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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-KSB

|      |  |                                                                                   
|----- |  | ----------------------------------------------------------------------------------
|[X]   |  | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|     
|      |  | For the fiscal year ended December 31, 2002.                                      
|     
|or   
|     
|[   ] |  | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|     
|      |  | For the transition period from ___________ to  ___________                        

Commission File Number 0-29185

SAVE THE WORLD AIR, INC.(Exact name of registrant as specified in its charter)

|                                                                     |  |                                               
|-------------------------------------------------------------------- |  | ----------------------------------------------
|Nevada(State or other jurisdiction of
incorporation or organization) |  | 52-2088326(I.R.S. Employer
Identification No.)

5125 Lankershim Boulevard
North Hollywood, California 91601(Address, including zip code, of principal executive offices)

(818) 487-8000(Registrants telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act: None.

Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $0.001 par value.

Check whether the Registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes [   ] No [X]

Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained herein, and will not be contained, to the best
of Registrants knowledge, in definitive proxy or information statements
incorporated by reference to Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [   ]

Registrants revenues for its most recent fiscal year: None.

The aggregate market value of voting and non-voting common equity held by
non-affiliates of the Registrant was approximately $51.6 million
as of February 29, 2004 based upon the closing price on the Pink Sheets 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
February 29, 2004 was 34,691,821 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Transitional Small Business Disclosure Format (Check one): Yes [   ]
No [X]



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SAVE THE WORLD AIR, INC.

FORM 10-KSB

INDEX

|                |  |                                                                                                |    |  |    |      |  | 
|--------------- |  | ---------------------------------------------------------------------------------------------- | -- |  | -- | ---- |  | 
|                |  |                                                                                                |    |  |    | Page
|                |  |                                                                                                |    |  |    |     
|PART I         
|ITEM 1          |  | Business                                                                                       |    |  | 2  |     
|ITEM 2          |  | Properties                                                                                     |    |  | 10 |     
|ITEM 3          |  | Legal Proceedings                                                                              |    |  | 11 |     
|ITEM 4          |  | Submission of Matters to a Vote of Security Holders                                            |    |  | 12 |     
|PART II        
|ITEM 5          |  | Market for Common Equity and Related Stockholder Matters                                       |    |  | 12 |     
|ITEM 6          |  | Managements Discussion and Analysis of Financial Condition and Results of Operation           |    |  | 12 |     
|ITEM 7          |  | Financial Statements                                                                           |    |  | 15 |     
|ITEM 8          |  | Change in and Disagreements With Accountants on Accounting and Financial Disclosure            |    |  | 43 |     
|ITEM 8A         |  | Controls and Procedures                                                                        |    |  | 43 |     
|PART III       
|ITEM 9          |  | Directors and Executive Officers of Registrant                                                 |    |  | 45 |     
|ITEM 10         |  | Executive Compensation                                                                         |    |  | 47 |     
|ITEM 11         |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |    |  | 49 |     
|ITEM 12         |  | Certain Relationships and Related Transactions                                                 |    |  | 51 |     
|ITEM 13         |  | Exhibits and Reports on Form 8-K                                                               |    |  | 52 |     
|ITEM 14         |  | Principal Accountant Fees and Services                                                         |    |  | 52 |     
|SIGNATURES      |  |                                                                                                | 53 | 
|EXHIBIT 10.1   
|EXHIBIT 10.2   
|EXHIBIT 10.3(A)
|EXHIBIT 31.1   
|EXHIBIT 31.2   
|EXHIBIT 32.1   



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Notice Regarding Prior Filings

This Annual Report on Form 10-KSB (Annual Report) for the fiscal year
ended December 31, 2002, together with any of our subsequent filings and public
disclosures, contain updated information and disclosures that may be material
to an understanding of the subject matter herein and the periods prior to the
period covered by this report.

Among other matters disclosed in our most recent filings with the
Securities and Exchange Commission (Commission or SEC), we have reported:

     The Commissions filing of an enforcement action against Save the World
Air, Inc. (SWA or the Company), its former sole director and officer, Jeffrey
Muller (Muller), and others for violation of U.S. securities laws;

     SWAs engagement of new and independent executive management team,
outside auditing and legal professionals, advisory board, research and
development team, and other outside consultants including the RAND
Corp.;

     SWAs settlement of the enforcement action against SWA, only, and active
cooperation with the Commission in its action against the remaining
defendants;

     SWAs filing of a cross-complaint against Muller and others which seeks,
among other things, cancellation of eight million shares of common stock plus common stock
purchase options for ten million shares and termination of the
royalty agreement with Muller;

     SWAs settlement of potential disputes concerning its patent rights for
the ZEFS device and certain potential claims of the Muller bankruptcy
estate;

     SWAs
filing of international patent applications for the ZEFs device;

     SWAs
successful capital raise of over $2.8 million in a private placement;

     SWAs engagement of RAND Corp. to conduct independent testing and review
of SWAs products and marketing feasibility studies;

     SWAs
successful initial testing of its products;

     SWAs
development of new products and technologies; and

     Other facts, transactions and events which may be material to an
investors understanding of SWAs history, future prospects, and the risks and
benefits of an investment in SWA.

PART I

Item 1. Business

Special Cautionary Note Regarding Forward-Looking Statements

This Annual Report contains forward-looking statements. These
forward-looking statements include predictions regarding our future:



| |  |  | revenues and profits;                                                                               
| | - |  | ----------------------------------------------------------------------------------------------------
|
| |  |  | customers;                                                                                          
|
| |  |  | research and development expenses;                                                                  
|
| |  |  | scientific test results;                                                                            
|
| |  |  | sales and marketing expenses;                                                                       
|
| |  |  | general and administrative expenses;                                                                
|
| |  |  | 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.

2



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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.

General

We develop proprietary devices that can be installed on motor vehicles and
are designed to reduce harmful emissions, improve fuel efficiency and improve
performance. Our prototype devices we call ZEFS are intended to
significantly reduce hydrocarbon and carbon monoxide emissions, while
significantly increasing fuel economy. We have devoted the bulk of our efforts
to complete the design and development of our production models and raising the
financing required to do so. We have generated no revenues and our business is
in the development stage. We have taken actions to secure our intellectual
property rights to the ZEFS device and we eventually plan to initiate marketing
efforts by sale or license of our ZEFS technology, which we intend to license
to automobile manufacturers and market to auto parts retailers.

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 device from Jeffrey Muller. During the past
three years, we have been acquiring new technologies, developing products using
our technologies and conducting scientific tests regarding our technologies.

Our mailing address and executive offices are located at 5125 Lankershim
Boulevard, North Hollywood, California, 91601. Our telephone number is (818)
487-8000. Our corporate website is www.savetheworldair.com. Information
contained on the website is not a part of this Annual Report.

Background

Our principle business focus currently rests with development and
distribution of a device designed to solve the complex problems caused by
automobile pollution. Throughout the past few years, we have designed and
tested multiple versions of the ZEFS device for use on carbureted and fuel
injection gasoline engines and are currently in the process of adapting this
technology to work on engines that use diesel fuels.

The incomplete and inefficient burning of fossil fuel in an automobile
engine results in unburned gases, such as hydrocarbons and carbon monoxide
being expelled as a by-product from the engines exhaust. These emissions from
automobile engines have contributed to significant air pollution and depletion
of the ozone layer that protects us from harmful ultraviolet radiation. As a
result, the world has experienced significant changes to its air quality since
the beginning of the 20th century and, because of the added vehicles, the
problem has gotten progressively worse with each passing year. Forecasts
published by the World Resources Institute indicate that by the year 2010 the
number of automobiles in operation worldwide will exceed 800 million.

SWA acquired the worldwide manufacturing and marketing rights to the ZEFS
device from its inventors. When the ZEFS device is fitted to internal
combustion engines, using diesel fuel or gasoline, it may reduce the emission
of dangerous polluting carbon monoxide, hydrocarbon exhaust gases and nitric
oxide gases.

The ZEFS device operates by using magnetic energy to reduce the size of
the fuel molecules passing from the carburetor or fuel injector of the vehicle
to the intake manifold prior to combustion. This, in turn, creates an
atomization process in which fuel molecules are able to bond effectively with
oxygen atoms resulting in cleaner fuel burning by the engine.

Strategy

Currently, we plan to refine and commercialize the ZEFS technology into a
wide variety of carbureted and fuel-injection based vehicles. In addition, we
are engaged in independent laboratory testing of the ZEFS technology premise in
order to gain better market acceptance by automobile manufacturers and
governmental regulatory officials.

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Independent Laboratory and Scientific Testing

Research and testing using government standard test equipment in the
United States has demonstrated that the ZEFS device may lead to reduced engine
emissions, such as carbon monoxide and hydrocarbons. In tests conducted at the
Northern California Diagnostics Laboratory, the ZEFS device reduced carbon
monoxide, hydrocarbons, and nitrous oxide fume levels and increased gas mileage
for the test vehicle.

In December 2002 we retained the RAND Corporation to study the validity
and market potential of our technology. RAND determined that sufficient
theoretical basis exists to warrant entry into a comprehensive product testing
program. In May 2003, we entered into an arrangement in which RAND would
coordinate and supervise both a theoretical scientific study of the concepts
underlying the ZEFS device as well as an
empirical study.

Governmental Mandates to Reduce Air Pollution

Governments internationally recognize the serious effects caused by air
pollution and have enacted legislation to mandate that automobile manufacturers
be required to reduce exhaust emissions caused by their products. The approach
used by auto makers 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 types of converters may be less
effective than our technology in reducing emissions, increasing horsepower and
increasing fuel economy in order to achieve emission reductions. We anticipate
that further government mandates may force automobile manufacturers to adopt
better solutions to reducing emissions.

Technology Transfer

We are actively continuing with our research on the ZEFS device for use on
gasoline-powered engines and have taken steps to finalize the development of
versions of the device to fit on carbureted, center point, and multi-port fuel
injection systems. We anticipate we will use these prototype devices to serve
as demonstration units, during presentations before the major automobile
manufacturers. It is our long-term objective to facilitate the adoption of
this technology by major automobile manufacturers.

We developed this strategy of technology transfer because auto makers will
likely require approximately two to three years to fully inspect, test, and
integrate the ZEFS devices into their new car designs, as well as to adapt it
to their legacy vehicles. Since the ZEFS device is presently protected by
international patent, we view the technology transfer strategy as the most
viable option to gain widespread adoption of the technology by major automobile
manufacturers without compromising our ownership of the technology. We intend
to assist these manufacturers with the full integration of our technology, by
not only supporting the required engineering and system integration efforts,
but also by reducing costs associated with such process so that they may not be
prohibitive to the endeavor.

Because of the complexity and enormity of the task of designing ZEFS
variants to fit every make and model of car manufactured over the past twenty
years, we will rely heavily on the cooperation of the major auto-makers to
support this function, including engineering, marketing, and installation of
the device. Additionally, we are cognizant that in order to preserve the
integrity of the warranties provided to car owners by the manufacturers, these
manufacturers must be involved in the process of designing and installing the
ZEFS device on legacy vehicles. We envision that a cooperative venture between
car makers and us will result in the most optimal mechanism for the
installation of ZEFS on the greatest percentage of cars possible, through
agreements between the company, the auto makers and their dealerships. This
approach to the distribution of the ZEFS device to the after market assures
compatibility with the original design specifications of the auto makers and
facilitates the continued manufacturer endorsement of the new car warranty
program. A revenue sharing arrangement is planned, between us, the automobile
makers, and their licensed dealers to assure equitable returns for all entities
relative to the distribution of the ZEFS device to the automobile after market.

Diesel Engine Market

In order to create a near term capital revenue stream for the company, we
are currently engaged in the development of a variant of the ZEFS device for
use on diesel engines such as those used on large trucks, buses, and electrical
generators. Because these types of vehicles use engines provided from Cummins,
Caterpillar, or

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Detroit Diesel almost exclusively, the number of ZEFS variants needed to
service these fleets is considerably less than the number required to satisfy
the automobile market. This fact alone makes entry into the diesel engine
market extremely attractive for our business, offering a large number of
potential customers with a minimum of expense for research and development of
product variants. This market is seen as extremely viable for us and our
products because of the expressed need by the trucking industry, large-scale
transportation providers, fleet operators, school districts, transit
authorities and corporations to reduce emissions and costs associated with fuel
expenditures and operations.

The business strategy relative to this particular market rests in the
realization that these professional transportation operators maintain large
fleets of vehicles that would directly benefit from the cost savings
associated with the fuel economy aspect of the ZEFS device, as well as these
entities realizing a significant residual benefit in improved customer
relations through a demonstrative reduction in the amount of pollution they
contribute on an annual basis to the environment. In addition to our plan of
negotiating distribution agreements with the manufacturers of diesel engines
(similar to the technology transfer strategy cited earlier for the automobile
manufacturers), we plan to market the diesel engine versions of the ZEFS device
to after market customers directly. It is believed that direct marketing of
the ZEFS device to large-scale entities like rapid transit districts, school
districts, large fleet operations, and trucking associations will facilitate
the immediate generation of a sustainable capital revenue stream that can be
used to enhance company operations, provide for expanded research, and return
dividends to its shareholders.

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.
While we believe that our technology has greater benefits, it may be unable to
gain market acceptance. Further, research and development throughout the world
is constantly uncovering new technologies. Although we are unaware of any,
there can be no assurance that no existing or future technology is currently or
will be superior to the ZEFS device.

