such notice, the Company’s failure to cure could result in a
termination of the License Agreements. Under the License Agreements the Company
must pay a penalty equal to 1% per month of the amounts due and unpaid under the
License Agreements.
  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. Pursuant to the
R&D Agreement, the Company will make payments to Temple University in the
aggregate amount of $500,000, payable in eight non-refundable installments
commencing with $123,750, which was paid in March 2007, and seven payments
of $53,750 every three months thereafter until paid in full. The payments of
$53,750 due in June, September and December 2007 have not been
paid.  The Company is in default under the R&D Agreement, however,
the Company has not received any notice of default from Temple University. 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.
  F-16
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 Consolidation policy
 
 The
accompanying consolidated financial statements of Save the World Air, Inc. and
Subsidiary include the accounts of Save the World Air, Inc. (the Parent) and its
wholly owned subsidiary STWA Asia Pte. Limited, incorporated on January 17,
2006.  To date STWA Asia Pte. Limited has had sales of $17,000.
 Intercompany transactions and balances have been eliminated in
consolidation.
 
 2.     Summary
of significant accounting policies
 
 Development stage enterprise
 
 The
Company is a development stage enterprise as defined by Statement of Financial
Accounting Standards (SFAS) No. 7, “Accounting and Reporting by Development
Stage Enterprises.”  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.
  Liquidity
 
 The
Company is subject to the usual risks associated with a development stage
enterprise. These risks include, among others, those associated with product
development, acceptance of the product by users and the ability to raise the
capital necessary to sustain operations. Since its inception, the Company has
incurred significant losses.  The Company anticipates increasing
expenditures over at least the next year as the Company continues its product
development and evaluation efforts, and begins its marketing activities. Without
significant revenue, these expenditures will likely result in additional
losses.
  Going
concern
 
 The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. As reflected in the
accompanying financial statements, the Company had a net loss of $6,262,743 and
a negative cash flow from operations of $3,172,816 for the year ended December
31, 2007, and had a working capital deficiency of $4,565,344 and a stockholders’
deficiency of $4,359,786 at December 31, 2007.  These factors raise
substantial doubt about the Company’s ability to continue as a going concern.
The ability of the Company to continue as a going concern is dependent upon the
Company’s ability to raise additional funds and implement its business plan. The
financial statements do not include any adjustments that might be necessary if
the Company is unable to continue as a going concern.
  Revenue
Recognition Policy
 
 The
Company has adopted Staff Accounting Bulletin 104, “Revenue Recognition” and
therefore recognizes revenue based upon meeting four criteria:
 
 ·
              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.
 
 F-17
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 The
Company contracts with manufacturers of fixed magnetic field products and sells
them to various original equipment manufacturers in the motor vehicle and small
utility motor markets. The Company negotiates 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, the Company recognizes the
revenue associated with the sale of the products to the customer.
  Accounts
Receivable Allowance Policy
 
 The
Company reports accounts receivable in relation to sales of
product.  The Company performs an analysis of the receivable balances
in order to determine if an allowance for doubtful accounts is
necessary.  As of December 31, 2007, no allowance is
necessary.
  Equipment
and depreciation
 
 Property
and equipment are stated at cost. Depreciation is computed using the
straight-line method based on the estimated useful lives of the assets,
generally ranging from three to ten years. Expenditures for major renewals and
improvements that extend the useful lives of property and equipment are
capitalized. Expenditures for repairs and maintenance are charged to expense as
incurred. Leasehold improvements are amortized using the straight-line method
over the shorter of the estimated useful life of the asset or the lease
term.
  Long-lived
assets
 
 The
Company accounts for the impairment and disposition of long-lived assets in
accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” In accordance with SFAS No. 144,
long-lived assets to be held are reviewed for events or changes in circumstances
that indicate that their carrying value may not be recoverable. The Company
periodically reviews the carrying values of long-lived assets to determine
whether or not an impairment to such value has occurred. No impairments were
recorded for the year ended December 31, 2007.  The Company recorded
an impairment of approximately $505,000 during the period from inception
(February 18, 1998) through December 31, 2007.
  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 years ended December 31, 2007 and 2006, the dilutive
impact of outstanding stock options of 4,188,445 and 3,999,559, respectively,
and outstanding warrants of 17,919,028, and 20,897,311 have been excluded
because their impact on the loss per share is anti-dilutive.
  Income
taxes
 
 Income
taxes are recognized for the amount of taxes payable or refundable for the
current year and deferred tax liabilities and assets are recognized for the
future tax consequences of transactions that have been recognized in the
Company’s financial statements or tax returns. A valuation allowance is provided
when it is more likely than not that some portion or all of the deferred tax
asset will not be realized.
  Stock-based
compensation
 
 On
January 1, 2006, the Company adopted Statements of Financial Accounting
Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors based on estimated
fair values. SFAS 123(R) supersedes the Company’s previous accounting under
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005,
the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the
provisions of SAB 107 in its adoption of SFAS 123(R).
  F-18
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 The
Company adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of January 1,
2006, the first day of the Company’s fiscal year 2006. The Company’s financial
statements for the years ended December, 2007 and 2006 reflect the impact of
SFAS 123(R). In accordance with the modified prospective transition method, the
Company’s financial statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation
expense recognized under SFAS 123(R) for employee and directors for the years
ended December 31, 2007 and 2006 were $67,592 and $2,716,889,
respectively.
  The
Company’s determination of fair value of share-based payment awards to employees
and directors on the date of grant uses the Black-Scholes model, which is
affected by the Company’s stock price as well as assumptions regarding a number
of highly complex and subjective variables. These variables include, but are not
limited to our expected stock price volatility over the term of the awards, and
actual and projected employee stock option exercise
behaviors.  Forfeitures are recognized as incurred.
  The
Company accounts for stock option and warrant grants issued to non-employees for
goods and services using the guidance of SFAS No. 123 and Emerging Issues
Task Force (“EITF”) No. 96-18: “Accounting for Equity Instruments that are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services,” whereby the fair value of such option and warrant grants is
determined using the Black-Scholes option pricing model at the earlier of the
date at which the non-employee’s performance is completed or a performance
commitment is reached.
  Business
and credit concentrations
 
 The
Company’s cash balances in financial institutions at times may exceed federally
insured limits. As of December 31, 2007 and 2006, before adjustments for
outstanding checks and deposits in transit, the Company had $65,449 and
$121,705, respectively, on deposit with three banks. The deposits are federally
insured up to $100,000 on each bank.
  Warranties
 
 The
Company has a warranty policy for its products. No warrant liability has been
recorded as of December 31, 2007 based on the limited sales and such amount is
deemed immaterial.
  Inventories
 
 Inventories
are valued at the lower of cost (first-in, first-out) or market and primarily
consist of finished goods.
  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.
  Fair
value of financial instruments
  The
carrying amounts of financial instruments, including cash, accounts payable and
accrued expenses, convertible notes, and payables to related parties approximate
fair value because of their short maturity as of December 31, 2007 and
2006.
 
 F-19
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
   Recent
accounting pronouncements
  Statement No. 157
  In
September 2006, the Financial Accounting Standards Board (the “FASB”) issued
Statement No. 157, “Fair Value      Measurements”
(“SFAS 157”), SFAS 157 establishes a formal framework for measuring fair value
under GAAP.  It defines and codifies the many definitions of fair
value included among various other authoritative literature, clarifies and, in
some instances, expands on the guidance for implementing fair value
measurements, and increases the level of disclosure required for fair value
measurements.  Although SFAS 157 applies to and amends the provisions
of existing FASB and AICPA pronouncements, it does not, of itself, require any
new fair value measurements, nor does it establish valuation
standards.  SFAS 157 applies to all other accounting pronouncements
requiring or permitting fair value measurements, except for; SFAS 123R,
share-based payment and related pronouncements, the practicability exceptions to
fair value determinations allowed by various other authoritative pronouncements,
and AICPA Statements of Position 97-2 and 98-9 that deal with software revenue
recognition.  This statement is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years.  Management is currently evaluating the
effect of this pronouncement on the Company’s financial statements.
  Statement
No. 159
  In
February 2007, the FASB issued Statement No. 159, “The Fair Value Option for
Financial Assets and Liabilities”. This Statement permits entities to choose to
measure many financial instruments and certain other items at fair value. The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions.  The fair value option established by this
Statement permits all entities to choose to measure eligible items at fair value
at specified election dates. A business entity shall report unrealized gains and
losses on items for which the fair value option has been elected in earnings (or
another performance indicator if the business entity does not report earnings)
at each subsequent reporting date. This Statement is effective as of the
beginning of an entity’s first fiscal year that begins after November 15,
2007.The Company does not believe that the adoption of SFAS 159 will have a
material affect on our financial statements.
  SFAS
No. 141 (R) and SFAS No. 160
  In
December 2007, the FASB issued SFAS No. 141 (R), Business Combinations, and SFAS
No. 160, Non-controlling Interests in Consolidated Financial Statements.
SFAS No. 141 (R) requires an acquirer to measure the identifiable assets
acquired, the liabilities assumed, and any non-controlling interest in the
acquiree at their fair values on the acquisition date, with goodwill being the
excess value over the net identifiable assets acquired. SFAS No. 160
clarifies that a non-controlling interest in a subsidiary should be reported as
equity in the consolidated financial statement. The calculation of earnings per
share will continue to be based on income amounts attributable to the parent.
SFAS No. 141 (R) and SFAS No. 160 are effective for financial
statements issued for fiscal years beginning after December 15, 2008. Early
adoption is prohibited. We have not yet determined the effect on our financial
statements, if any, upon adoption of SFAS No. 141 (R) or SFAS No.
160.
  Management
does not believe that there are any recently-issued, but not yet effective
accounting pronouncements, which could have a material effect on the
accompanying condensed consolidated financial statements
 3.    
Certain relationships and related transactions
  Loans from related parties
 
