UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549


Form 10-K




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







For
the fiscal year ended December 31, 2008


or


o TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For
the transition period from ____________ to ____________





Commission
File Number 0-29185




Save
the World Air, Inc.


(Exact
name of registrant as specified in its charter)




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




235
Tennant Avenue


Morgan
Hill, California 95037


(Address,
including zip code, of principal executive offices)




(408)-778-0101


(Registrant’s
telephone number, including area code)




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


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




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.    Yes o   No x
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act.    Yes o    No  x
  Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes x   No o
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and “small
reporting company” in Rule 12b-2 of the Exchange Act.
  Large
Accelerated filer  o     
Accelerated filer  o       
Non-accelerated filer o     
Smaller reporting company x
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).    Yes o    No x
  The
aggregate market value of the voting and non-voting common equity held by
non-affiliates (excluding voting shares held by officers and directors) as of
June 30, 2008 was $21,360,524.
  The
number of shares of the Registrant’s Common Stock outstanding as of March 2,
2009 was 64,498,834 shares.





DOCUMENTS
INCORPORATED BY REFERENCE





The
information required by Part III (Items 9, 10, 11 and 12) of this Form 10K is
herein incorporated by reference to Registrant’s definitive Proxy Statement for
its 2009 Annual Meeting of Stockholders.













SAVE
THE WORLD AIR, INC.


FORM
10-K


INDEX




PagePART
      IItem 1
                                      Business
                                      
                                      1Item
      1A
                                      Risk
      Factors
                                      
                                      18Item
      1B
                                      Unresolved
      Staff Comments
                                      
                                      26Item 2
                                      Properties
                                      
                                      26Item 3
                                      Legal
      Proceedings
                                      
                                      26Item 4
                                      Submission
      of Matters to a Vote of Security Holders
                                      
                                      27PART
      IIItem 5
                                      Market
      for Common Equity and Related Stockholder Matters
                                      
                                      28Item
      6
                                      Selected
      Financial DataItem 7
                                      Management’s
      Discussion and Analysis or Plan of Operation
                                      
                                      29Item
      7A
                                      Quantitative and
      Qualitative Disclosures About Market RiskItem 8
                                      Financial
      Statements
                                      
                                      37Item 9
                                      Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
                                      
                                      37Item 9A(T)
                                      Controls
      and Procedures
                                      
                                      37Item 9B
                                      Other
      Information
                                      
                                      38PART
      IIIItem 10
                                      Directors
      and Executive Officers of Registrant
                                      
                                      39Item 11
                                      Executive
      Compensation
                                      
                                      39Item 12
                                      Security
      Ownership of Certain Beneficial Owners and Management and
      Related  Stockholder Matters
                                      
                                      39Item 13
                                      Certain
      Relationships and Related Transactions
                                      
                                      39Item
      14
                                      Principal
      Accountant Fees and Services
                                      
                                      39PART
  IVItem 15
                                      Exhibits
                                      
                                      40SIGNATURES
                                      
                                      44





i


PART
I





Forward-Looking
Statements





This
Annual Report on Form 10-K contains forward-looking statements. These
forward-looking statements include predictions regarding our
future:




●
            revenues
      and profits;●
            customers;●
            research
      and development expenses and efforts;●
            scientific
      and other third-party test results;●
            sales
      and marketing expenses and efforts;●
            liquidity
      and sufficiency of existing cash;●
            technology
      and products;●
            the
      outcome of pending or threatened litigation; and●
            the
      effect of recent accounting pronouncements on our financial condition and
      results of operations.





You can
identify these and other forward-looking statements by the use of words such as
“may,” “will,” “expects,” “anticipates,” “believes,” “estimates,” “continues,”
or the negative of such terms, or other comparable terminology. Forward-looking
statements also include the assumptions underlying or relating to any of the
foregoing statements.





Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth below under the heading “Risk Factors.” All forward-looking statements
included in this document are based on information available to us on the date
hereof. We assume no obligation to update any forward-looking
statements.





Item 1.  
Business





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





Overview





Save the
World Air, Inc. (“STWA” or “Company” or “we”) designs, licenses and develops
products to increase engine performance, reduce harmful emissions and increase
fuel efficiency.  We are a green technology company that leverages a
suite of patented, patent-pending and licensed intellectual properties related
to the treatment of fuels. Technologies patented by or licensed to us utilize
either magnetic or uniform electrical fields to alter physical characteristics
of fuels and are designed to create cleaner combustion. Cleaner combustion has
been shown to improve performance, enhance fuel economy and/or reduce harmful
emissions in laboratory testing.




We have
three product lines; MAG ChargRTM and ECO ChargRTM, ELEKTRATM and AOT (Applied Oil
Technology).




MAG
ChargR is past the development stage and we believe that an initial small run of
several thousand units may be manufactured and sold by the end of second quarter
2009.  We
believeELEKTRA may be nearing the end of the product development cycle
which we believe could culminate in an upcoming Society of Automotive Engineers
(SAE)  test to prove and certify the level of fuel
savings.  AOT is in the research and development phase.




The
Company believes that its current product line represents a large addressable
market of approximately $6.9 billion made up of existing tractor trailer owners,
diesel fleet managers, diesel OEM manufacturers, individual automobile
enthusiasts and motorcycle OEM manufacturers.




1


We have obtained a license from Temple
University for their patent-pending uniform electric field technology, called
ELEKTRA. The ELEKTRA technology consists of passing fuel through a
dynamically-controlled strong electrical field.  Although ELEKTRA has
a similar effect on fuels as our ZEFS and MK IV technologies, ELEKTRA
incorporates a uniform electrical field principle versus the fixed magnetic
field used by ZEFSTM and MK IVTM technologies in the MAG ChargR and ECO ChargR
products.




The
Company holds US Patent # 6901917, effective May 21, 2001 for “DEVICE FOR SAVING
FUEL AND REDUCING EMISSIONS” covered in the United States, Australia, Canada,
China, Russia, India, Indonesia and Mexico for the ZEFS technology used in the
MAG ChargR and ECO ChargR.




We are
also working with Temple University and have had discussions with domestic and
international corporations to develop the AOT (Applied Oil Technology) product
line for oil refineries and pipelines.  The AOT product line uses the
same dynamically-controlled strong electrical field concepts to reduce viscosity
as ELEKTRA but is designed for pipeline applications that use thicker, more
viscous fuels than the ELEKTRA market.  The AOT product is intended to
improve the speed of highly viscous fluids such as crude oil traveling through
pipelines.




Our MAG
ChargRTM and ECO ChargRTM  products use fixed magnetic fields to alter
some physical properties of fuel by incorporating our patented and
patent-pending ZEFS and MK IV technologies.  We differentiate MAG
ChargR and ECO ChargR products based on their differing attributes and marketing
focus. ECO ChargR products are primarily designed to reduce harmful emissions
and MAG ChargR products are primarily designed to enhance performance and fuel
economy. Our ECO ChargR product is intended to reduce exhaust emissions in
vehicle and small utility motors.  We intend that the ECO ChargR will
be marketed primarily to original equipment manufacturers (“OEMs”) as well as to
pilot and government-mandated emissions programs.  Our MAG ChargR
product is intended to increase power and improve mileage. MAG ChargR is being
marketed to municipal fleets and to the specialty consumer accessories market
for many types of vehicles, including but not limited to cars, trucks,
motorcycles, scooters, all terrain vehicles (“ATVs”), snowmobiles, personal
watercraft and small utility motors.




Our first
revenues in 2006 and 2007 were
generatedfrom initial sales in Asia for our ECO ChargR product in the
motorcycle industry. We plan on commencing sales of ECO ChargR to customers in
the United States in the motorcycle industry in second quarter of 2009. We also
plan on commencing initial sales of our MAG ChargR in the United States in
the automobile and motorcycle industry in the second quarter of
2009.  See “Recent Developments” and “Sales and Marketing”
below.




We
operate in a highly competitive industry.  Many of our activities are
subject to governmental regulation.  We have taken aggressive steps to
protect our intellectual property.  See “Competition”, “Government
Regulation and Environmental Matters”and “Intellectual
Property” below.




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




We are a
development stage Company that generated minimal revenues in 2006 and 2007. We
did not generate any sales or revenues in 2008. Our expenses to date have been
funded primarily through the sale of stock and convertible debt, as well as
proceeds from the exercise of stock purchase warrants. We raised capital in 2008
and will need to raise substantial additional capital in 2009, and beyond, to
fund our sales and marketing efforts, continuing research and development, and
certain other expenses, until our revenue base grows sufficiently to cover such
expenditures.  See “Management’s Discussion and Analysis”
below.





Our
company was incorporated on February 18, 1998, as a Nevada corporation,
under the name Mandalay Capital Corporation. We changed our name to Save the
World Air, Inc. on February 11, 1999, following the acquisition of
marketing and manufacturing rights of the ZEFS technologies. Our mailing address
is 235 Tennant Avenue, Morgan Hill, California 95037. Our telephone number is
(323) 932-7040. Our corporate website is www.stwa.com.




Our
common stock is quoted under the symbol “ZERO” on the Over-the-Counter Bulletin
Board.




Recent
Developments





In
December 2008, Dr. Luke Turgeon was retained by us as an engineering
consultant  to work on the design and engineering of the Company’s
ELEKTRA products for its commercialization.  His depth of knowledge
and experience in the designing of analog integrated circuits should be helpful
to us in moving our efforts to produce and sell our ELEKTRA
products.


2





On
February 24, 2009,  we received notice from the California Air
Resources Board (CARB) that we have been issued an Executive Order (EO number
D-659) approving the MagChargR products for sale in California.  A
CARB Executive Order is recognized by the EPA, meaning the product can also be
legally sold in all 50 states subject to any applicable state
regulations.





On
February 20, 2009, we entered into a distribution agreement for the MagChargR
with Magnumforce Race Car Fabrication, Inc. (Magnumforce).The
agreement provides for an initial order of $125,000, payment of which is
contingent upon Magnumforce selling our product to its customers.  The
product was tested in 2007 in connection with fuel savings and emission
reduction and the CARB certification was necessary before distribution and sales
could occur.  Magnumforce manufactures and markets a broad line of
racing and high performance products for Dodge, Chrysler and Plymouth vehicles
through multiple points of distribution.





Our
Business Strategy




Our
business strategy is to fill the need created by three major trends, the
increasing cost of fuel, the desire to reduce fuel consumption and the desire to
reduce pollution related to transportation.




The Crisis of the
Effect of Motor Emissions on Air Pollution





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





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





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





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





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





We believe there is a large worldwide
demand for products which could increase fuel efficiency and enhanced
performance in vehicles and our efforts and focus are directed toward that
end.


3




Our
Technologies and Products




ELEKTRA




We have
obtained a license from Temple University for its patent-pending electric field
technology, called ELEKTRATM. The ELEKTRA technology consists of passing fuel
through a specific strong electrical field.  A 2008 paper published by Dr.
Rongjia Tao, Ph.D., Chair of the Physics Department at Temple University titled
“Electrorheology Leads to Efficient Combustion” says that ELEKTRA lowers the viscosity of
fuel, resulting in better atomization of the fuel and improved
combustion.




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




We have
entered into three License Agreements with Temple University covering Temple
University’s current patent applications concerning certain electric field
effects on gasoline, kerosene and diesel fuel particle size distribution, and
concerning electric field effects on crude oil and edible oil
viscosity.  The License Agreements are exclusive and the territory
licensed to us is worldwide. Pursuant to the License Agreements, we are required
to pay to Temple University (i) license fees in the aggregate amount of
$300,000.  A payment of $50,000 was due on November 1, 2006; a payment
of $100,000 was due on March 2, 2007; a payment of $75, 000 was due on February
2, 2008 and the final payment was due on February 2, 2009.  Annual
maintenance fees of $25,000 for the first license were due on November 1, 2007
and November 1, 2008.  Annual maintenance payments of $125,000 for two
of the licenses were due January 1, 2008. In addition, each License Agreement
separately provides that we will pay royalties to Temple University on net sales
of products incorporating the technology licensed under that License Agreement
in an amount equal to 7% of the first $20 million of net sales, 6% of the
next $20 million of net sales and 5% of net sales in excess of
$40 million. Sales under the three License Agreements are not aggregated
for purposes of calculating the royalties payable to Temple University. In
addition, we have agreed to bear all costs of obtaining and maintaining patents
in any jurisdiction where we direct Temple University to pursue a patent for
either of the licensed technologies. Should we not wish to pursue a patent in a
particular jurisdiction, that jurisdiction would not be included in the
territory licensed to  us.




At
December 31, 2008 we were in default in the amount of $300,000 in connection
with our payment obligations under the License Agreements and maintenance
payments.  On November 10, 2008, we received written notice from Temple
University of a material breach relating to required payments under the License
Agreements.  The notice provides us with 60 days’ notice to cure the
material breach.  Our failure to cure could result in a termination of
the License Agreements. If the termination occurs,  we estimate this
would have a material adverse impact on our financial condition and
operations.  Under the License Agreements we are subject to a penalty
of 1% per month of the amounts due and unpaid under the License
Agreements.  As of December 31. 2008, we estimate the penalty to be
$40,250, and we have accrued this in the accompanying financial
statements.




We have
also entered into a research and development agreement (R&D Agreement) with
Temple University to conduct further research on the ELEKTRA technology. Under
the R&D Agreement Temple University will conduct a 24-month research project
towards expanding the scope of, and developing products utilizing, the
technologies covered under the License Agreements, including design and
manufacture of prototypes utilizing electric fields to improve diesel, gasoline
and kerosene fuel injection in engines using such fuels and a device utilizing a
magnetic field to reduce crude oil viscosity for crude oil (paraffin and mixed
base) and edible oil flow in pipelines. If the research project yields results
within the scope of the technologies licensed pursuant to the License
Agreements, those results will be deemed included as rights licensed to us
pursuant to the License Agreements. If the research project yields results
outside of the scope of the technologies covered by the License Agreements, we
have a six-month right of first negotiation to enter into a new worldwide,
exclusive license agreement with Temple University for the intellectual property
covered by those results.  Pursuant to the R&D Agreement, we will
make payments to Temple University in the aggregate amount of
$500,000.





At
December 31, 2008 we were in default in the amount of $376,250 under the R&D
Agreement.  On November 10, 2008, we received written notice of
default from Temple University. The notice provides us with 60 days to cure the
material breach.  Our failure to cure the breach could result in the
termination of the R&D Agreement.  If the termination occurs, we
estimate this would have a material adverse impact on our financial condition
and operations.


4





At
November 30, 2008, we owed to Temple University a total of $716,500 for the
License Agreements, Maintenance Fees, R&D Agreement and
penalties.  On January 9, 2009, we entered into a Letter Agreement
with Temple University wherein Temple University granted to us an extension of
time to cure the above-referenced breaches until March 31, 2009.  The
Letter Agreement provides for payments of $100,000 on each of January 31, 2009,
February 28, 2009 and March 31, 2009.   We made the January 31,
2009 payment but did not make the payment due on February 28, 2009. On
March 26, 2009 we received a written extension for both the February 28, 2009
payment and the March 31, 2009 payment until April 30, 2009.  All
additional amounts past due as of November 10, 2008 will be re-negotiated on or
before March 31, 2009, however, this has now been extended to April 30,
2009.  A penalty equal to 1% of the amount due and unpaid on the first
day of each calendar month will be added to the outstanding amount due Temple
University.




We
believe that the applications for products incorporating the ELEKTRA technology
will include gas, diesel and bio-fuel injected motor vehicles, as well as
applications in aviation, marine, oil pipeline and refining industries.Subject to our
cash flow and liquidity limitations,we are currently
developing diesel tractor trailer applications and our present intention,
subject to change, is to seek joint venture partners to commercialize the
ELEKTRA technology in various applications.  Subject to adequate
financing, we currently believe that we may be able to commence sales of ELEKTRA
products by the third quarter of 2009.




Applied
Oil Technology (AOT)




We have
also entered into a research and development agreement (“R&D Agreement”)
with Temple University to conduct further research on the ELEKTRA technology.
Under the R&D Agreement Temple University in conducting an ongoing research
project towards expanding the scope of, and developing products utilizing, the
technologies covered under the License Agreements, including a device utilizing
a magnetic field to reduce crude oil viscosity for crude oil (paraffin and mixed
base) and edible oil flow in pipelines.




ZEFS
and MK IV Technologies in MAG ChargR and ECO ChargR




The ZEFS
and the MK IV technology in the MAG ChargR and ECO ChargR products place a
magnetic field in and around the fuel and air that lowers fuel thickness and
influences oxygen to improve combustion. MAG ChargR and ECO ChargR contain
permanent rare-earth magnets, which produce a very strong magnetic field. This
field, when arranged in specific manner of shape and strength, causes a change
in the fuel as it passes through the field. As fuel passes through the magnetic
field, a change in the fuel occurs facilitating a decline in both viscosity and
surface tension. This allows for finer atomization, resulting in a more
optimized mixture and therefore more efficient combustion.  Depending
on the specific application of these products to specific makes and models of
vehicles, this improved combustion may offer one or more of the following
benefits; (i) lower emissions, (ii) more horsepower and torque and (iii)
improved fuel economy.




The paper
titled, “Viscosity Reduction in Liquid Suspensions by Electric or Magnetic
Fields” published by Dr. Rongjia Tao, Ph.D., of Temple University, shows that
applying a magnetic field reduces thickness (viscosity) of oil by
17%.  The paper “Magnetic Field Effects on the Combustion Processes in
Diffusion Flames” published by LSU in 2005 demonstrates that oxygen is attracted
to a magnetic field.  The ZEFS and MK IV technologies used in the MAG
ChargR and ECO ChargR products use these properties of reduced fuel viscosity
and influenced flow of oxygen to improve combustion.




Improved
combustion increases engine power and performance.  We have introduced
the ECO ChargR, which incorporated our MK IV technology, and the MAG ChargR,
which incorporates either our ZEFS or MK IV technologies, depending upon the
application.  We have designed and tested various versions of our MAG
ChargR and ECO ChargR products for use on 2- and 4-stroke carbureted and fuel
injection gasoline engines.




We
differentiate our MAG ChargR and ECO ChargR products based on their differing
attributes and marketing focus. ECO ChargR products are primarily designed for
devices with engines that fall outside environmental regulation and often do not
have emissions control systems.  MAG ChargR products are primarily
designed for engines already subject to environmental regulation and vehicles
that often do already have some emissions control technology.




5


Additionally,
ECO ChargR products are primarily designed to reduce harmful emissions and MAG
ChargR products are primarily designed to enhance performance and fuel
economy.  The ECO ChargR is intended to reduce exhaust emissions in
vehicle and small utility motors.  ECO ChargR products will be
marketed primarily to OEMs as well as to pilot and government-mandated emissions
programs.  The MAG ChargR is intended to increase power and improve
mileage. MAG ChargR products will be marketed primarily to the specialty
consumer accessories market for many types of vehicles, including but not
limited to cars, trucks, motorcycles, scooters, ATVs, snowmobiles, personal
watercraft and small utility motors.  Because our MAG ChargR and ECO
ChargR products are customized to specific brands, models and engine sizes,
these products will require hundreds of individually developed models to
accommodate the market.




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




We
believe that testing by the Company, as well as by independent third-party
laboratories, has demonstrated that both MAG ChargR and ECO ChargR generate
significant reductions in THC and CO emissions and, in the case of MAG ChargR,
also improve fuel efficiency by lowering gas consumption and increase engine
performance.





Research
and Development





In late 2005, we established a research
and product development facility in Morgan Hill, California.   We have
tested products incorporating our ZEFS and MK IV technologies for multiple makes
and models of automobiles, motorcycles and ATVs.  We are engaged in
research and development of additional prototypes and products, including
ELEKTRA and other magnetic technologies and products, at our Morgan Hill
facility.




The
Company has entered into a research and development agreement (R&D
Agreement) with Temple University to conduct further research on the ELEKTRA
technology. Under the R&D Agreement Temple University will conduct a
24-month research project towards expanding the scope of, and developing
products utilizing, the technologies covered under the License Agreements,
including design and manufacture of prototypes utilizing electric fields to
improve diesel, gasoline and kerosene fuel injection in engines using such fuels
and a device utilizing a magnetic field to reduce crude oil viscosity for crude
oil (paraffin and mixed base) and edible oil flow in pipelines.





Independent
Laboratory and Scientific Testing




ECO
ChargR (ZEFS Technology)




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




Independent
third-party laboratories have conducted tests of devices incorporating our ZEFS
and MK IV technologies.  We believe that research and testing using
government standard test equipment in Thailand has demonstrated that the tested
devices incorporating our ZEFS technology improves
performance.




In 2006,
testing on a device incorporating our MK IV technology for Harley-Davidson style
motors was conducted at the EPA and CARB certified testing facility Olson Labs.
We believe that these tests yielded results that would allow these motors to
meet current and future EPA and CARB emissions standards without expensive fuel
injection and catalytic converters.




6


Further
testing on a used 4-stroke motorcycle incorporating our ZEFS technology was
conducted in November 2005 in Bangkok, Thailand at Automotive Emission
Laboratory, Pollution Control Department, Ministry of Natural Resources and
Environment of Thailand, and was performed jointly with S.P. Suzuki of Thailand,
the authorized distributor of Suzuki products in Thailand.  The test
results were as follows:









THC
      (g/km)
                CO
      (g/km)
                NOx
      (g/km)
                CO2
      (g/km)Without
      ECO ChargR (ZEFS)
                0.536
                0.162
                9.67
                52.851With
      ECO ChargR (ZEFS)
                0.52
                0.104
                1.42
                48.553%
      Change
                -3.00%
                -35.80%
                -85.32%
                -8.13%







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




Additional
testing was conducted in early March 2006 on a new Chinese-manufactured
carbureted 4-stroke Suyijia SZK125 motorcycle incorporating our ZEFS
technologies at Hong Kong Exhaust Emissions Laboratory (“HKEEL”).  The
test results were as follows:









THC
      (g/km)
                CO
      (g/km)
                NOx
      (g/km)
                CO2
      (g/km)Without
      ECO ChargR (ZEFS)
                0.36
                0.087
                2.59
                44.53With
      ECO ChargR (ZEFS)
                0.33
                0.108
                1.86
                43.6%
      Change
                -8.3%
                24.1%
                -28.2%
                -2.1%







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




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




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


7


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




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






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






Oxides
      of Nitrogen (NOx) Emissions (gms/km)Suzuki
      110cc
                
                RevTech
      100cc
                
                Merch
      125ccAVERAGE
      BASELINE
                
                
                0.066
                
                
                
                0.136
                
                
                
                0.287AVERAGE
      ECO ChargR
                
                
                0.063
                
                
                
                0.196
                
                
                
                0.268%
      Improvement
                
                
                4.5
                %
                
                
                -44.0
                %
                
                
                6.4
                %Fuel
      Economy (miles per gallon)Suzuki
      110cc
                
                RevTech
      100cc
                
                Merch
      125ccAVERAGE
      BASELINE
                
                
                241.97
                
                
                
                39.68
                
                
                
                34.83AVERAGE
      ECO ChargR
                
                
                253.16
                
                
                
                41.08
                
                
                
                34.82%
      Improvement
                
                
                4.6
                %
                
                
                3.5
                %
                
                
                0.0
                %






Sales
and Marketing




According
to the Goddard Institute for Space Studies, in 2000, the world's roads were
supporting about 800 million vehicles, almost 500 million of which are cars and
the remainder of which are trucks, buses, motorcycles and scooters. Vehicle
population is projected to increase by 50-100% by 2030. As a result, vehicles
will continue to apply pressure to the environment unless additional controls on
emissions are implemented.




8


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




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




Management
believes that US EPA, CARB and international governments will continue to lower
emission standards below even these recent levels. Yet, the cost of adding
emissions control devices to engines or vehicles has always been a challenge,
since manufacturers shift the cost of such devices to the
consumer.  In developing nations, where incomes are extremely low,
economics and the lack of government resources have hampered
progress.




We have
three product lines; MAG ChargRTM and ECO ChargRTM, ELEKTRATM and AOT (Applied Oil
Technology)   The MAG ChargR is past the development stage and
the Company believes that an initial small run of several thousand units may be
manufactured and sold by the end of second quarter 2009.  We believe
that ELEKTRA may be nearing the end of the product development cycle whichwebelieve
could culminate in an upcoming SAE (Society of Automotive Engineers) test to
prove and certify the level of fuel savings.  AOT is in the research
and development phase.




ELEKTRA




Management
believes that there is a large and active market for a product such as ELEKTRA
that can reduce the fuel consumption of diesel engines.  In 2006, the
US Department of Transportation published that there were 3.1 million “Truck,
combination” (tractor trailers), Busses and Class I locomotives in service in
the US. According to the Specialty Equipment Manufacturing Association’s
“2004/05 Diesel Market Study,” there were 3.1 million Diesel Light Trucks
registered in the US and 151,427 diesel cars sold in the US since
1991.




In a 2008
paper published by Dr. Rongjia Tao, Ph.D., Chair of the Physics Department at
Temple University titled “Electrorheology Leads to Efficient Combustion,” Dr.
Tao stated that over six months of testing that ELEKTRA increased highway
mileage of a Mercedes 300D 19% , from 32 mpg to 38 mpg and increased city
mileage 12% to 15%.




The
Company has had  preliminary discussions with the American Trucking
Association and with AITA (America’s Independent Truckers Association,
Inc)  The SAE (Society of Automotive Engineers) has advised us that
once the Type II fuel evaluation test results in verifyinga
meaningful fuel savings, they will publish a story on the product along with the
test results and accompanying photos and contact information.




Subject to proper capitalization, we
intend to embark upon a sales and marketing program through distributors in the
trucking industry.




Applied
Oil Technology




The
pipeline construction industry in the U.S. was approximately $11 billion in 2007
according to October 27 2008 “Pipeline Construction U.S. Industry Report” from
IBIS World.  The overall pipeline industry is forecast to grow at
4.7%.  Management is in the process of developing more specific
analysis of the market for the AOT products.