Intellectual Property and Royalties

In December 1998, Jeffrey Muller transferred to the Company all of the
marketing and manufacturing rights to the ZEFS technology in exchange for
5,000,000 shares of common stock, $500,000 and $10 royalty for each unit sold.
In November 2002, under our settlement with the Muller bankruptcy trustee, the
trustee transferred all ownership and legal rights to the international patent
application for the ZEFS device to us. In exchange for these rights, we gave
the bankruptcy trustee an option to purchase 500,000 shares of our common stock
at $1.00 share and $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 technology. He assigned to us all rights to the
ZEFS technology in exchange for an option to purchase 500,000 shares of our
common stock at $1.00 share and $0.20 royalty on each device we sell.

We obtained the patent application for the ZEFS device (PCT/AU1/00585)
filed originally by Jeff Muller in Australia in May 2000. The International
Filing Application for our ZEFS technology was filed on May 19, 2001 (Official
No. 10/275946) [PCT/AU1/00585] and modified as ZEFS Mark II on July 9, 2003.
If approved, the duration of the patent is 20 years from the date the original
application was filed. We are unable to state at this time how long the United
States patent review process will take and is unable to give any assurances
that the Patent will be granted. 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 66 countries worldwide.

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The following table summarizes the status of the ZEFS patent application
in the following countries.

|              |  |                   |  |              |  |                                         
|------------- |  | ----------------- |  | ------------ |  | ----------------------------------------
|Country       |  | Number            |  | Filing Date  |  | Status                                  
|              |  |                   |  |              |  |                                         
|Australia     |  | 2001 258057       |  | May 21, 2001 |  | Awaiting examination                    
|Brazil        |  | 0.111.365-8       |  | May 21, 2001 |  | Awaiting examination                    
|Canada        |  | 2409195           |  | May 21, 2001 |  | Awaiting examination                    
|China         |  | 01809802.9        |  | May 21, 2001 |  | Under examination                       
|Eurasian(1)   |  | 200201237         |  | May 21, 2001 |  | Under examination                       
|Europe(2)     |  | 019331222.2       |  | May 21, 2001 |  | Awaiting examination                    
|India         |  | IN/PCT/2002/01523 |  | May 21, 2001 |  | Awaiting examination                    
|Japan         |  | 586731/2001       |  | May 21, 2001 |  | Must request Examination by
May 21, 2008
|Mexico        |  | PA/A/2002/11365   |  | May 21, 2001 |  | Awaiting examination                    
|New Zealand   |  | 523113            |  | May 21, 2001 |  | Granted                                 
|South Africa  |  | 2002/10013        |  | May 21, 2001 |  | Awaiting Grant                          
|South Korea   |  | 2002 7015531      |  | May 21, 2001 |  | Must request Examination by
May 21, 2006
|United States |  | 10/275946         |  | May 21, 2001 |  | Examination requested
October 2003      

(1)  Eurasian patent application covers the countries of Azerbaijan,
Armenia, Belarus, Georgia, Kazakhstan, the Kyrgyz Republic, Moldova, the
Russian Federation, Tajikistan, Ukraine and Turkmenistan.

(2)  Europe patent application covers the countries of Austria, Belgium,
Switzerland, Lichtenstein, Cyprus, Germany, Denmark, Spain, Finland, France,
Great Britain, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal,
Sweden, Turkey, Lithuania, Latvia, Slovenia, Romania and Macedonia.

In November 2003, we completed the initial patent application process in
Australia for our Multiport Fuel Rail Emissions device and our ZEFS Mark III
system, a product designed to reduce emissions in fuel injection engines.

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.

Research and Development

We have established a research and development facility in Queensland,
Australia. We have purchased test vehicles, test engines and testing equipment.
We have completed testing on ZEFS devices for the VW Beetle and Ford Mustangs,
which has been provided to RAND for evaluation. Through 2003, we have
continued research on devices for the two and four-stroke engines and thin line
two and four barrel carbureted devices. We have expanded research and
development to include applications of the ZEFS technology to diesel engines,
motorbikes and boats. No proceeds were spent on research and development prior
to 2002. We spent $202,470 on research and development in fiscal year 2002 and
672,000 in fiscal year 2003.

Government Regulations and Probability of Affecting Business

We intend to control the sell licenses to manufacture of our products and
to market them worldwide through international distributorships. As such,
importation and exportation regulations may impact our activities. A breach of
such laws or regulations may result in the imposition of penalties, fines,
suspension or revocation of licenses. We are not currently involved in any
such judicial or administrative proceedings and believe that we are in
compliance with all applicable regulations.

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Although it is impossible to predict with certainty, the effect that
additional importation and exportation requirements and other regulations may
have on future earnings and operations, we are presently unaware of any future
regulations that may have a material effect on our financial position, but
cannot rule out the possibility.

Advisory Board

Our Advisory Board provides specific expertise in areas of research and
development relevant to our business and meets with our management personnel
from time to time to discuss our present and long-term research and development
activities. Advisory Board members include:

Sir Jack Brabham, Triple Formula One World Champion and Twice Formula One
World Constructors Champion and is an expert in the areas of racing car design.

Erin Brockovich Ellis, Director of Environmental Research, Masry and
Vititoe, P.C. Ms. Ellis is an environmental activist and a research expert
with respect to complex environmental matters.

Kevin Pro Hart, famous Australian artist and inventor of the ZEFS
device.

Jack Reader, Director, BIFS Technologies Corporation. Mr. Reader is
a systems engineer and an expert in business management and energy conservation.

Bobby Unser, Jr., Founder, Unser Driving, Inc. Mr. Unser is an expert in
motor racing and stunt driving.

Employees

As of December 31, 2003, we had four full-time employees, including our
Chief Operating Officer, Chief Financial Officer, and Executive Vice President,
Business Development. We utilize the services of three full-time consultants
in our R&D facility in Australia and four part-time consultants to assist us
with marketing and other matters. We intend to hire additional personnel, as
needed. We believe that our success depends, in part, on our ability to hire,
assimilate and retain additional qualified personnel.

Risk Factors

We expect to incur future losses and may not be able to achieve profitability.

We have incurred net losses every year since our inception in 1998.
Although we expect to generate revenue from sales of our ZEFS device, we
anticipate net losses and negative cash flow to continue for the foreseeable
future. We expect that our operating expenses will increase significantly in
the near term, due in part to significant investments we intend to make in
research and development. Consequently, we will need to generate significant
additional revenue to achieve profitability. Although our management is
optimistic that we will generate additional revenue, we may not be able to
operate profitability. If we cannot achieve or sustain profitability, we may
not be able to fund our expected cash needs or continue our operations.

We will need additional capital to meet our operating needs, and we cannot
be sure that additional financing will be available.

As of December 31, 2003, our primary business goal requires an investment
of approximately $400,000 per quarter and our current resources will be
sufficient to fund operations through June 30, 2004. We believe we will
require additional capital in order to operate beyond this six-month period.
Our management is cautiously optimistic that, given our recent private
financing and discussions with potential capital sources, it will be successful
in obtaining funds. However, additional capital may not be available on
favorable terms to us, or at all. If we cannot obtain needed capital, our
research and development, manufacturing and marketing plans, business and
financial condition and our ability to reduce losses and generate profits are
likely to be materially and adversely affected.

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As a company in the early stage of development 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 ZEFS products
using our technology that can be installed on motor vehicles that reduce
harmful emissions, improve fuel efficiency, reduce operating costs and improve
performance. We believe that our revenue growth and profitability, if any,
will substantially depend upon our ability to:



| |  |  | raise additional capital for research and development;
| | - |  | ------------------------------------------------------
|
| |  |  | complete development of new products; and             
|
| |  |  | successfully introduce and commercialize new products.

Many of our products are still under development, including ZEFS devices
employable with carburetors, multiport fuel injection, diesel engines and other
internal combustion engines. 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 device is unproven, and we may not be
able to attract customers.

To the best of our knowledge, no consumer or automobile manufacturer has
used the ZEFS device to reduce motor vehicle emissions to date. Although an
independent EPA-certified testing facility has tested the ZEFS device and
confirmed its core functionality in reducing harmful emissions, we have hired
Rand Corporation to undertake a comprehensive study regarding all aspects of
the ZEFS device and its market potential. Consequently, the commercial
viability of the ZEFS device is unproven at this time. If commercial
opportunities are not realized from the use of the ZEFS device, we may not be
able to attract customers.

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. Compared to these
technologies, our technology is unproven, and the use of our technology by
these companies 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 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.                                                                                                           

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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.

If we are not able to successfully market and distribute our products, our
ability to generate revenue will be adversely affected.

Our future success is dependent upon our ability to successfully develop
and maintain marketing, distribution or sales capabilities. We intend to sell
our products to consumers and industry partners, or major automobile
manufacturers, looking to sell new products and services in existing
distribution channels. However, if our marketing and distribution strategy is
unsuccessful, our ability to sell our products will be adversely affected and
our revenue will decrease.

Our future revenues are unpredictable, and our operating results are
likely to fluctuate from quarter to quarter.

We believe that our future operating results will fluctuate from quarter
to quarter 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.

A large portion of our expenses, including expenses for our facilities,
equipment and personnel, is relatively fixed. We plan to increase operating
expenses significantly in 2004 as we increase our research and development,
production and marketing activities. Although we expect to generate revenues
from sales of our products in the future, 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.

Our capitalization is uncertain, and the value of our shares may be
diluted.

Stock purchase options for 10 million shares issued to our former director
and CEO, Jeffrey Muller, and others are subject to ongoing litigation. In
addition, there are at least 8 million shares outstanding which we believe
are owned or controlled by Jeffrey Muller and which are also the subject of
litigation. We expect the court to order the cancellation of all these shares.
If we are unsuccessful in our litigation to void the 10 million options, the
larger number of outstanding shares from exercising these stock options and
shares will result in substantial dilution of the value of our shares.

If recent changes in our senior management are not successful, we may not
be able to achieve our business objectives.

Our senior management consists of four: President and Chief Executive
Officer, Edward L. Masry; Treasurer, Chief Financial Officer and Chief
Operating Officer, Eugene E. Eichler; Executive Vice President, Business
Development, Bruce H. McKinnon; and Vice President of Marketing and Sales,
Nathan Shelton. We also have appointed five members to our Board of Advisors
as follows: Bobby Unser, Jr., Erin Brockovich, John Reader, PhD, Sir Jack
Brabham and Kevin Pro Hart. In addition, we expect to add more industry
professionals to our management team. We believe our officers will
successfully manage our business and these advisors will provide us assistance
during this development period, however, any changes may place a strain on our
management processes. If these changes are not successful, we may not be able
to implement our business goals.

9



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If we lose our key personnel or are unable to 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 Edward L. Masry, Eugene Eichler, Bruce McKinnon, and
Nathan Shelton. 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. 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 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 technology 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 ZEFS device, may not result in the issuance
of any patents or any issued patents that will offer protection against
competitors with similar technology. Patents we 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.

On May 28, 2002, in settlement of Kevin Charles Pro Harts challenge to
our rights to the ZEFS international patent application, Pro Hart assigned all
his patent rights to us in exchange for certain stock options and other
consideration. This settlement with Pro Hart effectively was subject to our
resolution of Mr. Mullers claims to the ZEFS international patent application.
We have obtained a preliminary injunction prohibiting Mr. Muller, among
others, from selling, transferring or encumbering, among other things, all
interest he or Ms. Muller may have in the pending patent rights of the ZEFS
device. This litigation remains ongoing. However, as disclosed in a press
release and Form 8-K filed on November 12, 2002, we have reached a settlement
with the bankruptcy trustee for the estate of Mr. Muller and his wife, Lynette
A. Muller, transferring all ownership and legal rights to the international
patent application for the ZEFS device.

We may become subject to additional litigation involving our rights to
patents and inventions. Infringement and other intellectual property claims,
with or without merit, can be expensive and time-consuming to litigate and can
divert managements attention from core business. Further, as a result of
litigation or other proceedings, we may be required to seek licenses from third
parties that may not be available on reasonable terms, if at all.

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 principal administrative facility is located in approximately 1,000
square feet of leased office space in North Hollywood, California. We sublease
this space from KZ Golf, Inc. One of our directors, Bruce H. McKinnon, is an
owner of KZ Golf, Inc. The sublease of this facility will expire on October
31, 2005, with an option to extend the term for 24 months. We believe that our
present North Hollywood facility is adequate for our current and planned
administrative activities. Our research and development facility located in Queensland,
Australia is leased.

10



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##### Table of Contents



We believe that our present research and development facility is adequate
for our current and planned activities and that suitable additional or
replacement facilities in the Queensland area are readily available on
commercially reasonable terms should such facilities be needed in the future.
We do not have any policies with respect to investments in real estate or
interests in real estate, real estate mortgages or securities of or interests
in persons primarily engaged in real estate activities.

Item 3. Legal Proceedings

On December 19, 2001, the Securities and Exchange Commission (SEC) filed
civil charges in the United States Federal District Court, Southern District of
New York against us, our former President and sole director Jeffrey Muller,
and others alleging that we and the other defendants associated with the
promotion of our stock sales. 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 controlled by 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
pay any fines or restitution. The SECs action continues against Muller and
others.