 In May of
2007, a former officer and incumbent director of the Company loaned $31,404 to
pay a company obligation and in August 2007, the same party loaned $50,000 to
the Company so that it could pay certain operating expenses. These amounts are
unsecured, bear interest at 6% per annum and are due on demand.  At
December 31, 2007, the balance of these loans including interest was
$83,596.
  F-20
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 Lease
agreement with related party
  During
2003, the Company entered into a sublease agreement with Scottish Glen Golf
Company, Inc. (SGGC) to lease office space in North Hollywood, California for
its principal executive offices.  Bruce McKinnon, the former Chief
Executive Officer and former Director of the Company, is a beneficial owner of
the lessor.
  In August
2005, the Company amended this sublease agreement. The original lease term was
from November 1, 2003 through October 16, 2005 and carried an option
to renew for two additional years with a 10 percent increase in the rental
rate. Monthly rent under this lease is $3,740 per month under this
lease.  The Company exercised its option to renew the lease through
October 15, 2007.
  In
January 2006, the Company further amended this sublease agreement, as a result
of taking more space and obtaining expanded support services. The term of the
sublease was amended to July 31, 2007 and carries an option to renew for
two additional years with a 10 percent increase in the rental rate. Monthly
rent is $6,208 per month under this amended sublease agreement.
Additionally, the Company began leasing two additional office
spaces for $964 per month beginning July 2006 on a month-to-month
basis.  The Company did not exercise its option to renew this
sublease.
  On July
12, 2007, SGGC presented to the Company a Three-Day Notice to Pay or Quit,
demanding payment of unpaid rent, additional rent and penalties.  On
July 19, 2007, SGGC sued the Company in Los Angeles Superior Court, alleging
unlawful detainer by the Company of its then-leased corporate offices at 5125
Lankershim Boulevard, North Hollywood, California, and failure to pay past due
rent and penalties in the aggregate amount of $104,413.  The Company
vacated the premised on July 25, 2007.  (See Note 10 –Commitments and
contingencies-Legal matters, Litigation Involving Sublessor of Former Corporate
Offices).
  Investments
from related parties
  In June
2007, the Company received $100,000 proceeds for investment in the Spring
Offering, from an investor who is more than a 5% beneficial owner of
STWA.  (See Note 8-Convertible notes and warrants).
  In
December, the Company received $200,000 proceeds for investment in the Fall
Offering from a Director  who is more than a 5% beneficial owner of
STWA.  (See Note 8-Convertible notes and warrants).
  Accounts
Payable to related parties
  As
of  December 31, 2007, the Company had accounts payable to related
parties in the amount of $323,413, which was composed of $180,375 in unpaid
Directors Fees,  $41,342 in unreimbursed expenses incurred by Officers
and Directors  and $101,696 accrual for past due rent and contested
penalties payable to a company beneficially owned by a former Chief Executive
Officer and Director. (See Note 10, Litigation Matters and
Leases).
  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. SS Sales will also provide advice, assistance and
information on marketing the Company’s products in the automotive after-market,
and will seek to recruit and establish a market with distributors, wholesalers
and others. SS Sales will be paid a commission equal to 5% of the gross amount
actually collected on contracts the Company entered into during the term of the
agreement for existing or future customers introduced by SS Sales in the
Territory. 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. No
amount was due or paid under this agreement as of December 31,
2007.  SS Sales is owned by Nathan Shelton, who has served as one of
the directors of the Company since February 12, 2007.
 
 F-21
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 
 4.    
Equipment
  At
December 31, 2007 and 2006, equipment consists of the
following:
 
 December 31,2007
              
              
              2006Office
      equipment
              
              $
              53,043
              
              
              $
              50,670Delivery
      equipment
              
              
              34,672
              
              
              
              -Furniture
      and
      fixtures
              
              
              18,957
              
              
              
              18,957Machinery
      and
      equipment
              
              
              54,161
              
              
              
              54,161Dies
      and
      molds
              
              
              3,000
              
              
              
              3,000Testing
      equipment
              
              
              147,312
              
              
              
              147,312Leasehold
      improvements
              
              
              245,512
              
              
              
              236,142Subtotal
              
              
              556,657
              
              
              
              510,242Less
      accumulated
      depreciation
              
              
              (355,599
              )
              
              
              (188,219
              )Total
      current
      assets
              
              $
              201,058
              
              
              $
              322,023
 
 Depreciation
expense for the years ended December 31, 2007 and 2006, was $167,380 and
$154,457, respectively.  Depreciation expense for the period from
inception February 18, 1998 through December 31, 2007 was
$355,599.
 
 5.Income taxes
 
 Income tax provision consists of the following:
 
 For the years ended
      December 31,2007
              
              
              2006Current:Federal
              
              $
              —
              
              
              $
              —State
              
              
              800
              
              
              
              800Total
      current
              
              
              800
              
              
              
              800Deferred:Federal
              
              
              —
              
              
              
              —State
              
              
              —
              
              
              
              —Total
      deferred
              
              
              —
              
              
              
              —Total
      income tax
      provision
              
              $
              800
              
              
              $
              800
 
 As of
December 31, 2007, the Company has recorded a $12,113,659 valuation allowance
against a portion of its deferred tax assets, since it was believed that such
assets did not meet the more likely than not criteria to be recoverable through
projected future profitable operations in the foreseeable future.
 
 Failure
by the Company to successfully maintain improved margins, grow revenues and/or
maintain anticipated savings on future interest costs, and maintain profitable
operating results in the near term, could adversely affect the Company's
expected realization of some or all of its deferred tax assets and could require
the Company to record a valuation allowance against some or all of such assets,
which could adversely affect the Company's financial position and results of
operations.
 
 The total
income tax provision (benefit) was 0% of pretax income (loss) for the years
ended December 31, 2007 and 2006, respectively. A reconciliation of income taxes
with the amounts computed at the statutory federal rate follows:
 
 December 31,2007
              
              
              2006Computed
      tax provision (benefit) at federal statutory rate (34%)
              
              $
              (2,129,061
              )
              
              $
              (3,461,446
              )State
      income taxes, net of federal
      benefit
              
              
              (268,524
              )
              
              
              (406,769
              )Permanent
      items
              
              
              561,162
              
              
              
              1,087,922Credits
              
              
              —
              
              
              
              —Valuation
      allowance
              
              
              1,837,223
              
              
              
              2,781,093Income
      tax provision
              
              $
              800
              
              
              $
              800
  F-22
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 
 The
deferred tax assets and deferred tax liabilities recorded on the balance sheet
are as follows:
  December 31, 2007
              
              
              December 31, 2006Deferred
      tax
              
              
              Deferred
      tax
              
              
              Deferred
      tax
              
              
              Deferred
      taxassets
              
              
              liabilities
              
              
              assets
              
              
              liabilitiesCurrent:Accrued
      liabilities
              
              $
              538,747
              
              
              $
              —
              
              
              $
              382,359
              
              
              $
              —Other
              
              
              272
              
              
              
              —
              
              
              
              272
              
              
              
              —539,019
              
              
              
              —
              
              
              
              382,631
              
              
              
              —Noncurrent:Net
      operating loss carry
      forwards
              
              
              10,122,130
              
              
              
              —
              
              
              
              8,490,347
              
              
              
              —Unexercised
      stock options and
      warrants
              
              
              1,133,210
              
              
              
              —
              
              
              
              1,118,553
              
              
              
              —Credit
      carryovers
              
              
              256,757
              
              
              
              —
              
              
              
              259,391
              
              
              
              —Depreciation
              
              
              62,543
              
              
              
              —
              
              
              
              25,515
              
              
              
              —Valuation
      allowance
              
              
              (12,113,659
              )
              
              
              —
              
              
              
              (10,276,437
              )
              
              
              —(539,019
              )
              
              
              —
              
              
              