9






MAG
ChargR




In
October 2004, we commenced initial marketing efforts for MAG ChargR and ECO
ChargR products incorporating our ZEFS and MK IV technology.  We are
focused on selling or licensing our technologies and products domestically and
internationally to the consumer specialty accessories market, to municipalities,
to motorcycle, automobile, carburetor, fuel-injection and diesel engine
manufacturers and exhaust and muffler OEMs. We have made presentations of our
MAG ChargR and ECO ChargR products to OEMs in the United States, Asia and
Europe.  We have already had discussions with the Department of
General Services in California which maintains a fleet of more than 50,000
vehicles including more than 5000 police cars.




On most
automobiles, the MAG ChargR is installed between the throttle body and the
intake manifold.  The geometry of this part of the engine varies with
each automobile make, manufacturer, year and engine
displacement.  STWA has identified dozens of MAG ChargR models that
will fit popular models from Cadillac, Chevrolet, Chrysler, Dodge, Ford, GMC,
Hummer, Isuzu, Jeep, Lincoln, Mercury, Mitsubishi, Nissan, Pontiac and
Toyota.  The MAG ChargR models selected include nine of the top 50
bestselling automobiles of all time.




In
determining the order to bring MAG ChargR models to market, the following
criteria have been considered.




●
              Size
      of the installed base of cars applicable to an individual MAG ChargR
      model




●
              Probability
      that the owner of such an automobile would purchase and aftermarket
      performance enhancement
product




●
              Level
      of improvement that MAG ChargR delivers for a specific make, model, year
      and displacement




On
February 20, 2009, we entered into a distribution agreement for the MagChargR
with Magnumforce Race Car Fabrication, Inc.  (Magnumforce).The agreement provides for an initial order of $125,000, payment of which
is contingent upon Magnumforce selling our product to its
customers.  The product was tested in 2007 in connection with fuel
savings and emission reduction and the CARB certification was necessary before
distribution and sales could occur.  Magnumforce manufactures and
markets a broad line of racing and high performance products for Dodge, Chrysler
and Plymouth vehicles through multiple points of distribution.




We have
alsohad discussions with Brothers Performance and Motorcycle
Products Consulting Incorporated (MPCI) to carry the MAG ChargR
product.




According
to SEMA, buying behavior has shifted in the last twelve months with enthusiasts
now purchasing more performance products online than at retail.  To
that end, we have targeted online retailers as distribution
partners.




ECO
ChargR




In July 2006, we entered into a
separate agreement with SS Sales, to provide exclusive marketing and promotional
services in the western United States and western Canada for our MAG ChargR and
ECO ChargR products.  SS Sales will be paid a commission equal to 5% of the
gross amount actually collected on contracts we enter into during the contract
term for existing or future customers introduced by SS Sales. SS Sales is owned
by Nathan Shelton, one of the directors of the Company since February 12,
2007.  We also have an agreement pending with Scaffidi-Bolio &
Associates to be our sales agents in a defined territory in the eastern United
States and eastern Canada.




At this time we have devoted limited
resources to the marketing of our ECO ChargR while we focus on our MAG ChargR
and ELEKTRA.  Management is reassessing on a continuing basis the
devotion of the Company’s resources to its
products.





10





Manufacturing
and Product Development




ELEKTRA




As a
result of six months of field testing and refining, we are refitting the ELEKTRA
with a new power supply and electronics to optimize the exposure of the fuel to
the electric field in an attempt to  create peak efficiency. Dr. Luke
Turgeon and his company have recently been retained by us tobring simulation and electronic design skills in an attempt to allow us
to go from design to a stable cost effective volume production in the fastest
time possible.




Management
believes that having the SAE (Society of Automotive Engineers) Type II test
results verifying that ELEKTRA saves 10% of more on fuel consumption will be the
milestone that will allow the Company to begin closing sales of the
product.  The 10% fuel savings target is for the after-market ELEKTRA
product.  Management believes that the OEM product, integrated into
the manufacturer’s design may be able to yield higher levels of fuel savings due
to the fact that the manufacturer will have ELEKTRA communicate the engine’s
electronics to optimize the advantageous effect as the fuel flow changes over
time.




Upon
completion of our tests and the results being published, management will seek
contracts within the trucking industry and the selection of a manufacturing
company as follows:




Selecting
a Manufacturing Partner




We intend
to outsource the manufacturing of the ELEKTRA and are looking for three things
in selecting a manufacturing partner.  We are currently interviewing
candidates.




●
                Existing
      proven, large-scale manufacturing and distribution for transportation
      OEMs




●
              Existing
      relationships with fleet managers of large diesel truck
      operators




●
              Forward-looking
      proactive corporate vision looking to bold expand their market
      share




Applied
Oil Technology




The
Company has signed a Non-Disclosure Agreement with a multi-national energy
company with a market capitalization in excess of $250 billion.  The
Company is seeking to develop a manufacturing and product development plan for
AOT.




MAG
ChargR and ECO ChargR




As of
December 15, 2008, the Company has built and tested three working prototypes of
the MAG ChargR for the following make, model and engine
configurations.




Make
                                  Model
                                  Year
                                  EngineChrysler
                                  SRT8
                                  2006
                                  6.1L
      HemiDodge
                                  Challenger
                                  2008
                                  6.1L
      HemiChevrolet
                                  Suburban
                                  2005
                                  4.6L
      Big
Block




Of these
three models, the Company has received and published the following test results
for product performance.




Make
                                      Model
                                      Year
                                      Engine
                                      HP
      Increase @ 4680 RPM
                                      Torque
      Increase @ 4680 RPMChrysler
                                      SRT8
                                      2006
                                      6.1L
      Hemi
                                      3.4%
                                      5.4%Chevrolet
                                      Suburban
                                      2005
                                      Big
      Block
                                      11.5%
                                      8.9%





11




In order
to start sales in California, the Company is required to obtain a certification
for the MAG ChargR from the California Air Resources Board
(CARB).  The Company has received CARB certification and can now sell
and distribute throughout the United States.




For the
MAG ChargR product roll-out, we will attempt to have the  product
ready for the ten most popular general purpose automobiles listed above and the
ten most popular Muscle Cars that fit our value
proposition.  According to Musclecarfacts.net on December 14, 2008,
the ten most popular Muscle Cars in 2008 are, in order; the 2009 Camaro, the
1967 Camaro, the 1969 Camaro, the 1970 Challenger, the 1974 GTO, the 1970 AMX,
the 1970 Barracuda, the 1969 AMX, the 1968 Camaro, and the 1968
AMX.




The
manufacture of the magnets used in products incorporating our ZEFS or MK IV
technologies requires a rare-earth metal, neodymium. Neodymium is readily
available in China, at relatively stable prices.




Competition




The
automotive and motor engine industry is highly competitive. We have many
competitors in the United States and throughout the world developing
technologies to make engines more environmentally friendly and fuel-efficient.
Many of our competitors have greater financial, research, marketing and staff
resources than we do. For instance, automobile manufacturers have already
developed catalytic converters on automobiles in order to reduce emissions, but,
as discussed above, this creates greenhouse gases and makes controlling
emissions costly and complex. The industry has also proposed high-pressure fuel
injection systems for gas and diesel applications but these modifications are
extremely expensive.




Although
we are unaware of any technologies that compete directly with our technologies,
there can be no assurance that any unknown existing or future technology will
be, superior to products incorporation our ZEFS and MK IV technologies, as well
as any products we may produce incorporating the ELEKTRA  technology
may provide, the benefits of all of emission reductions, fuel efficiency and
engine performance enhancement.   There are competing products
which provide one or more of the beneficial attributes of our ZEFS, MK IV and
ELEKTRA technologies, but not all three benefits.  Additionally, we
believe that those competing products that show benefit in more than one area
demonstrate greater benefit in only one area and provide only minimal
improvements in other areas.




Competing
emissions reduction products are largely comprised of catalytic converters and
alternative fuels. Catalytic converters are much more expensive than products
incorporating our ZEFS and MK IV technologies, and are sensitive and subject to
damage caused by the poor quality or adulteration of fuel commonly used in
developing nations. In addition, while catalytic converters reduce emissions,
they do not improve fuel efficiency or engine performance. Domestically, there
are a large number of manufacturers and distributors of catalytic converters,
such as Engelhart Inc., Dow Corning Inc., Delphi Corporation and Car Sound
Exhaust System, Inc., among others. Internationally, most catalytic converters
are manufactured and distributed by Engelhart Inc., Delphi Corporation and a
large number of smaller businesses in a fragmented industry.




Alternative
fuels such as hydrogen, electricity, liquid natural gas and ethanol, generally
require more costly conversions and the fuels are not readily available, if at
all, in most of the world.




We
are not aware of any other technology using magnetic, uniform electrical field
fuel treatments or products based on such technology which has been proven to
significantly improve fuel mileage. There are many products currently on the
market that claim to increase fuel efficiency. We believe that the majority of
these products have not undergone or provided independent scientific validation
fromarecognized third
party, or testing at a certified laboratory. Fuel injection does improve fuel
efficiency and performance, but is extremely expensive from the perspective of
the developing nations of the world. Major domestic and international
manufacturers and distributors of fuel injection systems include Delphi
Corporation, Robert Bosch Corporation, Siemens Corporation, and a large number
of smaller businesses in a fragmented industry.




We are
not aware of any other technology using magnetic, uniform electrical field fuel
treatments or products based on such technology which has been proven to
significantly improve performance. There are many products which a consumer can
purchase to increase overall performance. All of the most effective such
products, including forced induction, nitrous oxide injection and exotic
exhaust, are very expensive, increase emissions, reduce fuel efficiency and
shorter the life of the engine. Major domestic and international manufacturers
and distributors of performance-enhancing systems include Holley Performance
Products, Inc., Nitrous Express Inc., Paxton Automotive Corporation, Eaton
Corporation, Vortec Engineering LLC, Flowermaster, Inc., Hedman Manufacturing,
Inc., Gibson Performance, Inc. and a large number of smaller businesses in a
fragmented industry.




12


Government
Regulation and Environmental Matters





Our
research and development activities are not subject to any governmental
regulations that would have a significant impact on our business and we believe
that we are in compliance with all applicable regulations that apply to our
business as it is presently conducted. Our products, as such, are not subject to
certification or approval by the EPA or other governmental agencies domestically
or internationally. Instead, such agencies test and certify a sample engine
fitted with our products.  Depending upon whether we manufacture or
license our products in the future and in which countries such products are
manufactured or sold, we may be subject to regulations, including environmental
regulations, at such time.





U.S.
Government Regulation





We are
currently pursuing EPA and CARB executive order exemptions for our products.
These exemptions would signify that our products do not adversely affect
vehicles emissions and would allow our products to be used on emissions control
equipped on and off-road vehicles. We are also submitting our technologies
to the EPA under the “511 Program” which was established in 1970 to evaluate new
emissions and fuel saving technologies for cars and trucks. In April 2007, we
made a formal request that the EPA consider our carbureted 4-stroke engine
device as part of this program, even though there are few carbureted cars and
trucks left on the road, because the EPA is tightening emissions regulation on
motorcycle, utility and non-road vehicles. We believe that these applications
are well suited for our technologies.  We are unable to estimate the
time it may take for the EPA to act upon our application or predict whether or
not such application will be favorably received, especially considering that we
are asking the EPA to amend its existing program.




EU
Regulation




The
current EU emissions standard for motorcycles is EURO 3, and for automobiles and
trucks the emissions standard is EURO 4. Although there is not a EURO 4 standard
for motorcycles currently, the current trend appears to be for stricter
regulation. On the other hand, the automobile standard is currently moving
towards adopting EURO 5 standards by 2009 and EURO 6 by 2014. These standards
are difficult to attain and the automotive industry is spending billions of
Euros to engineer solutions. European auto manufacturers are becoming
increasingly at odds with the European Commission (“EC”), the body which
evaluates the industry and makes regulatory standards recommendations to the EU,
over CO2 emissions
regulations.




The
CO2
emissions limits are currently a voluntary agreement between the EU and the auto
manufacturers. The EU target is to reach an average CO2
emissionof
120 g/km for all new passenger cars by 2012. However it has become
increasingly clear that the voluntary agreement will not succeed. The average
CO2
emissions per car have dropped only to 160 g/km in 2005, whereas the
average was 186 g/km in 1995.  Because of this, lawmakers have
started considering regulation.  In late 2005, the European Parliament
passed a resolution in support of mandatory CO2 emissions
standards to replace the current voluntary agreement. In late 2006, the EC
announced that it was working on a proposal for a legally-binding limit CO2 emissions
from cars. The EC is also proposing the doubling of the fuel efficiency of new
cars by 2020.




Currently
the only accepted method for reducing a vehicle’s CO, THC and NOx emissions is
catalytic converters, but this system converts these gases into largely CO2 and N2O,
both GHGs. Therefore the lower the CO, THC and NOx output, the higher the
CO2
production. The only remedy is increasing fuel efficiency and the automakers
argue this is costly and results in small low-power vehicles which consumers
will not want to buy.





13


Intellectual
Property





ELEKTRA




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




Method
and Apparatus for Treatment of a Fluid Patent Application




This is
an apparatus for the magnetic treatment of oils to improve
viscosity.  Under the 2004 License Agreement with Temple University,
we have filed the following patent applications, at our sole expense and for the
benefit of Temple University, in order to secure rights to license this
technology in these countries.  US PTO Application #11/519168 was
filed on May 13, 2005.   The priority date is May 14, 2004 from
Australian patent application 2004902563.  This has been registered in
other territories as follows.









Country
                  
                  Number
                  
                  Filing
      date
                  
                  StatusGCC
      *
                  
                  GCC/P/2005/5066
                  
                  22
      August 2005
                  
                  Application
      filed – awaiting examination.Brazil
                  
                  0510871-3
                  
                  13
      May 2005
                  
                  Examination
      to be requested by May 2008Canada
                  
                  2566739
                  
                  13
      May 2005
                  
                  Examination
      to be requested by May 2010China
                  
                  200580023369.3
                  
                  13
      May 2005
                  
                  Examination
      requested April 2007Algeria
                  
                  060593
                  
                  13
      May 2005
                  
                  Application
      filed – awaiting examinationEurasia
      **
                  
                  200602114
                  
                  13
      May 2005
                  
                  Under
      examination – response filed.Egypt
                  
                  PCT
      1087/2006
                  
                  13
      May 2005
                  
                  Application
      filed – awaiting examinationUnited
      Kingdom
                  
                  0624025.3
                  
                  13
      May 2005
                  
                  Under
      examination – response filedIndonesia
                  
                  WO0200603429
                  
                  13
      May 2005
                  
                  Application
      filed – examination to be requested by 13 May 2008Libya
                  
                  To
      be advised
                  
                  
                  
                  Application
      sent to agentMexico
                  
                  PA/a/2006/013206
                  
                  13
      May 2005
                  
                  Application
      filed – awaiting examinationNorway
                  
                  20065632
                  
                  13
      May 2005
                  
                  Application
      filed – awaiting examinationUnited
      States
                  
                  11/519168
                  
                  13
      May 2005
                  
                  Application
      filed – awaiting
examination




* Covers
Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and
Bahrain.




** The
Eurasian Patent Convention was signed on September 9, 1994 in Moscow by the
Heads of the Governments of the Republic of Azerbaijan, the Republic of Armenia,
the Republic of Belarus, Georgia, the Republic of Kazakstan, the Kyrgyz
Republic, the Republic of Moldova, the Russian Federation, the Republic of
Tajikistan, Ukraine and came into force on August 12, 1995 after Turkmenistan,
Belarus and Tajikistan deposited their instruments of accession to the
Convention to the WIPO Director General, on March 1, 1995, May 8, 1995 and May
12, 1995 respectively. To date, the Convention is also ratified by the Russian
Federation, the Republic of Kazakhstan, Republic of Azerbaijan, the Kyrgyz
Republic, the Republic of Moldova and the Republic of Armenia.  14


MAG
ChargR and ECO ChargR




ZEFS Patent
Applications




In
December 1998, we acquired all of the marketing and manufacturing rights to
the ZEFS technologies from the purported inventor of the technology in exchange
for 5,000,000 shares of our common stock, $500,000 and $10 royalty for each unit
sold. In November 2002, under our settlement with the bankruptcy trustee
for the estate of the purported inventor and his wife, the trustee transferred
all ownership and legal rights to an existing international patent application
for the ZEFS MK I technology to us. In exchange for these rights, we issued to
the bankruptcy trustee a warrant to purchase 500,000 shares of our common stock
at $1.00 share and granted a $0.20 royalty on each device we sell.




In
May 2002, we settled a dispute with Kevin “Pro” Hart, who claimed
proprietary rights to the ZEFS technologies. In November 2002, under our
settlement with the bankruptcy trustee for the estate of Mr. Hart, the trustee
assigned all ownership and legal rights to the international patent application
for the ZEFS technology to us, in exchange for an option to purchase 500,000
shares of our common stock at $1.00 share and a $0.20 royalty on each device we
sell. Mr. Hart died in March 2006.




We
obtained the patent application for the ZEFS MK1 device originally filed in
Australia on May 19, 2000. The United States Patent and Trademark Office
issued the patent on 7 June 2005 for the ZEFS MK1 device. The duration of the
patent is 20 years from the date the original application was filed.
Overall, we have applied for a patent on an international basis in approximately
64 countries worldwide.




ZEFS MK1—Device For Saving Fuel and
Reducing Emissions.Thisfuel saving device has a
disk- like nonmagnetic body provided with a central opening and a number of
permanent magnets having opposed polarities positioned about the central opening
to provide multidirectional magnetic fields. The device is positioned in a fuel
air mixture to reduce emissions.




The
following table summarizes the status of the ZEFS MK1 patent application in the
following countries:




Country
              
              Number
              
              Filing
      date
              
              StatusAustralia
              
              2001258057
              
              21
      May 2001
              
              GRANTEDCanada
      (small
                entity
      status)
              
              2409195
              
              21
      May 2001
              
              Examination
      requested April 2006China
              
              01809802.9
              
              21
      May 2001
              
              Under
      examination – response filedColumbia
              
              02115018
              
              21
      May 2001
              
              Examination
      requested 23 July 2004.Czech
      Republic
              
              PV
      2002-4092
              
              21
      May 2001
              
              Accepted  -
      awaiting Deed of Letters PatentEurasian
      +++
              
              200201237
              
              21
      May 2001
              
              GRANTED.
      Renewed in Russia only.Europe  ++
              
              019331222.2
              
              21
      May 2001
              
              Awaiting
      examinationHong
      Kong
              
              04100327.0
              
              21
      May 2001
              
              Automatic
      grant upon grant of the Chinese applicationIndia*
              
              IN/PCT/2002/01523
              
              21
      May 2001
              
              Under
      Examination – response filedIndonesia
              
              WO0200202844
              
              21
      May 2001
              
              Accepted
      – awaiting Deed of Letters
Patent


15





Korea
      [South]
              
              2002-7015531
              
              21
      May 2001
              
              Under
      examination – response filed.Japan
              
              586731/2001
              
              21
      May 2001
              
              Examination
      to be requested by 21 May 2008Mexico
              
              PA/A/2002/011365
              
              21
      May 2001
              
              GRANTEDNew
      Zealand
              
              523113
              
              21
      May 2001
              
              GRANTEDNorway
              
              20025531
              
              21
      May 2001
              
              Awaiting
      examinationPoland
              
              P358837
              
              21
      May 2001
              
              Awaiting
      examinationSingapore
              
              93310
                [WO
      01/90562]
              
              21
      May 2001
              
              GRANTEDSri
      Lanka
              
              12918
              
              21
      May 2001
              
              GRANTEDUnited
      States
              
              6901917
              
              21
      May 2001
              
              GRANTEDVietnam
              
              1-2002-01168
              
              21
      May 2001
              
              GRANTED


++European
patent application covers Austria Belgium Switzerland Liechtenstein Cyprus
Germany Denmark Spain Finland France Great Britain Greece Ireland Italy
Luxembourg Netherlands Portugal Sweden Turkey Lithuania Latvia Slovenia Romania
Macedonia.




+++
The Eurasian Patent Convention was signed on September 9, 1994 in Moscow by the
Heads of the Governments of the Republic of Azerbaijan, the Republic of Armenia,
the Republic of Belarus, Georgia, the Republic of Kazakhstan, the Kyrgyz
Republic, the Republic of Moldova, the Russian Federation, the Republic of
Tajikistan and Ukraine.




MK IV Patent
Applications




Device for Saving Fuel and Reducing
Emissions.This device is
similar to the Mark 1 device but uses stacked magnets.  The following
table summarizes the status of the MK IV patent application in the following
countries:




Country
              
              Number
              
              Filing
      date
              
              StatusChina
              
              NA
              
              20
      June 2006
              
              Application
      sent to AgentJapan
              
              NA
              
              20
      June 2006
              
              Application
      sent to AgentKorea
      [South]
              
              NA
              
              20
      June 2006
              
              Application
      sent to AgentMalaysia
              
              PI
      20062013
              
              2
      May 2006
              
              Examination
      due by 2 May 2008PCT
              
              PCT/AU2006/000861
              
              20
      June 2006
              
              Demand
      for IPE filed – IPRP favorable.Taiwan
              
              95115220
              
              28
      April 2006
              
              Examination
      due by 29 April 2009Thailand
              
              0601001997
              
              2
      May 2006
              
              Application
      filed - awaiting examinationUnited
      States
              
              NA
              
              20
      June 2006
              
              Application
      sent to Agent




The
priority date is June 21, 2005 from Australian patent application
2005903248.




16


Trademarks




ECO
ChargRTM




Country
              
              Number
              
              Filing
      Date
              
              StatusAustralia
              
              1121860
              
              4
      July 2006
              
              GRANTEDMadrid
      *
              
              1121860
              
              4
      January 2007
              
              GRANTEDCanada
              
              1330199
              
              4
      January 2007
              
              Accepted
      – awaiting Registration CertificateIndonesia
              
              D00
      2007 000330
              
              4
      January 2007
              
              Application
      filed – awaiting examinationMalaysia
              
              2007/00156
              
              4
      January 2007
              
              Application
      filed – awaiting examinationThailand
              
              649741
              
              4
      January 2007
              
              Application
      filed – awaiting examinationTaiwan
              
              96000462
              
              4
      January 2007
              
              Under
      examination – response filed.




* Madrid
Protocol application designates the following countries:




●
            China●
            European
      Community


●
            United
      States


●
            Japan●
            Korea


●
            Singapore


●
            Vietnam





MAG
ChargRTM




Country
              
              Number
              
              Filing
      Date
              
              StatusAustralia
              
              1121864
              
              4
      July 2006
              
              Registered
      Co-Existence Agreement with Mag InstrumentsMadrid
              
              1121864
              
              4
      January 2007
              
              GRANTEDCanada
              
              1330200
              
              4
      January 2007
              
              Under
      examination – response filedIndonesia
              
              D00
      2007 000331
              
              4
      January 2007
              
              Application
      filed – awaiting examinationMalaysia
              
              2007/00157
              
              4
      January 2007
              
              Application
      filed – awaiting examinationThailand
              
              649742
              
              4
      January 2007
              
              Application
      filed – awaiting examinationTaiwan
              
              96000465
              
              4
      January 2007
              
              Allowed/Accepted.





STWA
PERFORMANCETM




Country
              
              Number
              
              Filing
      Date
              
              StatusAustralia
              
              1140033
              
              11
      July 2006
              
              GRANTED


Madrid
            
            1140033
            
            10
      July 2007
            
            GRANTED






17




Non-Disclosure
Agreements




To further protect our intellectual
property, we have entered into agreements with certain employees and
consultants, which limit access to, and disclosure or use of, our technology.
There can be no assurance, however, that the steps we have taken to deter
misappropriation of our intellectual property or third party development of our
technology and/or processes will be adequate, that others will not independently
develop similar technologies and/or processes or that secrecy will not be
breached. In addition, although management believes that our technology has been
independently developed and does not infringe on the proprietary rights of
others, there can be no assurance that our technology does not and will not so
infringe or that third parties will not assert infringement claims against us in
the future. Management believes that the steps they have taken to date will
provide some degree of protection; however, no assurance can be given that this
will be the case.





Employees




As of
December 31, 2008, we had seven full-time employees. As of such date, we
also utilized the services of sixteen part-time consultants to assist us with
various matters, including engineering investment relations, public
relations, accounting and sales and marketing. We intend to hire additional
personnel to provide services when they are needed on a full-time basis. We
recognize that our efficiency largely depends, in part, on our ability to hire
and retain additional qualified personnel as and when needed and we have adopted
procedures to assure our ability to do so.




Item 1A. Risk
Factors





We have just begun to generate
revenues, we have a history of losses, and we cannot assure you that we will
ever become or remain profitable. As a result, you may lose your
entire investment.




We
generated our first revenues from operations in late 2006 and, accordingly, we
have incurred net losses every year since our inception in 1998. For the fiscal
years ended December 31, 2008 and 2007, we had net losses of $6,052,724 and
$6,262,743, respectively.  To date, we have dedicated most of our
financial resources to research and development, general and administrative
expenses and initial sales and marketing activities. We have funded all of our
activities through sales of our securities, including equity and
debt.  We anticipate net losses and negative cash flow to continue
until such time as our products are brought to market in sufficient amounts to
offset operating losses. As planned, we have significantly expanded both our
research and development efforts, and our sales and marketing efforts, during
the past year. Consequently, we will need to generate substantial additional
funds, from a combination of revenue and external financing activities, to fund
our operations. Our ability to achieve profitability is dependent upon our
continuing research and development, product development, and sales and
marketing efforts, to deliver viable products and the company’s ability to
successfully bring them to market. Although our management is optimistic that we
will succeed in marketing products incorporating our ZEFS, MK IV, CAT-MATE and
ELEKTRA technologies, there can be no assurance that we will ever generate
significant revenues or that any revenues that may be generated will be
sufficient for us to become profitable or thereafter maintain profitability. If
we cannot generate sufficient revenues or become or remain profitable, we may
have to cease our operations and liquidate our business.




Our independent
auditors have expressed doubt about our ability to continue as a going concern,
which may hinder our ability to obtain future
financing.