On July 2, 2002, after an investigation by a newly constituted board of
directors, we filed a cross-complaint in the SEC action against Jeffrey Muller
and others seeking injunctive relief, disgorgement 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. We are also seeking
cancellation of such shares and Mullers stock option agreement and royalty
arrangement. Among other things, we allege that Muller and certain others sold
stock without consideration and without registration 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 arrangements 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 Muller
and others, which prevents Muller and other cross-defendants from selling,
transferring, or encumbering any of our assets and property, from selling or
transferring any of our stock that they may own or control, or from taking any
action to injure us or our business and shareholders. The order also prevents
Muller from exercising any control over our corporation and serving as our
officer or director. While we believe that we have valid claims,
there can be no assurance that an adverse result or settlement would not have a
material adverse effect on our financial position or cash flow.

In the course of the litigation, we have obtained control over Mullers
patent rights to the ZEFS device. Under that certain Buy-Sell Agreement
between Jeffrey Muller and us dated December 29, 1998, Muller, who was listed
on the ZEFS devise patent application as the inventor of the ZEFS device,
granted us the marketing, manufacturing and distribution rights to the ZEFS
device. On November 7, 2002, under our settlement with the Muller bankruptcy
trustee, the trustee transferred all ownership and legal rights to this
international patent application for the ZEFS device to us. Pursuant to this
agreement, the company is also entitled to entire royalty rights previously
claimed by Muller.

The litigation against Muller and others has been pending before the Court
and will be scheduled for further proceedings and final disposition by summary
judgment motions within the near future. Although the outcome of these motions
cannot be predicted with any degree of certainty, it is expected that the
Courts ruling will either significantly narrow the issues for any later trial
or will result in a disposition of the case in a manner favorable to the
company. SWA is contending that it is entitled to a judgment divesting Muller
of any right to exercise option rights to 10 million shares of SWA stock, the
entry of an existing preliminary injunction to prevent Muller from any
involvement with the company and a monetary judgment against Muller and others
in the amount of several million dollars. While we belive that we have
valid claims, there can be no assurance that an adverse result or
settlement would not have a material adverse effect on our financial
position or cash flow.

11



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##### Table of Contents



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

No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 2002.

PART II

Item 5. Market for Common Equity and Related Stockholder Matters

Our common stock is traded on the Pink Sheets under the symbol ZERO. The
following table sets forth the high and low closing prices of the common stock
for the quarters indicated as quoted on the Pink Sheets.

|               |  |      |      |      |  |      |      |     |  |      |      |     |  |   |      |  |  |   |      |  |  |   |      | 
|-------------- |  | ---- | ---- | ---- |  | ---- | ---- | --- |  | ---- | ---- | --- |  | - | ---- |  |  | - | ---- |  |  | - | ---- | 
|               |  | 2001 |      | 2002 |  | 2003
|               |  |      |      |      |  |     
|               |  | High |      | Low  |  | High |      | Low |  | High |      | Low
|               |  |      |      |      |  |      |      |     |  |      |      |    
|First Quarter  |  | $    | 0.50 |      |  | $    | 0.19 |     |  | $    | 0.78 |     |  | $ | 0.15 |  |  | $ | 0.55 |  |  | $ | 0.30 | 
|Second Quarter |  | $    | 2.25 |      |  | $    | 0.25 |     |  | $    | 0.65 |     |  | $ | 0.25 |  |  | $ | 0.70 |  |  | $ | 0.33 | 
|Third Quarter  |  | $    | 1.15 |      |  | $    | 0.55 |     |  | $    | 0.70 |     |  | $ | 0.20 |  |  | $ | 0.95 |  |  | $ | 0.40 | 
|Fourth Quarter |  | $    | 1.65 |      |  | $    | 0.15 |     |  | $    | 0.58 |     |  | $ | 0.30 |  |  | $ | 2.50 |  |  | $ | 0.85 | 

According to the records of our transfer agent, we had 996 stockholders of
record of our common stock at December 31, 2003.

We currently expect 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.

From November 2002 through October 2003, we issued 13,917,414 shares of
our common stock and warrants to purchase an aggregate 13,442,414 shares of
common stock for approximately $2.8 million in cash from a group of private
investors, converting $500,000 in debt held by various lenders and legal
services valued at $20,853. The net proceeds from the financing equals
$2,548,286 after deductions of commissions. We issued two types of warrants in
this private financing. In November 2002, we issued warrants to purchase an
aggregate 950,000 shares of common stock at a purchase price per share of $0.20
exercisable within 18 months. From December 2002 through October 2003, we
issued warrants to purchase an aggregate 12,492,414 shares of common stock at a
per share purchase price of $0.50 exercisable within five years. The issuance
of shares and warrants described above was made in reliance on the exemptions
from registration set forth in Section 4(2) of the Securities Act of 1933 (the
Act), as amended. We made no public solicitation in connection with the
issuance of the above-mentioned securities. We relied on representation from
the recipients of the securities that they purchased the securities for
investment only and not with a view to any distribution thereof and that they
were aware of our business affairs and financial condition and had sufficient
information to reach an informed and knowledgeable decision regarding their
acquisition of the securities.

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 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. The forward-looking
statements set forth in this Form 10-KSB are as of December 31, 2003, and we
undertake no duty to update this information.

12



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##### Table of Contents



Capitalization

In the SEC action against Jeffrey Muller and others, we seek, among other
relief, the cancellation of eight million shares held beneficially and/or of
record by Muller and others, common stock purchase options for an additional
ten million shares, and Mullers original royalty agreement. See Item 3, Legal
Proceedings. The cancellation of these shares and options will have a
significant positive effect on our capitalization.

Results of Operation

To date, we have not generated any revenues and our business is in the
development stage. We have focused our efforts on verifying and developing the
ZEFS device. We expect to begin marketing the ZEFS device by the end of the
fourth quarter of 2004.

Our operating costs and expenses consist primarily of research and
development expenses and general and administrative expenses. We expect our
operating costs to increase once we begin to manufacture and market the ZEFS
device. Our research and development expenses include contractual payments to
RAND, consultants fees, capital expenditures, cost of services and supplies
We expect our research and development costs to increase as we continue to
develop the ZEFS device and develop new applications of our technology.

Our general and administrative expenses include compensation expenses
related to executive and other administrative personnel, facility lease, the
costs of our insurance and legal and accounting support. We expect our general
and administrative expenses to increase as we expand our infrastructure in
support of our anticipated increased operations.

We had a net loss of $2,749,199 for the year ended December 31, 2002,
compared to a net loss of $2,735,013 for the year ended December 31, 2001. We
expect an increase in net loss through 2004 attributable to increased general
and administrative expenses and commencement of marketing.

Liquidity and Capital Resources

We have incurred negative cash flow from operations in the developmental
stage since our inception in 1998. As of December 31, 2002 we had cash of
$107,489 and an accumulated deficit of $7.8 million. Our 2002 negative
operating cash flows were funded primarily through Masry & Vititoe, a law firm
in which our Chief Executive Officer and President, Edward Masry, is a member,
and a private financing that we commenced in November 2002. We anticipate
additional operating losses, which may increase, through at least 2004 as we
expand our research and development program and commence marketing of the ZEFS
device.

We believe that we have sufficient cash to fund our operations through
June 30, 2004. To the extent our capital resources are insufficient to meet
our future capital requirements, we will need to raise additional capital or
incur new debt to fund our operations. There can be no assurance that
additional equity or debt financing will be available. If we are unable to
obtain additional capital, we may be required to delay, reduce the scope of or
eliminate our research and development programs, reduce any marketing
activities or relinquish rights to technologies that we might otherwise seek to
develop or commercialize.

Critical Accounting Policies

Our discussion and analysis of financial condition and results of
operations is based upon our Financial Statements, which have been prepared in
accordance with accounting principles generally accepted in the United States
of America. The preparation of these 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 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

13



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##### Table of Contents



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. We believe the following critical accounting policies,
among others, require significant judgments and estimates used in the
preparation of our Financial Statements:

Stock-Based Compensation

We account for stock-based compensation to employees as defined by using
the intrinsic-value method prescribed in Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees.

We account for stock option and warrant grants issued to non-employees
using the guidance of SFAS No. 123, Accounting for Stock-Based Compensation
and 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.

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 our financial statements as described in Note 1 of our Financial
Statements. See Item 7, Financial Statements. Actual results could differ
from those estimates.

New Accounting Pronouncements

In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure. SFAS No. 148 amends SFAS
No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for
stock-based compensation. It also amends the disclosure method of accounting
for stock-based compensation. It also amends the disclosure requirements of
SFAS No. 123. If an entity elects to adopt the recognition provisions of the
fair value based method of accounting for stock-based compensation in a fiscal
year beginning before December 16, 2003, that change in accounting principle
shall be reported using either the (i) prospective method, (ii) the modified
prospective method, or (iii) the retroactive restatement method as defined in
SFAS No. 148. SFAS no. 148 is effective for fiscal years ending after December
15, 2002. Since the Company has elected to continue accounting for stock-based
compensation under APB No. 25, the adoption of SFAS No. 148 has had no impact
to the Companys financial position or results of operations. The Companys
financial statement disclosures have been designed to conform to the new
disclosure requirements prescribed by SFAS No. 148.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity.
SFAS No. 150 establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). The
provisions of SFAS No. 150 are effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003, except for mandatorily
redeemable financial instruments of nonpublic entities., which are subject to
the provisions of this statement for the first fiscal period beginning after
December 15, 2004. The Company believes that the adoption of SFAS No. 150 will
not have an impact on its financial position or results of operations.

14



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##### Table of Contents



Item 7. Financial Statements

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) YEARS ENDED DECEMBER 31, 2002 AND 2001 CONTENTS  
 PageIndependent auditors report
    
    
    16Financial statementsBalance sheets
    
    
    17Statements of operations
    
    
    18Statements of stockholders deficit
    
    
    19-21Statements of cash flows
    
    
    22-23Notes to financial statements
    
    
    24-43
 15




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##### Table of Contents



INDEPENDENT AUDITORS REPORT To the Board of Directors
Save the World Air, Inc. We have audited the accompanying balance sheets of Save the World Air, Inc. (a
development stage enterprise) as of December 31, 2002 and 2001 and the related
statements of operations, changes in stockholders deficiency and cash flows
for the years then ended and for the period from inception (February 18, 1998)
to December 31, 2002. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits in
accordance with standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Save the World Air, Inc. (a
development stage enterprise) as of December 31, 2002 and 2001 and the results
of its operations and its cash flows for the years then ended and for the
period from inception (February 18, 1998) to December 31, 2002, in conformity
with accounting principles generally accepted in the United States of America. WEINBERG & COMPANY, P.A. March 10, 2004
Boca Raton, Florida 16




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) BALANCE SHEETS
DECEMBER 31, 2002 AND 2001   2002
    
    2001ASSETSCurrent assetsCash
    
    $
    107,489
    
    
    $
    6,556Total current assets
    
    
    107,489
    
    
    
    6,556Property and equipment, net of accumulated
depreciation
    
    
    23,924
    
    
    
    1,006TOTAL ASSETS
    
    $
    131,413
    
    
    $
    7,562LIABILITIES
AND STOCKHOLDERS DEFICIENCYCurrent liabilitiesIncome taxes payable
    
    $
    4,927
    
    
    $
    3,838Payables to related parties
    
    
    553,022
    
    
    
    21,000Accrued expenses
    
    
    436,669
    
    
    
    237,787Total current liabilities
    
    
    994,618
    
    
    
    262,625Advances from founding executive officer
    
    
    1,017,208
    
    
    
    1,017,208Commitments and contingenciesStockholders deficiencyCommon stock, $.001 par value: 200,000,000
shares authorized, 20,235,847 and
18,085,847 shares issued and outstanding
at December 31, 2002 and 2001,
respectively
    
    
    20,236
    
    
    
    18,086Common stock to be issued
    
    
    389,875
    
    
    
    Additional paid-in capital
    
    
    7,133,081
    
    
    
    6,220,322Deferred compensation
    
    
    (1,572,060
    )
    
    
    (2,408,333
    )Deficit accumulated during the development stage
    
    
    (7,851,545
    )
    
    
    (5,102,346
    )Total stockholdersdeficiency
    
    
    (1,880,413
    )
    
    
    (1,272,271
    )TOTAL LIABILITIES AND STOCKHOLDERS DEFICIENCY
    
    $
    131,413
    
    
    $
    7,562
 See notes to financial statements. 17




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002 AND 2001 AND FOR THE PERIOD
FROM INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2002   Year Ended
    
    Year Ended
    
    CumulativeDecember 31,
    
    December 31,
    
    since2002
    
    2001
    
    inceptionNet sales
    
    $
    
    
    
    $
    
    
    
    $
    Expenses
    
    
    2,748,110
    
    
    
    2,733,844
    
    
    
    7,846,618Net loss before provision for income taxes
    
    
    (2,748,110
    )
    
    
    (2,733,844
    )
    
    
    (7,846,618
    )Provision for income taxes
    
    
    1,089
    
    
    
    1,169
    
    
    
    4,927Net loss
    
    $
    (2,749,199
    )
    
    $
    (2,735,013
    )
    
    $
    (7,851,545
    )Net loss per common share, basic and diluted
    
    $
    (0.15
    )
    
    $
    (0.17
    )Weighted average common shares outstanding,
basic and diluted
    
    
    18,568,861
    
    
    
    16,242,407
 See notes to financial statements. 18




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF STOCKHOLDERS DEFICIENCY
FROM INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2002 DeficitCommon Stock
    
    
    
    
    
    Additional
    
    
    
    
    
    accumulated
    
    TotalPrice per
    
    
    
    Common stock
    
    paid-in
    
    Deferred
    
    during the
    
    stockholders'share
    
    Shares
    
    Amount
    
    to be issued
    
    capital
    
    compensation
    
    development 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(as corrected, see Note 1)
    