              (382,631
              )
              
              
              —Total
      deferred taxes net of valuation allowance
              
              $
              —
              
              
              $
              —
              
              
              $
              —
              
              
              $
              —
 
 As
of December 31, 2007, the Company had net operating losses available for carry
forward for federal tax purposes of approximately $25.7 million expiring
beginning in 2018. These carryforward benefits may be subject to annual
limitations due to the ownership change limitations imposed by the Internal
Revenue Code and similar state provisions. The annual limitation, if imposed,
may result in the expiration of net operating losses before
utilization.
  Effective
January 1, 2007, the Company adopted Financial Accounting Standards Board
Interpretation No 48, “Accounting for Uncertainty in Income Taxes — an
interpretation of FASB Statement No 109, “Accounting for Income Taxes (“FIN
48”).” FIN 48 addresses the determination of whether tax benefits claimed or
expected to be claimed on a tax return should be recorded in the financial
statements. Under FIN 48, the Company may recognize the tax benefit from an
uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based on the
technical merits of the position. The tax benefits recognized in the financial
statements from such a position should be measured based on the largest benefit
that has a greater than 50% likelihood of being realized upon ultimate
settlement. FIN 48 also provides guidance on de-recognition,
classification, interest and penalties on income taxes, accounting in interim
periods and requires increased disclosures. At the date of adoption, and as of
December 31, 2007, the Company does not have a liability for unrecognized tax
benefits.
  The
Company files income tax returns in the U.S. federal jurisdiction and the state
of California. The Company is subject to U.S. federal or state income tax
examinations by tax authorities for years after 2002. During the periods open to
examination, the Company has net operating loss and tax credit carry forwards
for U.S. federal and state tax purposes that have attributes from closed
periods. Since these net operating losses and tax credit carry forwards may be
utilized in future periods, they remain subject to examination. The Company’s
policy is to record interest and penalties on uncertain tax provisions as income
tax expense. As of December 31, 2007, The Company has no accrued interest or
penalties related to uncertain tax positions. The Company believes that it has
not taken any uncertain tax positions that would impact its condensed
consolidated financial statements as of December 31, 2007. Also as of the date
of adoption, and as of December 31, 2007, the Company does not have a liability
for unrecognized tax benefits.
  6.    
Stockholders’ deficiency
 
 As of
December 31, 2007, the Company has authorized 200,000,000 shares of
its common stock, of which 46,470,413 shares were issued and
outstanding.
  F-23
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 In April
2006, the Company conducted an offering (the “Overseas Offering”) and sold
473,000 shares of the Company’s common stock at $1.56 per share and issued
warrants to purchase up to 118,250 shares of the Company’s common stock at an
exercise price of $2.60 per share, to two overseas investors. The Company raised
$737,881 gross proceeds ($667,803 net proceeds) in this offering.
  In May 2006, the Company conducted
an offering (the “2006 PIPE Offering”) and sold 873,018 shares of the Company’s
common stock (the “2006 PIPE Shares”) at $1.89 per share and issued warrants
(the “2006 PIPE Warrants”) to purchase up to 436,511 shares of the Company’s
common stock at $2.70 per share, through the Company’s exclusive placement
agent, Spencer Clarke LLC (“Spencer Clarke”). The Company raised $1,650,009
gross proceeds ($1,435,508 net proceeds) in the 2006 PIPE
Offering.  In addition, warrants exercisable for 87,302 shares
of the Company’s common stock were issued to the Company’s placement
agent.
  In
September 2006, the Company entered into what is sometimes termed an equity
arrangement with an investment banking firm.  Under the
arrangement the Company may sell (put) shares of common stock
from time to time over a 36-month period, at a purchase price calculated at 97%
of the lowest best closing bid for the Company’s common stock for the five
trading days following the put notice for cash.  The Company may draw
up to $10,000,000. Because the price of the common stock fluctuates, the number
of shares of common stock that the Company may issue when the Company
exercises the put rights will vary, the Company does not know how many
shares will actually be issued under the put. On October 6, 2006, the
Company filed a Registration Statement which was effective October 30, 2006
which registered and made available 7,000,000 shares of common stock for
possible future draws under the line of credit.
  During
the years ended December 31, 2007 and 2006, the Company drew down $ 992,055
($912,683 net of closing costs) and $380,095 ($349,695 net of closing costs) and
issued 1,880,421 and 487,484 shares of common stock respectively.  As
of December 31, 2007 the Company has drawn down $1,372,150 ($1,262,378 net
of closing costs) of this commitment and issued 2,367,905 shares at an average
price of $0.58 per share, leaving 4,632,095 shares available under the equity
line of credit.
  During
the year ended December 31, 2006, convertible notes in the amount of $2,576,379
of the Company’s previously issued and outstanding Investor Notes were converted
to 3,680,540 shares of common stock, at a conversion rate of $0.70 per
share.  In addition, $3,707 of accrued interest was converted to 5,296
shares of common stock, at a conversion rate of $0.70 per share.  The
Company did not receive any proceeds in connection with the conversion of the
Investor Notes.
  In
November and December 2006 the Company issued 487,484 shares of common stock
under the equity line of credit.  Gross proceeds received of $380,095
and net proceeds received of $349,695.
  During
the year ended December 31, 2006, individuals exercised outstanding warrants to
purchase 2,328,452 shares of common stock for gross and net proceeds of
$1,623,327.
  During
the year ended December 31, 2006, the Company issued 846,549 shares for
previously settled payables.
  In August
2007, the Company issued 2,597,524 shares in connection with the exercise of
options that were originally granted to the late Edward L. Masry.
  During
the year ended December 31, 2007 the Company issued 1,880,421 shares of common
stock under the equity line of credit.  Gross proceeds received of
$992,055 and net proceeds received of $912,683.
  During
the year ended December 31, 2007, the Company issued 1,910,711 shares of common
stock in exchange for conversion of  $526,480 of Convertible
Notes.
  7.    
Stock options and warrants
 
 The Company currently issues stock
options to employees, directors and consultants under the 2004 Stock Option Plan
(thePlan). 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
December 31, 2007, 3,061,555 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.
  F-24
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 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 December 31, 2007 was 7.10 years. Stock option
activity for the years ended December 31, 2007 and 2006, which includes
3,250,000 options granted outside and prior to the adoption of the Plan, was as
follows:
 
 Weighted
      Avg.
                Options
              
              
              Weighted
      Avg.
                Exercise PriceOptions,
      January 1,
      2004
              
              
              13,250,000
              
              
              
              0.11Options
      granted
              
              
              1,172,652
              
              
              
              1.03Options
      exercised
              
              
              —
              
              
              
              —Options
      cancelled
              
              
              —
              
              
              
              —Options,
      December 31,
      2004
              
              
              14,422,652
              
              
              
              0.18Options
      granted
              
              
              2,085,909
              
              
              
              0.92Options
      exercised
              
              
              —
              
              
              
              —Options
      cancelled
              
              
              (10,000,000
              )
              
              
              0.10Options,
      December 31,
      2005
              
              
              6,508,561
              
              
              
              0.53Options
      granted
              
              
              1,313,605
              
              
              
              1.21Options
      exercised
              
              
              (2,860,000
              )
              
              
              0.10Options
      forfeited
              
              
              (962,607
              )
              
              
              0.84Options
      cancelled
              
              
              —
              
              
              
              —Options,
      December 31,
      2006
              
              
              3,999,559
              
              
              $
              0.99Options
      granted
              
              
              238,679
              
              
              
              0.55Options
      exercised
              
              
              —
              
              
              
              —Options
      forfeited
              
              
              (49,793
              )
              
              
              1.96Options
      cancelled
              
              
              —
              
              
              
              —Options,
      December 31,
      2007
              
              
              4,188,445
              
              
              $
              0.95
 
 The
weighted average exercise prices, remaining contractual lives for options
granted, exercisable, and expected to vest under the Plan as of
December 31, 2007 were as follows:
 
 Number
                of
                Shares
              
              
              Weighted
                Average
                Exercise
                Price
              
              
              Weighted
                Average
                Remaining
                Contractual
                Life (Years)As
      of December 31, 2007:Outstanding
              
              
              4,188,455
              
              
              $
              0.95
              
              
              
              7.10Expected
      to
      Vest
              
              
              4,188,455
              
              
              $
              0.95
              
              
              
              7.10Exercisable
              
              
              3,999,766
              
              
              $
              0.97
              
              
              
              6.99
 
 As
of December 31, 2007, the exercise price of all options outstanding exceeds the
market price of the Company’s stock, and therefore there was no intrinsic
value.  Future compensation expense on the options which were not
exercisable at December 31, 2007 is $49,089.
  Black-Scholes
value of employee options
  During
the years ended December 31, 2007 and 2006, the Company valued employee
options for pro-forma purposes at the grant date using the Black-Scholes pricing
model with the following average assumptions:
 
 2007
              
              
              2006Expected
      life
      (years)
              
              
              5.06
              
              
              
              5.15Risk
      free interest
      rate
              
              
              4.42
              %
              
              
              4.59
              %Volatility
              
              
              116.82
              %
              
              
              262.84
              %Expected
      dividend
      yield
              
              
              0.00
              %
              
              
              0.00
              %
 
 The
weighted average fair value for options granted in 2007 and 2006 were $0.89 and
$1.66, respectively.
  During
the year ended December 31, 2007, the Company granted 238,679 options, to
certain employees, exercisable at amounts ranging from $0.35 to $0.85, vested
immediately or over one year with a one to ten year life. The options were
valued at an aggregate amount of $116,681 (or $0.49 per share on average) using
the Black Scholes pricing model using a 5.0 to 5.5 year expected term, 114% to
125% volatility, no annual dividends, and a discount rate of 3.82% to
4.86%.
  F-25
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 Warrants
 
 The
following table summarizes certain information about the Company’s stock
purchase warrants (including the warrants discussed in Note 10).
 