In their
report dated March27,
2009,our independent auditors stated that our consolidated
financial statements for the year ended December 31, 2008 were prepared
assuming that we would continue as a going concern. Our ability to continue as a
going concern is an issue raised as a result of our recurring negative cash
flows from operations and accumulated deficit. We had an accumulated deficit
of $42,743,064 as of December 31, 2008. Our ability to continue
as a going concern is subject to our ability to obtain significant additional
capital to fund our operations and to generate revenue from sales, of which
there is no assurance. The going concern qualification in the auditor’s report
could materially limit our ability to raise additional capital. If we fail to
raise sufficient capital, we may have to liquidate our business and you may lose
your investment.


18





Since
we have not yet begun to generate positive cash flow from operations, our
ability to continue operations is dependent on our ability to either begin to
generate positive cash flow from operations or our ability to raise capital from
outside sources.




We have
not generated positive cash flow from operations and have relied on external
sources of capital to fund operations. We had $59,346 in cash at December 31,
2008 and negative cash flow from operations of $2,163,656 for the year ended
December 31, 2008.




We
currently do not have credit facilities available with financial institutions or
other third parties, and historically have relied upon best efforts third-party
funding. Though we have been successful at raising capital on a best efforts
basis in the past, we can provide no assurance that we will be successful in any
future best-efforts financing endeavors. We will need to continue to rely upon
financing from external sources to fund our operations for the foreseeable
future. If we are unable to raise sufficient capital from external sources to
fund our operations, we may need to curtail operations.




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





As of
December 31, 2008 and thereafter, our expenses ran, and are expected to
continue to run, at a “burn rate” of approximately $200,000 per month, which
amount could increase during 2009. We are not currently able to fund operations
on a current basis, and we will require substantial additional capital in order
to operate.  In order to fund some of our capital needs, we
conductedprivate
offerings of our securities in 2007 and 2008. We also established what is
generally referred to as an equity line of credit of up to $10,000,000 with
Dutchess Private Equity Fund, LLP (“Dutchess”), under which we may put shares of
our common stock to Dutchess for sale into the marketplace and receive the
proceeds of these sales.  From November 6, 2006 through December 31,
2006, we raised $380,095 gross proceeds from such puts, and between January 1,
2007 and June 12, 2007, we raised an additional $992,055 gross proceeds
from such puts. We may need to rely substantially on additional puts from the
equity line of credit unless and until we can arrange additional interim or
permanent financings.  Reliance on the equity line of credit could
create downward pressure on the price of our common stock and is dilutive to our
existing shareholders.  While discussion regarding additional interim
and permanent financings are being actively conducted, management cannot predict
with certainty that the equity line of credit will be available to provide
adequate funds, or any funds at all, or whether any additional interim or
permanent financings will be available at all or, if it is available, if it will
be available on favorable terms. If we cannot obtain needed capital, our
research and development, and sales and marketing plans, business and financial
condition and our ability to reduce losses and generate profits will be
materially and adversely affected.  Additionally risks specifically
relating to our equity line of credit with Dutchess are set forth at the end
of this section.




We
will need additional capital to repay certain short-term debt as it
matures.




We have
$896,720 remaining principal amount of convertible subordinated notes due
February 2009, August 2009, October 2009 and December 2009 to certain
investors.  In January 2009, we issued $250,000 convertible notes in
our 2009 Winter Offering-I to certain investors, which will be due in April
2009. From February 13, 2009 to March 4, 2009 we issued $186,340 convertible
notes in our 2009 Winter Offering-II to certain investors, which will be due in
March 2010.




Due to
the Company’s limited capital resources, management cannot predict with
certainty that there will be cash available to repay these obligations, and
other obligations, on their respective maturity dates.  If we do not
raise adequate funds, we would be unable to repay these obligations as they
mature during the next twelve months and we could default on such
obligations.




19


As
a company with an unproven business strategy, our limited history of operations
makes evaluation of our business and prospects difficult.




Our
business prospects are difficult to predict because of our limited operating
history, early stage of development and unproven business strategy. Since our
incorporation in 1998, we have been and continue to be involved in development
of products using our technology, establishing manufacturing and marketing of
these products to consumers and industry partners. Although we believe our
technology and products in development have significant profit potential, we may
not attain profitable operations and our management may not succeed in realizing
our business objectives.




If
we are not able to devote adequate resources to product development and
commercialization, we may not be able to develop our products.




Our
business strategy is to develop, manufacture and market products incorporating
our ZEFS, MK IV and ELEKTRA technologies, and, to a lesser extent, our CAT-MATE
technology.  We also intend to develop, manufacture and market
products incorporating the ELEKTRA technology. We believe that our revenue
growth and profitability, if any, will substantially depend upon our ability
to:





●
              raise
      additional needed capital for research and development;●
              complete
      development of our products in development; and●
              successfully
      introduce and commercialize our new
products.





Certain
of our products are still under various stages of development. Because we have
limited resources to devote to product development and commercialization, any
delay in the development of one product or reallocation of resources to product
development efforts that prove unsuccessful may delay or jeopardize the
development of other product candidates. Although our management believes that
it can finance our product development through private placements and other
capital sources, if we do not develop new products and bring them to market, our
ability to generate revenues will be adversely affected.




The
commercial viability of the ZEFS and CAT-MATE technologies remains largely
unproven and we may not be able to attract customers.




Despite
the fact that have entered into various distribution agreements and made some
initial sales of our products to distributors, to the best of our knowledge, no
consumer or automobile manufacturer has used the products incorporating the ZEFS
or CAT-MATE technologies to reduce motor vehicle emissions to date. Accordingly,
the commercial viability of our devices is not known at this time. If commercial
opportunities are not realized from the use of products incorporating the ZEFS
and CAT-MATE technologies, our ability to generate revenue would be adversely
affected.  There can be no assurances that we will be successful in
marketing our products, or that customers will ultimately purchase our products.
Failure to have commercial success from the sale of our products will
significantly and negatively impact our financial condition.




The
commercial viability of the ELEKTRA technology remains largely unproven and we
may not be able to attract customers.




To the
best of our knowledge, no consumer or automobile manufacturer has used the
products incorporating the ELEKTRA technology to reduce motor vehicle emissions
to date. Accordingly, the commercial viability of our devices is not known at
this time. If commercial opportunities are not realized from the use of products
incorporating the ELEKTRA technology, our ability to generate revenue would be
adversely affected.  There can be no assurances that we will be
successful in marketing our products, or that customers will ultimately purchase
our products. Failure to have commercial success from the sale of our products
will significantly and negatively impact our financial condition.




20


If
our products and services do not gain market acceptance, it is unlikely that we
will become profitable.




The
market for products that reduce harmful motor vehicle emissions is evolving and
we have many successful competitors. Automobile manufacturers have historically
used various technologies, including catalytic converters, to reduce exhaust
emissions caused by their products. At this time, our technology is unproven,
and the use of our technology by others is limited. The commercial success of
our products will depend upon the adoption of our technology by auto
manufacturers and consumers as an approach to reduce motor vehicle emissions.
Market acceptance will depend on many factors, including:




●
              the
      willingness and ability of consumers and industry partners to adopt new
      technologies;●
              the
      willingness and ability of consumers and industry partners to adopt new
      technologies;●
              the
      willingness of governments to mandate reduction of motor vehicle
      emissions;●
              our
      ability to convince potential industry partners and consumers that our
      technology is an attractive alternative to other technologies for
      reduction of motor vehicle emissions;●
              our
      ability to manufacture products and provide services in sufficient
      quantities with acceptable quality and at an acceptable cost;
      and●
              our
      ability to place and service sufficient quantities of our
      products.




If our
products do not achieve a significant level of market acceptance, demand for our
products will not develop as expected and it is unlikely that we will become
profitable.




We
need to outsource and rely on third parties for the manufacture, sales and
marketing of our products, and our future success will be dependent on the
timeliness and effectiveness of the efforts of these third parties.




We do not
have the required financial and human resources or capability to manufacture
market and sell our products. Our business model calls for the outsourcing of
the manufacture, and sales and marketing of our products in order to reduce our
capital and infrastructure costs as a means of potentially improving our
financial position and the profitability of our business. Accordingly, we must
enter into agreements with other companies that can assist us and provide
certain capabilities that we do not possess. We have entered into certain
distribution agreements, but we may not be successful in entering into
additional such alliances on favorable terms or at all. Even if we do succeed in
securing additional distribution agreements, we may not be able to maintain
them. Furthermore, any delay in entering into agreements could delay the
development and commercialization of our products and reduce their
competitiveness even if they reach the market. Any such delay related to our
existing or future agreements could adversely affect our business.




We do not
currently have an agreement in place for the manufacture of products
incorporating our ZEFS or MK IV technologies.




If
any party to which we have outsourced certain functions fails to perform its
obligations under agreements with us, the development and commercialization of
our products could be delayed or curtailed.




To the
extent that we rely on other companies to manufacture, sell or market our
products, we will be dependent on the timeliness and effectiveness of their
efforts. If any of these parties do not perform its obligations in a timely and
effective manner, the commercialization of our products could be delayed or
curtailed because we may not have sufficient financial resources or capabilities
to continue such development and commercialization on our own.




21


Any
revenues that we may earn in the future are unpredictable, and our operating
results are likely to fluctuate from quarter to quarter.




We
believe that our future operating results will fluctuate due to a variety of
factors, including:





·
              delays
      in product development;·
              market
      acceptance of our new products;·
              changes
      in the demand for, and pricing, of our products;·
              competition
      and pricing pressure from competitive products;·
              manufacturing
      delays; and·
              expenses
      related to, and the results of, proceedings relating to our intellectual
      property.




A large
portion of our expenses, including expenses for our facilities, equipment and
personnel, is relatively fixed and not subject to further significant reduction.
In addition, we expect our operating expenses will increase in 2009 as
we continue our research and development and increase our production and
marketing activities, among other activities. Although we expect to generate
revenues from sales of our products, revenues may decline or not grow as
anticipated and our operating results could be substantially harmed for a
particular fiscal period. Moreover, our operating results in some quarters may
not meet the expectations of stock market analysts and investors. In that case,
our stock price most likely would decline.




Nondisclosure
agreements with employees and others may not adequately prevent disclosure of
trade secrets and other proprietary information.




In order
to protect our proprietary technology and processes, we rely in part on
nondisclosure agreements with our employees, licensing partners, consultants,
agents and other organizations to which we disclose our proprietary information.
These agreements may not effectively prevent disclosure of confidential
information and may not provide an adequate remedy in the event of unauthorized
disclosure of confidential information. In addition, others may independently
discover trade secrets and proprietary information, and in such cases we could
not assert any trade secret rights against such parties. Costly and
time-consuming litigation could be necessary to enforce and determine the scope
of our proprietary rights, and failure to obtain or maintain trade secret
protection could adversely affect our competitive business position. Since we
rely on trade secrets and nondisclosure agreements, in addition to patents, to
protect some of our intellectual property, there is a risk that third parties
may obtain and improperly utilize our proprietary information to our competitive
disadvantage. We may not be able to detect unauthorized use or take appropriate
and timely steps to enforce our intellectual property rights.




The
manufacture, use or sale of our current and proposed products may infringe on
the patent rights of others, and we may be forced to litigate if an intellectual
property dispute arises.




If we
infringe or are alleged to have infringed another party’s patent rights, we may
be required to seek a license, defend an infringement action or challenge the
validity of the patents in court. Patent litigation is costly and time
consuming. We may not have sufficient resources to bring these actions to a
successful conclusion. In addition, if we do not obtain a license, do not
successfully defend an infringement action or are unable to have infringed
patents declared invalid, we may:




·
              incur
      substantial monetary damages;·
              encounter
      significant delays in marketing our current and proposed product
      candidates;·
              be
      unable to conduct or participate in the manufacture, use or sale of
      product


22





·
              candidates or methods of
      treatment requiring licenses;·
              lose
      patent protection for our inventions and products; or·
              find
      our patents are unenforceable, invalid, or have a reduced scope of
      protection.




Parties
making such claims may be able to obtain injunctive relief that could
effectively block our ability to further develop or commercialize our current
and proposed product candidates in the United States and abroad and could result
in the award of substantial damages. Defense of any lawsuit or failure to obtain
any such license could substantially harm the company. Litigation, regardless of
outcome, could result in substantial cost to and a diversion of efforts by the
Company to operate its business.




We
may face costly intellectual property disputes.




Our
ability to compete effectively will depend in part on our ability to develop and
maintain proprietary aspects of our technologies and either to operate without
infringing the proprietary rights of others or to obtain rights to technology
owned by third parties. Our pending patent applications, specifically patent
rights of the MK IV, ELEKTRA and CAT-MATE technologies, may not result in the
issuance of any patents or any issued patents that will offer protection against
competitors with similar technology. Patents we have received for our ZEFS
technologies, and which we may receive, may be challenged, invalidated or
circumvented in the future or the rights created by those patents may not
provide a competitive advantage. We also rely on trade secrets, technical
know-how and continuing invention to develop and maintain our competitive
position. Others may independently develop substantially equivalent proprietary
information and techniques or otherwise gain access to our trade
secrets.




We
were involved in a patent infringement suit brought by our former sole director
and executive officer.




In
April 2005, Jeffrey A. Muller, the Company’s former sole director and
executive officer, filed a complaint against us seeking declaratory and
injunctive relief and alleging unfair competition in connection with a claimed
prior patent interest in the ZEFS technologies. Mr. Muller is seeking to
have the patent rights in the ZEFS technologies that were previously transferred
to us by Mr. Muller’s bankruptcy trustee declared null and void. Muller’s
claims for patent infringement against the Company were dismissed and the case
was closed on October 15, 2008, by order of George B. Daniels, United States
District Judge, Southern District of New York.




We
may not be able to attract or retain qualified senior personnel.




We
believe we are currently able to manage our current business with our existing
management team. However, as we expand the scope of our operations, we will need
to obtain the full-time services of additional senior management and other
personnel. Competition for highly-skilled personnel is intense, and there can be
no assurance that we will be able to attract or retain qualified senior
personnel. Our failure to do so could have an adverse effect on our ability to
implement our business plan. As we add full-time senior personnel, our overhead
expenses for salaries and related items will increase compensation packages,
these increases could be substantial.




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 Cecil Bond Kyte, our Chief Executive Officer, Charles
R. Blum, our President and Eugene E. Eichler, our Interim Chief Financial
Officer. The loss of the services of members of our senior management may
significantly delay or prevent the achievement of product development and other
business objectives. Because of the scientific nature of our business, we depend
substantially on our ability to attract and retain qualified marketing,
scientific and technical personnel, including consultants. There is intense
competition among specialized automotive companies for qualified personnel in
the areas of our activities. If we lose the services of, or do not successfully
recruit key marketing, scientific and technical personnel, the growth of our
business could be substantially impaired. We do not maintain key man insurance
for any of these individuals.




23





We
expect to incur increased costs under the Sarbanes-Oxley Act of
2002.




As a
public company, we incur significant legal, accounting and other expenses. In
addition, the Sarbanes-Oxley Act of 2002, as well as related rules adopted by
the SEC, has imposed substantial requirements on public companies, including
certain corporate governance practices and requirements relating to internal
control over financial reporting under Section 404 of the Sarbanes-Oxley
Act. We expect these rules and regulations to increase our legal and financial
compliance costs and to make some activities more time-consuming and costly.
Effective disclosure of controls and procedures and internal controls are
necessary for us to produce reliable financial reports and are important in
helping prevent financial fraud generally. In order to accomplish this, we have
retained an outside consulting firm to assist us in implementing proper
procedures. We will incur significant up-front expenses to do so. If we are
unable to achieve and maintain adequate disclosure controls and procedures and
internal controls, our business and operating results could be
harmed.




Changes
in stock option accounting rules may adversely affect our reported operating
results, our stock price, and our ability to attract and retain
employees.




In
December 2004, the Financial Accounting Standards Board (“FASB”) published
new rules that will require companies such as us to record all stock-based
employee compensation as an expense. The new rules apply to stock options
grants, as well as a wide range of other share-based compensation arrangements
including restricted share plans, performance-based awards, share appreciation
rights and employee share purchase plans. As required by FASB, we adopted these
rules effective January 1, 2006.  As a small company with limited
financial resources, we have depended upon compensating our officers, directors,
employees and consultants with such stock based compensation awards in the past
in order to limit our cash expenditures and to attract and retain officers,
directors, employees and consultants. Accordingly, if we continue to grant stock
options or other stock based compensation awards to our officers, directors,
employees, and consultants, our future earnings, if any, will be reduced (or our
future losses will be increased) by the expenses recorded for those grants.
These compensation expenses may be larger than the compensation expense that we
would be required to record were we able to compensate these persons with cash
in lieu of securities. Since we are a small company, the expenses we may have to
record as a result of future options grants may be significant and may
materially negatively affect our reported financial results.




Currently,
there is only very limited trading in our stock, so you may be unable to sell
your shares at or near the quoted bid prices if you need to sell your
shares.




The
shares of our common stock are thinly-traded on the OTC Bulletin Board, meaning
that the number of persons interested in purchasing our common shares at or near
bid prices at any given time may be relatively small or non-existent. This
situation is attributable to a number of factors, including the fact that we are
a small company engaged in a high risk business which is relatively unknown to
stock analysts, stock brokers, institutional investors and others in the
investment community that can generate or influence daily trading volume and
valuation. Should we even come to the attention of such persons, they tend to be
risk-averse and would be reluctant to follow an unproven, early stage company
such as ours or purchase or recommend the purchase of our shares until such time
as we became more seasoned and viable. As a consequence, there may be periods of
several days or more when trading activity in our shares is minimal or
non-existent, as compared to a seasoned issuer which has a large and steady
volume of trading activity that will generally support continuous trading
without negatively impacting our share price. We cannot provide any assurance
that a broader or more active public trading market for shares of our common
stock will develop or be sustained.  Due to these conditions, we
cannot give any assurance that shareholders will be able to sell their shares at
or near bid prices or at all.


24


The
market price of our stock is volatile.




The
market price for our common stock has been volatile during the last year,
ranging from a closing bid price of $0.86on March 18,
2008 to a closing bid price of $0.12 on November 21, 2008, and a closing bid
price of $0.40 on March 12, 2009. Additionally, the bid price of our stock has
been both higher and lower than those amounts on an intra-day basis in the last
year. Because our stock is thinly traded, its price can change dramatically over
short periods, even in a single day. The market price of our common stock could
fluctuate widely in response to many factors, including:




·
              developments
      with respect to patents or proprietary rights;·
              announcements
      of technological innovations by us or our
  competitors;





·
                  announcements
      of new products or new contracts by us or our
  competitors;·
                  actual
      or anticipated variations in our operating results due to the level of
      development expenses and other factors;·
                  changes
      in financial estimates by securities analysts and whether any future
      earnings of ours meet or exceed such
estimates;





·
                conditions
      and trends in our industry;·
                new accounting
      standards;·
                general economic, political and
      market conditions and other factors; and·
                the
      occurrence of any of the risks described in this Memorandum.




Substantial
sales of common stock could cause our stock price to fall.




In the
past year, there have been times when average daily trading volume of our common
stock has been extremely low, and there have been many days in which no shares
were traded at all. At other times, the average daily trading volume of our
common stock has been high...  Nevertheless, the possibility that
substantial amounts of common stock may be sold in the public market may
adversely affect prevailing market prices for our common stock and could impair
our ability to raise capital through the sale of our equity
securities.




Potential
issuance of additional shares of our common stock could dilute existing
stockholders.




We are
authorized to issue up to 200,000,000 shares of common stock. To the extent of
such authorization, our Board of Directors has the ability, without seeking
stockholder approval, to issue additional shares of common stock in the future
for such consideration as the Board of Directors may consider sufficient. The
issuance of additional common stock in the future will reduce the proportionate
ownership and voting power of the common stock offered hereby.


25


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 1B. Unresolved
Staff Comments









Item 2.Properties





Our
Executive Offices and our engineering, production and testing facility is
located at 235 Tennant Avenue, Morgan Hill, California, 95037.  In
September 2005, the Company entered into a lease for the term September 1,
2005 through August 31, 2007 and carried an option to renew for two
additional years at the then prevailing market rate. Monthly rent was
$2,240 per month under this lease. The lease was amended in February 2006
for additional space. Monthly rate under the amended lease was $4,160 per
month.  The Company renewed this lease on August 9, 2007 for an
additional two-year term.  The rent is $4,640 per month for the first
six months of the new term of the lease and $5,480 per month for the remaining
eighteen months of the new term of the lease.  We believe that this
space is adequate for our current and planned needs.





In May
2008, the Company entered into a lease agreement for its administrative offices
in Los Angeles, California.  The term of the lease was for $3,000 per
month from June 1, 2008 through November 20, 2008.  The Company is
currently on a month to month basis with rent payment of $3,750.





Item 3.
Legal
Proceedings





On
December 19, 2001, the SEC filed civil charges in the United States Federal
District Court, Southern District of New York, against us, our former President
and then sole director Jeffrey A. Muller, and others, alleging that we and the
other defendants were engaged in a fraudulent scheme to promote our stock. The
SEC complaint alleged the existence of a promotional campaign using press
releases, Internet postings, an elaborate website, and televised media events to
disseminate false and materially misleading information as part of a fraudulent
scheme to manipulate the market for stock in our corporation, which was then
controlled by Mr. Muller. On March 22, 2002, we signed a Consent to
Final Judgment of Permanent Injunction and Other Relief in settlement of this
action as against the corporation only, which the court approved on July 2,
2002. Under this settlement, we were not required to admit fault and did not pay
any fines or restitution.




On
July 2, 2002, after an investigation by our newly constituted board of
directors, we filed a cross-complaint in the SEC action against Mr. Muller
and others seeking injunctive relief, disgorgement of monies and stock and
financial restitution for a variety of acts and omissions in connection with
sales of our stock and other transactions occurring between 1998 and
2002.  Among other things, we alleged that Mr. Muller and certain
others sold Company stock without providing adequate consideration to us; sold
insider shares without making proper disclosures and failed to make necessary
filing required under federal securities laws; engaged in self-dealing and
entered into various undisclosed  related-party transactions;
misappropriated for their own use proceeds from sales of our stock; and entered
into various undisclosed arrangement regarding the control, voting and
disposition of their stock.




On
July 30, 2002, the U.S. Federal District Court, Southern District of New
York, granted our application for a preliminary injunction against
Mr. Muller and others, which prevented Mr. Muller and other
cross-defendants from selling, transferring, or encumbering any assets and
property previously acquired from us, from selling or transferring any of our
stock that they may have owned or controlled, or from taking any action to
injure us or our business and from having any direct contact with our
shareholders. The injunctive order also prevented Mr. Muller or his nominees
from engaging in any effort to exercise control over our corporation and from
serving as an officer or director of our company.




26


In the
course of the litigation, we have obtained ownership control over all patent
rights to the ZEFS device.




On
January 4, 2007, the Court entered a final judgment against Jeffrey Muller which
barred Mr. Muller from serving as an officer or director of a public
company for a period of 20 years, ordered Mr. Muller to disgorge any
shares of our stock that he still owns and directed the Company to cancel any
issued and outstanding shares of our stock still owned by Mr. Muller.
Mr. Muller was also ordered to disgorge unlawful profits in the amount of
$7.5 million and to pay a civil penalty in the amount of
$100,000.  Acting in accordance with the ruling and decision of the
Court, we have canceled (i) 8,047,403 shares of common stock that had been
held by Mr. Muller and/or his affiliates, (ii) options to acquire an
additional 10,000,000 shares of our common stock held by Mr. Muller
personally and (iii) $1,017,208 of debt which Mr. Muller claimed was owed
to him by the Company.  After an appeal filed by Mr. Muller was
dismissed the Judgment against him is considered final.





On
February 8, 2007, Federal Magistrate Judge Maas issued a post-judgment order, at
our request, which further concluded that all of the shares of the
Company’s stock held by Mr. Muller or any of his nominees directly or indirectly
owned or controlled were to be recaptured by the Company and were subject to
disgorgement and forfeiture.  The ruling provided that all shares,
options and any other obligations allegedly owed by the Company to Mr. Muller
were to be disgorged in our favor and confirmed the earlier judgment holding
Mr. Muller liable for $7.5 million in actual damages, imposing a
$100,000 fine and barring Mr. Muller from any involvement with a publicly traded
company for 20 years.  With prejudgment interest, this ruling
brings the actual damages against Muller to over
$11 million.  Additionally, the Court clarified that the order
required the disgorgement of any shares of the Company’s stock that
Mr. Muller or any of his nominees directly or indirectly owned or
controlled.  In furtherance of this order, the Company has taken
action to cancel over 3.6 million shares which had been issued to offshore
companies.  The Order also confirmed the appropriateness of actions
previously taken by the Company to acquire the patent rights and to consolidate
the manufacturing, marketing and distribution rights with its ownership of all
rights to the existing patents.  On February 11, 2009, Judge Maas
confirmed that his previous decision was modified and the Company’s Motion for
Summary Judgment was granted in favor of the Company as set forth in his order
of February 8, 2007.  A proposed Final Judgment in favor of the
Company is pending before the United States District Court, Southern District of
New York.




Patent
Infringement Claims by Jeffrey A. Muller





In
April 2005, Jeffrey A. Muller, the Company’s former sole director and
executive officer, filed a complaint against us in the Federal District Court
for the Central District of California, seeking declaratory and injunctive
relief and alleging unfair competition in connection with a claimed prior patent
interest in the ZEFS device and stock option rights. In seeking declaratory
relief, Mr. Muller is seeking to have the patent rights in the ZEFS device
that were previously transferred to us by Mr. Muller’s bankruptcy trustee
declared null and void.




This
lawsuit brought by Mr. Muller arose out of the same claims that were the
subject of litigation in the Federal District Court for the Southern
District of New York, in which the Court entered judgment against Mr.
Muller.  Those claims are pending further
proceedings.  While we believe that we have valid claims and defenses,
there can be no assurance that an adverse result or outcome on the pending
motions or a trial of this case would not have a material adverse effect on our
financial position or cash flow.  Muller’s claims for patent
infringement against the Company were dismissed and the case was closed on
October 15, 2008, by order of George B. Daniels, United States District Judge,
Southern District of New York.