    
    
    
    
    
    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(as corrected, see Note 1)
    
    
    
    
    
    
    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
    
    
    
    
    
    
    
    
    
    
    
    28,874Stock 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
    
    
    
    
    
    
    
    
    
    
    
    8,653
 See notes to financial statements. 19




---



##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF STOCKHOLDERS DEFICIENCY  Continued
FROM INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2002 DeficitCommon Stock
    
    
    
    
    
    Additional
    
    
    
    
    
    accumulated
    
    TotalPrice per
    
    
    
    Common stock
    
    paid-in
    
    Deferred
    
    during the
    
    stockholders'share
    
    Shares
    
    Amount
    
    to be issued
    
    capital
    
    compensation
    
    development stage
    
    deficiencyStock 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(as corrected, see Note 1)
    
    
    
    
    
    
    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 services on November 2, 2001
    
    
    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
    
    
    
    
    
    
    
    
    
    
    
    17,000Stock 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
    
    
    
    
    
    
    
    
    
    
    
    183,260
 See notes to financial statements. 20




---



##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF STOCKHOLDERS DEFICIENCY  Continued
FROM INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2002 DeficitCommon Stock
    
    
    
    
    
    Additional
    
    
    
    
    
    accumulated
    
    TotalPrice per
    
    
    
    Common stock
    
    paid-in
    
    Deferred
    
    during the
    
    stockholders'share
    
    Shares
    
    Amount
    
    to be issued
    
    capital
    
    compensation
    
    development stage
    
    deficiencyIntrinsic 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)
    
    
    0.17
    
    
    
    
    
    
    
    
    
    
    
    389,875
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    389,875Fair value of options issued to non-employees for services
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54,909
    
    
    
    (54,909
    )
    
    
    
    
    
    
    Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    891,182
    
    
    
    
    
    
    
    891,182Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,749,199
    )
    
    
    (2,749,199
    )Balance, December 31, 2002
    
    
    
    
    
    
    20,235,847
    
    
    $
    20,236
    
    
    $
    389,875
    
    
    $
    7,133,081
    
    
    $
    (1,572,060
    )
    
    $
    (7,851,545
    )
    
    $
    (1,880,413
    )
 See notes to financial statements. 21




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002 AND 2001 AND FOR THE PERIOD
FROM INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2002 Year Ended
    
    Year Ended
    
    CumulativeDecember 31,
    
    December 31,
    
    since2002
    
    2001
    
    inceptionCash flows from operating activitiesNet loss
    
    $
    (2,749,199
    )
    
    $
    (2,735,013
    )
    
    $
    (7,851,545
    )Adjustments to reconcile net loss to
net cash used in operating
activities:Write off of intangible assets
    
    
    
    
    
    
    
    
    
    
    505,000Fair value of options issued for services
    
    
    
    
    
    
    142,318
    
    
    
    642,318Issuance of common stock for services
    
    
    860,000
    
    
    
    2,042,571
    
    
    
    3,309,854Amortization of deferred compensation
    
    
    891,182
    
    
    
    191,667
    
    
    
    1,082,849Depreciation
    
    
    492
    
    
    
    35
    
    
    
    527Changes in operating liabilities:Income taxes payable
    
    
    1,089
    
    
    
    1,169
    
    
    
    4,927Accrued expenses
    
    
    198,882
    
    
    
    184,475
    
    
    
    436,669Net cash used in operating activities
    
    
    (797,554
    )
    
    
    (172,778
    )
    
    
    (1,869,401
    )Cash flows from investing activitiesPurchase of property and equipment
    
    
    (19,860
    )
    
    
    (1,041
    )
    
    
    (20,901
    )Net cash used in investing activities
    
    
    (19,860
    )
    
    
    (1,041
    )
    
    
    (20,901
    )Cash flows from financing activitiesIncrease in payables to related parties
    
    
    528,472
    
    
    
    21,000
    
    
    
    549,472Advances from founding executive officer
    
    
    
    
    
    
    159,375
    
    
    
    517,208Issuance of common stock for cash
    
    
    
    
    
    
    
    
    
    
    541,236Cash received for common stock to be issued
    
    
    389,875
    
    
    
    
    
    
    
    389,875Net cash provided by financing activities
    
    
    918,347
    
    
    
    180,375
    
    
    
    1,997,791Net increase in cash
    
    
    100,933
    
    
    
    6,556
    
    
    
    107,489Cash, beginning of period
    
    
    6,556
    
    
    
    
    
    
    
    Cash, end of period
    
    $
    107,489
    
    
    $
    6,556
    
    
    $
    107,489
 See notes to financial statements. 22




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) STATEMENTS OF CASH FLOWS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001 AND FOR THE PERIOD
FROM INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2002 Year Ended
    
    Year Ended
    
    CumulativeDecember 31,
    
    December 31,
    
    since2002
    
    2001
    
    inceptionSupplemental disclosures of cash flow
informationCash paid during the year forInterest
    
    $
    
    
    
    $
    
    
    
    $
    Income taxes
    
    $
    
    
    
    $
    
    
    
    $
    Non-cash investing and financing
activitiesAcquisition of intangible asset
through advance from related
party and issuance of common
stock
    
    $
    
    
    
    $
    
    
    
    $
    505,000Deferred compensation from stock options issued
for services
    
    
    54,909
    
    
    
    2,600,000
    
    
    
    2,654,909Purchase of property and equipment financed
by advance from related party
    
    
    3,550
    
    
    
    
    
    
    
    3,550
 See notes to financial statements. 23




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002 AND 2001    1.
    
    Description of business, significant matters and prior period corrections Description of business Save the World Air, Inc. (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 signing of an agreement by and between the Company and
Jeffrey Alan Muller, the Companys founding executive officer and
director, with respect to the Companys purchase of the Zero Emission
Fuel-Saving Device (the Agreement). Under the terms of the Agreement,
the Company issued 5,000,000 shares of its common stock to Mr. Muller
and agreed to pay him a total of $500,000 for the marketing and
distribution rights of the device, and a $10 royalty for every unit of
the device sold (see additional discussion in the Significant Matters
and prior period corrections section of this note). The Company
acquired the worldwide exclusive manufacturing, marketing and
distribution rights for the Zero Emission Fuel-Saving Device (ZEFS) by
entering into the Agreement. The ZEFS is a product, which is fitted to
an internal combustion engine and is expected to reduce carbon monoxide
hydrocarbons and toxic exhaust emissions. The ZEFS is currently
undergoing testing to determine the achievable levels of reduced
emissions and commercial viability. Significant matters On December 19, 2001, the Securities and Exchange Commission (SEC)
filed civil charges in federal district court in New York, New York,
against the Company, Mr. Muller, and others associated with the
promotion of Company stock sales, alleging that they engaged in a
fraudulent scheme to manipulate the market for the Companys stock. 24




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    1.
    
    Description of business and significant matters and prior period
corrections- Continued Significant matters  Continued The SECs complaint alleges that from at least February 1999 through at
least April 2001, the Company and Mr. Muller carried out a fraudulent
promotional campaign using press releases, Internet postings, an
elaborate Internet website, and televised media events to disseminate
false and materially misleading information about the Companys product
and commercial prospects. The complaint also alleges that the Companys
and Mr. Mullers actions led to the artificial inflation of the price
and trading volume of the Company stock, causing its market
capitalization to be as much as $218,728,062. The promotional
information distributed by the Company and Mr. Muller included: (1)
announcements of significant licensing agreements and other important
business developments, and (2) announcements concerning public
automotive demonstrations that purportedly proved or would prove that
the ZEFS materially reduces emissions and improves fuel economy in motor
vehicles. The complaint further alleges that the purported licensing
agreements and other purported business events simply did not exist, and
the then current ZEFS demonstrations did not prove that the ZEFS
actually worked as represented. At the same time that he publicly
promoted the Company, Mr. Muller privately sold millions of shares of
the Companys restricted stock that, if sold at then-prevailing market
prices, would have provided him with over $9 million in personal
profits. He concealed these sales by failing to disclose in SEC
filings, as required, any changes in his beneficial ownership in the
Company. The SEC complaint also states that the Company and Mr. Muller
made at least nine SEC filings that contain false financial statements
and disclosures. 25




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    1.
    
    Description of business and significant matters and prior period
corrections- Continued Significant matters  Continued In October 2001, Edward Masry became the Companys new President and
Chief Executive Officer. Because of the nature and scope of the SECs
allegations regarding the Companys financial statements and SEC
filings, Masry has assembled a new management team and newly constituted
board of directors for the Company, in addition to selecting new
independent auditors and corporate counsel. The Company entered into discussions with the SEC concerning the SECs
complaint and negotiated a consent order in which it agreed, among other
terms, to observe all securities laws. Based upon this consent order
and related judgment, the proceedings against the Company were
terminated. The Company has since caused an investigation into the
facts and circumstances surrounding the allegations in the SECs
complaint. Based upon review of the history leading to the filing of
the complaint, the Companys board of directors authorized the filing of
cross-claims against Mr. Muller and others (including ten offshore
companies) seeking disgorgement of stock obtained from the Company, to
invalidate the transfer of several million shares to Mr. Muller and
family members for inadequate or no consideration, rescission of stock
options transferred to Mr. Muller and/or his family members, for the
transfer of rights to patent claims from Mr. Muller to the Company and
rescission of royalty rights held by Mr. Muller and/or his family
members. Upon filing of the cross complaint, in July 2002, the Company
obtained a temporary restraining order against Mr. Muller which, among
other things, prohibits Mr. Muller from serving as an officer or
director of the Company and enjoins Mr. Muller and others from selling,
conveying, transferring or encumbering any shares which Mr. Muller
controls or in which he has an interest. The Company believes the
temporary restraining order may affect as many as seventeen million shares or
more of the Companys stock, in the form of issued shares and
option rights. In the course of the legal proceedings, the Company has obtained
complete control over all ownership claims to the ZEFS patent rights and
all royalty interests previously held and claimed by Mr. Muller and
certain others. 26




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    1.
    
    Description of business and significant matters and prior period
corrections- Continued Significant matters  Continued The Company has continued to prosecute its claims and has substantially
completed all pretrial procedures in preparation for the disposition of
the case through dispositive pretrial motions and/or eventual trial on
the merits of the claims. Based upon the substantial discovery
completed and other evidence obtained to date, the Company believes
there is very little risk of an adverse decision on the merits of its
cross complaint. Based on the status of current legal proceedings, the Company believes
it will not have to pay $1,017,208 of advances due to Mr. Muller. The
Company also believes that the option Mr. Muller holds to purchase
10,000,000 shares of the Companys stock will be cancelled (see Note 3). Prior period corrections The Companys new management team has evaluated the results of
operations since inception and has corrected certain previously reported
balances and results of operations. Those corrections are reflected in
the cumulative since inception amounts reported in the financial
statements herein. However, the financial statements previously filed
with the SEC which include the three quarterly financial statements
filed for 2001, the financial statements filed for the year ended
December 31, 2000, including each of the 2000 quarterly financial
statements filed, the financial statements filed for the year ended
December 31, 1999, and the financial statements filed for the period
from inception (February 18, 1998) to December 31, 1998, have not been
restated to reflect such corrections. Those corrections include, among
other things, the reversal of $125,000 of revenue recorded in 1999 and
the write off of $505,000 recorded as an intangible asset for the rights
to the ZEFS device first reported on the balance sheet at December 31,
1999, and subsequent annual and quarterly periods ending through
September 30, 2001. 27




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    1.
    
    Description of business and significant matters and prior period
corrections- Continued Prior period corrections  Continued The corrections also include adjustments of the stockholders equity and
expense accounts to reflect the issuance of stock options to
non-employees for services and certain fraudulent activity that the
Company alleges was carried out by Mr. Muller. In addition to the
complaints filed by the SEC, the Company has alleged that Mr. Muller
sold shares of the Companys stock and fraudulently diverted the
proceeds away from the Company. The Company has alleged that Mr. Muller
spent and distributed the proceeds for personal gain, and other purposes
that did not benefit the Company. The actual amount of proceeds that
was misappropriated has not been determined, but has been estimated by
management to be $516,684 as described below. These estimated losses
have been recorded in expenses in the accompanying cumulative since
inception statement of operations. In connection with the corrections, the Company analyzed all of the
sales of the Companys stock from inception until October 2001, when the
new management team was put into place. It was discovered that certain
of the Companys stock sales were recorded at par value at times when
the trading price of the stock was substantially higher than par. The
Company believes that Mr. Muller sold the stock at prices above par and
spent the proceeds for personal use and other activities that did not
benefit the Company. The Company believes that most of this alleged
fraudulent activity took place in 1999 when 5,267,125 shares of the
Companys stock were issued and a $571,449 increase in common stock
and additional paid-in capital was reported in the Companys financial
statements. Of the 5,267,125 shares, 5,000,000 were issued to Mr.
Muller, at .001 par value, 69,122 were issued for services of $49,513
and 198,003 were issued to investors for $516,936. The Company believes
that the 198,003 shares were sold by Mr. Muller to the investors and
that the proceeds were diverted away from the Company. The actual
selling prices for some of these shares are unknown and have been
estimated by the Company as described in the paragraph below. During
1999, the trading price of the Companys stock ranged from $0.10 to
$8.25, with a weighted average trading price (weighted by trading
volume) of $0.85. In addition, the Company confirmed the number of shares and
selling price with individual stockholders that purchased shares
in 1999 private placements noting that, based on responses to
confirmation inquires, the Companys stock was sold at prices ranging
from $1.00 to $6.40, with a weighted average selling price of $2.57. 28




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    1.
    