 Warrants
              
              
              Weighted
      Avg.
                Exercise PriceWarrants
      outstanding, January 1,
      2004
              
              
              14,252,414
              
              
              
              0.48Warrants
      granted
              
              
              2,372,500
              
              
              
              1.27Warrants
      exercised
              
              
              (960,500
              )
              
              
              0.20Warrants
      cancelled
              
              
              —
              
              
              
              —Warrants
      outstanding, December 31,
      2004
              
              
              15,664,414
              
              
              
              0.62Warrants
      granted
              
              
              5,198,574
              
              
              
              1.16Warrants
      exercised
              
              
              (50,500
              )
              
              
              0.99Warrants
      cancelled
              
              
              (20,000
              )
              
              
              1.50Warrants
      outstanding, December 31,
      2005
              
              
              20,792,488
              
              
              
              0.75Warrants
      granted
              
              
              3,624,894
              
              
              
              1.28Warrants
      exercised
              
              
              (2,328,452
              )
              
              
              0.68Warrants
      cancelled
              
              
              (1,191,619
              )
              
              
              1.46Warrants
      outstanding, December 31,
      2006
              
              
              20,897,311
              
              
              $
              0.81Warrants
      granted
              
              
              3,602,701
              
              
              
              0.64Warrants
      exercised
              
              
              —
              
              
              
              —Warrants
      cancelled
              
              
              (6,580,984
              )
              
              
              1.06Warrants
      outstanding, December 31,
      2007
              
              
              17,919,028
              
              
              $
              0.67
 
 At
December 31, 2007 the price of the Company’s common stock was less than the
exercise price of all of the warrants, and therefore there was no intrinsic
value.
 
 8.   
Convertible notes and warrants
 
 During
February 2006, the Company issued 250,000 performance based warrants to an
outside consultant. These warrants are to be exercisable at $.40 per share,
are fully vested and exercisable immediately. These warrants were valued at
$401,130 using the Black-Scholes option valuation model with the following
assumptions: risk-free interest rate of 4.59%, dividends yield of 0%, volatility
factors of the expected market price common of 130.61%, and an expected life of
five years.
  In April
2006, the Company entered into a one-year agreement with an outside consultant
to provide public relations services. The terms of the agreement calls for
monthly payments of $7,000. Additionally, the Company issued a five-year warrant
to the consultant. The warrant is exercisable for up to 100,000 shares of common
stock at an exercise price of $2.30 per share and vests as to 8,333 shares per
month commencing April 30, 2006. The shares issuable upon exercise of the
warrant have piggyback registration rights.  In August 2006 the
Company terminated the agreement.  The consultant earned 41,665
warrants and the remaining balance of 58,335 was forfeited.
  During
the year ended December 31, 2006, the Company issued additional Notes totaling
$1,000,000 which included the conversion of $45,000 of debt owed to the
Company’s Chief Financial Officer.  The Company paid related
transaction fees of $89,500 resulting in net proceeds to the Company of
$865,500.  In addition to the cash paid for transaction fees, 117,857
additional Warrants were issued to certain placement agents. These Warrants
expire between August 31, 2010 and February 9, 2011 and are exercisable at a
price of $1.00 per share.­­­­­­­­­­ As
of December 31, 2007, 104,670 Warrants remained unexercised.
  The
aggregate value of the Warrants issued in connection with the offering and to
the finder were valued at $620,252 using the Black-Scholes option valuation
model with the following assumptions; risk-free interest rate of 4.35% to 4.66%;
dividend yield of 0%; volatility factors of the expected market price of common
stock of 130.61%; and an expected life of two years (statutory
term).  The company also determined that the notes contained a
beneficial conversion feature of $290,248.
  F-26
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 The value
of the Warrants of $620,252, the conversion option of $290,248, and the
transaction fees of $89,500 are considered as debt discount and are being
amortized over the life of the Notes.
  During
the year ended December 31, 2006, convertible notes in the amount of $2,576,379
of the Notes were converted to 3,680,540 shares of stock at $0.70 per
share.  In addition, $3,707 of accrued interest was converted to 5,296
shares at $0.70 per share.
  For the
year ended December 31, 2006, $2,257,620 of the warrant valuations and
beneficial conversion factors have been amortized and included in the
accompanying statement of operations.
  2006-2007
Morale Orchards, LLC, Offering
  On
December 5, 2006, the Company entered into a Note Purchase Agreement (the
“Agreement”) with Morale Orchards, LLC, a limited liability company formed under
the laws of the State of Oregon (“Morale”). The entire equity interest in Morale
is beneficially owned by Leodis Matthews who provides legal services to the
Company. The 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 the Company’s common stock (the “Common Stock”). The aggregate
purchase price for the Notes and Warrants is $1,000,000. Therefore, while the
stated interest on the Notes is 0%, the effective interest rate is 22.5% because
the Notes are being purchased at a discount from their face amount.
  Each of
the Morale Notes is convertible into shares of the Company’s common stock at a
per share conversion price initially equal to the closing price of a share of
the Company’s common stock on the trading day prior to the date of issuance of
such Note.  The conversion right is exercisable during the period
commencing 90 days prior to the maturity of each Note. Concurrently with the
issuance of a Note, for no additional consideration, Morale will acquire
Warrants to purchase a number of shares of common stock equal to 50% of the
number of shares of common stock initially issuable on conversion of the
associated Note. The Morale Warrants become exercisable 180 days after the date
of their issuance.
  The Note
in the amount of $612,500 was purchased by Morale on December 5, 2006 for
$500,000 and is convertible at the rate of $0.85 per share into 720,588 shares
of the Company’s common stock and the Morale Warrants are exercisable at the
same per share price for 360,294 shares of the Company’s common
stock.  The Note in the amount of $612,500 purchased by Morale on
January 10, 2007 for $500,000 is convertible at the rate of $0.70 per share into
875,000 shares of the Company’s common stock and the Morale Warrants are
exercisable at the same per share for 437,500 shares of the Company’s common
stock.
  Repayment
of each Note is to be made monthly, at an amount equal to at least $3,750 for
each Note. Additional payments may be made prior to maturity with no prepayment
penalties. In the event the Company has not repaid each Note in full by the
anniversary date of its issuance, the remaining balance shall be increased by
10% as an initial penalty, and the Company shall pay additional interest of 2.5%
per month, compounded daily, for each month until such Note is paid in
full.
  Morale
has piggyback registration rights pursuant to which Morale may require the
Company to include the shares of the Company’s common stock issuable upon
conversion of the Morale Notes and exercise of the Morale Warrants in certain
future registration statements the Company may elect to file, subject to the
right of the Company and/or its underwriters to reduce the number of shares to
be included in such a registration in good faith based on market or other
conditions.
  The
aggregate value of the Morale Warrants issued in connection with the December 5,
2006 purchase were valued at $118,348 using the Black-Scholes option valuation
model with the following assumptions; risk-free interest rate of 4.39%; dividend
yield of 0%; volatility factors of the expected market price of common stock of
110.21%; and an expected life of five years (statutory term) and vest over 180
days.  The Company also determined that the notes contained a
beneficial conversion feature of $230,848.  The value of the Morale
Warrants of $118,348, the conversion option of $230,848, and the transaction
fees of $112,500 are considered as debt discount and are being amortized over
the life of the Note.
  F-27
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 The
aggregate value of the Morale Warrants issued in connection with the January 10,
2007 purchase were valued at $118,955 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
245%; and an expected life of five years (statutory term) and vest over 180
days.  The Company also determined that the notes contained a
beneficial conversion feature of $231,455.  The value of the Morale
Warrants of $118,955, the conversion option of $231,455 and the transaction fees
of $112,500 are considered as debt discount and are being amortized over the
life of the Note.
  At
December 31, 2007, the December 5, 2006 Moral Note was in default and Default
Penalty of $59,750 and Default Interest of $14,742 have been
accrued.  (See “Note 11. Subsequent Events-Moral Orchards, LLC
Modification Agreement”)
  2007 PIPE
Offering.  During the year ended December 31, 2007, the Company
conducted an offering (the “2007 PIPE Offering”), through Spencer Clarke LLC, as
exclusive placement agent, of up to $2,000,000 principal amount of its 10%
convertible notes (the “2007 PIPE Notes”).  Interest on the 2007 PIPE
Notes, at a rate of 10% per annum, is payable quarterly.  The Notes
are due nine months from date of issuance.  The 2007 PIPE Notes are
convertible into shares of common stock at an initial conversion price of $0.70
per share (the “Conversion Shares”).  There is no reset to the
conversion price for any beneficial conversion feature.
  The
Company has the right to redeem any or all of the outstanding 2007 PIPE Notes in
its sole discretion anytime after the termination of the 2007 PIPE Offering and
prior to the maturity date of the 2007 PIPE Notes. The redemption price shall be
the face amount of the redeemed 2007 PIPE Notes plus accrued and unpaid interest
thereon.  Subject to the following sentence, at any time prior to the
maturity date of the 2007 PIPE Notes, for each additional $1,000,000 of gross
proceeds raised from one or more offerings of the Company’s equity or
quasi-equity securities, the Company shall redeem 2007 PIPE Notes with a minimum
face value of $500,000 together with accrued and unpaid interest, until the
entire outstanding 2007 PIPE Note is redeemed. Certain financings that the
Company may conduct outside of North America are exempt from this provision to
redeem the 2007 PIPE Notes in whole or in part.
  Investors
in the 2007 PIPE Offering also received a warrant (the “2007 PIPE
Warrant”), entitling the holder to purchase a number of shares of the Company’s
common stock equal to 150% of the number of shares of common stock into which
the 2007 PIPE Notes are convertible (the “Warrant Shares”). The 2007 PIPE
Warrant will be exercisable on a cash basis only and will have registration
rights.  The 2007 PIPE Warrant is exercisable at an initial price of
$1.00 per share, and is exercisable immediately upon issuance and for a period
of three years from the date of issuance.
  Promptly,
but no later than 90 days following the closing date of the 2007 PIPE Offering,
the Company is required to file a Registration Statement with the SEC to
register the Conversion Shares and the Warrant Shares. The Company shall use its
best efforts to ensure that such Registration Statement is declared effective
within 120 days after filing.
  Pursuant
to the terms of the PIPE Notes, if a Registration Statement is not filed on
the 91st day following the closing date, (i) the interest rate on the PIPE Notes
increased from 10% to 18% per annum until the event of default is cured and (ii)
the holders of the PIPE Notes became entitled to receive additional warrants in
an amount equal to 25% of the PIPE Warrants originally issued, for each 60-day
period that the Company remains in default.
  During
the year ended December 31, 2007, the Company issued $400,000 of the PIPE Notes
which could be converted into 571,429 shares of the Company’s common stock and
2007 PIPE Warrants to purchase 857,144 shares of the Company’s common stock.
These warrants expire March 1, March 30 and April 2, 2010 and are exercisable at
a price of $1.00 per share. The Company had related transaction fees of $48,000,
resulting in net proceeds to the Company of $352,000. In addition to the
transaction fees, warrants to purchase 57,143 shares of the Company’s common
stock were issued to Spencer Clarke LLC, the Company’s exclusive placement agent
for the 2007 PIPE Offering. These warrants expire March 1, March 30 and April 2,
2010 and are exercisable at a price of $0.70 per share.
  The
aggregate value of the 2007 PIPE Warrants issued in connection with this
offering and the warrants issued to the placement agent were valued at $256,533
using the Black-Scholes option valuation model with the following assumptions:
risk-free interest rate of 4.40% to 5.16%; dividend yield of 0%; volatility
factors of the expected market price of common stock of 100.28% to 114.98%; and
an expected life of two years (statutory term). The Company also determined that
the notes contained a beneficial conversion feature of $62,857.
  The
Company was unable to meet its obligations to file the Registration Statement
required under the terms of the 2007 PIPE Offering in a timely manner. In early
July 2007, the Company began discussions with Spencer Clarke, acting on behalf
of the holders of the PIPE Notes and PIPE Warrants, for an extension of time to
file the Registration Statement. Notwithstanding such discussions, Spencer
Clarke issued a Notice of Default dated August 1, 2007 (the "Notice") to the
Company for its failure to file the Registration Statement in a timely
manner.
  F-28
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 On August
29, 2007, the Company entered into a Modification Agreement with the 2007 PIPE
note holders. The Modification Agreement was entered into as a result of
negotiations between the Company and Spencer Clarke, LLC ("Spencer Clarke"), the
Company's exclusive placement agent for the 2007 PIPE Offering, after the
Company failed to file with the Securities and Exchange Commission (the "SEC")
in a timely manner a Registration Statement to register the shares of the
Company's common stock into which the PIPE Notes are convertible and for which
the PIPE Warrants may be exercised.
 