Litigation
Involving Scottish Glen Golf Company




We were
involved in litigation with Scottish Glen Golf Company, Inc. (SGGC) doing
business as KZ Golf, Inc., the Company’s previous landlord on claims in the
aggregate amount of $104,413.   The Company does not dispute the
fact that certain amounts of unpaid past rent are due but does dispute that it
owes the aggregate of $104,413 demanded by SGGC; more than half of which are
purported “late fees” which was assessed at the rate of $100 per
day.  It was the Company’s position that the late fees are void and
unenforceable and that the Company is entitled to a set-off for office space
that reverted back to SGGC.





On April
30, 2008 the Company and SGGC settled their pending litigation relating to the
Company’s prior offices.  The Company agreed to pay SGGC $51,000 in full
settlement of SGGC’s claims.  On May 28, 2008 the initial payment of
$34,000 was made and on July 9, 2008 the final payment of $17,000 was made and
the Complaint was dismissed, with prejudice.   The Company
recorded $52,069 as other income and as a reduction of accounts
payable.





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





Not
Applicable


27








PART
II





Item 5.Market
for Common Equity and Related Stockholder
Matters





Through
May 21, 2007, our common stock was traded on the Over the Counter Bulletin Board
(the “OTCBBJ under
the symbol “ZERO”. Effective May 22, 2007, our common stock was removed from the
OTCBB and placed on the “Pink Sheets”. Effective February 8, 2008, our
common stock was reinstated and currently trades on the OTCBB. The following
table sets forth the high and low bid prices of the Company’s common stock for
the quarters indicated as quoted on the Pink Sheets or the OTCBB, as applicable,
as reported by Yahoo Finance.These quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not represent actual transactions.




2008
                          
                          
                          2007High
                          
                          
                          Low
                          
                          
                          High
                          
                          
                          LowFirst
      First Quarter
                          
                          $
                          0.86
                          
                          
                          $
                          0.30
                          
                          
                          $
                          1.17
                          
                          
                          $
                          0.60Snd
      Second Quarter
                          
                          $
                          0.79
                          
                          
                          $
                          0.37
                          
                          
                          $
                          0.80
                          
                          
                          $
                          0.25Th    Third
      Quarter
                          
                          $
                          0.45
                          
                          
                          $
                          0.27
                          
                          
                          $
                          0.60
                          
                          
                          $
                          0.17Fou   Fourth
      Quarter
                          
                          $
                          0.40
                          
                          
                          $
                          0.12
                          
                          
                          $
                          0.48
                          
                          
                          $
                          0.15





According
to the records of our transfer agent, we had 907 stockholders of record of
ourcommon
stock at March 2, 2009. The Company believes that the number of beneficial
owners is substantially higher than this amount.




We do not
pay a dividend on our common stock and we currently intend to retain future cash
flows to finance our operations and fund the growth of our business. Any payment
of future dividends will be at the discretion of our Board of Directors and will
depend upon, among other things, our earnings, financial condition, capital
requirements, level of indebtedness, contractual restrictions in respect to the
payment of dividends and other factors that our Board of Directors deems
relevant.





Issuances of Unregistered
Securities in Last Fiscal Year





2007/2008 Winter
Offering





From December 27, 2007 to February 29,
2008, the Company conducted an offering (the “2007/2008 Winter Offering”) and
issued convertible notes in the aggregate face amount of
$521,400.  These notes were sold for an aggregate purchase price of
$474,000.  The notes are convertible into 1,042,800 shares of the
Company’s common stock and in addition, investors received warrants entitling
the holders to purchase up to 521,400 shares of the Company’s common
stock.  (See “Details of Recent Financial Transactions”.)





2008 Spring
Offering





On May 27, 2008, the Company made an
offering (the “2008 Spring Offering”) with a certain investor and issued a
Convertible Note in the amount of $66,000.  The note was sold for a
purchase price of $60,000.  The note is convertible into 132,000
shares of the Company’s common stock and in addition the investor received
warrants entitling the holder to purchase up to 66,000 shares of the Company’s
common stock.  (See “Details of
Recent Financial Transactions”.)





2008 Summer
Offering





From July 17, 2008 to August 31, 2008,
the Company conducted an offering (the “2008 Summer Offering”) and issued
Convertible Notes in the aggregate amount of $484,000.  These Notes
were sold for an aggregate purchase price of $440,000.  The Notes are
convertible into 1,423,530 shares of the Company’s common stock and in addition,
investors received warrants entitling the holders to purchase up to 711,764
shares of the Company’s common stock.  (See “Details of Recent
Financial Transactions”.)





28


2008 Fall
Offering





From September 8, 2008 to October 31,
2008, the Company conducted an offering (the “2008 Fall Offering”) and
issued  Convertible Notes in the aggregate amount of
$198,220.  These Notes were sold for an aggregate purchase price of
$180,200.  The Notes are convertible into 1,321,466 shares of the
Company’s common stock and in addition, investors received warrants entitling
the holders to purchase up to 660,734 shares of the Company’s common
stock.  (See “Details of Recent Financial Transactions”.)





2008 Winter
Offering





From November 24, 2008 to December 5,
2008, the Company conducted an offering (the “2008 Winter Offering”) and issued
Convertible Notes in the aggregate amount of $524,700.  These Notes
were sold for and aggregate purchase price of $477,000.  The Notes are
convertible into 3,086,470 shares of the Company’s common stock and in addition,
investors received warrants entitling the holders to purchase up to 1,543,235
shares if the Company’s common stock.  (See “Details of Recent
Financial Transactions”.)




Other
Issuances




During
the year ended December 31, 2008, convertible notes in the amount of $3,986,439
of our previously issued and outstanding Investor Notes were converted to
11,025,930 shares of common stock.





During
the year ended December 31, 2008, we issued 2,744,898 shares of common stock in
settlement of payables and loan in the amount of $963,396.





During
the year ended December 31, 2008, we issued 1,635,000 shares of common stock for
consulting services.





During
the year ended December 31, 2008, we received $532,325 from warrants exercised
and issued 1,064,650 shares of common stock.




Item 6.
Selected Consolidated Financial Data


Not Applicable





Item 7.
Management’s Discussion and
Analysis or Plan of Operation





The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and supplementary data referred to in Item 7 of this Form
10-K.




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-K, particularly in “Risk Factors,” that could cause actual results to differ
materially from those projected. Unless otherwise expressly indicated, the
information set forth in this Form 10-K is as of December 31, 2008, and we
undertake no duty to update this information.





Overview





We are a
development stage company that generated its first initial revenues in the
fourth quarter of 2006. Our focus is on research and development, and initial
sales and marketing, of products incorporating our proprietary and patented
technology, which is designed to reduce harmful emissions, and/or improve fuel
efficiency and engine performance on equipment and vehicles driven by internal
combustion engines. We have devoted the bulk of our efforts to the completion of
the design, the development of our production models, testing of devices and the
promotion of our products in the marketplace. We anticipate that these efforts
will continue during 2009.




29





Our
expenses to date have been funded primarily through the sale of stock and
convertible debt, as well as proceeds from the exercise of stock purchase
warrants. We raised capital in 2008 and will need to raise substantial
additional capital in 2009, and possibly beyond, to fund our sales and marketing
efforts, continuing research and development, and certain other expenses, until
our revenue base grows sufficiently.





Results
of Operation





Revenues
were $0 for the fiscal year ended December 31, 2008, compared to $39,000 a year
ago, a decrease of $39,000. Cost of goods sold were $0 for the fiscal year ended
December 31, 2008, compared to $10,720 for the fiscal year ended December 31,
2007. We realized a gross profit of $0 for the fiscal year ended December 31,
2008, compared to $28,280 for the fiscal year ended December 31, 2007, a
decrease of $28,280.




Operating
expenses were $3,298,918 for the fiscal year ended December 31, 2008,
compared to $3,956,345 for the fiscal year ended December 31, 2007, a
decrease of $657,427. The decrease is attributable to a decrease in cash
expenses of $1,633,932 offset by an increase in non-cash expenses of $976,505.
Specifically, the decrease in cash expenses is attributable to decreases in
salaries and benefits expenses ($631,554); consulting and professional fees
($618,433); office and other expenses ($133,008); corporate expenses ($132,573);
travel ($89,032); exhibit and trade shows ($29,332). The increase in non-cash
expenses is attributable to increases in stocks, options and warrants given to
employees, consultants and lawyer ($1,104,975); and bad debt ($1,380); offset by
a decrease in depreciation expense ($129,850).




Research
and development expenses were $652,363 for the fiscal year ended December 31,
2008, compared to $600,816 for the fiscal year ended December 31, 2007, an
increase of $51,547. Our research and development expenses include
contracts with RAND and Temple University, consultant’s fees, travel, cost of
services and supplies. The increase in research and development expenses is
primarily attributable to an increase in contracts with RAND Corporation and
Temple University of $156,903. This increase was offset by decreases in testing
tools and supplies ($71,090); travel expenses ($18,169); and consultant’s fees
($16,097).




Interest
and other income was $200 for the fiscal year ended December 31, 2008, compared
to $3,475 for the fiscal year ended December 31, 2007, a decrease of
$3,275. This decrease is attributable to a decrease in dyno-testing and
consulting income.  Interest expense was $2,153,449 for the fiscal
year ended December 31, 2008, compared to $1,736,537 for the fiscal year ended
December 31, 2007.  This increase of $416,912 is attributable to an
increase in non-cash interest expense and financing fees of $413,562 and an
increase in cash interest expense and financing fees of $3,350.




We had a
net loss of $6,052,724 or $0.11 per share for the fiscal year ended December 31,
2008 compared to a net loss of $6,262,743, or $0.16 per share for the fiscal
year ended December 31, 2007.




Liquidity
and Capital Resources





General





We have
incurred negative cash flow from operations in the developmental stage since our
inception in 1998. As of December 31, 2008, we had cash of $59,346 and an
accumulated deficit of $42,743,064. Our negative operating cash flow in 2008 was
funded primarily through the sale convertible notes as well as sale of our stock
by Dutchess Private Equity Fund, LLC (“Dutchess”) under our equity line of
credit.





The
accompanying consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the settlement
of liabilities and commitments in the normal course of business. As reflected in
the accompanying consolidated financial statements, the Company had a net loss
of $6,052,724 and a negative cash flow from operations of $2,163,656 for the
year ended December 31, 2008, and had a working capital deficiency of $2,677,084
and a stockholders’ deficiency of $2,589,865 at December 31,
2008.  These factors raise substantial doubt about its ability to
continue as a going concern. The ability of the Company to continue as a going
concern is dependent upon the Company’s ability to raise additional funds and
implement its business plan. The consolidated financial statements do not
include any adjustments that might be necessary if the Company is unable to
continue as a going concern.


30


During
2008, we raised an aggregate of $2,163,525 gross and net proceeds from the sale
of our stock and the issuance of debt, as follows:




●
                Gross
      and net proceeds of $474,000 from the issuance of convertible notes and
      warrants in a Spring 2008 offering.  The face amount of the
      notes is $521,400.●
                Gross
      and net proceeds of $60,000 from the issuance of convertible notes and
      warrants in a Spring 2008 offering.  The face amount of the
      notes is $66,000.


●
                Gross
      and proceeds of $440,000 from the issuance of convertible notes and
      warrants in a Summer 2008 offering.  The face amount of the
      notes is $484,000.●
                Gross
      and net proceeds of $180,200 from the issuance of convertible notes and
      warrants in a Fall 2008 offering.  The face amount of the notes
      is $198,220.●
                Gross
      and net proceeds of $477,000 from the issuance of convertible notes and
      warrants in a Winter 2008 (2nd) offering.  The face amount of
      the notes is $524,700.●
                Gross
      and net proceeds of $532,325 from the issuance of stock upon exercise
      warrants.




Subsequent
to fiscal year ended December 31, 2008 and through March 12, 2009, we raised an
aggregate of $683,320 gross and net proceeds from issuance of convertible
notes and warrants in our 2009 Winter Offering 1 & 2.





Details
of Recent Financing Transactions




2007-2008
Winter Offering





From
December 27, 2007 to February 29, 2008  the Company conducted an
offering (the “2007-2008 Winter Offering”) of up to $1,000,000 aggregate face
amount of its convertible notes (the “2007- 2008 Winter Notes”) with a small
number of accredited investors.  Of this amount, $521,400 aggregate
face amount of the 2007-2008 Winter Notes were sold for an aggregate purchase
price of $474,000 net proceeds.  Therefore, while the stated interest
rate on the 2008 Winter Notes is 0%, the implied interest rate on the 2007-2008
Winter Notes is 10%.  The 2007-2008 Winter Notes mature on the first
anniversary of their date of issuance.  The 2007-2008 Winter Notes are
convertible, at the option of the noteholder, into shares of common stock of the
Company (the “Conversion Shares”) at a conversion price equal to the average of
the closing bid price of the Company’s common stock for the five trading days
preceding the closing date of the 2007-2008 Winter Offering (the “Conversion
Price”).  Up to $1,042,800 Conversion Shares are issuable at a
Conversion Price of $0.50 per share.




Each of
the investors in the 2007-2008 Winter Offering received, for no additional
consideration, a warrant (the “2007-2008 Winter Warrants”), entitling the holder
to purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the (2007-2008 Winter Notes) are
convertible (the “2007-2008 Warrant
Shares”)  Each  2007-2008 Winter Warrant is exercisable on a
cash basis only at a Price of $0.50 per share, and is exercisable for a period
of two years from the date of issuance.  Up to 521,400 2007-2008
Warrant Shares are initially issuable on exercise of the 2007-2008 Winter
Warrants.  As of December 31, 2008, investors have converted $455,400
of the Convertible Notes into 910,800 shares of the Company’s common
stock.  The outstanding balance at December 31, 2008 is $66,000. These
Notes were converted in January 2009.





2008
Spring Offering





On May
27, 2008,  the Company made an offering (the “2008 Spring Offering”)
with a certain investor of which, $66,000 face amount of the 2008 Spring
Note was sold for $60,000 net proceeds.  Therefore, while the stated
interest rate on the 2008 Spring Note is 0%, the implied interest rate on the
2008 Spring Note is 10%. The 2008 Spring Note will mature on the first
anniversary of the date of issuance.  The 2008 Spring Note is
convertible, at the option of the noteholder, into shares of common stock of the
Company (the “Conversion Shares”) at a conversion price equal to the average of
the closing bid price of the Company’s common stock for the five trading days
preceding the closing date of the 2008 Spring Offering (the “Conversion
Price”).  The 132,000 Conversion Shares are issuable at a Conversion
Price of $0.50 per share.




31





The
investor in the 2008 Spring Offering received, for no additional consideration,
a warrant (the “ 2008 Spring Warrants”), entitling the holder to purchase a
number of shares of the Company’s common stock equal to 50% of the number of
shares of common stock into which the ( 2008 Spring Notes) are convertible (the
“2008 Spring Warrant Shares”).  The 2008 Spring Warrant Shares is
exercisable on a cash basis only at a Price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  The
66,000 2008 Spring Warrant Shares are initially issuable upon exercise of the
2008 Spring Warrants.  As of December 31, 2008, investors have
converted $66,000 of the Convertible Notes into 132,000 shares of the Company’s
common stock.  There   was no outstanding balance at
December 31, 2008.





2008
Summer Offering





From July
17, 2008 to August 31, 2008,  the Company conducted an offering (the
“2008 Summer Offering”) of up to $600,000 aggregate face amount of its
convertible notes “the”2008 Summer Offering) with a small number of accredited
investors. Of this amount $484,000 aggregate face amount of the 2008 Summer
Notes were sold for an aggregate purchase price of $440,000 net
proceeds.  Therefore, while the stated interest rate on the 2008
Summer Notes is 0%, the implied interest rate on the 2008 Summer Notes is
10%.  The 2008 Summer Notes will mature on the first anniversary of the
date of issuance.  The 2008 Summer Notes are convertible, at the
option of the noteholders, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Summer Offering (the “Conversion Price”).  Up
to 1,423,530 Conversion Shares are issuable at a Conversion Price of $0.34 per
share.




Each of
the investors in the 2008 Summer Offering received, for no additional
consideration, a warrant (the “ 2008 Summer Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Summer Notes) are
convertible (the “2008 Summer Warrant Shares”). Each 2008 Summer Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 711,764 2008 Summer Warrant Shares are initially issuable upon exercise of
the 2008 Summer Warrants.  As of December 31, 2008, investors have
converted $143,000 of the Convertible Notes into 420,589 shares of the Company’s
common stock.  The outstanding balance at December 31, 2008 was
$341,000.





2008
Fall Offering





From
September 8, 2008 to October 31, 2008, the Company conducted an offering (the
“2008 Fall Offering”) of up to $500,000 aggregate face amount of its Convertible
Notes.  A total of $198,220 aggregate face amount of the 2008 Fall
Notes were sold for an aggregate purchase price of $180,220 net
proceeds.  Therefore, while the stated interest on the 2008 Fall Notes
is 0%, the implied interest rate on the 2008 Fall Notes is 10%.  The
2008 fall notes will mature on the first anniversary of the date of
issuance.  The 2008 Fall Notes are convertible, at the option of the
noteholders, into shares of common stock of the Company (the “Conversion
Shares”) at a conversion price equal to the average of the closing bid price of
the Company’s common stock for the five trading days preceding the closing date
of the 2008 Fall Offering (the “Conversion Price”).  Up to 1,321,466
Conversion Shares are issuable at a Conversion Price of $0.15 per
share.





Each of
the investors in the 2008 Fall Offering received, for no additional
consideration, a warrant (the “ 2008 Fall Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Fall Notes) are
convertible (the “2008 Fall Warrant Shares”). Each 2008 Fall Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 660,734 2008 Fall Warrant Shares are initially issuable upon exercise of the
2008 Fall Warrants.  As of December 31, 2008, investors have converted
$46,200 of the Convertible Notes into 308,000 shares of the Company’s common
stock.  The outstanding balance at December 31, 2008 was
$152,020.  During January 2009, $24,200 Notes were
converted.





32





2008
Winter Offering





From
November 24, 2008 to December 5, 2008, the Company conducted an offering (the
“2008 Winter Offering”) of up to $500,000 aggregate face amount of its
Convertible Notes.  A total of $524,700 aggregate face amount of the
2008 Winter Notes were sold for an aggregate purchase price of $477,000 net
proceeds.  Therefore, while the stated interest on the 2008 Winter
Notes is 0%, the implied interest rate on the 2008 Winter Notes is
10%.  The 2008 Winter Notes will mature on the first anniversary of
the date of issuance.  The 2008 Winter Notes are convertible, at the
option of the noteholders, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Winter Offering (the “Conversion Price”).  Up
to 3,086,470 Conversion Shares are issuable at a Conversion Price of $0.17 per
share.





Each of
the investors in the 2008 Winter Offering received, for no additional
consideration, a warrant (the “ 2008 Winter Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Winter Notes) are
convertible (the “2008 Winter Warrant Shares”). Each 2008 Winter Warrant is
exercisable on a cash basis only at a price of $0.30 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 1,543,235 2008 Winter Warrant Shares are initially issuable upon exercise of
the 2008 Winter Warrants.  As of December 31, 2008, investors have
converted $187,000 of the Convertible Notes into 1,099,999 shares of the
Company’s common stock.  The outstanding balance at December 31, 2008
was $337,700.  During January 2009, $110,000 Notes were
converted.





Summary




We have
cash on hand to meet expenses only for a short period of time.  In
order to fund the repayment of our outstanding notes, we must raise additional
funds. At December 31, 2008, these notes included the Winter 2007/2008 Notes due
in February 2009, the Summer 2008 Notes due in August 2009,  the Fall
2008 Notes due in October 2009 and the Winter 2008 Notes due in December
2009.  In addition to the funds required to continue to operate our
business, including without limitation the expenses we will incur in connection
with the license and research and development agreements with Temple University,
costs associated with product development and commercialization of the ELEKTRA
technology, costs to manufacture and ship our products, costs to design and
implement an effective system of internal controls and disclosure controls and
procedures, costs of maintaining our status as a public company by filing
periodic reports with the SEC, and costs required to protect our intellectual
property. In addition, as discussed below, we have substantial contractual
commitments, including without limitation salaries to our executive officers
pursuant to employment agreements, certain severance payments to a former
officer and consulting fees, during the remainder of 2009 and
beyond.




In light
of the Company’s financial commitments over the next several months and its
liquidity constraints, we have implemented cost reduction measures in all areas
of operations, including but not limited to personnel lay-offs, marketing and
advertising, deferral of placing orders to manufacturers of our ECO ChargR and
MAG ChargR products for sale to our existing distributors, research and
development and product development of ELEKTRA products, and certain other
expenses.  We intend to review these measures on an ongoing basis and
make additional decisions as may be required.




Therefore,
in addition to the completed 2008 Winter Offering, the 2009 Winter Offering
and  the 2009 Winter Offering #2, the Company is actively pursuing
additional financing alternatives   No assurance can be given that any
future financing will be available or, if available, that it will be on terms
that are satisfactory to the Company. At present, we have relatively few
financing options available to us.




33


Contractual
Obligations




The
following table discloses our contractual commitments for future periods.
Long-term commitments are comprised operating leases and minimum guaranteed
compensation payments under employment and other agreements.  See Note
10 to Notes to Consolidated Financial Statements, “Commitments and
Contingencies”.





Year ending December 31,
                  
                  Operating
      Leases (1)
                  
                  
                  Guaranteed
      Payments2009
                  
                  $
                  43,840
                  
                  
                  $
                  466,200
                  (2)2010
                  
                  
                  0
                  
                  
                  
                  142,567
                  (3)Total
                  
                  $
                  43,840
                  
                  
                  $
                  608,767




(1)
            Consists
      of rent for our Morgan Hill Facility expiring on August 31, 2009. (For
      description of this property, see Part 1, Item 2, and
      “Property”.


(2)
            Consists
      of an aggregate of $72,967 in total compensation, including base salary
      and certain contractually-provided benefits, to   one
      executive officer, pursuant to an employment agreement that expires on
      July 25, 2009; $193,233 in total compensation, including base salary and
      certain contractually-provided benefits, to an executive officer, pursuant
      to an employment agreement that expires on January 30, 2010 and $200,000
      in licensing and maintenance fees to Temple
  University.


(3)
            Consists
      of  an aggregate of $17,567 in total compensation, including
      base salary and certain contractually-provided benefits to an executive
      officer, pursuant to an employment agreement that expires on January 30,
      2010 and $125,000 in licensing and maintenance fees due to Temple
      University.




Licensing Fees to
Temple University.For details of the licensing agreements
with Temple University, see Part I, Item 1, “Business - Our Business Strategy -
Our Technologies and Products”.





Critical
Accounting Policies and Estimates




Our
discussion and analysis of financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these consolidated financial statements and related
disclosures requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, expenses, and related disclosure of contingent
assets and liabilities. We evaluate, on an on-going basis, our estimates and
judgments, including those related to the useful life of the assets. We base our
estimates on historical experience and assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates.




The
methods, estimates and judgments we use in applying our most critical accounting
policies have a significant impact on the results that we report in our
consolidated financial statements. The SEC considers an entity’s most critical
accounting policies to be those policies that are both most important to the
portrayal of a company’s financial condition and results of operations and those
that require management’s most difficult, subjective or complex judgments, often
as a result of the need to make estimates about matters that are inherently
uncertain at the time of estimation. . For a more detailed discussion of the
accounting policies of the Company, see Note 2 of the Notes to the Consolidated
Financial Statements, “Summary of Significant Accounting Policies”.




We
believe the following critical accounting policies, among others, require
significant judgments and estimates used in the preparation of our consolidated
financial statements.




The
preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Certain significant estimates were made in connection with
preparing our consolidated financial statements as described in Note 1 to Notes
to Consolidated Financial Statements. See Item 7, “Financial Statements”.
Actual results could differ from those estimates.




34


Revenue
Recognition




The
Company has adopted Staff Accounting Bulletin 104, “Revenue Recognition” and
therefore recognizes revenue based upon meeting four criteria:





●
                Persuasive
      evidence of an arrangement exists;●
                Delivery
      has occurred or services rendered;●
                The
      seller’s price to the buyer is fixed or determinable;
  and●
                Collectability
      is reasonably assured.





The
Company contract manufactures fixed magnetic field products and sells them to
various original equipment manufacturers in the motor vehicle and small utility
motor markets. The Company negotiates an initial contract with the customer
fixing the terms of the sale and then receives a letter of credit or full
payment in advance of shipment. Upon shipment, the Company recognizes the
revenue associated with the sale of the products to the
customer.  Freight charges pertaining to shipments are recorded as
General and Administrative Expense.




Accounts
Receivable Allowance Policy




The
Company reports accounts receivable in relation to sales of
product.  The Company performs an analysis of the receivable balances
in order to determine if an allowance for doubtful accounts is
necessary.  As of December 31, 2008, no allowance is
necessary.




Property
and equipment and depreciation




Property
and equipment are stated at cost. Depreciation is computed using the
straight-line method based on the estimated useful lives of the assets,
generally ranging from three to ten years. Expenditures for major renewals and
improvements that extend the useful lives of property and equipment are
capitalized. Expenditures for repairs and maintenance are charged to expense as
incurred. Leasehold improvements are amortized using the straight-line method
over the shorter of the estimated useful life of the asset or the lease
term.





Long-lived
assets




The
Company accounts for the impairment and disposition of long-lived assets in
accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” In accordance with SFAS No. 144,
long-lived assets to be held are reviewed for events or changes in circumstances
that indicate that their carrying value may not be recoverable. The Company
periodically reviews the carrying values of long-lived assets to determine
whether or not impairment to such value has occurred. No impairments were
recorded for the year ended December 31, 2007.  The Company recorded
an impairment of approximately $505,000 during the period from inception
(February 18, 1998) through December 31, 2007.