    Description of business and significant matters and prior period
corrections- Continued Prior period corrections  Continued The Company performed a search of the corporate and accounting records
to determine how much cash was received for the historical issuances of
the Companys common stock, and how much the fair value of the services
rendered was for stock issued for services. In certain cases, no
documentation was available to support the amounts for which stock was
issued for cash or services. In order to reconstruct the accounting for
the Companys equity issuances the Company employed a variety of methods
to determine or estimate the value of the issuances including; written
confirmation from stockholders, stockholder statements, and estimation
of fair value. In instances where the Company estimated the fair value
of stock issued for cash, the fair value was determined using
managements judgment and the information available, including
established fair value of stock sold at a date near the issuance in
question and trends in the trading price of the stock. In instances
where stock was issued for services, the Company recorded the issuances
based on the trading price of the stock on the date the services were
performed, which was assumed to be the date the stock was issued. These
corrections resulted in adjustments to the previously reported
stockholders equity accounts and results of operations for 1999 and
2000. The Companys analysis of the stock transactions resulted in the
determination that the loss due to Mr. Mullers alleged fraudulent
activity was in the range of approximately $400,000 to $600,000. The
actual loss that should have been recorded in the 1999 financial
statements is $516,684. This loss has been recorded in the cumulative
since inception statement of operations presented herein. The following
corrections have been made to the Companys previously reported
financial statements. The impact of these corrections is reflected in
the stockholders deficiency and deficit accumulated during the development
stage presented herein. December 31,1999
    
    2000Decrease in assets
    
    
    (505,000
    )
    
    
    (505,000
    )Increase in additional paid in capital
    
    
    566,182
    
    
    
    1,423,603Decrease in revenue
    
    
    (125,000
    )
    
    
    (9,980
    )Increase in expenses
    
    
    947,599
    
    
    
    897,930Increase in deficit accumulated during the development stage
    
    
    1,072,599
    
    
    
    1,980,509
 The corrections of the financial statements reflect managements best
estimates of the business and financial activity for those items for
which source documentation of the transactions was not available.
Actual results of those transactions could differ from managements
estimates. 29




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    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. A team has been assembled for the research and development of the
technology and potential markets for the ZEFS and to establish
relationships with potential customers. Significant design work has been
completed, and patent applications have been filed in 64 countries.
There is no assurance that any of the filed patents will be granted.
The Company is continuing in its product development efforts and several
studies are underway to evaluate the effectiveness of the ZEFS in
eliminating pollutants and emissions from internal combustion engines.
The Company has had no sales to date. As such, the Company continues to
remain a development stage enterprise. The ability of the Company to
commercialize its products will depend on, among other things, the
Companys ability to demonstrate the merits of the ZEFS and develop
markets and distribution channels. 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 increases,
these expenditures will likely result in additional losses. The Company
has obtained $553,022 of working capital and expense advances from
related parties and $517,208 of working capital advances from its
founding executive officer (see Note 3). The Company is in the process
of raising additional funds and has raised $2,372,510 in 2003 through
the sale of 9,484,000 shares of its common stock in private placement
transactions (see Note 9). 30




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    2.
    
    Summary of significant accounting policies- Continued 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. 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 value of
long-lived assets to determine whether or not an impairment to such
value has occurred. No impairments were recorded during the period from
inception (February 18, 1998) through December 31, 2002, and the years
ended December 31, 2002 and 2001. Earnings (loss) per share Basic earnings (loss) per share is computed by dividing net income
(loss) available to common stockholders by the weighted average number
of common shares outstanding during the period. Diluted earnings 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 earnings of the
Company. In computing diluted earnings 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 will 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, 2002 and
2001, the dilutive impact of outstanding stock options of 14,000,000 and
13,900,000, respectively, and 1,850,000 warrants in 2002 has been
excluded because their impact on the loss per share is antidilutive. 31




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    2.
    
    Summary of significant accounting policies- Continued Income taxes The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income
Taxes. Under SFAS No. 109, 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 The Company accounts for stock-based compensation using the
intrinsic-value method prescribed in Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees. The Company accounts for stock option and warrant grants issued to
non-employees using the guidance of SFAS No. 123, Accounting for
Stock-Based Compensation and 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, 2002, before
adjustments for outstanding checks and deposits in transit, the Company
had $205,521 on deposit with a bank. The deposits are federally insured
up to $100,000. 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 as
described in Note 1. Actual results could differ from those estimates. 32




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    2.
    
    Summary of significant accounting policies- Continued Fair value of financial instruments The carrying amounts of financial instruments, including cash, accrued
expenses, and payables to related parties and founding officer
approximate fair value because of their short maturity as of December
31, 2002. Recent accounting pronouncements In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. SFAS No. 146 nullifies
Emerging Issues Task Force Issue No. 94-3: Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). SFAS
No. 146 requires that a liability be recognized for those costs only
when the liability is incurred, that is, when it meets the definition of
a liability in the FASBs conceptual framework. SFAS No. 146 also
establishes fair value as the objective for initial measurement of
liabilities related to exit or disposal activities. SFAS No. 146 is
effective for exit or disposal activities that are initiated after
December 31, 2002, with earlier adoption encouraged. Management does
not expect the adoption of SFAS No. 146 will have a material impact on
the Companys financial position or results of operations. In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation-Transition and Disclosure. SFAS No. 148
amends SFAS No. 123 to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for
stock-based compensation. It also amends the disclosure requirements of
SFAS No. 123. If an entity elects to adopt the recognition provisions
of the fair value based method of accounting for stock-based
compensation in a fiscal year beginning before December 16, 2003, that
change in accounting principle shall be reported using either the (i)
prospective method, (ii) the modified prospective method, or (iii) the
retroactive restatement method as defined in SFAS No. 148. SFAS No. 148
is effective for fiscal years ending after December 15, 2002. Since the
Company has elected to continue accounting for stock-based compensation
under APB No. 25, the adoption of SFAS No. 148 has had no impact to the
Companys financial position or results of operations. The Companys
financial statement disclosures have been designed to conform to the new
disclosure requirements prescribed by SFAS No. 148. 33




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    2.
    
    Summary of significant accounting policies- Continued Recent accounting pronouncements  Continued In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity. SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an
issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). The provisions of SFAS
No. 150 are effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003, except for
mandatorily redeemable financial instruments of nonpublic entities,
which are subject to the provisions of this statement for the first
fiscal period beginning after December 15, 2004. The Company believes
that the adoption of SFAS No. 150 will not have an impact on its
financial position or results of operations. In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, which clarifies the
application of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, relating to consolidation of certain entities.
In December 2003, the FASB issued a revised FIN 46 46R that replaced
the original FIN 46. FIN 46R requires identification of a companys
participation in variable interest entities (VIEs), which are defined as
entities with a level of invested equity that is not sufficient to fund
future activities to permit it to operate on a standalone basis. For
entities identified as a VIE, FIN 46R sets forth a model to evaluate
potential consolidation based on an assessment of which party to the VIE
(if any) bears a majority of the exposure to its expected losses, or
stands to gain from a majority of its expected returns. FIN 46R also
sets forth certain disclosures regarding interests in VIEs that are
deemed significant, even if consolidation is not required. The Company
is not currently participating in, or invested in any VIEs, as defined
in FIN 46R.  3.
    
    Certain relationships and related transactions Advances from founding executive officer All of the marketing and manufacturing rights for the ZEFS were acquired
from Mr. Muller, for 5,000,000 shares of common stock, $500,000 and a
$10 royalty for each unit sold (see discussion below), pursuant to the
Agreement entered into in December 1998, by and between the Company and
Mr. Muller. Working capital advances in the amount of $517,208 and
payment in the amount of $500,000 for marketing and distribution rights
of the ZEFS are due to Mr. Muller. Such amounts are interest free and
do not have any due dates for payment (see Note 1). 34




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    3.
    
    Certain relationships and related transactions- Continued Advances from founding executive officer  Continued In January 2000, the Company entered into an agreement offering Mr.
Muller and Lynne Muller, Mr. Mullers wife, the option to purchase
5,000,000 shares each at $0.10 per share as consideration for work
performed for the Company. Mrs. Muller subsequently transferred her
option to Mr. Muller. In connection with the Companys legal proceedings against Mr. Muller,
the Company is attempting to obtain a judgment that will relieve the
Company of $1,017,208, which represents all amounts due Mr. Muller.
These amounts include the $500,000 due for the marketing and
distribution rights of the ZEFS and the working capital advances of
$517,208. As described in the Significant Matters section of Note 1,
the Company has already been relieved of the $10 royalty interest that
Mr. Muller held for each unit sold. In addition, the Company is also
attempting to obtain a judgment that will cancel the options to purchase
10,000,000 shares granted to Mr. and Mrs. Muller, collectively. Based
on the status of current legal proceedings, the Company does not believe
that it will have to pay Mr. Muller the $500,000 for the rights to the
ZEFS device and the $517,208 of advances. The Company also believes
that the option Mr. Muller holds to purchase 10,000,000 shares of the
Companys stock will be cancelled and no longer valid. Due to related parties Masry & Vititoe, a law firm in which Edward Masry is a partner, has
advanced $553,022 and $21,000 as of December 31, 2002 and 2001,
respectively, to the Company for working capital purposes. The advances
payable to Masry & Vititoe were allocations to the Company for shared
expenses, primarily payroll. These advances are unsecured, non-interest
bearing, and are due on demand. These advances have subsequently been
converted to common stock (see Note 9).  4.
    
    Property and equipment At December 31, 2002 and 2001, property and equipment consist of the
following: December 31,
    
    December 31,2002
    
    2001Office equipment
    
    $
    24,451
    
    
    $
    1,041Less accumulated depreciation
    
    
    (527
    )
    
    
    (35
    )$
    23,924
    
    
    $
    1,006
 35




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    5.
    
    Income taxes The Company has net operating loss (NOL) carryforwards in the amount of
approximately $2.3 million, which begin to expire in 2018. The deferred
tax asset related to these NOL carryforwards has been fully reserved.
The provision for income taxes represents the minimum state income taxes
payable plus estimated penalties and interest. The Companys ability to utilize its NOL is dependent upon current filing
status with the Internal Revenue Service (IRS) and is subject to the
IRSs statute of limitations. Currently, the Company has not filed any
returns with the IRS. A reconciliation of the Companys tax provision to income taxes at the
applicable statutory rates is shown below. 2002
    
    2001Income taxes at statutory federal rate
    
    
    (934,388
    )
    
    
    (929,904
    )State income taxes, net of federal benefit
    
    
    (164,952
    )
    
    
    (164,101
    )Valuation allowance
    
    
    1,099,680
    
    
    
    1,094,005Minimum state income taxes, plus penalties and interest
    
    
    1,089
    
    
    
    1,169$
    1,089
    
    
    $
    1,169
  6.
    
    Stockholders deficiency As of December 31, 2002, the Company has authorized 200,000,000 shares of
its common stock, of which 20,235,847 shares were issued and outstanding
and 2,305,000 shares were to be issued. As described in Note 1,
estimates and judgments were used by management to determine the fair
value for certain issuances of the outstanding shares. These estimates
have impacted the amounts previously recorded in the 2000 and 1999
financial statements for common stock, additional paid-in capital and
expenses (see Note 1). 36




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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    6.
    
    Stockholders deficiency- Continued The Companys significant stockholders are as follows: Number
    
    Percentageof shares
    
    ownershipMr. Jeffrey Muller and controlled by Mr. Muller
through beneficial ownership
    
    
    8,716,710
    
    
    
    43.1
    %Mr. Edward Masry
    
    
    1,000,000
    
    
    
    4.9
    %Edward Skoda
    
    
    4,000,000
    
    
    
    19.8
    %Remaining stockholders
    
    
    6,519,137
    
    
    
    32.2
    %20,235,847
    
    
    
    100.0
    %
 In connection with the cross complaint the Company has filed against Mr.
Muller, the Company is seeking various legal remedies relating to at
least 7,000,000 of the 8,716,710 shares controlled by Mr. Muller (see
Note 1). The Company is also seeking the rescission of options to
purchase 10,000,000 shares of the Companys stock held by Mr. Muller (see
Notes 1 and 3). Management cannot predict the outcome of any of the
pending matters related to the shares controlled by Mr. Muller, or if the
10,000,000 option shares will be rescinded. In 2002, 2,150,000 shares of stock were issued to directors and officers
of the Company for services rendered. The aggregate fair value of these shares on
the date of issuance was $860,000, and has been recorded as
compensation expense in 2002. In November and December 2002, the Company sold 2,305,000 shares of its
common stock in a series of private placement transactions. The Company
received proceeds, net of offering costs, in the amount of $389,875 for
the shares prior to December 31, 2002, but did not issue the stock
certificates until March 20, 2003. These shares are shown as common
stock to be issued in the accompanying financial statements. In 2001, 2,439,912 shares of stock were for services rendered. The
aggregate fair value of these shares on the date of issuance was
$2,042,571, and has been recorded as compensation expense in 2001. 37




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    7.
    