 Pursuant
to the Modification Agreement, the parties have agreed as follows:
 §
              Promptly,
      but no later than November 30, 2007 (instead of on or before July 2,
      2007), the Company shall file the Registration Statement with the SEC to
      register the Conversion Shares and the Warrant
  Shares.
 §
              Effective
      August 1, 2007, the interest rate on the PIPE Notes shall be increased
      from 10% per annum to 18% per annum until such time as the Registration
      Statement is declared effective by the
SEC.
 §
              The
      price at which the PIPE Notes may be converted into Conversion Shares (the
      "Conversion Price") shall be reduced from $0.70 to $0.45 per
      share.
 §
              Each
      Investor shall receive, for no additional consideration, additional
      warrants ("Additional Warrants") in an amount equal to an additional 50%
      of the PIPE Warrants originally issued pursuant to the terms of the 2007
      PIPE Offering. These Additional Warrants total 428,575 and shall have the
      same registration rights as are described in the Private Placement
      Memorandum dated January 12, 2007 (the "Offering Memorandum") used in
      connection with the 2007 PIPE Offering applicable to the PIPE Warrants;
      shall be exercisable immediately upon issuance; shall remain exercisable
      for a period of five years from the date of the Modification Agreement, on
      a cash basis only, at an initial exercise price of $0.45 per share; and
      shall, in all other respects, have the same terms and conditions, and be
      in the same form, as the PIPE
Warrants.
 §
              If
      the Company does not file the Registration Statement with the SEC by
      November 30, 2007, each Investor shall receive, for no additional
      consideration, warrants ("Delay Warrants") in an amount equal to an
      additional 50% of the PIPE Warrants originally issued pursuant to the
      terms of the Offering Memorandum. The Delay Warrants shall have the same
      registration rights as are described in the Offering Memorandum applicable
      to the PIPE Warrants; shall be exercisable immediately upon issuance;
      shall remain exercisable for a period of five years from the date of this
      Agreement, on a cash basis only, at an initial exercise price of $0.45 per
      share; and shall, in all other respects, have the same terms and
      conditions, and be in the same form, as the PIPE
  Warrants.
 