Stock-Based
Compensation





On
January 1, 2006, the Company adopted Statements of Financial Accounting
Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors based on estimated
fair values. SFAS 123(R) supersedes the Company’s previous accounting under
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005,
the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the
provisions of SAB 107 in its adoption of SFAS 123(R).




The
Company adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of January 1,
2006, the first day of the Company’s fiscal year 2006. The Company’s financial
statements for the years ended December, 2008 and 2007 reflect the impact of
SFAS 123(R). In accordance with the modified prospective transition method, the
Company’s financial statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation
expense recognized under SFAS 123(R) for employee and directors for the years
ended December 31, 2008 and 2007 were $645,745 and $67,592,
respectively.




35





The
Company’s determination of fair value of share-based payment awards to employees
and directors on the date of grant uses the Black-Scholes model, which is
affected by the Company’s stock price as well as assumptions regarding a number
of highly complex and subjective variables. These variables include, but are not
limited to our expected stock price volatility over the term of the awards, and
actual and projected employee stock option exercise
behaviors.  Forfeitures are recognized as incurred.




The
Company accounts for stock option and warrant grants issued to non-employees for
goods and services using the guidance of SFAS No. 123 and Emerging Issues
Task Force (“EITF”) No. 96-18: “Accounting for Equity Instruments that are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services,” whereby the fair value of such option and warrant grants is
determined using the Black-Scholes option pricing model at the earlier of the
date at which the non-employee’s performance is completed or a performance
commitment is reached.




Recent
accounting pronouncements
  In March
2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments
and Hedging Activities, an amendment of FASB Statement No. 133" (SFAS 161). This
Statement requires enhanced disclosures about an entity's derivative and hedging
activities, including (a) how and why an entity uses derivative instruments, (b)
how derivative instruments and related hedged items are accounted for under SFAS
No. 133,  "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133), and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity's financial position,
financial performance, and cash flows. SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008.
 
 In
December 2007, the FASB issued FASB Statement No. 141 (R), "Business
Combinations" (FAS 141(R)), which establishes accounting principles and
disclosure requirements for all transactions in which a company obtains control
over another business.  Statement 141 (R) applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008.  Earlier adoption is prohibited.
 
 In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51".  SFAS
No. 160 establishes accounting and reporting standards that require that the
ownership interests in subsidiaries held by parties other than the parent be
clearly identified, labeled, and presented in the consolidated statement of
financial position within equity, but separate from the parent's equity; the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income; and changes in a parent's ownership interest
while the parent retains its controlling financial interest in its subsidiary be
accounted for consistently.  SFAS No. 160 also requires that any
retained noncontrolling equity investment in the former subsidiary be initially
measured at fair value when a subsidiary is deconsolidated.  SFAS No.
160 also sets forth the disclosure requirements to identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners.  SFAS No. 160 applies to all entities that prepare
consolidated financial statements, except not-for-profit organizations, but will
affect only those entities that have an outstanding noncontrolling interest in
one or more subsidiaries or that deconsolidate a subsidiary.  SFAS No.
160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  SFAS No. 160 must be applied prospectively as of the
beginning of the fiscal year in which it is initially applied, except for the
presentation and disclosure requirements.  The presentation and
disclosure requirements are applied retrospectively for all periods
presented.


36


Item
7A.  Quantitative
and Qualitative Disclosure About Market Risk
 
 Not
Applicable




Item 8.  
Financial
Statements





Our
consolidated financial statements as of and for the years ended December 31,
2008 and 2007 are presented in a separate section of this report following Item
14 and begin with the index on page F-1.





Item 9. 
Changes in and Disagreements
with Accountants on Accounting and Financial Disclosure





None.





Item 9A(T). 
Controls and
Procedures





Evaluation
of Disclosure Controls and Procedures





Our
management evaluated, with the participation of our Chief Executive Officer and
Interim Chief Financial Officer, the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this Annual Report on Form
10-K. Based on this evaluation, our Chief Executive Officer and Interim Chief
Financial Officer have concluded that our disclosure controls and procedures (as
defined in Rules 13a-15(b) under the Securities Exchange Act of 1934 (the
“Exchange Act”)  are not adequate to ensure that information required
to be disclosed by us in reports that we file or submit under the Exchange Act
is recorded, processed, summarized and reported within the time periods
specified in SEC rules and forms.





Management’s
Annual Report on Internal Control over Financial Reporting.





Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles and includes those policies and procedures that
(i) pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transaction and dispositions of our assets; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that our receipts and expenditures are being made
only in accordance with authorizations of our management and directors; and
(iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a
material effect on the financial statements.




Because
of its inherent limitation, internal control over financial reporting cannot
provide absolute assurance of achieving financial reporting
objectives.




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as required in Rule 13a-15(b).  In
December 2006 our Controller retired and in January 2007 our Chief Financial
Officer retired, although our former Controller still provides certain financial
consulting services for us.  We have hired an Interim Chief Financial
Officer and a full-time Controller.  We have retained a consulting
firm and are conducting an evaluation to design and implement adequate systems
of accounting and financial statement disclosure controls. We expect to complete
this review during 2009 to comply with the requirements of the
SEC.  We believe that the ultimate success of our plan to improve
our internal control over financial reporting will require a
combination of additional financial resources, outside consulting services,
legal advice, additional personnel, further reallocation of responsibility among
various persons, and substantial additional training of those of our officers,
personnel and others, including certain of our directors such as our Chairman of
the Board and committee chairs, who are charged with implementing and/or
carrying out our plan.  It should also be noted that the design of any
system of controls and procedures is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.




Our
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting and
management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the SEC that permit us to provide
only Management’s report in this annual report.


37





Other
than as described above, there were no changes in our internal control over
financial reporting that occurred during the period covered by this Annual
Report on Form 10-K that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.





Item 9B.Other
Information





On January 9, 2009,  weentered into an Agreement with (Endeavor Group, LLC). We have retained
Endeavor Group, LLC as our non-exclusive financial advisor and investment
banking advisor to provide general financial advisory and investment banking
service to us. We paid Endeavor Group, LLC $10,000 upon execution of the
agreement and will pay additional fees relating to capital investments which may
be received by us. We mayissue to
Endeavor stock certificates representing an aggregate of 500,000 shares of
common stock of which 250,000 shares were issued upon execution of this
Agreement, with the remaining 250,000 shares, to be issued as compensation for
investment fundsreceived by us, if
any, ifcertain goals are met.





On January 28, 2009, we entered into an
Agreement with a consultant to provide services to prepare a five year business
plan including detailed income, balance and cash flow statements; capital
requirements; use of proceeds; competition analysis and an AOT market
analysis.  The consultant is to be paid $7,000 for the first month and
$5,000 for the second and third monthsof his
services for a total of $17,500.  The consultant has
received 30,000 restricted shares of common stock.





On January 30, 2009, Cecil Bond Kyte
was appointed Chief Executive Officer of the Company, replacing Charles R.
Blum.  Mr. Blum continues to serve as President of the
Company.


From
January 13, 2009, through January 26, 2009, the Company conducted and concluded
a private offering (the “Winter 2009 Offering”) of up to $250,000 aggregate face
amount of its convertible notes (the “Winter 2009 Notes”) with 8 accredited
investors. A total of $250,000 aggregate face amount of the Winter 2009 Notes
were sold for an aggregate purchase price of $250,000.  The Winter
2009 Notes bear interest at 10% per annum, payable at maturity. The Winter 2009
Notes mature three months from  their date of issuance. The Winter
2009 Notes are convertible, at the option of the noteholder, into shares of
common stock of the Company (the “Conversion Shares”) at an initial conversion
price equal to the average of the closing bid price of the Company’s common
stock for the five trading days preceding the closing dates of the Winter 2009
Offering (the “Conversion Price”). Up to 694,444 Conversion Shares are initially
issuable at a Conversion Price of $0.36 per share.





Each of
the investors in the Winter 2009 Offering received, for no additional
consideration, a warrant (the “Winter 2009 Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Winter 2009 Notes are
convertible (the “Warrant Shares”).  Each Winter 2009 Warrant is
exercisable on a cash basis only at an initial price of $0.50 per share, and is
exercisable immediately upon issuance and for a period of two (2) years from the
date of issuance. Up to 347,722 Warrant Shares are initially issuable on
exercise of the Winter 2009 Warrants.





We
received $250,000 in net proceeds in the Winter 2009 Offering which will be used
for general corporate purposes and working capital.





From February 4, 2009 to March 11,
2009,  we conducted and concluded a private offering (the “2009 Winter
Offering #2”)  of up to $250,000 aggregate face amount of its
convertible notes (the “Winter 2009 #2 Notes”) with 17 accredited
investors.  A total of $247,302 aggregate face amount of the Winter
2009 #2 Notes were sold for an aggregate purchase price of
$224,820.  While the stated interest rate on the Winter 2009 #2 Notes
is 0%, the actual interest rate on the Winter 2009 #2 Notes is 10% per
annum.  The Winter 2009 #2 Notes mature on the first anniversary of
their date of issuance.  The Winter 2009 #2 Notes are convertible, at
the option of the noteholder, into shares of common stock of the Company (the
“Conversion Shares”) at an initial conversion price equal to the average of the
closing bid price of the Company’s common stock for the five trading days
preceding the closing dates of the Winter 2009 #2 Offering (the
“Conversion  Price”).  Up to 772,818 Conversion Shares are
initially issuable at a Conversion Price of $0.32 per share.





38


Each of the investors in the Winter
2009 #2 Offering received, for no additional consideration, a warrant (the
“Winter 2009 #2 Warrants”), entitling the holder to purchase a number of shares
of the Company’s common stock equal to 50% of the number of shares of common
stock into which the Winter 2009 #2 Notes are convertible (the “Warrant
Shares”).  Each Winter 2009 #2 Warrant is exercisable on a cash basis
only at an initial price of $0.50 per share, and is exercisable immediately upon
issuance and for a period of two (2) years from the date of
issuance.  Up to 386,409 Warrant Shares are initially issuable on
exercise of the Winter 2009 #2 Warrants.





We received $224,820 in net proceeds in
the Winter 2009 #2 Offering which will be used for general corporate purposes
and working capital.








PART
III





Information
required by Part III is incorporated by reference from our Proxy Statement
to be filed with the Securities and Exchange Commission in connection with the
solicitation of proxies for our 2009 Annual Meeting of Stockholders, currently
scheduled to be held on April 30, 2009 (the “Proxy Statement”).





Item 10.Directors and Executive
Officers of Registrant





The
information required by this section is incorporated by reference to the Proxy
Statement.





Code of Business
Conduct.





We have
adopted codes of business conduct and ethics for our directors, officers and
employees which also meet the requirements of a code of ethics under
Item 406 of Regulation S-K. You can access the Company’s Code of
Business Conduct and Ethics and our Code of Ethics for Senior Executives and
Financial Officers on the Corporate Governance page of the Company’s website
atwww.stwa.com.
Any shareholder who so requests may obtain a printed copy of the Code of Conduct
by submitting a request to the Company’s Corporate Secretary.





Item 11.Executive
Compensation





The
information required by this section is incorporated by reference to the Proxy
Statement.





Item 12.Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder
Matters





The
information required by this section is incorporated by reference to the Proxy
Statement.





Item 13.Certain Relationships
and Related Transactions





The information required by this
section is incorporated by reference to the Proxy Statement.





Item 14.  
Principal Accountant Fees and
Services




The Audit
Committee has selected Weinberg & Company, P.A. to audit our financial
statements for the fiscal year ended December 31, 2008.




39





Weinberg &
Company, P.A. was first appointed in fiscal year 2003, and has audited our
financial statements for fiscal years 2002 through 2008.




Audit
and Other Fees




The
following table summarizes the fees charged by Weinberg & Company, P.A.
for certain services rendered to the Company during 2008 and 2007.




AmountType of
      Fee
                
                Fiscal
                  Year 2008
                
                
                Fiscal
                  Year 2007Audit(1)
                
                $
                103,850
                
                
                $
                193,186Audit
      Related(2)
                
                
                0
                
                
                
                0Taxes
      (3)
                
                
                0
                
                
                
                0All
      Other (4)
                
                
                0
                
                
                
                0Total
                
                $
                103,850
                
                
                $
                193,186






(1)
            This
      category consists of fees for the audit of our annual financial statements
      included in the Company’s annual report on Form 10-K and review of
      the financial statements included in the Company’s quarterly reports on
      Form 10-Q. This category also includes advice on audit and accounting
      matters that arose during, or as a result of, the audit or the review of
      interim financial statements, statutory audits required by
      non-U.S. jurisdictions and the preparation of an annual “management
      letter” on internal control matters.(2)
            Represents
      services that are normally provided by the independent auditors in
      connection with statutory and regulatory filings or engagements for those
      fiscal years, aggregate fees charged for assurance and related services
      that are reasonably related to the performance of the audit and are not
      reported as audit fees. These services include consultations regarding
      Sarbanes-Oxley Act requirements, various SEC filings and the
      implementation of new accounting requirements.(3)
            Represents
      aggregate fees charged for professional services for tax compliance and
      preparation, tax consulting and advice, and tax
  planning.(4)
            Represents
      aggregate fees charged for products and services other than those services
      previously reported.







PART
IV





Item 15.  
Exhibits





(a)
            The
      following documents are filed as part of this Form
  10-K.





Financial
Statements:





Reference
is made to the contents to the consolidated financial statements of Save the
World Air, Inc. under Item 7 of this Form 10-K.





(b)
            Exhibits:





40





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




Exhibit
      No.
              
              Description3.1(1)
              
              Articles
      of Incorporation, as amended, of the Registrant.3.2(1)
              
              Bylaws
      of the Registrant.10.1(2)
              
              Commercial
      Sublease dated October 16, 2003 between the Registrant and KZ Golf,
      Inc.10.2(9)
              
              Amendment
      dated June 15, 2004 to Exhibit 10.110.3
      (10)
              
              Amendment
      dated August 14, 2005 to Exhibit 10.110.4(10)
              
              General
      Tenancy Agreement dated March 14, 2006 between the Registrant and Autumlee
      Pty Ltd.10.5(3)
              
              Agreement
      dated December 13, 2002 between the Registrant and
    RAND.10.6(2)**
              
              Agreement
      dated May 7, 2003 between the Registrant and RAND.10.7(5)
              
              Modification
      No. 1 dated as of August 21, 2003 to
      Exhibit 10.510.8(5)
              
              Modification
      No. 2 dated as of October 17, 2003 to
      Exhibit 10.510.9(5)
              
              Modification
      No. 3 dated as of January 20, 2004 to
      Exhibit 10.510.10(4)
              
              Deed
      and Document Conveyance between the Trustee of the Property of Jeffrey Ann
      Muller and Lynette Anne Muller (Bankrupts).10.11(4)
              
              Assignment
      and Bill of Sale dated May 28, 2002 between the Registrant and Kevin
      Charles Hart.10.12(11)†
              
              Amended
      and Restated Employment Agreement dated October 5, 2005 between the
      Registrant and Eugene E. Eichler.10.13(15)†
              
              Severance
      Agreement dated November 8, 2006 between the Registrant and Eugene E.
      Eichler10.14(11)†
              
              Amended
      and Restated Employment Agreement dated October 5, 2005 between the
      Registrant and Bruce H. McKinnon.10.15(6)
              
              Save
      the World Air, Inc. 2004 Stock Option Plan10.16(8)
              
              Form
      of Incentive Stock Option Agreement under 2004 Stock Option
      Plan10.17(8)
              
              Form
      of Non-Qualified Stock Option Agreement under 2004 Stock Option
      Plan10.18(8)
              
              Consulting
      Agreement dated as of October 1, 2004 between the Registrant and John
      Fawcett10.19(7)
              
              License
      Agreement dated as of July 1, 2004 between the Registrant and Temple
      University – The Commonwealth System of Higher Education10.20(8)
              
              Consulting
      Agreement dated as of November 19, 2004 between the Registrant and London
      Aussie Marketing, Ltd.10.21(13)
              
              Amendment
      dated September 14, 2006 to Exhibit 10.2010.22(8)†
              
              Employment
      Agreement dated September 1, 2004 with Erin Brockovich10.23(15)†
              
              Amendment
      dated as of July 31, 2006 to Exhibit 10.2210.24(8)
              
              Assignment
      of Patent Rights dated as of September 1, 2003 between the Registrant
      and Adrian Menzell10.25(8)
              
              Global
      Deed of Assignment dated June 26, 2004 between the Registrant and
      Adrian Menzell10.26(11)†
              
              Amended
      and Restated Employment Agreement dated as of March 1, 2006 between the
      Registrant and John Richard Bautista III10.27(9)
              
              Lease
      dated August 15, 2005 between the Registrant and Thomas L.
      Jackson10.28(10)
              
              Amendment
      dated February 1, 2006 to Exhibit 10.2710.29(10)
              
              Form
      of 9% Convertible Note issued in the 2005 Interim
Financing10.30(10)
              
              Form
      of Stock Purchase Warrant issued in the 2005 Interim
    Financing10.31(10)
              
              Form
      of Stock Purchase Warrant issued in the 2005 Bridge
    Financing10.32(11)
              
              Form
      of Stock Purchase Warrant issued in 2006 Regulation S
      financing10.33(11)
              
              Form
      of Stock Purchase Warrant issued in 2006 PIPE financing10.34(12)
              
              Commercial
      Sublease between the Registrant and KZG Golf dated January 1,
      200610.35(12)
              
              Investment
      Agreement dated September 15, 2006 between the Registrant and Dutchess
      Private Equities Fund10.36(12)
              
              Registration
      Rights Agreement dated September 15, 2006 between the registrant and
      Dutchess Private Equities Fund, LLP10.37(17)
              
              License
      Agreement between the Registrant and Temple University dated February 2,
      2007


41





10.38(17)
                            
                            License
      Agreement between the Registrant and Temple University dated February 2,
      200710.39(17)
                            
                            R&D
      Agreement between the Registrant and Temple University dated February 2,
      200710.40(14)
                            
                            Note
      Purchase Agreement dated December 5, 2006 between the registrant and
      Morale Orchards LLC10.41(14)
                            
                            Form
      of Stock Purchase Warrant issued to Morale Orchards LLC10.42(14)
                            
                            Form
      of Convertible Note issued to Morale Orchards LLC10.43(16)
                            
                            Consulting
      Agreement dated January 4, 2007 between the Registrant and Spencer Clarke
      LLC10.44(15)
                            
                            Agreement
      dated as of July 15, 2006 between the Company and SS Sales and Marketing
      Group10.45(15)
                            
                            Engagement
      Agreement between the Registrant and Charles K. Dargan II10.46(15)
                            
                            Form
      of 10% Convertible Note issued in 2007 PIPE Offering10.47(15)
                            
                            Form
      of Stock Purchase Warrant issued in 2007 PIPE Offering10.48(18)
                            
                            Appointment
      of New Directors, Nathan Shelton, Steven Bolio and Dennis
      Kenneally10.49(19)
                            
                            Issuance
      of RAND Final Report10.50(20)
                            
                            Delisting
      from OTCBB to OTC Pink Sheets10.51(21)
                            
                            Resignation
      of Director, Dennis Kenneally10.52(22)
                            
                            Resignation
      of Officer, Bruce H. McKinnon10.53(23)
                            
                            Form
      of 10% Convertible Note issued in 2007 Spring Offering10.54(23)
                            
                            Form
      of Stock Purchase Warrant issued in 2007 Spring Offering10.55(24)
                            
                            Termination
      of North Hollywood Lease10.56(25)
                            
                            Modification
      Agreement of 10% 2007 PIPE Convertible Notes10.57(26)
                            
                            Form
      of 10% Convertible Note issued in 2007 Summer Offering10.58(26)
                            
                            Form
      of Stock Purchase Warrant issued in 2007 Summer Offering10.59(27)
                            
                            Resignation
      of Director, J. Joseph Brown10.60(28)
                            
                            Resignation
      of Chief Financial Officer and Appointment of Interim Chief Financial
      Officer10.61(29)
                            
                            Severance
      Agreement dated June 15, 2007 between Registrant and Bruce H.
      McKinnon10.62(30)
                            
                            Resignation
      of Director, Bruce H. McKinnon10.63(31)
                            
                            Second
      Modification Agreement of 10% 2007 PIPE Convertible Notes10.64(32)
                            
                            Form
      of 10% Convertible Note issued in 2007 Fall Offering10.65(32)
                            
                            Form
      of Stock Purchase Warrant issued in 2007 Fall Offering10.66(33)
                            
                            Resignation
      of Director, Joseph Helleis10.67(34)
                            
                            Form
      of 10% Convertible Note issued in 2007/8 Winter Offering10.68(34)
                            
                            Form
      of Stock Purchase Warrant issued in 2007/8 Winter Offering10.69(34)
                            
                            Modification
      and Satisfaction Agreement of Convertible Notes with Morale Orchards, LLP
      and Matthews & Partners10.70(35)
                            
                            Termination
      of employment relationship with John Bautista10.71(36)
                            
                            Form
      of 10% Convertible Note issued in 2008 Summer OfferingForm
      of Stock Purchase Warrant issued in 2008 Summer Offering10.72(37)
                            
                            Form
      of 10% Convertible Note issued in 2008 Fall OfferingForm
      of Stock Purchase Warrant issued in 2008 Fall Offering10.73(38)
                            
                            Form
      of 10% Convertible Note issued in 2008 Winter OfferingForm
      of Stock Purchase Warrant issued in 2008 Winter Offering10.74(39)
                            
                            Letter
      Agreement with Temple University extending default date10.75(40)
                            
                            Notice
      of first payment to Temple University under Letter
    AgreementAnnouncement
      of date of 2009 Annual Shareholder MeetingAppointment
      of Cecil Bond Kyte as new Chief Executive Officer10.76(41)
                            
                            Form
      of 10% Convertible Note issued in 2009 Winter OfferingForm
      of Stock Purchase Warrant issued in 2009 Winter Offering10.77(42)*
                            
                            Employment
      Agreement with Cecil Bond Kyte, January 30, 200910.78(43)
                            
                            Form
      of 10% Convertible Note issued in 2009 Winter #2 OfferingForm
      of Stock Purchase Warrant issued in 2009 Winter #2
Offering21
                            
                            List
      of Subsidiaries24*
                            
                            Power
      of Attorney (included on Signature Page)31.1*
                            
                            Certification
      of Chief Executive Officer of Annual Report Pursuant to
      Rule 13(a)—15(e) or Rule 15(d)—15(e).31.2*
                            
                            Certification
      of Chief Financial Officer of Annual Report Pursuant to 18 U.S.C.
      Section 1350.32.1*
                            
                            Certification
      of Chief Executive Officer and Chief Financial Officer of Annual Report
      pursuant to Rule 13(a)—15(e) or
Rule 15(d)—15(e).


42





*
            
            Filed
      herewith.**
            
            Confidential
      treatment previously requested.†
            
            Management
      contract or compensatory plan or arrangement.(1)
            
            Incorporated
      by reference from Registrant’s Registration Statement on Form 10-SB
      (Registration Number 000-29185), as amended, filed on March 2,
      2000.(2)
            
            Incorporated by reference from
      Registrant’s Form 10-KSB for the fiscal year ended December 31,
      2002.(3)
            
            Incorporated by reference from
      Registrant’s Form 8-K filed on December 30,
      2002.(4)
            
            Incorporated by reference from
      Registrant’s Form 8-K filed on November 12,
      2002.(5)
            
            Incorporated by reference from
      Registrant’s Form 10-QSB for the quarter ended March 31,
      2004.(6)
            
            Incorporated by reference from
      Appendix C of Registrant’s Schedule 14A filed on April 30,
      2004, in connection with its Annual Meeting of Stockholders held on
      May 24, 2004.(7)
            
            Incorporated by reference from
      Registrant Form 8-K filed on July 12,
    2004.(8)
            
            Incorporated by reference from
      registrant’s Form 10-KSB for the fiscal year ended December 31,
      2004.(9)
            
            Incorporated by reference from
      Registrant’s Form 10-QSB for the quarter ended September 30,
      2005(10)
            
            Incorporated by reference from
      Registrant’s Form 10-KSB for the fiscal year ended December 31,
      2005(11)
            
            Incorporated by reference from
      Registrant’s Form SB-2 filed on June 28, 2006 (SEC File No. 333-
      333-135415)(12)
            
            Incorporated by reference from
      Registrant’s Form 8-K filed on September 21,
    2006(13)
            
            Incorporated by reference from
      Registrant’s Form SB-2 filed on October 6, 2006 (SEC File No.
      333-137855)(14)
            
            Incorporated by reference from
      Registrant’s Form 8-K filed on December 11,
    2006(15)
            
            Incorporated by reference from
      Registrant’s Form 10KSB for the fiscal year ended December 31,
      2006(16)
            
            Incorporated by reference from
      Registrant’s form 8-K filed on January 10,
    2007(17)
            
            Incorporated
      by reference from Registrant’s form 8K filed on February 8,
      2007(18)
            
            Incorporated
      by reference from Registrant’s form 8K filed on February 16,
      2007(19)
            
            Incorporated
      by reference from Registrant’s form 8K filed on May 3,
      2007(20)
            
            Incorporated
      by reference from Registrant’s form 8K filed on May 22
      2007(21)
            
            Incorporated
      by reference from Registrant’s form 8K filed on June 8,
      2007(22)
            
            Incorporated
      by reference from Registrant’s form 8K filed on June 15,
      2007(23)
            
            Incorporated
      by reference from Registrant’s form 8K filed on July 2,
      2007(24)
            
            Incorporated
      by reference from Registrant’s form 8K filed on July 18,
      2007(25)
            
            Incorporated
      by reference from Registrant’s form 8K filed on August 30,
      2007(26)
            
            Incorporated
      by reference from Registrant’s form 8K filed on October 9,
      2007(27)
            
            Incorporated
      by reference from Registrant’s form 8K filed on October 23,
      2007(28)
            
            Incorporated
      by reference from Registrant’s form 8K filed on November 9,
      2007(29)
            
            Incorporated
      by reference form Registrant’s Form 10QSB for the nine months ended
      September 30, 2007(30)
            
            Incorporated
      by reference from Registrant’s form 8K filed on November 15,
      2007(31)
            
            Incorporated
      by reference from Registrant’s form 8K filed on December 11,
      2007(32)
            
            Incorporated
      by reference from Registrant’s form 8K filed on December 20,
      2007(33)
            
            Incorporated
      by reference from Registrant’s form 8K filed on February 25,
      2008(34)
            
            Incorporated
      by reference from Registrant’s form 8K filed on March 11,
    2008(35)
            
            Incorporated
      by reference from Registrant’s form 8K filed on March 27,
    2008(36)
            
            Incorporated
      by reference from Registrant’s form 8K filed on September 3,
      2008(37)
            
            Incorporated
      by reference from Registrant’s form 8K filed on November 6,
      2008(38)
            
            Incorporated
      by reference from Registrant’s form 8K filed on December 11,
      2008(39)
            
            Incorporated
      by reference from Registrant’s form 8K filed on January 13,
      2009(40)
            
            Incorporated
      by reference from Registrant’s form 8K filed on January 28,
      2009(41)
            
            Incorporated
      by reference from Registrant’s form 8K filed on January 29,
      2009(42)
            
            Incorporated
      by reference from Registrant’s form 10K for the twelve months ended
      December 31, 2009(43)
            
            Incorporated
      by reference from Registrant’s form 8K filed on March 17,
    2009





43







SIGNATURES








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


Save
      The World Air, Inc.By:
              /s/ CECIL BOND KYTECecil Bond KyteDate:
      March 30, 2009
              
              Chief Executive
      Officer


POWER OF ATTORNEY





KNOW ALL
PERSONS BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints, jointly and severally, Cecil Bond Kyte and Eugene E.
Eichler, and each of them, as his or her true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for him or her and
in his or her name, place and stead, in any and all capacities, to sign any and
all amendments to this Annual Report on Form 10-KSB, and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as he or she might or could do in person,
hereby ratifying and confirming all that said attorneys-in-fact and agents, or
any of them, or their or his or her substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.