    Stock options and Warrants The Company issues stock options to employees, directors and consultants
under no formal plan. Employee options vest according to the terms of
the specific grant and expire from 8 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, 2002 was 8.13 years. Stock option activity
for the years ended December 31, 2001 and 2002, was as follows: Weighted Avg.Options
    
    Exercise PriceOptions outstanding, January 1, 2001
    
    
    10,000,000
    
    
    $
    0.10Options granted
    
    
    3,900,000
    
    
    
    0.17Options exercised
    
    
    
    
    
    
    Options cancelled
    
    
    
    
    
    
    Options, December 31, 2001
    
    
    13,900,000
    
    
    
    0.13Options granted
    
    
    100,000
    
    
    
    1.00Options exercised
    
    
    
    
    
    
    Options cancelled
    
    
    
    
    
    
    Options, December 31, 2002
    
    
    14,000,000
    
    
    $
    0.13
 Options outstanding at December 31, 2002 and the related weighted average
exercise price and remaining life information is as follows: TotalWeighted
    
    weighted
    
    
    
    
    
    WeightedRange of
    
    Total
    
    average
    
    average
    
    
    
    
    
    averageexercise
    
    options
    
    remaining
    
    exercise
    
    Options
    
    exerciseprices
    
    outstanding
    
    life in years
    
    price
    
    exercisable
    
    price$0.10
    
    
    10,000,000
    
    
    
    N/A
    
    
    $
    0.10
    
    
    
    10,000,000
    
    
    $
    0.100.10
    
    
    3,000,000
    
    
    
    7.83
    
    
    
    0.10
    
    
    
    1,000,000
    
    
    
    0.100.40
    
    
    750,000
    
    
    
    9.79
    
    
    
    0.40
    
    
    
    250,000
    
    
    
    0.400.50
    
    
    150,000
    
    
    
    4.71
    
    
    
    0.50
    
    
    
    150,000
    
    
    
    0.501.00
    
    
    100,000
    
    
    
    9.67
    
    
    
    1.00
    
    
    
    100,000
    
    
    
    1.00$0.10-$1.00
    
    
    14,000,000
    
    
    
    8.13
    
    
    $
    0.13
    
    
    
    11,500,000
    
    
    $
    0.20
 38




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    7.
    
    Stock options and Warrants- Continued The 10,000,000 options exercisable at $0.10 per share in the table above
are held by Mr. Muller. The options have been accounted for as employee
stock options under the provisions of APB No. 25. Accordingly, no
compensation expense has been recorded in the statements of operations.
However, the $1,000,000 fair value of the options has been reflected in
the pro forma net loss below. The 10,000,000 options do not have an
expiration date and vested in 1999. For purposes of computing fair value
method stock-based employee compensation expense for the 10,000,000
employee options above, a ten-year life was used in the Black-Scholes
option-pricing model, as ten years is the longest term for other option
grants. Intrinsic value of employee options Certain employee options have been granted with exercise prices less the
than fair market value of the Companys stock at the date of grant. As
the grants were to employees, the intrinsic value method, as allowed
under APB No. 25, was used to calculate the related compensation
expense. In 2000 and 2001, $2,600,000 and $191,667, respectively, of deferred
compensation and related amortization to expense was recognized for
these options. In 2002, $850,000 of employee deferred compensation was
amortized and recognized as expense. The remaining deferred
compensation expense will be recognized over the remaining vesting
periods of the employee options through 2004. Non-employee warrants and options In 2002, 1,850,000 warrants and 100,000 options were issued to
non-employees. In 2001, 650,000 options were issued to non-employees.
The Company estimated the combined fair values of the warrants and
options for each respective year to be $684,464 and $442,316,
respectively, using the Black-Scholes option-pricing model. In 2002,
$629,555 of the total fair value was related to the 1,850,000 warrants
issued for private placement finders fees. Accordingly, this amount
was offset against the proceeds. The remaining $54,909 was for the
100,000 options issued for non-employee services and was recorded as
deferred compensation and will be amortized to expense as the services
are provided. In 2002, $41,182 was amortized to expense. In 2001,
$299,998 of the total fair value was related to options issued for
private placement finders fees. This amount was also offset against
the proceeds. The remaining $142,318 was for services and was charged
to expense in 2001. 39




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    7.
    
    Stock options and Warrants- Continued The following table summarizes certain information about the companys
stock purchase warrants. Weighted Avg.Warrants
    
    Exercise PriceWarrants outstanding, January 1, 2001
    
    
    
    
    
    $
    Warrants granted
    
    
    
    
    
    
    Warrants exercised
    
    
    
    
    
    
    Warrants cancelled
    
    
    
    
    
    
    Warrants outstanding, December 31, 2001
    
    
    
    
    
    
    Warrants granted
    
    
    1,850,000
    
    
    
    0.35Warrants exercised
    
    
    
    
    
    
    Warrants cancelled
    
    
    
    
    
    
    Warrants outstanding, December 31, 2002
    
    
    1,850,000
    
    
    $
    0.35
 The Company has elected to account for stock-based compensation using
the intrinsic value method prescribed in APB No. 25 and related
interpretations, and follow the pro forma disclosure requirements of
SFAS No. 123. Accordingly, no compensation expense has been recognized
related to the granting of stock options, except as noted above. The
following table illustrates the effect on net income as if the Company
had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation. Cumulativesince2002
    
    2001
    
    inceptionNet loss, as reported
    
    $
    (2,749,199
    )
    
    $
    (2,735,013
    )
    
    $
    (7,851,545
    )Add: total fair value method stock-based
employee compensation expense
    
    
    (949,977
    )
    
    
    (308,328
    )
    
    
    (2,258,302
    )Less: deferred compensation amortization for
below market employee options
    
    
    850,000
    
    
    
    191,667
    
    
    
    1,041,667Pro forma net loss
    
    $
    (2,849,176
    )
    
    $
    (2,851,674
    )
    
    $
    (9,068,183
    )Pro forma loss per share
    
    $
    (0.15
    )
    
    $
    (0.18
    )
 40




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    7.
    
    Stock options- Continued The fair market value of the stock options at the grant date was
estimated using the Black-Scholes pricing model with the following
weighted average assumptions: Expected life (years)
    
    
    8.15Risk free interest rate
    
    
    5.57
    %Volatility
    
    
    289.12
    %Expected dividend yield
    
    
    0.00
    %
  8.
    
    Commitments and contingencies Legal matters On December 19, 2001, the Securities and Exchange Commission (SEC) filed
civil charges in the United States Federal District Court, Southern
District of New York against the Company, its former President and sole
director Jeffrey Muller, and others associated with the promotion of
Company stock sales. The SEC complaint alleged the existence of a
promotional campaign using press releases, internet postings, and
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 controlled by
Mr. Muller. On March 22, 2002, management 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 pay any
fines or restitution. The SECs action continues against Mr. Muller and
others. On July 2, 2002, after an investigation by a newly constituted board of
directors, the Company filed a cross-complaint in the SEC action against
Mr. Muller and others seeking injunctive relief, disgorgement and
financial restitution for a variety of acts and omissions in connection
with sales of Company stock and other transactions occurring between
1998 and 2002. The Company is also seeking cancellation of such shares
and Mr. Mullers stock option agreement and royalty arrangement. Among
other things, the Company alleges that Mr. Muller and certain others
sold stock without consideration and without registration 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 stock; and entered into various undisclosed
arrangements regarding the control, voting and disposition of their
stock. 41




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    8.
    
    Commitments and contingencies- Continued Legal matters  Continued 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 prevents Mr. Muller and other
cross-defendants from selling, transferring, or encumbering any of the
Companys assets and property, from selling or transferring any of the
Companys stock that they may own or control, or from taking any action
to injure the Company or its business and shareholders. The order also
prevents Mr. Muller from exercising any control over the corporation and
serving as officer or director. While management believes that the
Company has valid claims, there can be no assurance that an adverse
result or settlement would not have a material adverse effect on the
Companys financial position or cash flow. In the course of the litigation, the Company has obtained control over
Mr. Mullers patent rights to the ZEFS device. Under that certain
Buy-Sell Agreement with Mr. Muller dated December 29, 1998, Mr. Muller,
who was listed on the ZEFS devise patent application as the inventor of
the ZEFS device, granted the Company the marketing, manufacturing and
distribution rights to the ZEFS device. On November 7, 2002, under the
settlement with the Muller bankruptcy trustee, the trustee transferred
all ownership and legal rights to this international patent application
for the ZEFS device to the Company. Pursuant to this agreement, the
Company is also entitled to entire royalty rights previously claimed
by Mr. Muller. The litigation against Mr. Muller and others has been pending before the
Court and will be scheduled for further proceedings and final
disposition by summary judgment motions within the near future.
Although the outcome of these motions cannot be predicted with any
degree of certainty, it is expected that the Courts ruling will either
significantly narrow the issues for any later trial or will result in a
disposition of the case in a manner favorable to the Company. The
Company contends that it is entitled to a judgment divesting Mr. Muller
of any right to exercise option rights to 10 million shares of Company
stock, the entry of an existing preliminary injection to prevent Mr.
Muller from any involvement with the Company and a monetary judgment
against Mr. Muller and others in the amount of several million dollars.
While Company management believes that the Company has valid claims,
there can be no assurance that an adverse result or settlement would not
have a material adverse effect on the Companys financial position or
cash flow. 42




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##### Table of Contents



SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE) NOTES TO FINANCIAL STATEMENTS  Continued
YEARS ENDED DECEMBER 31, 2002 AND 2001    8.
    
    Commitments and contingencies- Continued Royalty agreements The Company has entered into various royalty agreements whereby it has
agreed to provide an aggregate of $0.80 per unit for each ZEFS device
sold. Certain of these royalty agreements were reached in exchange for
the royalty recipients release of their claims to the intellectual
property rights to the ZEFS. In connection with these royalty agreements, the Company has committed
to issue options to purchase an aggregate of 1,000,000 shares of common
stock at $1.00 per share. The options expire 10 years from the date of
grant and will be granted when the Company is in full compliance with
the SEC. Also, in connection with the royalty agreements, the Company has
committed to issue an aggregate of 728,000 shares of common stock
according to the following schedule:  (1)
    
    300,000 shares on April 4, 2004(2)
    
    300,000 shares on April 4, 2005(3)
    
    128,000 shares upon completion of successful ZEFS
testing, as defined. Leases In 2002 and 2001, the Company had no leases of any property. In October
2003, the Company subleased a portion of a building in North Hollywood,
California. The lease term is from November 1, 2003 through October 31,
2005 and carries an option to renew for two additional years with a 10
percent increase in the rental rate. Monthly rent is $2,000.  9.
    
    Subsequent events In 2003, the Company sold 9,484,000 shares of common stock for $2,372,510
in private placements. In 2003, the Company issued warrants to purchase common stock in
connection with the private placements. Warrants to purchase a total of
11,517,414 shares of common stock at $0.50 per share were issued. These
warrants have a 5-year term. In 2003, Masry and Vititoe converted $500,000 of its advances due from
the Company, in the amount of $553,022, to 2,000,000 shares of common
stock. 43




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##### Table of Contents



Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

Effective April 10, 2002, we approved a change in our independent public
accountants for the year ended December 31, 2002, from Hoiberg Business Group,
of Carrara, Queensland, Australia to Good Swartz Brown & Berns LLP.

We did not consult with Good Swartz Brown & Berns LLP during the fiscal
years ended December 31, 2000 and 2001, and the interim period from December
31, 2001 through July 30, 2002, with respect to (i) the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our financial statements
or (ii) any matter that was the subject of any prior disagreement between us
and our previous independent accountant.

The report of Hoiberg Business Group for the years ended December 31, 2000
and December 31, 2001 contained no adverse opinions, disclaimer of opinion or
qualification or modification as to uncertainty, audit scope or accounting
principles. During the fiscal years ended December 31, 2000 and 2001, and the
interim period from December 31, 2001 through November 4, 2002, there were no
disagreements between us and Hoiberg Business Group on any accounting
principles or practices, financial statement disclosure or auditing scope or
procedure, which, if not resolved to the satisfaction of Hoiberg Business
Group, would have caused it to make reference to the subject matter of the
disagreement in connection with its report. No event described in paragraph
(a)(1)(iv) of Item 304 of Regulation S-B has occurred within our fiscal years
ended December 31, 2000 and 2001, or the period from December 31, 2001 through
April 10, 2002.

In April 2003, the SEC promulgated that no annual or quarterly report
submitted to the SEC may include financial reports audited by independent
public accountants unregistered with the Public Company Accounting Oversight
Board (PCAOB). Our current accountants, Good Swartz Brown & Berns LLP,
recently indicated that they would not be registered with the PCAOB,
and as such, they resigned as our independent public accountants. In
November 2003, our Board of Directors retained Weinberg & Co., an independent accounting firm
that was registered with the PCAOB.

Item 8A. Controls and Procedures

(a) 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,

43



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##### Table of Contents



our Chief Executive Officer and Chief Financial Officer have concluded
that our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are
effective 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 Securities and
Exchange Commission rules and forms. It should be noted that the design of any
system of controls 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.

(b)  Changes in internal control over financial reporting: There was no
change 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.