 The terms
and conditions of the Offering Memorandum, the PIPE Notes and the PIPE Warrants,
to the extent not expressly amended in the Modification Agreement, remain in
full force and effect. The issuance of the Additional Warrants (“Delay
Warrants”), if any, and the reduction of the Conversion Price of the PIPE Notes,
has the potential to dilute the percentage ownership interest of the Company's
existing shareholders.
  The
aggregate value of the 2007 PIPE Warrants issued in connection with this
Modification Agreement were valued at $138,107 using the Black-Scholes option
valuation model with the following assumptions: risk-free interest rate of
4.43%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 113.55%; and an expected life of two years (statutory
term).
  On
November 30, 2007, the Company and the Investors entered into the Second
Modification Agreement and pursuant to this agreement have agreed as
follows:
  §
                The
      Investors have agreed to forgive all accrued interest on their PIPE Notes,
      from the date of issuance thereof through December 14,
      2007.
 §
                On
      December 14, 2007, the Company agreed to pay all Investors 50% of the
      principal amount of their original PIPE Notes which equals a total cash
      repayment of $200,000.  Additionally, in repayment of the other
      50% of the principal amount of the original PIPE Notes, the Company, on
      December 14, 2007, agreed to issue to Investors a total of 1,060,000
      shares of the Company’s common stock (the “Conversion
      Shares”).
 §
                Concurrently
      with the cash payment and the issuance of the Conversion Shares as noted
      in paragraph 2 above, the Investors agreed to deliver to the Company the
      original of the PIPE Notes, which will be marked and deemed cancelled and
      of no further force or
effect.
 §
                In
      further consideration of the above terms and conditions, the Investors
      have agreed that the Company shall not be required to, and shall not, file
      a Registration Statement with the Securities and Exchange Commission or
      any state securities agency to register or qualify the PIPE Notes, the
      Conversion Shares, the PIPE Warrants, or any shares issuable pursuant to
      the PIPE Warrants (the Warrant Shares”).  The Conversion Shares
      and Warrant Shares when issued will be deemed restricted securities and
      bear appropriate legends.
 §
                The
      terms and conditions of the PIPE Warrants, to the extent not expressly
      amended in the Second Modification Agreement, shall remain in full force
      and effect in furtherance of the terms and conditions set forth in the
      Modification Agreement.
  F-29
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
    Payment
of $200,000 was made by the Company in accordance with the Second Modification
Agreement, the Original Notes were surrendered by the Investors and 1,060,000
shares of common stock were issued to the Investors on December 27,
2007.  Included in interest expense is the excess of the cost to
settle the obligation over the carrying value at the settlement date totaling
$222,368.
  2007 Spring
Offering.From
June 13, 2007 through June 26, 2007, the Company conducted a private
offering (the “Spring 2007 Offering”) of up to $550,000 aggregate face amount of
its convertible notes (the “Spring 2007 Notes”) with a small number of
accredited investors. Of this amount, $451,000 aggregate face amount of the
Spring 2007 Notes were sold for an aggregate purchase price of $410,000 net
proceeds. Therefore, while the stated interest rate on the Spring 2007 Notes is
0%, the implied interest rate on the Spring 2007 Notes is 10%. The Spring 2007
Notes mature on the first anniversary of their date of issuance. The Spring 2007
Notes are convertible, at the option of the noteholders, 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 Spring 2007 Offering
(the “Conversion Prices”). On the first closing, 1,002,941 Conversion Shares are
issuable at Conversion Price of $0.34 per share. On the second closing,
207,548 conversion shares are issuable at a conversion price of $0.53 per
share. The per share price of the Company’s common stock on the Pink Sheets
during this period ranged from a low bid price (intraday) of $0.35 to a high bid
price (intraday) of $0.59.
  Each of
the investors in the Spring 2007 Offering also received a warrant (the
“Spring 2007 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 2007 Notes are convertible (the “Warrant Shares”). Each
Spring 2007 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 years from the date of issuance. A total of 605,242 Warrant Shares were
issued.  Investors converted $110,000 of the Convertible Notes into
265,538 shares of the Company’s common stock during October and November
2007.
  The
aggregate value of the Spring 2007 Offering Warrants issued in connection with
the June 13, 2007 closing were valued at $59, 296 using the Black-Scholes option
valuation model with the following assumptions; risk-free interest rate of
5.11%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 113.56%; 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 $119,472.  The
value of the Spring 2007 Offering Warrants of $59,296, the conversion option of
$119,472, and the transaction fees of $31,000 are considered as debt discount
and are being amortized over the life of the Note.
  The
aggregate value of the Spring 2007 Offering Warrants issued in connection with
the June 26, 2007 closing were valued at $19, 580 using the Black-Scholes option
valuation model with the following assumptions; risk-free interest rate of
5.11%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 117.65%; 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 $21,655.  The value
of the Spring 2007 Offering Warrants of $19,580, the conversion option of
$21,655 and the transaction fees of $112,500 are considered as debt discount and
are being amortized over the life of the Note.
  F-30
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 2007 Summer
Offering.From August 8, 2007
through September 27, 2007, the Company conducted a private offering (the
"Summer 2007 Offering") of up to $330,000 aggregate face amount of its
convertible notes (the "Summer 2007 Notes") with a small number of accredited
investors. Of this amount, $309,980 aggregate face amount of the Summer 2007
Notes were sold for an aggregate purchase price of $281,800 net proceeds. While
the stated interest rate on the Summer 2007 Notes is 0%, the implied interest
rate on the Summer 2007 Notes is 10%. The Summer 2007 Notes mature on the first
anniversary of their date of issuance. The Summer 2007 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 Summer 2007 Offering (the "Conversion Prices"). Up to
837,784 Conversion Shares are issuable at a Conversion Price of $0.37 per
share.
  Each of
the investors in the Summer 2007 Offering also received a warrant (the
"Summer 2007 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 Summer 2007 Notes are convertible (the "Warrant Shares"). Each
Summer 2007 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. A
total of 418,892 Warrant Shares were issued. In November 2007, Investors
converted $216,480 of the Convertible Notes into 585,173 shares of the Company’s
common stock.
  The
aggregate value of the Summer 2007 Offering Warrants issued in connection with
the September 28, 2007 closing were valued at $60,678 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of 4,87%; dividend yield of 0%; volatility factors of the expected market price
of common stock of 124.83%; 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 $69,055.  The
value of the Summer 2007 Offering Warrants of $60,678, the conversion option of
$69,055 and the transaction fees of $28,180 are considered as debt discount and
are being amortized over the life of the Note.
  2007 Fall
Offering.From November 14, 2007
through December 17, 2007, the Company conducted a private offering (the "Fall
2007 Offering") of up to $1,100,000 aggregate face amount of its convertible
notes (the "Fall 2007 Notes") with a small number of accredited investors. Of
this amount, $622,600 aggregate face amount of the Fall 2007 Notes were sold for
an aggregate purchase price of $566,000 net proceeds. While the stated interest
rate on the Fall 2007 Notes is 0%, the implied interest rate on the Fall 2007
Notes is 10%. The Fall 2007 Notes mature on the first anniversary of their date
of issuance. The Fall 2007 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 Fall 2007 Offering (the "Conversion Prices"). Up to 1,596,410 Conversion
Shares are issuable at a Conversion Price of $0.39 per share.
  Each of
the investors in the Fall 2007 Offering also received a warrant (the "Fall
2007 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 (Fall 2007 Notes) are convertible (the "Warrant Shares"). Each Fall
2007 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
796,205 Warrant Shares are initially issuable on exercise of the Fall 2007
Warrants.
  The
aggregate value of the Fall 2007 Offering Warrants issued in connection with the
December 17, 2007 closing were valued at $95,290 using the Black-Scholes option
valuation model with the following assumptions; risk-free interest rate of
5.11%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 137.25%; 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 $63,362.  The value
of the Fall 2007 Offering Warrants of $95,290, the conversion option of $63,362,
and the transaction fees of $56,600 are considered as debt discount and are
being amortized over the life of the Note.
  On March
10, 2008, 442,820 shares of the Company’s common stock were issued to
noteholders in the 2007 Fall Offering who converted and cancelled Convertible
Notes in the amount of $172,700 at a conversion price of $0.39 per
share.
 
 9.   
Research and development
 
 The
Company has research and development facilities in Morgan Hill, California. The
Company has expanded research and development to include application of the
ZEFS, MK IV and CAT-MATE technologies for diesel engines, motorbikes, boats,
generators, lawnmowers and other small engines.  The Company has
purchased test vehicles, test engines and testing equipment.  The
Company has completed testing on products incorporating its ZEFS, MK IV and
CAT-MATE technologies for multiple automobiles, trucks, motorcycles, off-road
vehicles and stationary engines, the results of which were provided to RAND
Corporation (RAND) for evaluation.  The Company spent $600,816 and
$401,827 for the years ended December 31, 2007 and 2006,
respectively.
 