Pursuant
to the requirements of the Securities Exchange Act of 1934 this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.





NAME
                  
                  TITLE
                  
                  DATE/s/
      CECIL BOND KYTE
                  
                  Chief
      Executive Officer and Chairman of the Board of Directors
                  
                  March
      30, 2009Cecil
      Bond Kyte/s/
      CHARLES R. BLUM
                  
                  President
                  
                  March
      30, 2009Charles
      R. Blum/s/
      EUGENE E. EICHLER
                  
                  Interim
      Chief Financial Officer
                  
                  March
      30, 2009Eugene
      E. Eichler/s/
      JOHN PRICE
                  
                  Director
                  
                  March
      30, 2009John
      Price/s/
      NATHAN SHELTON
                  
                  Director
                  
                  March
      30, 2009Nathan
      Shelton/s/
      STEVEN BOLIO
                  
                  Director
                  
                  March
      30, 2009Steven
      Bolio





44




INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 SAVE
THE WORLD AIR, INC. AND SUBSIDIARY
 (A
DEVELOPMENT STAGE ENTERPRISE)
 DECEMBER 31, 2008 AND
2007
 
  PageReport
      of Independent Registered Public Accounting Firm
              F-2Consolidated
      balance sheets
              F-3Consolidated
      statements of operations
              F-4Consolidated
      statements of stockholders’ deficiency
              F-5Consolidated
      statements of cash flows
              F-18Notes
      to consolidated financial statements
              F-19
   F-1
 
  REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To the
Board of Directors and Stockholders of:
 Save The
World Air, Inc. and Subsidiary
 
 We have
audited the accompanying consolidated balance sheets of Save The World Air, Inc.
and Subsidiary (a development stage enterprise) (the “Company”) as of December
31, 2008 and 2007, and the related consolidated statements of operations,
stockholders’ deficiency and cash flows for the years then ended and for
the period from February 18, 1998 (inception) to December 31, 2008.  These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
 
 We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion.  An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Save The World
Air, Inc. and Subsidiary as of December 31, 2008 and 2007, and the results of
their operations and their cash flows for the years then ended and for
the period from February 18, 1998 (inception) to December 31, 2008 ,
in conformity with accounting principles generally accepted in the United
States of America.
 
 The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 2 to
the financial statements, the Company has incurred recurring losses
from operations since its inception. These matters raise substantial
doubt about the Company's ability to continue as a going concern.
Management’s plans in regard to these matters are also described in Note 2.
The consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
 
 /s/Weinberg
& Company, P.A.
  Weinberg
& Company, P.A.  Los
Angeles, California
 March
27,
2009




F-2




SAVE
THE WORLD AIR, INC.


(A
DEVELOPMENT STAGE ENTERPRISE)





CONSOLIDATED
BALANCE SHEETS





December 31,2008
                    
                    
                    2007ASSETSCurrent
      assetsCash
                    
                    $
                    59,346
                    
                    
                    $
                    47,660Accounts
      receivable
                    
                    
                    80
                    
                    
                    
                    1,380Inventories
                    
                    
                    —
                    
                    
                    
                    30,256Other
      current assets
                    
                    
                    33,195
                    
                    
                    
                    20,552Total
      current assets
                    
                    
                    92,621
                    
                    
                    
                    99,848Property andEquipment,net
                    
                    
                    131,969
                    
                    
                    
                    201,058Other
      assets
                    
                    
                    11,250
                    
                    
                    
                    4,500Total
      assets
                    
                    $
                    235,840
                    
                    
                    $
                    305,406LIABILITIES
      AND STOCKHOLDERS’ DEFICIENCYCurrent
      liabilitiesAccounts
      payable- related parties
                    
                    $
                    93,003
                    
                    
                    $
                    323,413Accounts
      payable – License Agreements
                    
                    
                    716,500
                    
                    
                    
                    161,250Accounts
      payable- other
                    
                    
                    384,467
                    
                    
                    
                    555,736Accrued
      expenses
                    
                    
                    795,448
                    
                    
                    
                    742,719Accrued
      research and development fees
                    
                    
                    8,347
                    
                    
                    
                    53,347Accrued
      professional fees
                    
                    
                    390,535
                    
                    
                    
                    274,499Loan
      payable- related party
                    
                    
                    78,280
                    
                    
                    
                    83,596Loans
      and other payable due to Morale/Matthews
                    
                    
                    —
                    
                    
                    
                    1,748,452Convertible
      debentures, net- related parties
                    
                    
                    12,466
                    
                    
                    
                    227,136Convertible
      debentures, net- others
                    
                    
                    290,659
                    
                    
                    
                    495,044Total
      current liabilities
                    
                    
                    2,769,705
                    
                    
                    
                    4,665,192Commitments
      and contingenciesStockholders’
      deficiencyCommon
      stock, $.001par value: 200,000,000 shares authorized, 62,940,891 and
      46,470,413, shares issued and outstanding atDecember
      31, 2008 and 2007, respectively
                    
                    
                    62,941
                    
                    
                    
                    46,471Common
      stock to be issued
                    
                    
                    16,500
                    
                    
                    
                    4,000Additional
      paid-in capital
                    
                    
                    40,129,758
                    
                    
                    
                    32,280,083Deficit
      accumulated during the development stage
                    
                    
                    (42,743,064
                    )
                    
                    
                    (36,690,340)Total
      stockholders’ deficiency
                    
                    
                    (2,533,865
                    )
                    
                    
                    (4,359,786
                    )Total
      liabilities and stockholder’s deficiency
                    
                    $
                    235,840
                    
                    
                    $
                    305,406





See notes
to consolidated financial statements.





F-3





SAVE
THE WORLD AIR, INC.


(A
DEVELOPMENT STAGE ENTERPRISE)




CONSOLIDATED
STATEMENTS OF OPERATIONS





Inception(February18,
      1998) toYears
      Ended December 31,
            
            
            December
      31,2008
            
            
            2007
            
            
            2008Net
      sales
            
            $
            —
            
            
            $
            39,000
            
            
            $
            69,000Cost
      of goods sold
            
            
            —
            
            
            
            10,720
            
            
            
            24,120Gross
      profit
            
            
            —
            
            
            
            28,280
            
            
            
            44,880Operating
      expenses
            
            
            3,062,537
            
            
            
            3,956,345
            
            
            
            29,921,858Research
      and development expenses
            
            
            652,363
            
            
            
            600,816
            
            
            
            5,458,593Non-cash
      patent settlement cost
            
            
            —
            
            
            
            —
            
            
            
            1,610,066Loss
      before other income
            
            
            (3,714,900
            )
            
            
            (4,528,881
            )
            
            
            (36,945,637
            )Other
      income (expense)Other
      income (loss)
            
            
            (4,648)
            
            
            
            3,384
            
            
            
            (1,140)Interest
      income
            
            
            —
            
            
            
            91
            
            
            
            16,342Interest
      expense
            
            
            (1,461,927)
            
            
            
            (1,736,537
            )
            
            
            (5,954,306
            )Loss
      on disposition of equipment
            
            
            (14,426
            )
            
            
            —
            
            
            
            (14,426
            )Settlement
      of Debt Due Morale/ Matthews
            
            
            (927,903)
            
            
            
            —
            
            
            
            (927,903)Settlement
      of litigation and debt
            
            
            71,880
            
            
            
            —
            
            
            
            1,089,088Loss
      before provision for income taxes
            
            
            (6,051,924
            )
            
            
            (6,261,943
            )
            
            
            (42,737,982
            )Provision
      for income taxes
            
            
            800
            
            
            
            800
            
            
            
            5,082Net
      loss
            
            $
            (6,052,724
            )
            
            $
            (6,262,743
            )
            
            $
            (42,743,064
            )Net
      loss per common share, basic and diluted
            
            $
            (0.11
            )
            
            $
            (0.16
            )Weighted
      average common shares outstanding, basic and diluted
            
            
            55,130,756
            
            
            
            38,378,845





See notes
to consolidated financial statements.





F-4





SAVE
THE WORLD AIR, INC.


(A
DEVELOPMENT STAGE ENTERPRISE)





CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY


FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008




Price
      per
            
            
            Common
      Stock
            
            
            Common
      Stock
              to
      be
            
            
            Additional
              Paid-in
            
            
            Deferred
            
            
            Deficit
              Accumulated
              During
      the
              Development
            
            
            Total
              Stockholders’Share
            
            
            Shares
            
            
            Amount
            
            
            Issued
            
            
            Capital
            
            
            Compensation
            
            
            Stage
            
            
            DeficiencyBalance, February 18, 1998(date of inception)
            
            
            
            
            
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —Issuance
      of common stock on April 18, 1998
            
            
            .0015 -
      .01
            
            
            
            10,030,000
            
            
            
            10,030
            
            
            
            —
            
            
            
            14,270
            
            
            
            —
            
            
            
            —
            
            
            
            24,300Net
      loss
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (21,307
            )
            
            
            (21,307
            )Balance,
      December 31, 1998
            
            
            
            
            
            
            10,030,000
            
            
            $
            10,030
            
            
            $
            —
            
            
            
            14,270
            
            
            $
            —
            
            
            $
            (21,307
            )
            
            $
            2,993Issuance
      of common stock on May 18, 1999
            
            
            1.00 -
      6.40
            
            
            
            198,003
            
            
            
            198
            
            
            
            —
            
            
            
            516,738
            
            
            
            —
            
            
            
            —
            
            
            
            516,936Issuance
      of common stock for ZEFS on September 14, 1999
            
            
            .001
            
            
            
            5,000,000
            
            
            
            5,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,000Stock
      issued for professional services on May 18, 1999
            
            
            0.88
            
            
            
            69,122
            
            
            
            69
            
            
            
            —
            
            
            
            49,444
            
            
            
            —
            
            
            
            —
            
            
            
            49,513Net
      loss
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,075,264
            )
            
            
            (1,075,264
            )Balance,
      December 31, 1999
            
            
            
            
            
            
            15,297,125
            
            
            $
            15,297
            
            
            $
            —
            
            
            $
            580,452
            
            
            $
            —
            
            
            $
            (1,096,571
            )
            
            $
            (500,822
            )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
            
            
            
            —
            
            
            
            —
            
            
            
            6,675




(continued)
 F-5





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
  CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008





Price
      per
            
            
            Common
      Stock
            
            
            Common
      Stock
              to
      be
            
            
            Additional
              Paid-in
            
            
            Deferred
            
            
            Deficit
              Accumulated
              During
      the
              Development
            
            
            Total
              Stockholders’Share
            
            
            Shares
            
            
            Amount
            
            
            Issued
            
            
            Capital
            
            
            Compensation
            
            
            Stage
            
            
            Deficiency




Stock
      issued for employee compensation on June26, 2000
            
            
            5.31
            
            
            
            22,000
            
            
            
            22
            
            
            
            —
            
            
            
            116,798
            
            
            
            —
            
            
            
            —
            
            
            
            116,820Stock
      issued for consulting services on June26, 2000
            
            
            5.31
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            52,203
            
            
            
            —
            
            
            
            —
            
            
            
            52,213Stock
      issued for promotional services on July28, 2000
            
            
            4.88
            
            
            
            9,675
            
            
            
            9
            
            
            
            —
            
            
            
            47,205
            
            
            
            —
            
            
            
            —
            
            
            
            47,214Stock
      issued for consulting services on July28, 2000
            
            
            4.88
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            47,975
            
            
            
            —
            
            
            
            —
            
            
            
            47,985Stock
      issued for consulting services on August4, 2000
            
            
            2.13
            
            
            
            35,033
            
            
            
            35
            
            
            
            —
            
            
            
            74,585
            
            
            
            —
            
            
            
            —
            
            
            
            74,620Stock
      issued for promotional services on August16, 2000
            
            
            2.25
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            56,225
            
            
            
            —
            
            
            
            —
            
            
            
            56,250Stock
      issued for consulting services on September5, 2000
            
            
            2.25
            
            
            
            12,833
            
            
            
            13
            
            
            
            —
            
            
            
            28,861
            
            
            
            —
            
            
            
            —
            
            
            
            28,874


Stock
      issued for consulting services on September 10, 2000
            
            
            1.50
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            14,740
            
            
            
            —
            
            
            
            —
            
            
            
            14,750Stock
      issued for consulting services on November 2, 2000
            
            
            0.88
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            8,643
            
            
            
            —
            
            
            
            —
            
            
            
            8,653Stock
      issued for consulting services on November 4, 2000
            
            
            0.88
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            8,643
            
            
            
            —
            
            
            
            —
            
            
            
            8,653Stock
      issued for consulting services on December 20, 2000
            
            
            0.50
            
            
            
            19,082
            
            
            
            19
            
            
            
            —
            
            
            
            9,522
            
            
            
            —
            
            
            
            —
            
            
            
            9,541Stock
      issued for filing services on December 20, 2000
            
            
            0.50
            
            
            
            5,172
            
            
            
            5
            
            
            
            —
            
            
            
            2,581
            
            
            
            —
            
            
            
            —
            
            
            
            2,586Stock
      issued for professional services on December 26, 2000
            
            
            0.38
            
            
            
            12,960
            
            
            
            13
            
            
            
            —
            
            
            
            4,912
            
            
            
            —
            
            
            
            —
            
            
            
            4,925Other
      stock issuance on August 24, 2000
            
            
            2.13
            
            
            
            2,000
            
            
            
            2
            
            
            
            —
            
            
            
            4,258
            
            
            
            —
            
            
            
            —
            
            
            
            4,260Common
      shares cancelled
            
            
            
            
            
            
            (55,000
            )
            
            
            (55
            )
            
            
            —
            
            
            
            (64,245
            )
            
            
            —
            
            
            
            —
            
            
            
            (64,300
            )Net
      loss
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (1,270,762
            )
            
            
            (1,270,762
            )Balance,
      December 31, 2000
            
            
            
            
            
            
            15,645,935
            
            
            $
            15,646
            
            
            $
            —
            
            
            $
            1,437,873
            
            
            $
            —
            
            
            $
            (2,367,333
            )
            
            $
            (913,814
            )Stock
      issued for consulting services on January 8, 2001
            
            
            0.31
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            3,038
            
            
            
            —
            
            
            
            —
            
            
            
            3,048Stock
      issued for consulting services on February 1, 2001
            
            
            0.33
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            3,235
            
            
            
            —
            
            
            
            —
            
            
            
            3,245Stock
      issued for consulting services on March 1, 2001
            
            
            0.28
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            2,743
            
            
            
            —
            
            
            
            —
            
            
            
            2,753








(continued)
 F-6





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
  CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Stock
      issued for legal services on March 13, 2001
            
            
            0.32
            
            
            
            150,000
            
            
            
            150
            
            
            
            —
            
            
            
            47,850
            
            
            
            —
            
            
            
            —
            
            
            
            48,000Stock
      issued for consulting services on April 3, 2001
            
            
            0.25
            
            
            
            9,833
            
            
            
            10
            
            
            
            —
            
            
            
            2,448
            
            
            
            —
            
            
            
            —
            
            
            
            2,458Stock
      issued for legal services on April 4, 2001
            
            
            0.25
            
            
            
            30,918
            
            
            
            31
            
            
            
            —
            
            
            
            7,699
            
            
            
            —
            
            
            
            —
            
            
            
            7,730Stock
      issued for professional services on April 4, 2001
            
            
            0.25
            
            
            
            7,040
            
            
            
            7
            
            
            
            —
            
            
            
            1,753
            
            
            
            —
            
            
            
            —
            
            
            
            1,760Stock
      issued for consulting services on April 5, 2001
            
            
            0.25
            
            
            
            132,600
            
            
            
            132
            
            
            
            —
            
            
            
            33,018
            
            
            
            —
            
            
            
            —
            
            
            
            33,150Stock
      issued for filing fees on April 30, 2001
            
            
            1.65
            
            
            
            1,233
            
            
            
            1
            
            
            
            —
            
            
            
            2,033
            
            
            
            —
            
            
            
            —
            
            
            
            2,034Stock
      issued for filing fees on September 19, 2001
            
            
            0.85
            
            
            
            2,678
            
            
            
            2
            
            
            
            —
            
            
            
            2,274
            
            
            
            —
            
            
            
            —
            
            
            
            2,276Stock
      issued for professional services on September 28,
2001
            
            
            0.62
            
            
            
            150,000
            
            
            
            150
            
            
            
            —
            
            
            
            92,850
            
            
            
            —
            
            
            
            —
            
            
            
            93,000Stock
      issued for directors services on October 5, 2001
            
            
            0.60
            
            
            
            100,000
            
            
            
            100
            
            
            
            —
            
            
            
            59,900
            
            
            
            —
            
            
            
            —
            
            
            
            60,000Stock
      issued for legal services on October 17, 2001
            
            
            0.60
            
            
            
            11,111
            
            
            
            11
            
            
            
            —
            
            
            
            6,655
            
            
            
            —
            
            
            
            —
            
            
            
            6,666Stock
      issued for consulting services on October 18, 2001
            
            
            0.95
            
            
            
            400,000
            
            
            
            400
            
            
            
            —
            
            
            
            379,600
            
            
            
            —
            
            
            
            —
            
            
            
            380,000Stock
      issued for consulting services on October 19, 2001
            
            
            1.25
            
            
            
            150,000
            
            
            
            150
            
            
            
            —
            
            
            
            187,350
            
            
            
            —
            
            
            
            —
            
            
            
            187,500Stock
      issued for exhibit fees on October 22, 2001
            
            
            1.35
            
            
            
            5,000
            
            
            
            6
            
            
            
            —
            
            
            
            6,745
            
            
            
            —
            
            
            
            —
            
            
            
            6,751Stock
      issued for directors
            
            
            0.95
            
            
            
            1,000,000
            
            
            
            1,000
            
            
            
            —
            
            
            
            949,000
            
            
            
            —
            
            
            
            —
            
            
            
            950,000Stock
      issued for consulting services on November 7, 2001
            
            
            0.85
            
            
            
            20,000
            
            
            
            20
            
            
            
            —
            
            
            
            16,980
            
            
            
            —
            
            
            
            —
            
            
            
            17,000


Stock
      issued for consulting services on November 20, 2001
            
            
            0.98
            
            
            
            43,000
            
            
            
            43
            
            
            
            —
            
            
            
            42,097
            
            
            
            —
            
            
            
            —
            
            
            
            42,140Stock
      issued for consulting services on November 27, 2001
            
            
            0.98
            
            
            
            10,000
            
            
            
            10
            
            
            
            —
            
            
            
            9,790
            
            
            
            —
            
            
            
            —
            
            
            
            9,800Stock
      issued for consulting services on November 28, 2001
            
            
            0.98
            
            
            
            187,000
            
            
            
            187
            
            
            
            —
            
            
            
            183,073
            
            
            
            —
            
            
            
            —
            
            
            
            183,260Intrinsic
      value of options issued to employees
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,600,000
            
            
            
            (2,600,000
            )
            
            
            —
            
            
            
            —Fair
      value of options issued to non-employees for services
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            142,318
            
            
            
            —
            
            
            
            —
            
            
            
            142,318








(continued)
 F-7





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Amortization
      of deferred compensation
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            191,667
            
            
            
            —
            
            
            
            191,667Net
      loss
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,735,013
            )
            
            
            (2,735,013
            )Balance,
      December 31, 2001
            
            
            
            
            
            
            18,085,847
            
            
            $
            18,086
            
            
            $
            —
            
            
            $
            6,220,322
            
            
            $
            (2,408,333
            )
            
            $
            (5,102,346
            )
            
            $
            (1,272,271
            )Stock
      issued for directors services on December 10, 2002
            
            
            0.40
            
            
            
            2,150,000
            
            
            
            2,150
            
            
            
            —
            
            
            
            857,850
            
            
            
            —
            
            
            
            —
            
            
            
            860,000Common
      stock paid for, but not issued (2,305,000 shares)
            
            
            0.15-0.25
            
            
            
            —
            
            
            
            —
            
            
            
            389,875
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            389,875Fair
      value of options issued to non-employees for services
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            54,909
            
            
            
            (54,909
            )
            
            
            —
            
            
            
            —Amortization
      of deferred compensation
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            891,182
            
            
            
            —
            
            
            
            891,182Net
      loss for the year ended December 31, 2002
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,749,199
            )
            
            
            (2,749,199
            )Balance,
      December 31, 2002
            
            
            
            
            
            
            20,235,847
            
            
            $
            20,236
            
            
            $
            389,875
            
            
            $
            7,133,081
            
            
            $
            (1,572,060
            )
            
            $
            (7,851,545
            )
            
            $
            (1,880,413
            )Common
      stock issued, previously paid for
            
            
            0.15
            
            
            
            1,425,000
            
            
            
            1,425
            
            
            
            (213,750
            )
            
            
            212,325
            
            
            
            —
            
            
            
            —
            
            
            
            —Common
      stock issued, previously paid for
            
            
            0.25
            
            
            
            880,000
            
            
            
            880
            
            
            
            (220,000
            )
            
            
            219,120
            
            
            
            —
            
            
            
            —
            
            
            
            —Stock
      issued for cash on March 20, 2003
            
            
            0.25
            
            
            
            670,000
            
            
            
            670
            
            
            
            —
            
            
            
            166,830
            
            
            
            —
            
            
            
            —
            
            
            
            167,500Stock
      issued for cash on April 4, 2003
            
            
            0.25
            
            
            
            900,000
            
            
            
            900
            
            
            
            —
            
            
            
            224,062
            
            
            
            —
            
            
            
            —
            
            
            
            224,962Stock
      issued for cash on April 8, 2003
            
            
            0.25
            
            
            
            100,000
            
            
            
            100
            
            
            
            —
            
            
            
            24,900
            
            
            
            —
            
            
            
            —
            
            
            
            25,000Stock
      issued for cash on May 8, 2003
            
            
            0.25
            
            
            
            1,150,000
            
            
            
            1,150
            
            
            
            —
            
            
            
            286,330
            
            
            
            —
            
            
            
            —
            
            
            
            287,480Stock
      issued for cash on June 16, 2003
            
            
            0.25
            
            
            
            475,000
            
            
            
            475
            
            
            
            —
            
            
            
            118,275
            
            
            
            —
            
            
            
            —
            
            
            
            118,750Stock
      issued for legal services on June 27, 2003
            
            
            0.55
            
            
            
            83,414
            
            
            
            83
            
            
            
            —
            
            
            
            45,794
            
            
            
            —
            
            
            
            —
            
            
            
            45,877Debt
      converted to stock on June 27, 2003
            
            
            0.25
            
            
            
            2,000,000
            
            
            
            2,000
            
            
            
            —
            
            
            
            498,000
            
            
            
            —
            
            
            
            —
            
            
            
            500,000Stock
      and warrants issued for cash on July 11, 2003
            
            
            0.25
            
            
            
            519,000
            
            
            
            519
            
            
            
            —
            
            
            
            129,231
            
            
            
            —
            
            
            
            —
            
            
            
            129,750Stock
      and warrants issued for cash on September 29, 2003
            
            
            0.25
            
            
            
            1,775,000
            
            
            
            1,775
            
            
            
            —
            
            
            
            441,976
            
            
            
            —
            
            
            
            —
            
            
            
            443,751Stock
      and warrants issued for cash on October 21, 2003
            
            
            0.25
            
            
            
            1,845,000
            
            
            
            1,845
            
            
            
            —
            
            
            
            459,405
            
            
            
            —
            
            
            
            —
            
            
            
            461,250Stock
      and warrants issued for cash on October 28, 2003
            
            
            0.25
            
            
            
            1,570,000
            
            
            
            1,570
            
            
            
            —
            
            
            
            390,930
            
            
            
            —
            
            
            
            —
            
            
            
            392,500Stock
      and warrants issued for cash on November 19, 2003
            
            
            0.25
            
            
            
            500,000
            
            
            
            500
            
            
            
            —
            
            
            
            124,500
            
            
            
            —
            
            
            
            —
            
            
            
            125,000




(continued)
 F-8





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
  CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Finders’
      fees related to stock issuances
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            43,875
            
            
            
            (312,582
            )
            
            
            —
            
            
            
            —
            
            
            