44



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##### Table of Contents



PART III

Item 9. Directors and Executive Officers of Registrant

The following table sets forth information regarding our directors and
executive officers as of December 31, 2003:

|                              |  |     |    |          |                |                                                                          |  |  |      | 
|----------------------------- |  | --- | -- | -------- | -------------- | ------------------------------------------------------------------------ |  |  | ---- | 
|Name                          |  | Age |    | Position | Director Since
|                              |  |     |    |          |               
|Edward L. Masry, Esq.(3)      |  |     | 71 |          |                | Chief Executive Officer,
President, Chairman of the
Board                |  |  | 2001 | 
|Eugene E. Eichler, CPA(1)(4)  |  |     | 76 |          |                | Chief Operating Officer,
Chief Financial Officer,
Treasurer and Director |  |  | 2002 | 
|Bruce H. McKinnon(1)(2)(3)(4) |  |     | 61 |          |                | Director and Executive
Vice President                                    |  |  | 2002 | 
|Nathan Shelton(4)             |  |     | 54 |          |                | Vice President of
Marketing and Distribution                             |  |  | N/A  | 
|Robert F. Sylk(4)             |  |     | 65 |          |                | Director and Vice President                                              |  |  | 2001 | 
|Hon. J. Joseph Brown, AO(2)   |  |     | 72 |          |                | Director                                                                 |  |  | 2002 | 
|John F. Price, PhD(2)         |  |     | 60 |          |                | Director                                                                 |  |  | 2002 | 
|Joseph Helleis(1)(2)          |  |     | 66 |          |                | Director                                                                 |  |  | 2002 | 
|Janice Holder(6)              |  |     | 57 |          |                | Corporate Secretary                                                      |  |  | N/A  | 
|Jeffrey Muller(5)             |  |     | 50 |          |                | Director                                                                 |  |  | 1999 | 



---

|(1) |  | Member of the Audit Committee.                                                                                                                         
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Member of the Compensation Committee.                                                                                                                  
|   
|   
|   
|   
|(3) |  | Member of the Nominating and Corporate Governance Committee.                                                                                           
|   
|   
|   
|   
|(4) |  | Member of the Disclosure Committee.                                                                                                                    
|   
|   
|   
|   
|(5) |  | On July 30, 2002, Jeffrey Muller was prohibited by court order from
acting as our officer or director. See Item 3 above for a more detailed
discussion.
|   
|   
|   
|   
|(6) |  | Ms. Holders status as an
executive officer was approved by our board of directors on
November 21, 2003.                                               

There are no family relationships between any director and executive
officer.

Edward L. Masry, Esq.has served as our Chairman of the Board of
Directors, Chief Executive Officer and President since October 2001. Mr. Masry
has been a member of the law firm of Masry & Vititoe since 1986 and was Mayor
of Thousand Oaks City and currently a member of the City Council. From 1960 to
1986, he was a partner of various law firms. Mr. Masry was corporate director
of Merlin Olsen Porsche Audi from 1970 to 1988 and corporate director of
Gabriel Olsen Volkswagen from 1969 to 1973. Mr. Masry received a J.D. from
Loyola Law School, Los Angeles.

Eugene E. Eichler, CPAhas served as our Chief Operating Officer, Chief
Financial Officer and Treasurer since October 2001 and as our director since
May 2002. 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.

Bruce H. McKinnonhas served as our director since May 2002 and our
Executive Vice-President  Business Development since December 2003. Mr.
McKinnon has served as Chief Executive Officer and President of KZ Golf, Inc.,
an international golf equipment company, since 1994. From 1990 to 1994, he was
President and Chief Executive Officer of TTL Corporation and Novaterra, Inc.,
environmental remediation and technology corporations. Prior to 1990, Mr.
McKinnon was an owner, Chairman and Chief Executive Officer of several
international trading and manufacturing corporations.

45



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##### Table of Contents



Nathan Sheltonhas served as our Vice President of Marketing and
Distribution since 2003. From 2002 until present, he operates his own
consulting firm. He was the Chief Executive Officer and Chief Marketing
Officer at K&N Engineering from 1984 to 2002 and was also Chairman of the
Specialty Equipment Market Association, a trade association of automotive after
market manufacturers and distributors.

Robert F. Sylkhas served as our director since October 2001 and our Vice
President  Investor Relations since May 2002. He currently is one of the
board of directors of the La Quinta Chamber of Commerce and Chairman of the
Ambassadors Committee. From 1991 to 2003, he has served as a senior executive
of Mirage Resorts. He was a delegate to the California Tourism and Trade
Commission from 1994 to 1998. From 1993 to 1997, he was Senior Vice President
of the Marina Del Rey Chamber of Commerce. He was a board member for the L.A.
County Department of Beaches and Harbors and on the Board of the U.S.O. from
1993 to 2000. Mr. Sylk is presently a director for the Agua Caliente Casino,
located in Rancho Mirage, Calif.

Hon. J. Joseph Brown AOhas served as our director since May 2002. He has
served as Chairman of the Australian Tourism Task Force since 1989 and
currently is a professional consultant to Service Corporation International
Australia. Mr. Brown has also served as director of Macquarie Tourism and
Leisure since 1990. From 1983 to 1988, Mr. Brown was Minister for Sport and
Tourism for the Australian government and from 1987 to 1988 he was the Minister
for the Environment. He was a member of the Olympic Bid teams for Brisbane
(1992), Melbourne (1996) and the successful Sydney Bid (2000). Mr. Brown was
Founding Director of the Sydney Olympic Games Organizing Committee in 1992 and
the Sydney Paralympic Organizing Committee in 1998.

John F. Price, PhDhas served as our director since May 2002. He
co-founded and has served as Chairman of the Board of Conscious Investing Pty
Ltd., a software company, since May 2001. In June 1998, Mr. Price founded
Price Value, Inc., a software company to market software that he developed. He
has served as Chairman of the Board of Price Value, Inc. since 1998. Since
October 1997, Mr. Price has held various teaching positions in mathematics and
physics at University of New South Wales. From 1990 to 1998, he was professor
and head of the Mathematics Department at Maharishi University of Management.
Mr. Price received a B.Sc. and M.Sc. from the University of Melbourne and a
Ph.D. from the Australian National University.

Joseph Helleishas served as our director since May 2002. 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.
From 1981 to 2000, he served in senior executive capacities as Chairman/CEO,
President/CEO, and Chief Credit Officer with number of financial institutions
in the southern California region. From 2000 to 2002, he was President/Chief
Executive Officer with Bank of Whittier. From 2002 to present, he has been
operating his own financial services consulting firm, Joseph Helleis and
Associates. Mr. Helleis has an AA degree from the National Institute of
Credit.

Janice Holderhas served as our Corporate Secretary since October 2001.
From 1964 through 1984, Ms. Holder managed various medical facilities in Orange
County. Since 1984, she has been the Office Manager for the Law Offices of
Masry & Vititoe.

Jeffrey Mullerwas elected as our director in February, 1999. In July
2002, he was enjoined by court order from acting as a director or officer of
our corporation.

Section 16(a) Beneficial Ownership Reporting
Compliance

Section 16(a) of the
Securities Exchange Act of 1934, as amended, requires our executive
officers, directors and ten percent or greater stockholders to file reports of
ownership and changes in ownership with the SEC. The same persons are
required to furnish us with copies of all Section 16(a) forms
they file. Based solely upon a review of the copies of the forms
furnished to us and the representations made by the reporting persons
to us, we believe that during 2002 our directors, officers and ten
percent or greater stockholders complied with all filing requirements under
Section 16(a) of the Exchange Act.

46



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##### Table of Contents



Item 10. Executive Compensation

The following table sets forth compensation information for our Chief
Executive Officer and other executive officers as of the end of fiscal year
2002.

Summary Compensation Table

|                          |                                 |             |                     |        |                        |        |         |          |  |         |            |              |        |       |            |           |  |  |   |   | 
|------------------------- | ------------------------------- | ----------- | ------------------- | ------ | ---------------------- | ------ | ------- | -------- |  | ------- | ---------- | ------------ | ------ | ----- | ---------- | --------- |  |  | - | - | 
|                          |                                 |             | Annual Compensation |        | Long-term Compensation
|                          |                                 |             |                     |        |                       
|                          |                                 |             |                     |        |                        |        |         |          |  |         | Awards     |              |        |       |           
|                          |                                 |             |                     |        |                        |        |         |          |  |         |            |              |        |       |           
|                          |                                 |             |                     |        |                        |        |         |          |  |         |            |              |        |       | Securities |           |  |  |  
|                          |                                 |             |                     |        |                        |        |         |          |  |         | Restricted |              | Under- |       | All       
|Name                      |                                 |             |                     |        |                        |        |         |          |  | Stock   |            | lying        |        | Other
|and                       |                                 |             |                     |        |                        | Salary |         | Award(s) |  | Options |            | Compensation
|Principal Position        |                                 | Fiscal Year |                     | ($)(4) |                        | ($)(5) |         | (#)      |  | ($)    
|                          |                                 |             |                     |        |                        |        |         |          |  |        
|Edward L. Masry, Esq. (1) |                                 |             | 2002                |        |                        | $      |        |          |  | $       |           |              |        |       |           |           |  |  |  |  
|                          | President and Chief             |             |                     | 2001   |                        |        |         |         |  |         |            | 950,000      |        |       |            | 3,000,000 |  |  |   |  | 
|                          | Executive Officer               |             |                     | 2000   |                        |        |         |         |  |         |            |             |        |       |            |          |  |  |   |  | 
|Eugene Eichler, CPA (2)   |                                 |             | 2002                |        |                        |        | 167,670 |          |  |         | 150,000    |              |        |       |           |           |  |  |  |  
|                          | Chief Operating                 |             |                     | 2001   |                        |        |         |         |  |         |            |             |        |       |            | 250,000   |  |  |   |  | 
|                          | Officer, Chief                  |             |                     | 2000   |                        |        |         |         |  |         |            |             |        |       |            |          |  |  |   |  | 
|                          | Financial Officer and
Treasurer |             |                     |        |                        |        |         |          |  |         |            |              |        |       |            |           |  |  |   |   | 
|Janice Holder (3)         |                                 |             | 2002                |        |                        |        | 28,800  |          |  |         | 15,000     |              |        |       |           |           |  |  |  |  
|                          | Corporate Secretary             |             |                     | 2001   |                        |        |         |         |  |         |            |             |        |       |            |          |  |  |   |  | 
|                          |                                 |             | 2000                |        |                        |        |        |          |  |         |           |              |        |       |           |           |  |  |  |  



---

|(1) |  | Mr. Masry was appointed President and Chief Executive Officer in October
2001 at no annual salary. Prior to being appointed President and Chief
Executive Officer, Mr. Masry was not an executive officer of the Company.                                                                                                                                                                                                                                                                                       
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(2) |  | Mr. Eichler was appointed Chief Operating Officer, Chief Financial Officer
and Treasurer in October 2001. Prior to being appointed to these positions,
Mr. Eichler was not an executive officer of the Company.                                                                                                                                                                                                                                                                                                 
|   
|   
|   
|   
|(3) |  | Ms. Holder was appointed
Corporate Secretary in October 2001 and given executive officer
status in November 2003. Prior to
being appointed Corporate Secretary, Ms. Holder was not an executive officer of
the Company.                                                                                                                                                                                                                                                                                         
|   
|   
|   
|   
|(4) |  | The law firm Masry & Vititoe, PC paid for Mr. Eichlers and Ms. Holders
salaries from January 1, 2002 through December 2002 pursuant to an arrangement
in which we reimbursed Masry & Vititoe, PC for a portion of their respective
salaries.                                                                                                                                                                                                                                                                  
|   
|   
|   
|   
|(5) |  | The number and value of vested and unvested restricted stock based upon the
closing market price of the common stock at December 31, 2002 ($0.35) were as
follows: Masry, 1,000,000 vested shares valued at $350,000; Eichler, 500,000
unvested shares valued at $175,000; and Holder, 50,000 unvested shares valued
at $17,500. Mr. Eichlers and Ms. Holders respective shares vest 12 months
from their issuance on October 21, 2002. The board does not intend to pay
dividends on these restricted shares.

47



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##### Table of Contents



Option Grants in Last Fiscal Year

The following table sets forth information regarding options granted
during fiscal year 2002 to each of the persons named in the Summary
Compensation Table.

|                    |  |             |   |                     |  |             |     |                 |  |        |     |             |  |                        |     |  |  |                      |     |  |  |  |     | 
|------------------- |  | ----------- | - | ------------------- |  | ----------- | --- | --------------- |  | ------ | --- | ----------- |  | ---------------------- | --- |  |  | -------------------- | --- |  |  |  | --- | 
|                    |  |             |   |                     |  |             |     |                 |  |        |     |             |  |                        |     |  |  | Potential Realizable
|                    |  |             |   |                     |  |             |     |                 |  |        |     |             |  |                        |     |  |  | Value of Assumed    
|                    |  | Number of   |   | Percentage of Total |  |             |     |                 |  |        |     |             |  | Annual Rates of Stock 
|                    |  | Securities  |   | Options/SARs        |  |             |     |                 |  |        |     |             |  | Price Appreciation for
|                    |  | Underlying  |   | Granted to          |  | Exercise or |     |                 |  |        |     | Option Term
|                    |  | Options     |   | Employees in        |  | Base Price  |     |                 |  |        |     |            
|Name                |  | Granted (#) |   | Fiscal Year         |  | ($/Sh)      |     | Expiration Date |  | 5% ($) |     | 10% ($)    
|                    |  |             |   |                     |  |             |     |                 |  |        |     |            
|Edward Masry, Esq   |  |             |  |                     |  |             | N/A |                 |  |        | N/A |             |  |                        | N/A |  |  |                      | N/A |  |  |  | N/A | 
|Eugene Eichler, CPA |  |             |  |                     |  |             | N/A |                 |  |        | N/A |             |  |                        | N/A |  |  |                      | N/A |  |  |  | N/A | 
|Janice Holder       |  |             |  |                     |  |             | N/A |                 |  |        | N/A |             |  |                        | N/A |  |  |                      | N/A |  |  |  | N/A | 