 F-31
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
  10.  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 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.
  F-32
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 Patent
Infringement Claims by Jeffrey A. Muller
  In
April 2005, Jeffrey A. Muller, the Company’s former sole director and
executive officer, filed a complaint against the Company in the Federal District
Court for the Central District of California, seeking declaratory and injunctive
relief and alleging unfair competition in connection with a claimed prior patent
interest in the ZEFS device and stock option rights. In seeking declaratory
relief, Mr. Muller is seeking to have the patent rights in the ZEFS device
that were previously transferred to the Company by Mr. Muller’s bankruptcy
trustee declared null and void.
  This
lawsuit brought by Mr. Muller arose out of the same claims that were the
subject of litigation in the Federal District Court for the Southern District of
New York, in which the Court entered judgment against Mr.
Muller.  Those claims are pending further
proceedings.  While the Company believes that the Company has valid
claims and defenses, there can be no assurance that an adverse result or outcome
on the pending motions or a trial of this case would not have a material adverse
effect on the Company’s financial position or cash flow.
  Litigation Involving Scottish Glen Golf Company
  We are
involved in litigation with Scottish Glen Golf Company, Inc. (SGGC) doing
business as KZ Golf, Inc., the Company’s previous landlord on claims in the
aggregate amount of $104,413.   The Company does not dispute the
fact that certain amounts of unpaid past rent are due but does dispute that it
owes the aggregate of $104,413 demanded by SGGC; more than half of which are
purported “late fees” which was assessed at the rate of $100 per
day.  It is the Company’s position that the late fees are void and
unenforceable and that the Company is entitled to a set-off for office space
that reverted back to SGGC.
  While the
Company believes that the Company has valid claims and defenses, given the
inherent uncertainties of litigation, the Company cannot predict the outcome of
this matter.  Accordingly, there can be no assurance that an adverse
result or outcome of this matter would not have a material adverse effect on the
Company’s financial position or cash flow.  The Company believes that
these claims arose from acts of a related party involving a former officer and
director and his wife as a beneficial owners of SGGC.
  Employment
agreements
  In July
2005, the Company entered into an employment agreement with John Bautista to
serve as a Vice President of Operations for the Company. The agreement
expired December 31, 2005, with an automatic one-year extension and
provided for annual base salary of not less than $120,000 per
year.  Effective February 21, 2006, the individual was promoted to
Executive Vice President, his annual base salary was increased from $120,000 per
year to $150,000 per year and the term of his employment agreement was extended
to December 31, 2007.  Effective August 8, 2006, the individual was
promoted to Chief Operating Officer and his annual base salary was increased
from $150,000 per year to $200,000 per year.  During the employment
term, the individual is eligible to participate in certain incentive plans,
stock option plans and similar arrangements in accordance with the Company’s
recommendations at award levels consistent and commensurate with the position
and duties hereunder.
  On
November 9, 2006, Eugene Eichler, who served as the Company’s Chief Executive
Officer and Chief Financial Officer, resigned due to a medical disability. His
resignation as Chief Executive Officer took effect on November 20, 2006 and his
resignation as Chief Financial Officer took effect on January 8, 2007. He
continued to serve as a director of the Company.
  F-33
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 Under the
terms of the separation agreement as an officer of the Company, Mr. Eichler is
entitled to be paid out the remainder of the cash portion of his employment
agreement, at a rate of $300,000 per annum, through December 31, 2007, in
accordance with the Company’s normal pay policies. Options granted to him in
February 2006 have been accelerated, fully vested on November 20, 2006
and the related compensation was expensed.  Additionally, Mr. Eichler
will have until November 20, 2007 to exercise such options. Mr. Eichler is also
entitled to receive a stock option grant in 2007 equal to the lesser of (i) the
number of stock options he was granted in 2006 or (ii) the highest number of
options granted to any of the then Chief Executive Officer, President or Chief
Financial Officer on an annualized basis, on terms no less favorable as granted
to such person; provided, however, that such options to be granted to the former
officer shall be fully vested upon grant and shall be exercisable for one year
from the date of grant. The Company and the former officer have waived any
claims they may have against each other and have agreed to mutual
indemnification.  The Company expensed $345,000 for the remaining term
of Mr. Eichler’s employment agreement and benefits for the year ended December
31, 2006. (See below for additional Transactions related to Mr.
Eichler)
  On
June 15, 2007, the Company and Bruce H. McKinnon agreed and entered into an
agreement that Mr. McKinnon would resign as Chief Executive Officer of the
Company effective on the first to occur of (i) the appointment of a new
Chief Executive Officer by the Board of Directors and (ii) July 31,
2007.  At the time of the filing of the Current Report on Form 8-K
announcing such matter (the “Form 8-K”), and as stated therein, it was intended
that Mr. McKinnon would continue to serve as President of the Company and
would continue to receive the compensation provided for in accordance with the
provisions of the employment agreement dated as of October 5, 2005 between
the Company and Mr. McKinnon, through December 31, 2007, the end of
the term of that agreement. Additionally, as stated in the Form 8-K,
Mr. McKinnon will continue to serve as a director of the Company, until Mr.
McKinnon has resigned, been removed by the stockholders or not been re-elected
to the Board. The Company and Mr. McKinnon have waived any claims the
Company and Mr. McKinnon may have against each other and have agreed to mutual
indemnification.
  On July
18, 2007, Bruce H. McKinnon was removed by the Board of Directors as President
and Chief Executive Officer of the Company and its wholly-owned subsidiary, STWA
Asia, effective immediately.  Mr. McKinnon also was removed by the
Board of Directorsas a director of STWA
Asia, effective immediately.  Mr. McKinnon continued to serve as
a director of the Company, until Mr. McKinnon resigned in November 2007. The
Company expensed $111,381 for the remaining term of Mr. McKinnon’s employment
agreement and benefits for the year ended December 31, 2007.
  As an
interim matter, on July 18, 2007, the Board of Directors appointed incumbent
director and former President and Chief Executive Officer of the Company Eugene
E. Eichler as Interim President and Chief Executive Officer of the
Company.  Mr. Eichler served without cash compensation and resigned on
July 25, 2007 at which time Charles Blum assumed the positions of President and
Chief Executive Officer. On October 18, 2007, the Board appointed Mr. Eichler as
Interim Chief Financial Officer to serve in this capacity at no salary until a
replacement is appointed and extended the expiration date of Mr. Eichler’s
options to November 20, 2008.  These options would have expired on
November 20, 2007.  Mr. Eichler did not stand for reelection as a
director at the December 13, 2007 Shareholder Meeting.
  EffectiveJuly 18, 2007, the
Company entered into an employment agreement with Mr. Charles R. Blum to serve
as the Company’s President and Chief Executive Officer.  Pursuant to
the Employment Agreement, Mr. Blum’s employment is for a one-year term, subject
to automatic one-year extensions and provides for annual base compensation of
$200,000 per year, subject to periodic review and adjustment.  In
addition, Mr. Blum will receive an automobile allowance of $900 per month and
four weeks of paid vacation annually.  Also, Mr. Blum is entitled to
participate in all employee benefit plans that the Company makes available to
the Company’s employees generally; provided that if Mr. Blum elects not to
participate in the Company’s group medical insurance plan, Mr. Blum will be
reimbursed in an amount equal to the lesser of (i) the premium the Company would
have paid to include Mr. Blum as a participant in that group health insurance
plan and (ii) the sums paid by Mr. Blum in connection with maintaining Mr.
Blum’s private health insurance.  The Company will also reimburse Mr.
Blum the reasonable costs paid by Mr. Blum for maintaining DSL Internet
access and other direct costs of maintaining an office at Mr. Blum’s home, but
only until such time as the Company shall provide Mr. Blum with an office at a
location reasonably acceptable to Mr. Blum.
  Minimum
guaranteed compensation payments under Mr. Blum’s employment agreement amounts
to approximately $123,000 for the year 2008.
  F-34
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 Consulting
agreements
  In April
2006, the Company entered into a one-year agreement with an outside consultant
to provide public relations services. The terms of the agreement calls for
monthly payments of $7,000. Additionally, the Company issued a five-year warrant
to the consultant. The warrant is exercisable for up to 100,000 shares of common
stock at an exercise price of $2.30 per share and vests as to 8,333 shares per
month commencing April 30, 2006. The shares issuable upon exercise of the
warrant have piggyback registration rights.  In August 2006 the
Company terminated the agreement.  The consultant earned 41,665
warrants and the remaining balance of 58,335 was forfeited.
  On
January 4, 2007, the Company entered into a Consulting Agreement (the
“Consulting Agreement”) with Spencer Clarke LLC (“Spencer Clarke”) pursuant to
which Spencer Clarke has agreed that for a twelve-month period beginning January
4, 2007, Spencer Clarke will provide the Company with financial consulting
services (including but not limited to executive search, strategic partnerships,
research on new markets, strategic visibility, etc) to help further develop the
Company’s strategic business plan.
  For
Spencer Clarke’s services the Company has agreed to pay Spencer Clarke a
nonrefundable fee of $20,000 per month, payable in advance. The first payment,
in the amount of $60,000 and covering three months, was due by the Company on
March 1, 2007. No payments have been made under this agreement. The Company will
also reimburse Spencer Clarke for expenses it incurs in connection with the
performance of its services under the Consulting Agreement, provided that
expenses in excess of $2,000 require the Company’s prior approval before such
expenses may be incurred by Spencer Clarke.
  On
December 13, 2007, the Company entered into an agreement with a consultant to
provide financial and marketing services.  Compensation is to be paid
on an hourly rate, half in cash and half in the Company’s common stock to be
issued on the first day of the second month after services are
provided.
  On
December 13, 2007, the Company entered into an agreement with a consultant to
provide coordination services with various governmental agencies, in California
for a fee of $2,500 plus 10,000 shares of the Company’s common
stock.
  Leases
  In
September 2005, the Company entered into a lease for a testing facility located
in Morgan Hill, California. The term of the lease is from September 1, 2005
through August 31, 2007 and carries an option to renew for two additional
years at the then prevailing market rate. Monthly rent is $2,240 per month
under this lease. The lease was amended in February 2006 for additional space.
Monthly rate under the amended lease is $4,160 per month.  The
Company renewed this lease on August 9, 2007 for an additional two-year
term.  The rent is $4,640 per month for the first six months of the
new term of the lease and $5,480 per month for the remaining eighteen months of
the new term of the lease.
  Total
rent expense under these leases for the years ended December 31, 2007 and
2006, is $177,799 and $165,879, respectively.
  The
following is a schedule by years of future minimum rental payments required
under the non-cancelable operating lease at the Company’s Morgan Hill facility
as of December 31, 2007.
 