            (268,707
            )Common
      stock paid for, but not issued (25,000 shares)
            
            
            0.25
            
            
            
            —
            
            
            
            —
            
            
            
            6,250
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            6,250Amortization
      of deferred comp
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            863,727
            
            
            
            —
            
            
            
            863,727Net
      loss for year ended December 31, 2003
            
            
            
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (2,476,063
            )
            
            
            (2,476,063
            )Balance,
      December 31, 2003
            
            
            
            
            
            
            34,128,261
            
            
            $
            34,128
            
            
            $
            6,250
            
            
            $
            10,162,177
            
            
            $
            (708,333
            )
            
            $
            (10,327,608
            )
            
            $
            (833,386
            )Common
      stock issued, previously paid for
            
            
            0.25
            
            
            
            25,000
            
            
            
            25
            
            
            
            (6,250
            )
            
            
            6,225
            
            
            
            —
            
            
            
            —
            
            
            
            —Stock
      issued for director services on March 31, 2004
            
            
            1.50
            
            
            
            50,000
            
            
            
            50
            
            
            
            —
            
            
            
            74,950
            
            
            
            —
            
            
            
            —
            
            
            
            75,000Stock
      issued for finders fees on March 31, 2004
            
            
            0.15
            
            
            
            82,500
            
            
            
            82
            
            
            
            —
            
            
            
            12,293
            
            
            
            —
            
            
            
            —
            
            
            
            12,375Stock
      issued for finders fees on March 31, 2004
            
            
            0.25
            
            
            
            406,060
            
            
            
            407
            
            
            
            —
            
            
            
            101,199
            
            
            
            —
            
            
            
            —
            
            
            
            101,606Stock
      issued for services on April 2, 2004
            
            
            1.53
            
            
            
            65,000
            
            
            
            65
            
            
            
            —
            
            
            
            99,385
            
            
            
            —
            
            
            
            —
            
            
            
            99,450Debt
      converted to stock on April 2, 2004
            
            
            1.53
            
            
            
            60,000
            
            
            
            60
            
            
            
            —
            
            
            
            91,740
            
            
            
            —
            
            
            
            —
            
            
            
            91,800Stock
      issued upon exercise of warrants on May 21, 2004
            
            
            0.20
            
            
            
            950,000
            
            
            
            950
            
            
            
            —
            
            
            
            189,050
            
            
            
            —
            
            
            
            —
            
            
            
            190,000Stock
      issued for directors services on June 8, 2004
            
            
            1.70
            
            
            
            600,000
            
            
            
            600
            
            
            
            —
            
            
            
            1,019,400
            
            
            
            —
            
            
            
            —
            
            
            
            1,020,000Stock
      issued for cash on August 25, 2004
            
            
            1.00
            
            
            
            550,000
            
            
            
            550
            
            
            
            —
            
            
            
            549,450
            
            
            
            —
            
            
            
            —
            
            
            
            550,000Stock
      issued upon exercise of options on August 30, 2004
            
            
            0.40
            
            
            
            4,000
            
            
            
            4
            
            
            
            —
            
            
            
            1,596
            
            
            
            —
            
            
            
            —
            
            
            
            1,600Stock
      issued for cash on September 8, 2004
            
            
            1.00
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            24,975
            
            
            
            —
            
            
            
            —
            
            
            
            25,000Stock
      issued for consulting services on September 15, 2004
            
            
            1.31
            
            
            
            50,000
            
            
            
            49
            
            
            
            —
            
            
            
            65,451
            
            
            
            —
            
            
            
            —
            
            
            
            65,500Stock
      issued for patent settlement on September 22, 2004
            
            
            1.24
            
            
            
            20,000
            
            
            
            20
            
            
            
            —
            
            
            
            24,780
            
            
            
            —
            
            
            
            —
            
            
            
            24,800Stock
      issued for research and development on October 6,
2004
            
            
            1.40
            
            
            
            65,000
            
            
            
            65
            
            
            
            —
            
            
            
            90,935
            
            
            
            —
            
            
            
            —
            
            
            
            91,000Stock
      issued for cash on October 6, 2004
            
            
            1.00
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            24,975
            
            
            
            —
            
            
            
            —
            
            
            
            25,000Stock
      issued for cash on October 15, 2004
            
            
            1.00
            
            
            
            150,000
            
            
            
            150
            
            
            
            —
            
            
            
            149,850
            
            
            
            —
            
            
            
            —
            
            
            
            150,000Stock
      issued upon exercise of stock options on October 21,
    2004
            
            
            0.40
            
            
            
            6,500
            
            
            
            6
            
            
            
            —
            
            
            
            2,594
            
            
            
            —
            
            
            
            —
            
            
            
            2,600Stock
      issued for cash on November 3, 2004
            
            
            1.00
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            24,975
            
            
            
            —
            
            
            
            —
            
            
            
            25,000








(continued)
 F-9





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Stock
      issued for cash on November 18, 2004
            
            
            1.00
            
            
            
            172,500
            
            
            
            173
            
            
            
            —
            
            
            
            172,327
            
            
            
            —
            
            
            
            —
            
            
            
            172,500Stock
      issued for cash on December 9, 2004
            
            
            1.00
            
            
            
            75,000
            
            
            
            75
            
            
            
            —
            
            
            
            74,925
            
            
            
            —
            
            
            
            —
            
            
            
            75,000Stock
      issued for cash on December 23, 2004
            
            
            1.00
            
            
            
            250,000
            
            
            
            250
            
            
            
            —
            
            
            
            249,750
            
            
            
            —
            
            
            
            —
            
            
            
            250,000Finders
      fees related to stock issuances
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (88,384
            )
            
            
            —
            
            
            
            —
            
            
            
            (88,384
            )Common
      stock paid for, but not issued (119,000 shares)
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            119,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            119,000Intrinsic
      value of options issued to employees
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            248,891
            
            
            
            (248,891
            )
            
            
            —
            
            
            
            —


Fair
      value of options issued to non-employees for services
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            55,381
            
            
            
            (55,381
            )
            
            
            —
            
            
            
            —Fair
      value of warrants issued for settlement costs
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            
            
            
            
            1,585,266
            
            
            
            —
            
            
            
            —
            
            
            
            1,585,266Fair
      value of warrants issued to non-employees for services
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            28,872
            
            
            
            —
            
            
            
            —
            
            
            
            28,872Amortization
      of deferred compensation
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            936,537
            
            
            
            —
            
            
            
            936,537Net
      loss for year ended December 31, 2004
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (6,803,280
            )
            
            
            (6,803,280
            )Balance,
      December 31, 2004
            
            
            
            
            
            
            37,784,821
            
            
            $
            37,784
            
            
            $
            119,000
            
            
            $
            15,043,028
            
            
            $
            (76,068
            )
            
            $
            (17,130,888
            )
            
            $
            (2,007,144
            )Common
      stock issued, previously paid for
            
            
            1.00
            
            
            
            69,000
            
            
            
            69
            
            
            
            (69,000
            )
            
            
            68,931
            
            
            
            —
            
            
            
            —
            
            
            
            —Stock
      issued upon exercise of warrants, previously paid for
            
            
            1.00
            
            
            
            50,000
            
            
            
            50
            
            
            
            (50,000
            )
            
            
            49,950
            
            
            
            —
            
            
            
            —
            
            
            
            —Stock
      issued for cash on January 20, 2005
            
            
            1.00
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            24,975
            
            
            
            —
            
            
            
            —
            
            
            
            25,000Stock
      issued upon exercise of warrants on January 31, 2005
            
            
            0.40
            
            
            
            500
            
            
            
            1
            
            
            
            —
            
            
            
            199
            
            
            
            —
            
            
            
            —
            
            
            
            200Stock
      issued for cash on February 17, 2005
            
            
            1.00
            
            
            
            325,000
            
            
            
            325
            
            
            
            —
            
            
            
            324,675
            
            
            
            —
            
            
            
            —
            
            
            
            325,000Stock
      issued for cash on March 31, 2005
            
            
            1.00
            
            
            
            215,000
            
            
            
            215
            
            
            
            —
            
            
            
            214,785
            
            
            
            —
            
            
            
            —
            
            
            
            215,000Stock
      issued for cash on May 17, 2005
            
            
            1.00
            
            
            
            5,000
            
            
            
            5
            
            
            
            —
            
            
            
            4,995
            
            
            
            —
            
            
            
            —
            
            
            
            5,000Stock
      issued for cash on June 7, 2005
            
            
            1.00
            
            
            
            300,000
            
            
            
            300
            
            
            
            —
            
            
            
            299,700
            
            
            
            —
            
            
            
            —
            
            
            
            300,000








(continued)
 F-10





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Stock
      issued for cash on August 5, 2005
            
            
            1.00
            
            
            
            480,500
            
            
            
            480
            
            
            
            —
            
            
            
            480,020
            
            
            
            —
            
            
            
            —
            
            
            
            480,500Stock
      issued for cash on August 9, 2005
            
            
            1.00
            
            
            
            100,000
            
            
            
            100
            
            
            
            —
            
            
            
            99,900
            
            
            
            —
            
            
            
            —
            
            
            
            100,000Stock
      issued for cash on October 27, 2005
            
            
            1.00
            
            
            
            80,000
            
            
            
            80
            
            
            
            —
            
            
            
            79,920
            
            
            
            —
            
            
            
            —
            
            
            
            80,000Common
      stock cancelled on December 7, 2005
            
            Various
            
            
            
            (8,047,403
            )
            
            
            (8,047
            )
            
            
            —
            
            
            
            8,047
            
            
            
            —
            
            
            
            —
            
            
            
            —Stock
      issued for settlement of payables on December 21,
2005
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            57,092
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            57,092Stock
      issued for settlement of payables on December 31,
2005
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            555,429
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            555,429Finders
      fees related to stock issuances
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (109,840
            )
            
            
            —
            
            
            
            —
            
            
            
            (109,840
            )Intrinsic
      value of options issued to employees
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            243,750
            
            
            
            (243,750
            )
            
            
            —
            
            
            
            —Fair
      value of options issued for settlement costs
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            31,500
            
            
            
            —
            
            
            
            —
            
            
            
            31,500Fair
      value of warrants issued for settlement costs
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,957
            
            
            
            —
            
            
            
            —
            
            
            
            4,957Fair
      value of warrants issued to non-employees for services
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            13,505
            
            
            
            —
            
            
            
            —
            
            
            
            13,505Amortization
      of deferred compensation
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            177,631
            
            
            
            —
            
            
            
            177,631Warrants
      issued with convertible notes
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            696,413
            
            
            
            —
            
            
            
            —
            
            
            
            696,413Intrinsic
      value of beneficial conversion associated with convertible
      notes
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            756,768
            
            
            
            —
            
            
            
            —
            
            
            
            756,768


Net
      loss for year ended December 31, 2005
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (3,115,186
            )
            
            
            (3,115,186
            )Balance,
      December 31, 2005
            
            
            
            
            
            
            31,387,418
            
            
            $
            31,387
            
            
            $
            612,521
            
            
            $
            18,336,178
            
            
            $
            (142,187
            )
            
            $
            (20,246,074
            )
            
            $
            (1,408,175
            )Stock
      issued, for previously settled payables
            
            
            —
            
            
            
            846,549
            
            
            
            847
            
            
            
            (612,521
            )
            
            
            611,674
            
            
            
            —
            
            
            
            —
            
            
            
            —Stock
      issued upon exercise of warrants on March 23, 2006
            
            
            1.50
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            37,475
            
            
            
            —
            
            
            
            —
            
            
            
            37,500Stock
      issued upon exercise of warrants on March 27, 2006
            
            
            1.50
            
            
            
            50,000
            
            
            
            50
            
            
            
            —
            
            
            
            74,950
            
            
            
            —
            
            
            
            —
            
            
            
            75,000




(continued)
 F-11





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Stock
      issued upon exercise of warrants on March 27, 2006
            
            
            0.50
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            12,475
            
            
            
            —
            
            
            
            —
            
            
            
            12,500Stock
      issued upon exercise of warrants on March 30, 2006
            
            
            1.00
            
            
            
            10,000
            
            
            
            10
            
            
            
            —
            
            
            
            9,990
            
            
            
            —
            
            
            
            —
            
            
            
            10,000Stock
      issued upon exercise of warrants on April 10, 2006
            
            
            0.50
            
            
            
            36,250
            
            
            
            36
            
            
            
            —
            
            
            
            18,089
            
            
            
            —
            
            
            
            —
            
            
            
            18,125Common
      stock issued for convertible debt on April 10, 2006
            
            
            0.70
            
            
            
            269,600
            
            
            
            270
            
            
            
            —
            
            
            
            188,450
            
            
            
            —
            
            
            
            —
            
            
            
            188,720Stock
      issued for cash on April 24, 2006
            
            
            1.56
            
            
            
            473,000
            
            
            
            473
            
            
            
            —
            
            
            
            737,408
            
            
            
            —
            
            
            
            —
            
            
            
            737,881Stock
      issued upon exercise of warrants on April 26, 2006
            
            
            0.50
            
            
            
            125,000
            
            
            
            125
            
            
            
            —
            
            
            
            62,375
            
            
            
            —
            
            
            
            —
            
            
            
            62,500Stock
      issued upon exercise of warrants on April 26, 2006
            
            
            1.50
            
            
            
            100,000
            
            
            
            100
            
            
            
            —
            
            
            
            149,900
            
            
            
            —
            
            
            
            —
            
            
            
            150,000Common
      stock issued for convertible debt on April 26, 2006
            
            
            0.70
            
            
            
            35,714
            
            
            
            36
            
            
            
            —
            
            
            
            24,964
            
            
            
            —
            
            
            
            —
            
            
            
            25,000Stock
      issued upon exercise of warrants on May 6, 2006
            
            
            0.50
            
            
            
            200,000
            
            
            
            200
            
            
            
            —
            
            
            
            99,800
            
            
            
            —
            
            
            
            —
            
            
            
            100,000Stock
      issued upon exercise of warrants on May 15, 2006
            
            
            1.50
            
            
            
            25,000
            
            
            
            25
            
            
            
            —
            
            
            
            37,475
            
            
            
            —
            
            
            
            —
            
            
            
            37,500Stock
      issued upon exercise of warrants on May 15, 2006
            
            
            0.50
            
            
            
            50,000
            
            
            
            50
            
            
            
            —
            
            
            
            24,950
            
            
            
            —
            
            
            
            —
            
            
            
            25,000Stock
      issued for cash on June 7, 2006
            
            
            1.89
            
            
            
            873,018
            
            
            
            872
            
            
            
            —
            
            
            
            1,649,136
            
            
            
            —
            
            
            
            —
            
            
            
            1,650,008Common
      stock issued for convertible debt on June 7, 2006
            
            
            0.70
            
            
            
            1,535,716
            
            
            
            1,536
            
            
            
            —
            
            
            
            1,073,464
            
            
            
            —
            
            
            
            —
            
            
            
            1,075,000Stock
      issued upon exercise of warrants on June 8, 2006
            
            
            0.50
            
            
            
            900,000
            
            
            
            900
            
            
            
            —
            
            
            
            449,100
            
            
            
            —
            
            
            
            —
            
            
            
            450,000Stock
      issued upon exercise of warrants on June 9, 2006
            
            
            0.50
            
            
            
            9,000
            
            
            
            9
            
            
            
            —
            
            
            
            4,491
            
            
            
            —
            
            
            
            —
            
            
            
            4,500Stock
      issued upon exercise of warrants on June 23, 2006
            
            
            0.50
            
            
            
            150,000
            
            
            
            150
            
            
            
            —
            
            
            
            74,850
            
            
            
            —
            
            
            
            —
            
            
            
            75,000Stock
      issued upon exercise of warrants on June 23, 2006
            
            
            1.50
            
            
            
            15,000
            
            
            
            15
            
            
            
            —
            
            
            
            22,485
            
            
            
            —
            
            
            
            —
            
            
            
            22,500Common
      stock issued for convertible debt on June 30, 2006
            
            
            0.70
            
            
            
            219,104
            
            
            
            219
            
            
            
            —
            
            
            
            153,155
            
            
            
            —
            
            
            
            —
            
            
            
            153,374Common
      stock issued for convertible debt on July 11, 2006
            
            
            0.70
            
            
            
            14,603
            
            
            
            15
            
            
            
            —
            
            
            
            10,207
            
            
            
            —
            
            
            
            —
            
            
            
            10,222Common
      stock issued for convertible debt on August 7, 2006
            
            
            0.70
            
            
            
            1,540,160
            
            
            
            1,540
            
            
            
            —
            
            
            
            1,076,572
            
            
            
            —
            
            
            
            —
            
            
            
            1,078,112




(continued)
 F-12





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Common
      stock issued upon exercise of warrants on August 7, 2006
            
            
            1.50
            
            
            
            175,000
            
            
            
            175
            
            
            
            —
            
            
            
            262,325
            
            
            
            —
            
            
            
            —
            
            
            
            262,500Common
      stock issued upon exercise of warrants on August 21, 2006
            
            
            1.50
            
            
            
            50,000
            
            
            
            50
            
            
            
            —
            
            
            
            74,950
            
            
            
            —
            
            
            
            —
            
            
            
            75,000Common
      stock issued for cash on August 22, 2006
            
            
            1.00
            
            
            
            14,519
            
            
            
            15
            
            
            
            —
            
            
            
            14,504
            
            
            
            —
            
            
            
            —
            
            
            
            14,519Common
      stock issued upon exercise of warrants on August 23, 2006
            
            
            1.00
            
            
            
            3,683
            
            
            
            4
            
            
            
            —
            
            
            
            3679
            
            
            
            —
            
            
            
            —
            
            
            
            3,683Common
      stock issued upon exercise of warrants on August 28, 2006
            
            
            1.50
            
            
            
            5,000
            
            
            
            5
            
            
            
            —
            
            
            
            7,495
            
            
            
            —
            
            
            
            —
            
            
            
            7,500Common
      stock issued for convertible debt on September 13, 2006
            
            
            0.70
            
            
            
            4,286
            
            
            
            4
            
            
            
            —
            
            
            
            2,996
            
            
            
            —
            
            
            
            —
            
            
            
            3,000Common
      stock issued upon exercise of warrants on September 13,
    2006
            
            
            0.50
            
            
            
            150,000
            
            
            
            150
            
            
            
            —
            
            
            
            74,850
            
            
            
            —
            
            
            
            —
            
            
            
            75,000Common
      stock issued for convertible debt on October 16, 2006
            
            
            0.70
            
            
            
            66,654
            
            
            
            67
            
            
            
            —
            
            
            
            46,591
            
            
            
            —
            
            
            
            —
            
            
            
            46,658Common
      stock issued upon exercise of warrants on November 3, 2006
            
            
            0.50
            
            
            
            210,000
            
            
            
            210
            
            
            
            —
            
            
            
            104,790
            
            
            
            —
            
            
            
            —
            
            
            
            105,000Common
      stock issued for put on equity line of credit on November 7,
      2006
            
            
            1.22
            
            
            
            94,4700
            
            
            
            94
            
            
            
            —
            
            
            
            115,368
            
            
            
            —
            
            
            
            —
            
            
            
            115,462Common
      stock issued for put on equity line of credit on November 14,
      2006
            
            
            1.14
            
            
            
            7,300
            
            
            
            7
            
            
            
            —
            
            
            
            8,349
            
            
            
            —
            
            
            
            —
            
            
            
            8,356Common
      stock issued for put on equity line of credit on November 27,
      2006
            
            
            0.83
            
            
            
            27,500
            
            
            
            28
            
            
            
            —
            
            
            
            22,913
            
            
            
            —
            
            
            
            —
            
            
            
            22,941Common
      stock issued for put on equity line of credit on November 28,
      2006
            
            
            0.82
            
            
            
            36,500
            
            
            
            36
            
            
            
            —
            
            
            
            30,059
            
            
            
            —
            
            
            
            —
            
            
            
            30,095Common
      stock issued for put on equity line of credit on December 6,
      2006
            
            
            0.78
            
            
            
            73,863
            
            
            
            74
            
            
            
            —
            
            
            
            57,244
            
            
            
            —
            
            
            
            —
            
            
            
            57,318Common
      stock issued for put on equity line of credit on December 26,
      2006
            
            
            0.55
            
            
            
            18,800
            
            
            
            19
            
            
            
            —
            
            
            
            10,377
            
            
            
            —
            
            
            
            —
            
            
            
            10,396Common
      stock issued for put on equity line of credit on December 31,
      2006
            
            
            0.59
            
            
            
            229,050
            
            
            
            229
            
            
            
            —
            
            
            
            135,300
            
            
            
            —
            
            
            
            —
            
            
            
            135,529








(continued)
 F-13





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Common
      stock paid for, but not issued
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            60,000
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            60,000Fair
      value of options issued to employees and officers
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            2,253,263
            
            
            
            —
            
            
            
            —
            
            
            
            2,253,263Fair
      value of warrants issued for services
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            401,130
            
            
            
            —
            
            
            
            —
            
            
            
            401,130Write
      off of deferred compensation
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (142,187
            )
            
            
            142,187
            
            
            
            —
            
            
            
            —


Warrants
      issued for consulting
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            62,497
            
            
            
            —
            
            
            
            —
            
            
            
            62,497Warrants
      issued with convertible notes
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            408,596
            
            
            
            —
            
            
            
            —
            
            
            
            408,596Intrinsic
      value of beneficial conversion associated with convertible
      notes
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            851,100
            
            
            
            —
            
            
            
            —
            
            
            
            851,100Finders
      fees related to stock issuances
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (284,579
            )
            
            
            —
            
            
            
            —
            
            
            
            (284,579
            )Fees
      paid on equity line of credit
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (30,402
            )
            
            
            —
            
            
            
            —
            
            
            
            (30,402
            )Net
      loss for year ended December 31, 2006
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (10,181,523
            )
            
            
            (10,181,523
            )Balance,
      December 31, 2006
            
            
            
            
            
            
            40,081,757
            
            
            $
            40,082
            
            
            $
            60,000
            
            
            $
            29,430,821
            
            
            $
            —
            
            
            $
            (30,427,597
            )
            
            $
            (896,694
            )Common
      stock issued for put on equity line of credit on January 11,
      2007
            
            
            0.63
            
            
            
            63,000
            
            
            
            63
            
            
            
            —
            
            
            
            39,659
            
            
            
            —
            
            
            
            —
            
            
            
            39,722Common
      stock issued for put on equity line of credit on January 22,
      2007
            
            
            0.73
            
            
            
            58,150
            
            
            
            58
            
            
            
            —
            
            
            
            42,246
            
            
            
            —
            
            
            
            —
            
            
            
            42,304Common
      stock issued for put on equity line of credit on February 9,
      2007
            
            
            0.73
            
            
            
            35,800
            
            
            
            36
            
            
            
            —
            
            
            
            26,009
            
            
            
            —
            
            
            
            —
            
            
            
            26,045Common
      stock issued for put on equity line of credit on February 16,
      2007
            
            
            0.70
            
            
            
            162,000
            
            
            
            162
            
            
            
            —
            
            
            
            112,979
            
            
            
            —
            
            
            
            —
            
            
            
            113,141Common
      stock issued for put on equity line of credit on February 26,
      2007
            
            
            0.66
            
            
            
            71,000
            
            
            
            71
            
            
            
            —
            
            
            
            46,761
            
            
            
            —
            
            
            
            —
            
            
            
            46,832Common
      stock issued for put on equity line of credit on March 5,
    2007
            
            
            0.66
            
            
            
            42,600
            
            
            
            43
            
            
            
            —
            
            
            
            28,056
            
            
            
            —
            
            
            
            —
            
            
            
            28,099Common
      stock issued for put on equity line of credit on March 12,
      2007
            
            
            0.67
            
            
            
            92,900
            
            
            
            93
            
            
            
            —
            
            
            
            62,085
            
            
            
            —
            
            
            
            —
            
            
            
            62,178








(continued)
 F-14





SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008
 
 Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deferred
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Compensation
              
              
              Stage
              
              
              Deficiency


Common
      stock issued for put on equity line of credit on March 19,
      2007
            
            
            0.64
            
            
            
            47,500
            
            
            
            48
            
            
            
            —
            
            
            
            30,362
            
            
            
            —
            
            
            
            —
            
            
            
            30,410Common
      stock issued for put on equity line of credit on March 26,
      2007
            
            
            0.63
            
            
            
            7,500
            
            
            
            7
            
            
            
            —
            
            
            
            4,722
            
            
            
            —
            
            
            
            —
            
            
            
            4,729Common
      stock issued for put on equity line of credit on March 31,
      2007
            
            
            0.61
            
            
            
            25,500
            
            
            
            25
            
            
            
            —
            
            
            
            15,558
            
            
            
            —
            
            
            
            —
            
            
            
            15,583Fees
      paid on equity line of credit
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (32,723
            )
            
            
            —
            
            
            
            —
            
            
            
            (32,723
            )Warrants
      issued with convertible notes
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            291,936
            
            
            
            —
            
            
            
            —
            
            
            
            291,936Intrinsic
      value of beneficial conversion associated with convertible
      notes
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            274,312
            
            
            
            —
            
            
            
            —
            
            
            
            274,312Fair
      value of warrants issued to non-employee for services
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            35,340
            
            
            
            —
            
            
            
            —
            
            
            
            35,340Fair
      value of options issued to an officer
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            16,302
            
            
            
            —
            
            
            
            —
            
            
            
            16,302


Common
      stock issued for put on equity line of credit on April 9,
    2007
            
            
            0.63
            
            
            
            56,300
            
            
            
            56
            
            
            
            —
            
            
            
            35,441
            
            
            
            —
            
            
            
            —
            
            
            
            35,497Common
      stock issued for put on equity line of credit on April 17,
      2007
            
            
            0.56
            
            
            
            73,835
            
            
            
            74
            
            
            
            —
            
            
            
            41,466
            
            
            
            —
            
            
            
            —
            
            
            
            41,540Common
      stock issued for put on equity line of credit on April 24,
      2007
            
            
            0.56
            
            
            
            122,857
            
            
            
            123
            
            
            
            —
            
            
            
            68,996
            
            
            