Aggregated Option Exercises in Fiscal Year 2002 and Year-End Option Values

The following table sets forth information with respect to persons named
in the Summary Compensation Table concerning exercised and unexercised options
held as of December 31, 2002.

|                    |  |          |   |          |  |             |   |               |  |                                |           |                              |  |  |           |  |  |   |         |  |  |   |         | 
|------------------- |  | -------- | - | -------- |  | ----------- | - | ------------- |  | ------------------------------ | --------- | ---------------------------- |  |  | --------- |  |  | - | ------- |  |  | - | ------- | 
|                    |  |          |   |          |  |             |   |               |  | Number of Securities           |           |                              |  |  |           |  |  |  
|                    |  |          |   |          |  |             |   |               |  | Underlying Unexercised         |           | Value of Unexercised        
|                    |  |          |   |          |  |             |   |               |  | Options at Fiscal Year-End (#) |           | In-the-Money Options ($) (1)
|                    |  |          |   |          |  |             |   |               |  |                                |           |                             
|                    |  | Shares   |   |          |  |             |   |               |  |                                |           |                              |  |  |           |  |  |   |         |  |  |  
|                    |  | Acquired |   |          |  |             |   |               |  |                                |           |                              |  |  |           |  |  |   |         |  |  |  
|                    |  | On       |   | Value    |  |             |   |               |  |                                |           |                              |  |  |           |  |  |   |         | 
|                    |  | Exercise |   | Realized |  |             |   |               |  |                                |           |                              |  |  |           |  |  |   |         | 
|Name                |  | (#)      |   | ($)      |  | Exercisable |   | Unexercisable |  | Exercisable                    |           | Unexercisable               
|                    |  |          |   |          |  |             |   |               |  |                                |           |                             
|Edward Masry, Esq   |  |          |  |          |  | $           |  |               |  |                                | 2,000,000 |                              |  |  | 1,000,000 |  |  | $ | 500,000 |  |  | $ | 250,000 | 
|Eugene Eichler, CPA |  |          |  |          |  |             |  |               |  |                                | 250,000   |                              |  |  |          |  |  |   | 62,500  |  |  |   |        | 
|Janice Holder       |  |          |  |          |  |             |  |               |  |                                |          |                              |  |  |          |  |  |   |        |  |  |   |        | 



---

|(1) |  | Market value of our common stock at fiscal year-end minus the exercise
price. The market value of our common stock on December 31, 2002 was $0.35 per
share.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

Section 16(a) of the Securities Exchange Act requires our executive
officers, directors and ten percent stockholders to file reports of ownership
and changes in ownership with the SEC. Based solely on our review of such
forms, we believe that all our executive officers, directors and ten percent
stockholders complied with the applicable filing requirements.

48



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##### Table of Contents



Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The following table sets forth information regarding the beneficial
ownership of our common stock as of February 29, 2004 as to (i) each of the
executive officers named in the Summary Compensation Table, (ii) each director
and nominee for director, (iii) each person who is known by us to own
beneficially more than five percent of our outstanding common stock and (iv)
all directors and executive officers as a group. Unless otherwise indicated,
the address of each listed stockholder is c/o Save the World Air, Inc., 5125
Lankershim Boulevard, North Hollywood, California 91601. As of
February 29, 2004, there were 34,691,821 shares of common stock outstanding.

|                                                   |              |                                                                         |            |                     |  |                     |      |      |   | 
|-------------------------------------------------- | ------------ | ----------------------------------------------------------------------- | ---------- | ------------------- |  | ------------------- | ---- | ---- | - | 
|                                                   |              |                                                                         |            | Number of Shares of |  |                     |      |     
|                                                   |              |                                                                         |            | Common Stock        |  | Percentage of      
|                                                   |              |                                                                         |            | Beneficially        |  | Shares Beneficially
|Name and Address of Beneficial Owner               |              | Owned(1)                                                                |            | Owned(2)           
|                                                   |              |                                                                         |            |                    
|Named Executive Officers and
Directors             |              |                                                                         |            |                     |  |                     |      |     
|Edward L. Masry, Esq.(3)                           |              |                                                                         | 7,000,000  |                     |  |                     | 17.2 | %   
|Eugene Eichler, CPA(4)                             |              |                                                                         | 750,000    |                     |  |                     | 2.1  | %   
|Bruce H. McKinnon(5)                               |              |                                                                         | 409,100    |                     |  |                     | 1.2  | %   
|Nathan Shelton                                     |              |                                                                         | 50,000     |                     |  |                     |      |     
|Robert F. Sylk                                     |              |                                                                         | 335,000    |                     |  |                     | *    |     
|                                                   |              | 4143 Via Marina, #1118
Marina Del Rey, CA 90292                         |            |                     |  |                     |      |      |   | 
|Hon. J. Joseph Brown, AO                           |              |                                                                         | 250,000    |                     |  |                     | *    |     
|                                                   |              | Level 10, Westfield Towers
100 William Street
Sydney NSW 2011
Australia |            |                     |  |                     |      |      |   | 
|John F. Price, PhD                                 |              |                                                                         | 291,000    |                     |  |                     | *    |     
|                                                   |              | 14/2 New McLean Street
Edgecliff, NSW 2027
Australia                    |            |                     |  |                     |      |      |   | 
|Joseph Helleis                                     |              |                                                                         | 250,000    |                     |  |                     | *    |     
|                                                   |              | 2639 Barefoot Lane
Rowland Heights, CA 91748                            |            |                     |  |                     |      |      |   | 
|Janice Holder                                      |              |                                                                         | 50,000     |                     |  |                     |      |     
|Jeffrey Muller(6)                                  |              |                                                                         | 10,000,000 |                     |  |                     | 22.4 | %   
|                                                   |              | 41 Murlong Crescent,
Palm Beach
Queensland, Australia 4221              |            |                     |  |                     |      |      |   | 
|Five Percent Stockholders                          |              |                                                                         |            |                     |  |                     |      |     
|Edward Skoda(7)                                    |              |                                                                         | 4,000,000  |                     |  |                     | 11.5 | %   
|                                                   |              | 1773 Nelson Street, Suite 101
Vancouver, BC
Canada V6G 1M6              |            |                     |  |                     |      |      |   | 
|Cecil Kyte(8)                                      |              |                                                                         | 2,261,855  |                     |  |                     | 6.3  | %   
|                                                   |              | 2934 Torito Road
Santa Barbara, CA 93108                                |            |                     |  |                     |      |      |   | 
|All Executive Officers and
Directors as a Group(9) |              |                                                                         |            |                     |  |                     |      |     
|                                                   | (10 persons) |                                                                         |            | 19,385,100          |  |                     |      | 38.0 | %
|                                                   |              |                                                                         |            |                     |  |                     |      |     

49



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##### Table of Contents



Notes

Less than one percent.

(1)  Unless otherwise indicated, all persons named in the table have sole voting
and investment power with respect to the shares of common stock beneficially
owned by them, which includes the shares of common stock that such individual
has the right to acquire either currently or within 60 days of February 29, 2004, including upon the exercise of an option.

(2)  Percentage of beneficial ownership is
based upon 34,691,821 shares of our
common stock outstanding as of February 29, 2004. For each named person, this
percentage includes common stock that such person has the right to acquire
either currently or within 60 days of February 29, 2004, including upon the
exercise of an option, however, such common stock is not deemed outstanding for
the purpose of computing the percentage owned by any other person.

(3)  Includes stock options to purchase 2,000,000 shares of our common stock
exercisable either currently or within 60 days of February 29, 2004. Also
includes 2,000,000 shares and warrants to purchase an aggregate 2,000,000
shares held by Masry & Vititoe, PC, with respect to which Mr.
Masry disclaims beneficial ownership except to
the extent of his proportional share therein. Mr. Masry, our Chief Executive
Officer and President, is a member of Masry & Vititoe, PC, and may be deemed a
beneficial owner of the shares held by such entity because of his status as a
member.

(4)  Includes stock options to purchase 250,000 shares of our common stock
exercisable either currently or within 60 days of February 29, 2004.

(5)  Mr. McKinnon is a participant in the KZ Golf, Inc. Defined Benefit Pension
Plan, which is the owner of 9,100 shares of our common stock.

(6)  Includes stock options to purchase 10,000,000 shares of our common stock.
These shares and options held by Mr. Muller are subject to pending litigation.
Management has previously refused requests by Muller to exercise these options. See Item 3 above.

(7)  These shares are subject to pending litigation against Jeffrey Muller, our
former Chief Executive Officer and sole director, his immediate family and
various other persons and entities in the United States District Court,
Southern District of New York, Case Number 01 Civ. 11586. We believe Edward
Skoda acted in concert with Mr. Muller with respect to these shares.

(8)  Includes warrants to purchase 1,060,000 shares of our common stock
exercisable either currently or within 60 days of February 29, 2004.

(9)  Includes shares of our common stock issuable upon exercise of stock options
or warrants currently exercisable within 60 days of February 29, 2004, as well
as shares held by the entity referenced in footnote 3 that is affiliated with
Mr. Masry.

50



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##### Table of Contents



Item 12. Certain Relationships and Related Transactions

During fiscal year 2002, we entered into an agreement with Mr. Masry, our
Chairman of the Board, President and Chief Executive Officer, for the
reimbursement of a $500,000 loan made by Masry & Vititoe, PC, of which Mr.
Masry is a member, to us. In June 2003, we paid this loan in full by issuing
an aggregate 2,000,000 shares at a price per share of $0.25 and warrants to
purchase an aggregate 2,000,000 shares at an exercise price of $0.50 for a
five-year period.

In October 2003, we entered into a lease agreement with KZ Golf, Inc. to
lease office space for our primary administrative facility. Mr. McKinnon, one
of our directors is an owner of KZ Golf, Inc. See Item 2 herein for detailed
information on this lease.

See Item 3 above regarding settlement agreement with Muller bankruptcy
trustee.

51



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##### Table of Contents



Item 13. Exhibits and Reports on Form 10-KSB

The exhibits listed below are required by Item 601 of Regulation S-B.

|            |  |                                                                                                                                        
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                            
|            |  |                                                                                                                                        
|3(i)(1)     |  | Articles of Incorporation, as amended, of the Registrant.                                                                              
|3(ii)(1)    |  | Bylaws of the Registrant.                                                                                                              
|10.1        |  | Commercial Sublease between the Registrant and KZ Golf, Inc., dated October 16, 2003.                                                  
|10.2        |  | General Tenancy Agreement between the Registrant and Autumlee Pty Ltd., dated November 15, 2003.                                       
|10.3(2)     |  | Agreement between the Registrant and RAND, dated December 13, 2002.                                                                    
|10.3(a)*    |  | Agreement between the Registrant and RAND, dated May 7, 2003.                                                                          
|10.4(3)     |  | Deed and Document Conveyance between the Trustee of the Property of Jeffrey Ann Muller and Lynette Anne Muller (Bankrupts).            
|10.5(3)     |  | Assignment and Bill of Sale between Pro Hart and the Registrant dated May 28, 2002.                                                    
|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).



---

|*   |  | Confidential Treatment Requested.                                                                                                                    
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(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 8-K filed on December
30, 2002.                                                                     
|   
|   
|   
|   
|(3) |  | Incorporated by reference from Registrants Form 8-K filed on November
12, 2002.                                                                     

We filed two reports on Form 8-K during the last quarter of the fiscal
year ending December 31, 2002, in which we reported a letter to the
stockholders from our CEO on our settlement with Pro Hart and Jeffrey Mullers
bankruptcy trustee on November 12, 2002, and our agreement with RAND on
December 30, 2002.

Item 14. Principal Accountant Fees and Services

Weinberg & Co. was first appointed in fiscal year 2003 but audited our
financial statements for fiscal years 2002 and 2001.

Fees Billed by Weinberg & Co. During Fiscal Years 2002 and 2001

There were no fees billed to us during fiscal year 2002 by Weinberg & Co.,
an independent accounting firm that our board of directors recently retained to
provide only audit services.

52



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##### Table of Contents



SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
has caused this report to be signed on its behalf by the undersigned, hereunto
duly authorized.

|                     |  |                          |  |                                               
|-------------------- |  | ------------------------ |  | ----------------------------------------------
|                     |  | SAVE THE WORLD AIR, INC.
|                    
|Date: March 25, 2004 |  | By:                      |  | /s/ EDWARD L. MASRY                           
|                     |  |                          |  |                                               
|                     |  |                          |  | Edward L. Masry, Esq., Chief Executive Officer

In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities listed
below on March 25, 2004.

|                                              |  |                                                                                       
|--------------------------------------------- |  | --------------------------------------------------------------------------------------
|Name                                          |  | Title                                                                                 
|/s/ EDWARD L. MASRY

Edward L. Masry, Esq.    |  | Chief Executive Officer and Chairman of the Board                                     
|                                             
|/s/ EUGENE E. EICHLER

Eugene E. Eichler, CPA |  | President, Chief Financial Officer,
Treasurer and Director                            
|                                             
|/s/ BRUCE H. MCKINNON

Bruce H. McKinnon      |  | Executive Vice President  Business Development, Chief Operating Officer  and
Director
|                                             
|/s/ ROBERT F. SYLK

Robert F. Sylk            |  | Director                                                                              
|                                             
|/s/ JOHN BROWN

Hon. J. Joseph Brown, AO      |  | Director                                                                              
|                                             
|/s/ JOHN F. PRICE

John F. Price, PhD         |  | Director                                                                              
|                                             
|/s/ JOSEPH HELLEIS

Joseph Helleis            |  | Director                                                                              

53