 Years Ending
      December 31,2008
              
              $
              65,2802009
              
              
              44,800Total
              
              $
              110,080
  11.  Subsequent
events
 
 Morale Orchard, LLC Modification
Agreement
  A
Modification and Satisfaction Agreement was entered into effective as of January
31, 2008, by and among Save the World Air, Inc. (the “Company”), Morale
Orchards, LLC (“Morale”) and Matthews & Partners, a law firm (the “Matthews
Law Firm”).
  F-35
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 On
December 5, 2006, the Company entered into a Note Purchase Agreement (the “Note
Purchase Agreement”) with Morale, pursuant to which Morale purchased from the
Company two (2) Convertible Promissory Notes, one dated December 5, 2006 (the
“2006 Morale Note”), in the principal face amount of $612,500, and another,
dated January 10, 2007 (the “2007 Morale Note”), also in the principal face
amount of $612,500 (collectively, the “Morale Notes”), and two (2) warrants, one
accompanying the 2006 Morale Note, and the other accompanying the 2007 Morale
Note.  Each warrant provides Morale the right to purchase shares of
common stock of the Company. The aggregate purchase price for the Morale Notes
and Morale Warrants was $1,000,000, of which $500,000 was paid by Morale and
received by the Company on or about December 5, 2006, and of which $500,000 was
paid by Morale and received by the Company on or about January 10,
2007;
  The 2006
Morale Note is convertible at the rate of $0.85 per share into 720,588 shares of
the Company’s common stock, and the 2007 Morale Note is convertible at the rate
of $0.70 per share into 875,000 shares of the Company’s common
stock;
  The 2006
Morale Warrant is exercisable at $0.85 per share for 360,294 shares of the
Company’s common stock, and the 2007 Morale Warrant is exercisable at $.70 per
share for 437,500 shares of the Company’s common stock;
  The Note
Purchase Agreement provides, in pertinent part, that in the event the Company
has not repaid each of the Morale Notes in full by the anniversary date of their
issuances, the principal balances of each note shall be increased by ten percent
(10%) and the Company shall pay interest at two and one-half percent (21⁄2%) per
month, compounded daily, for each month until each of the Morale Notes is paid
in full.
  As of
January 31, 2008, both the 2006 and 2007 Morale Notes were unpaid, and neither
of the Morale Notes nor the Morale Warrants have been converted into shares of
common stock of the Company.
  Morale
also has piggy-back registration rights pursuant to which Morale may require the
Company to include the shares of the Company’s common stock issuable upon
conversion of the Morale Notes and exercise of the Morale Warrants in certain
future registration statements the Company may elect to file.
  The
amount due and owing as of January 31, 2008, under the 2006 Morale Note is
$689,327. The amount due and owing as of January 31, 2008, under the 2007 Morale
Note is $672,885.
  The
Company borrowed the principal sum of $20,000 from Morale on October 30, 2007,
at an interest rate of ten percent (10%) per annum. Principal and accrued
interest under the Morale Note is due on demand, and no payments there under
have been made by the Company.
  Morale is
beneficially owned by Leodis Matthews, who, through his law firm, the Matthews
Law Firm, serves as outside legal counsel to the Company.  The Company
is indebted to the Matthews Law Firm for unpaid legal fees and costs through
January 31, 2008, in the aggregate amount of $472,762.
  The
Company, Morale and the Matthews Law Firm now desire to modify the terms and
provisions of, and to provide for the satisfaction of the Company’s obligations
under, the Morale Notes, the Additional Morale Note and the Matthews Law Firm
Debt, pursuant to the terms and conditions set forth in this Modification and
Satisfaction Agreement.
  The
Company, Morale and the Matthew Law Firm agreed to the following:
  1. Waiver of
Interest.
  (i)
                Morale
      agrees to forgive and waive any and all accrued interest on the Morale
      Notes from and after January 31,
2008;
  (ii)
                Morale
      agrees to forgive and waive any and all accrued interest due on the
      Additional Morale Note from the date of its issuance;
  and
  (iii)
                The
      Matthews Law Firm agrees to forgive any and all interest which may have
      accrued on the Matthews Law Firm
Debt.
  2. Cancellation
of Notes, Debt and Obligations.  Upon the
execution of this Modification and Satisfaction Agreement, the 2006 Morale Note,
the 2007 Morale Note, the Additional Morale Note, the Unpaid 2006 Morale Note
Debt, the Unpaid 2007 Morale Note Debt, the Unpaid Additional Morale Note Debt
and the Matthews Law Firm Debt, shall all be cancelled, be deemed satisfied in
full and be of no further force or effect, effective January 31,
2008.
  F-36
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 3. No
Registration Rights.  Upon execution
hereof, the Morale Registration Rights shall be cancelled and be of no further
force or effect.
  4. Issuance
of Shares.  In consideration
of this Modification and Satisfaction Agreement, including the waivers and
cancellations as set forth in paragraphs 1 and 2, above, upon execution hereof,
and concurrently with the waivers and cancellations provided hereunder, the
Company shall issue a total of 7,421,896 shares of its common stock to Morale
and the Matthews Law Firm, allocable as follows:  (i) 2,759,308 shares
shall be issued to Morale arising out of and in exchange for cancellation of the
2006 Morale Note and the Unpaid 2006 Morale Note Debt; (ii) 2,691,540 shares
shall be issued to Morale arising out of and in exchange for cancellation of the
2007 Morale Note and the Unpaid 2007 Morale Note Debt; (iii) 80,000 shares shall
be issued to Morale arising out of and in exchange for cancellation of the
Additional Morale Note and the Unpaid Additional Morale Note Debt; and (iv)
1,891,048 shares shall be issued to the Matthews Law Firm arising out of and in
exchange for cancellation of the Matthews Law Firm Debt.  The Company
shall not be required to, and shall not, file a Registration Statement with the
Securities and Exchange Commission or any state securities agency to register or
qualify the shares of common stock of the Company issuable to Morale and the
Matthews Law Firm hereunder, and all such shares when issued shall be deemed
restrictive securities and bear appropriate legends.
  5. Morale
Warrants.  The terms and
conditions of the Morale Warrants, to the extent not expressly amended in this
Modification and Satisfaction Agreement, shall remain in full force and
effect.
  On March
10, 2008, 80,000 shares of the Company’s common stock were issued to Morale
Orchards, LLP, in cancellation of a note payable in the amount of $20,000 as
part of the Modification Agreement entered into on January 31, 2008 between the
Company and Morale Orchards, LLP and Matthews & Partners.
  On March
10, 2008, 5,450,848 shares of the Company’s common stock were issued to Morale
Orchards, LLP, in conversion and cancellation of the Convertible Notes issued
December 5, 2006 and January 10, 2007 in the amount of $1,362,712 as part of the
Modification Agreement entered into on January 31, 2008 between the Company and
Morale Orchards, LLP and Matthews & Partners.
  On March
10, 2008, 1,891,048 shares of the Company’s common stock were issued to Leodis
C. Matthews, APC, in cancellation of accrued professional fees in the amount of
$472,762 as part of the Modification Agreement entered into on January 31, 2008
between the Company and Morale Orchards, LLP and Matthews &
Partners.
  As a
result of the debt cancelled and shares of common stock issued in connection
with the Modification Agreement, the Company incurred non-cash interest expense
of $691,665 and non-cash legal expense of $236,572 which was recorded in the
first quarter of 2008.
  2008
Winter Offering
  From
December 27, 2007 to February 29, 2008  the Company conducted an
offering (the “2008 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 2008 Winter Notes were sold for an aggregate purchase price of $474,000
net proceeds.  Therefore, while the stated interest rate on the 2008
Winter Notes is 0%, the implied interest rate on the 2008 Winter Notes is
10%.  The 2008 Winter Notes mature on the first anniversary of their
date of issuance.  The 2008 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 2008 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 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 Warrant Shares”)  Each  2008 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 2008 Winter Warrants.
  F-37
 
  SAVE
THE WORLD AIR, INC. AND SUBISIDARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 The
aggregate value of the Winter 2008 Offering Warrants issued in connection with
the February 29, 2008 closing were valued at $96,883 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of  4.16%; dividend yield of 0%; volatility factors of the expected
market price of common stock of 136.14%; 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
$117,739.  The value of the 2008 Winter Offering Warrants of $96,883,
the conversion option of $117,739, and the transaction fees of $47,400 are
considered as debt discount and are being amortized over the life of the
Note.
  Loan
from Director
  On
January 30, 2008, a Company Director advanced $10,000 for operating expenses and
was repaid on February 27, 2008.
   
  F-38