            —
            
            
            
            —
            
            
            
            69,119Common
      stock issued for put on equity line of credit on May 1,
    2007
            
            
            0.55
            
            
            
            226,081
            
            
            
            226
            
            
            
            —
            
            
            
            124,774
            
            
            
            —
            
            
            
            —
            
            
            
            125,000Common
      stock issued for put on equity line of credit on May 8,
    2007
            
            
            0.66
            
            
            
            29,400
            
            
            
            29
            
            
            
            —
            
            
            
            19,363
            
            
            
            —
            
            
            
            —
            
            
            
            19,392Common
      stock issued for put on equity line of credit on May 15,
    2007
            
            
            0.43
            
            
            
            403,502
            
            
            
            404
            
            
            
            —
            
            
            
            171,811
            
            
            
            —
            
            
            
            —
            
            
            
            172,215Common
      stock issued for put on equity line of credit on May 22,
    2007
            
            
            0.39
            
            
            
            119,800
            
            
            
            120
            
            
            
            —
            
            
            
            46,362
            
            
            
            —
            
            
            
            —
            
            
            
            46,482Common
      stock issued for put on equity line of credit on May 30,
    2007
            
            
            0.33
            
            
            
            80,996
            
            
            
            81
            
            
            
            —
            
            
            
            26,631
            
            
            
            —
            
            
            
            —
            
            
            
            26,712Common
      stock issued for put on equity line of credit on June 6,
    2007
            
            
            0.32
            
            
            
            54,700
            
            
            
            55
            
            
            
            —
            
            
            
            17,454
            
            
            
            —
            
            
            
            —
            
            
            
            17,509








(continued)
 F-15




SAVE
THE WORLD AIR, INC.
 (A
DEVELOPMENT STAGE ENTERPRISE)
 
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
 FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008





Price
      per
                          
                          
                          Common
      Stock
                          
                          
                          Common
      Stock to be
                          
                          
                          Additional
      Paid-in
                          
                          
                          Deficit
      Accumulated During the Development
                          
                          
                          Total
      Stockholders'Share
                          
                          
                          Shares
                          
                          
                          Amount
                          
                          
                          Issued
                          
                          
                          Capital
                          
                          
                          Stage
                          
                          
                          DeficiencyCommon
      stock issued for put on equity line of credit on June 15,
    2007
                          
                          
                          0.27
                          
                          
                          
                          94,500
                          
                          
                          
                          95
                          
                          
                          
                          —
                          
                          
                          
                          25,571
                          
                          
                          
                          —
                          
                          
                          
                          25,666Common
      stock issued for put on equity line of credit on June 21,
    2007
                          
                          
                          0.31
                          
                          
                          
                          12,500
                          
                          
                          
                          12
                          
                          
                          
                          —
                          
                          
                          
                          3,868
                          
                          
                          
                          —
                          
                          
                          
                          3,880Fees
      paid on equity line of credit
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (46,641
                          )
                          
                          
                          —
                          
                          
                          
                          (46,641
                          )Warrants
      issued with convertible notes
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          260,718
                          
                          
                          
                          —
                          
                          
                          
                          260,718Fair
      value of options issued to an officer
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          8,898
                          
                          
                          
                          —
                          
                          
                          
                          8,898Common
      stock issued, previously paid for
                          
                          
                          —
                          
                          
                          
                          2,597,524
                          
                          
                          
                          2,597
                          
                          
                          
                          (60,000
                          )
                          
                          
                          57,403
                          
                          
                          
                          —
                          
                          
                          
                          —Fair
      value of options issued to  officers
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          20,574
                          
                          
                          
                          —
                          
                          
                          
                          20,574Warrants
      issued with convertible notes
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          267,930
                          
                          
                          
                          —
                          
                          
                          
                          267,930Common
      stock issued for convertible debt on October 5, 2007
                          
                          
                          0.53
                          
                          
                          
                          51,887
                          
                          
                          
                          52
                          
                          
                          
                          —
                          
                          
                          
                          27,448
                          
                          
                          
                          —
                          
                          
                          
                          27,500Common
      stock issued for convertible debt on November 12, 2007
                          
                          
                          0.37
                          
                          
                          
                          255,081
                          
                          
                          
                          255
                          
                          
                          
                          —
                          
                          
                          
                          94,125
                          
                          
                          
                          —
                          
                          
                          
                          94,380Common
      stock issued for convertible debt on November 12, 2007
                          
                          
                          0.53
                          
                          
                          
                          51,887
                          
                          
                          
                          52
                          
                          
                          
                          —
                          
                          
                          
                          27,448
                          
                          
                          
                          —
                          
                          
                          
                          27,500Common
      stock issued for convertible debt on November 14, 2007
                          
                          
                          0.34
                          
                          
                          
                          80,882
                          
                          
                          
                          81
                          
                          
                          
                          —
                          
                          
                          
                          27,419
                          
                          
                          
                          —
                          
                          
                          
                          27,500Common
      stock issued for convertible debt on November 14, 2007
                          
                          
                          0.37
                          
                          
                          
                          95,227
                          
                          
                          
                          95
                          
                          
                          
                          —
                          
                          
                          
                          35,105
                          
                          
                          
                          —
                          
                          
                          
                          35,200Common
      stock issued for convertible debt on November 15, 2007
                          
                          
                          0.37
                          
                          
                          
                          163,514
                          
                          
                          
                          164
                          
                          
                          
                          —
                          
                          
                          
                          60,336
                          
                          
                          
                          —
                          
                          
                          
                          60,500Common
      stock issued for convertible debt on November 16, 2007
                          
                          
                          0.37
                          
                          
                          
                          71,351
                          
                          
                          
                          71
                          
                          
                          
                          —
                          
                          
                          
                          26,329
                          
                          
                          
                          —
                          
                          
                          
                          26,400Common
      stock issued for convertible debt on November 16, 2007
                          
                          
                          0.34
                          
                          
                          
                          80,882
                          
                          
                          
                          81
                          
                          
                          
                          —
                          
                          
                          
                          27,419
                          
                          
                          
                          —
                          
                          
                          
                          27,500Warrants
      issued with convertible notes
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          158,652
                          
                          
                          
                          —
                          
                          
                          
                          158,652


Common
      stock to be issued for consulting services
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          4,000
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          4,000Common
      stock issued for convertible debt on December 28, 2007
                          
                          
                          0.17
                          
                          
                          
                          1,060,000
                          
                          
                          
                          1,060
                          
                          
                          
                          —
                          
                          
                          
                          198,940
                          
                          
                          
                          —
                          
                          
                          
                          200,000Fair
      value of options issued to an officer
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          21,818
                          
                          
                          
                          —
                          
                          
                          
                          21,818Net
      loss for year ended December 31, 2007
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (6,262,743
                          )
                          
                          
                          (6,262,743
                          )Balance,
      December 31, 2007
                          
                          
                          
                          
                          
                          
                          46,470,413
                          
                          
                          $
                          46,471
                          
                          
                          $
                          4,000
                          
                          
                          $
                          32,280,083
                          
                          
                          $
                          (36,690,340
                          )
                          
                          $
                          (4,359,786
                          )




(continued)
 F-16





SAVE
THE WORLD AIR, INC.


(A
DEVELOPMENT STAGE ENTERPRISE)





CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)


FROM
INCEPTION (FEBRUARY 18, 1998) TO DECEMBER 31, 2008


Price
      per
              
              
              Common
      Stock
              
              
              Common
      Stock
                to
      be
              
              
              Additional
                Paid-in
              
              
              Deficit
                Accumulated
                During
      the
                Development
              
              
              Total
                Stockholders’Share
              
              
              Shares
              
              
              Amount
              
              
              Issued
              
              
              Capital
              
              
              Stage
              
              
              Deficiency


Common
      stock issued for convertible debt
                                  
                                  
                                  0.17-0.53
                                  
                                  
                                  
                                  5,575,082
                                  
                                  
                                  
                                  5,574
                                  
                                  
                                  
                                  16,500
                                  
                                  
                                  
                                  1,936,171
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,958,245Common
      stock issued for Morale/ Matthews settlement
                                  
                                  
                                  0.38
                                  
                                  
                                  
                                  7,421,896
                                  
                                  
                                  
                                  7,422
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  2,776,289
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  2,783,711Common
      stock issued for services
                                  
                                  
                                  0.17
      – 0.49
                                  
                                  
                                  
                                  2,398,850
                                  
                                  
                                  
                                  2,399
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  516,230
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  518,629Common
      stock issued upon exercise of warrants
                                  
                                  
                                  0.50
                                  
                                  
                                  
                                  1,064,650
                                  
                                  
                                  
                                  1,065
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  531,260
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  532,325Fair
      value of options issued as compensations
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  645,745
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  645,745Fair
      value of warrants issued and intrinsic value of beneficial conversion
      associated with convertible notes
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,323,077
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  1,323,077Fair
      value of warrants issued to PIPE holders
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  116,913
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  116,913Common
      stock issued for services
                                  
                                  
                                  0.17
                                  
                                  
                                  
                                  10,000
                                  
                                  
                                  
                                  10
                                  
                                  
                                  
                                  (4,000
                                  )
                                  
                                  
                                  3,990
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —Net
      loss for year ended December 31, 2008
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  (6,052,724
                                  )
                                  
                                  
                                  (6,052,724
                                  )Balance,
      December 31, 2008
                                  
                                  
                                  
                                  
                                  
                                  
                                  62,940,891
                                  
                                  
                                  $
                                  62,941
                                  
                                  
                                  $
                                  16,500
                                  
                                  
                                  $
                                  40,129,758
                                  
                                  
                                  $
                                  (42,743,064
                                  )
                                  
                                  $
                                  (2,533,865
                                  )




See notes
to consolidated financial statements.





F-17


SAVE
THE WORLD AIR, INC. AND SUBSIDIARY


(A
DEVELOPMENT STAGE ENTERPRISE)





CONSOLIDATED
STATEMENTS OF CASH FLOWS


Inception
                (February
      18, 1998)Years
      Ended December 31,
              
              
              to
      December 31,2008
              
              
              2007
              
              
              2008Cash
      flows from operating activitiesNet
      Loss
              
              $
              (6,052,724
              )
              
              $
              (6,262,743
              )
              
              $
              (42,743,064
              )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Write
      off of intangible assets
              
              
              —
              
              
              
              —
              
              
              
              505,000Settlement
      of litigation and debt
              
              
              —
              
              
              
              —
              
              
              
              (1,017,208
              )Settlement
      of Debt Due Morale/Matthews
              
              
              927,903
              
              
              
              —
              
              
              
              927,903Stock
      based compensation expense
              
              
              645,745
              
              
              
              67,592
              
              
              
              3,614,921Issuance
      of common stock for services
              
              
              518,629
              
              
              
              4.000
              
              
              
              5,190,731Issuance
      of options for legal settlement
              
              
              —
              
              
              
              —
              
              
              
              31,500Issuance
      of warrants for legal settlement
              
              
              —
              
              
              
              —
              
              
              
              4,957Issuance
      of warrants for financing fees
              
              
              116,913
              
              
              
              35,340
              
              
              
              152,253Non-cash
      increase in convertible notes recorded as expense
              
              
              89,470
              
              
              
              74,492
              
              
              
              163,962Patent
      acquisition cost
              
              
              —
              
              
              
              —
              
              
              
              1,610,066Amortization
      of issuance costs and original issue debt discountsincluding
      beneficial conversion feature-part of interest expense
              
              
              1,245,408
              
              
              
              1,573,596
              
              
              
              5,618,309Amortization
      of deferred compensation
              
              
              —
              
              
              
              —
              
              
              
              3,060,744Loss
      on disposition of assets
              
              
              14,426
              
              
              
              —
              
              
              
              14,426Depreciation
      and amortization of leasehold improvements
              
              
              37,530
              
              
              
              167,380
              
              
              
              393,129Bad
      debt
              
              
              1,300
              
              
              
              —
              
              
              
              1,300Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              —
              
              
              
              ( 1,380)
              
              
              
              (1,380
              )Inventory
              
              
              30,256
              
              
              
              (8,942
              )
              
              
              —Prepaid
      expenses and other
              
              
              (12,643
              )
              
              
              60,680
              
              
              
              (33,195
              )Other
      assets
              
              
              (6,750
              )
              
              
              —
              
              
              
              (11,250
              )Accounts
      payable and accrued expenses
              
              
              277,336
              
              
              
              1,191,661
              
              
              
              3,701,111Net
      cash used in operating activities
              
              
              (2,167,200
              )
              
              
              (3,098,324
              )
              
              
              (18,815,785
              )Cash
      flows from investing activitiesPurchase
      of equipment
              
              
              (345
              )
              
              
              (46,415
              )
              
              
              (553,452
              )Proceeds
      from sale of equipment
              
              
              17,477
              
              
              
              —
              
              
              
              17,478Net
      cash used in investing activities
              
              
              17,132
              
              
              
              (46,415
              )
              
              
              (535,974
              )Cash
      flows from financing activitiesNet
      proceeds under equity line of credit
              
              
              —
              
              
              
              912,691
              
              
              
              1,262,386(Decrease)
      increase in payables to related parties and stockholder
              
              
              (5,316
              )
              
              
              103,930
              
              
              
              610,064Advances
      from founding executive officer
              
              
              —
              
              
              
              —
              
              
              
              517,208Net
      proceeds from issuance of convertible notes and warrants
              
              
              1,634,745
              
              
              
              2,157,800
              
              
              
              6,460,423Repayment
      of convertible notes
              
              
              —
              
              
              
              (226,250)
              
              
              
              (226,250
              )Proceeds
      from exercise of warrants
              
              
              532,325
              
              
              
              —
              
              
              
              10,787,274Net
      cash provided by financing activities
              
              
              2,161,754
              
              
              
              2,948,171
              
              
              
              19,411,105Net
      (decrease) increase in
      cash
              
              
              11,686
              
              
              
              (196,568
              )
              
              
              59,346Cash, beginning of
      period
              
              
              47,660
              
              
              
              244,228
              
              
              
              —Cash, end of
      period
              
              $
              59,346
              
              
              $
              47,660
              
              
              $
              59,346Supplemental
      disclosures of cash flow informationCash
      paid during the year forInterest
              
              $
              1,355
              
              
              $
              1,239
              
              
              $
              136,399Income
      taxes
              
              $
              —
              
              
              $
              800
              
              
              $
              3,482Non-cash
      investing and financing activitiesAcquisition
      of intangible asset through advance from related party and issuance of
      common stock
              
              $
              —
              
              
              $
              —
              
              
              $
              505,000Deferred
      compensation for stock options issued for services
              
              
              —
              
              
              
              —
              
              
              
              3,202,931Purchase
      of property and equipment financed by advance from related
      party
              
              
              —
              
              
              
              —
              
              
              
              3,550Conversion
      of related party debt to equity
              
              
              —
              
              
              
              —
              
              
              
              515,000Issuance
      of common stock in settlement of payable
              
              
              —
              
              
              
              —
              
              
              
              113,981Cancellation
      of stock
              
              
              —
              
              
              
              —
              
              
              
              8,047Conversion
      of accounts payable and accrued expenses to common stock
              
              
              —
              
              
              
              —
              
              
              
              612,521Conversion
      of related party debt to convertible debentures
              
              
              —
              
              
              
              —
              
              
              
              45,000Conversion
      of convertible debentures to common stock
              
              
              1,958,245
              
              
              
              526,480
              
              
              
              4,931,679Issuance
      of shares for settlement of loans and other payable to
      Morale/Matthews
              
              
              2,783,711
              
              
              
              —
              
              
              
              2,783,711Write
      off of deferred compensation
              
              
              —
              
              
              
              —
              
              
              
              142,187Non-cash
      equity-warrant valuation and intrinsic value of beneficial conversion
      associated with convertible notes
              
              
              1,323,077
              
              
              
              1,253,548
              
              
              
              5,406,415





See notes
to consolidated financial statements.


F-18





SAVE
THE WORLD AIR, INC. AND SUBISIDARY


(A
DEVELOPMENT STAGE ENTERPRISE)





NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE YEARS ENDED DECEMBER 31, 2008 AND 2007




1.    
Description of business





Description
of business





Save the
World Air, Inc. (“STWA”) designs, licenses and develops products to increase
engine performance, reduce harmful emissions and increase fuel
efficiency.  The Company is a green technology company that leverages
a suite of patented, patent-pending and licensed intellectual properties related
to the treatment of fuels. Technologies patented by or licensed to us utilize
either magnetic or uniform electrical fields to alter physical characteristics
of fuels and are designed to create cleaner combustion. Cleaner combustion has
been shown to improve performance, enhance fuel economy and/or reduce harmful
emissions in laboratory testing.




The
Company was incorporated on February 18, 1998, as a Nevada corporation,
under the name Mandalay Capital Corporation. The Company changed its name to
Save the World Air, Inc. on February 11, 1999, following the acquisition of
marketing and manufacturing rights of the ZEFS technologies. The mailing address
is 235 Tennant Avenue, Morgan Hill, California 95037. The telephone number
is (323) 932-7040. The corporate website is www.stwa.com.  The
common stock is quoted under the symbol “ZERO” on the Over-the-Counter Bulletin
Board




The
Company has three product lines; MAG ChargRTM and ECO ChargRTM, ELEKTRATM and AOT
(Applied Oil Technology).  MAG ChargR is past the development stage
and the Company believes that an initial small run of several thousand units
will be manufactured and sold by the end of second quarter
2009.  ELEKTRA is nearing the end of the product development cycle
which will culminate in an upcoming SAE (Society of Automotive Engineers) test
to prove and certify the level of fuel savings.  AOT is in the
research and development phase.




The MAG
ChargRTM and ECO ChargRTM are products which use fixed magnetic fields to alter
some physical properties of fuel by incorporating our patented and
patent-pending ZEFS and MK IV technologies.  The Company
differentiates MAG ChargR and ECO ChargR products based on their differing
attributes and marketing focus. ECO ChargR products are primarily designed to
reduce harmful emissions and MAG ChargR products are primarily designed to
enhance performance and fuel economy. The ECO ChargR product is intended to
reduce exhaust emissions in vehicle and small utility motors and will be
marketed primarily to original equipment manufacturers (“OEMs”) as well as to
pilot and government-mandated emissions programs.  The MAG ChargR
product is intended to increase power and improve mileage and is being marketed
to municipal fleets and to the specialty consumer accessories market for many
types of vehicles, including but not limited to cars, trucks, motorcycles,
scooters, all terrain vehicles (“ATVs”), snowmobiles, personal watercraft and
small utility motors.




Consolidation
policy





The
accompanying consolidated financial statements of Save the World Air, Inc. and
Subsidiary include the accounts of Save the World Air, Inc. (the Parent) and its
wholly owned subsidiary STWA Asia Pte. Limited, incorporated on January 17,
2006.  Intercompany transactions and balances have been eliminated in
consolidation.





F-19





2.     Summary
of significant accounting policies





Development stage enterprise





The
Company is a development stage enterprise as defined by Statement of Financial
Accounting Standards (SFAS) No. 7, “Accounting and Reporting by Development
Stage Enterprises.”  All losses accumulated since the inception of the
Company have been considered as part of the Company’s development stage
activities.




The
Company’s focus is on product development and marketing of proprietary devices
that are designed to reduce harmful emissions, and improve fuel efficiency and
engine performance on equipment and vehicles driven by internal combustion
engines and has not yet generated meaningful revenues.  The
technologies are called “ZEFS”, “MK IV”, “ELEKTRA” and “CAT-MATE”. The Company
is currently marketing its ECO and MAG ChargR products incorporating ZEFS and MK
IV technologies, worldwide; and the Company is in the early stages of developing
ELEKTRA products.  Expenses have been funded through the sale of
company stock, convertible notes and the exercise of warrants.  The
Company has taken actions to secure the intellectual property rights to the
ZEFS, MK IV and CAT-MATE devices and is the worldwide exclusive licensee for
patent pending technologies associated with the development of
ELEKTRA.




The
Company is subject to the usual risks associated with a development stage
enterprise. These risks include, among others, those associated with product
development, acceptance of the product by users and the ability to raise the
capital necessary to sustain operations. Since its inception, the Company has
incurred significant losses.  The Company anticipates increasing
expenditures over at least the next year as the Company continues its product
development and evaluation efforts, and begins its marketing activities. Without
significant revenue, these expenditures will likely result in additional
losses.





Going
concern





The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. As reflected in the
accompanying financial statements, the Company had a net loss of $6,052,724 and
a negative cash flow from operations of $2,167,200 for the year ended December
31, 2008, and had a working capital deficiency of $2,677,084 and a stockholders’
deficiency of $2,533,865 at December 31, 2008.  In addition, the
Company is in default of its obligations under its License Agreements with
Temple University (see Note 7).  These factors raise substantial doubt
about the Company’s ability to continue as a going concern. The ability of the
Company to continue as a going concern is dependent upon the Company’s ability
to raise additional funds and implement its business plan. The financial
statements do not include any adjustments that might be necessary if the Company
is unable to continue as a going concern.




Revenue
Recognition Policy





The
Company has adopted Staff Accounting Bulletin 104, “Revenue Recognition” and
therefore recognizes revenue based upon meeting four criteria:





●
            
            Persuasive
      evidence of an arrangement exists;●
            
            Delivery
      has occurred or services rendered;●
            
            The
      seller’s price to the buyer is fixed or determinable;
  and●
            
            Collectability
      is reasonably assured.





The
Company contracts with manufacturers of fixed magnetic field products and sells
them to various original equipment manufacturers in the motor vehicle and small
utility motor markets. The Company negotiates an initial contract with the
customer fixing the terms of the sale and then receives a letter of credit or
full payment in advance of shipment. Upon shipment, the Company recognizes the
revenue associated with the sale of the products to the customer.





F-20





Accounts
Receivable Allowance Policy





The
Company reports accounts receivable in relation to sales of
product.  The Company performs an analysis of the receivable balances
in order to determine if an allowance for doubtful accounts is
necessary.  As of December 31, 2008, no allowance is
necessary.




Equipment
and depreciation





Property
and equipment are stated at cost. Depreciation is computed using the
straight-line method based on the estimated useful lives of the assets,
generally ranging from three to ten years. Expenditures for major renewals and
improvements that extend the useful lives of property and equipment are
capitalized. Expenditures for repairs and maintenance are charged to expense as
incurred. Leasehold improvements are amortized using the straight-line method
over the shorter of the estimated useful life of the asset or the lease
term.




Long-lived
assets





The
Company accounts for the impairment and disposition of long-lived assets in
accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” In accordance with SFAS No. 144,
long-lived assets to be held are reviewed for events or changes in circumstances
that indicate that their carrying value may not be recoverable. The Company
periodically reviews the carrying values of long-lived assets to determine
whether or not an impairment to such value has occurred. No impairments were
recorded for the year ended December 31, 2008.  The Company recorded
an impairment of approximately $505,000 during the period from inception
(February 18, 1998) through December 31, 2008.





Loss
per share





Basic
loss per share is computed by dividing net loss available to common stockholders
by the weighted average number of common shares outstanding during the period.
Diluted loss per share reflects the potential dilution, using the treasury stock
method, that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the loss of the Company. In computing diluted
loss per share, the treasury stock method assumes that outstanding options and
warrants are exercised and the proceeds are used to purchase common stock at the
average market price during the period. Options and warrants may have a dilutive
effect under the treasury stock method only when the average market price of the
common stock during the period exceeds the exercise price of the options and
warrants. For the years ended December 31, 2008 and 2007, the dilutive
impact of outstanding stock options of 4,601,225 and 4,188,445, respectively,
and outstanding warrants of 10,400,003, and 17,919,028 have been excluded
because their impact on the loss per share is anti-dilutive.




Income
taxes





Income
taxes are recognized for the amount of taxes payable or refundable for the
current year and deferred tax liabilities and assets are recognized for the
future tax consequences of transactions that have been recognized in the
Company’s financial statements or tax returns. A valuation allowance is provided
when it is more likely than not that some portion or all of the deferred tax
asset will not be realized.




Stock-based
compensation





On
January 1, 2006, the Company adopted Statements of Financial Accounting
Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors based on estimated
fair values. SFAS 123(R) supersedes the Company’s previous accounting under
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005,
the Securities and Exchange Commission issued Staff Accounting Bulletin
No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the
provisions of SAB 107 in its adoption of SFAS 123(R).





F-21





The
Company adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of January 1,
2006, the first day of the Company’s fiscal year 2006. The Company’s financial
statements for the years ended December, 2008 and 2007 reflect the impact of
SFAS 123(R). In accordance with the modified prospective transition method, the
Company’s financial statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation
expense recognized under SFAS 123(R) for employee and directors for the years
ended December 31, 2008 and 2007 were $645,745 and $67,592,
respectively.




The
Company’s determination of fair value of share-based payment awards to employees
and directors on the date of grant uses the Black-Scholes model, which is
affected by the Company’s stock price as well as assumptions regarding a number
of highly complex and subjective variables. These variables include, but are not
limited to our expected stock price volatility over the term of the awards, and
actual and projected employee stock option exercise
behaviors.  Forfeitures are recognized as incurred.




The
Company accounts for stock option and warrant grants issued to non-employees for
goods and services using the guidance of SFAS No. 123 and Emerging Issues
Task Force (“EITF”) No. 96-18: “Accounting for Equity Instruments that are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
Goods or Services,” whereby the fair value of such option and warrant grants is
determined using the Black-Scholes option pricing model at the earlier of the
date at which the non-employee’s performance is completed or a performance
commitment is reached.





Reclassifications





Certain
reclassifications have been made to 2007 balance sheet amounts to conform to the
2008 presentation.





Business
and credit concentrations





The
Company’s cash balances in financial institutions at times may exceed federally
insured limits. As of December 31, 2008 and 2007, before adjustments for
outstanding checks and deposits in transit, the Company had $84,539 and $65,449,
respectively, on deposit with three banks. The deposits are federally insured up
to $250,000 on each bank.




Warranties





The
Company has a warranty policy for its products. No warrant liability has been
recorded as of December 31, 2008 based on the limited sales and such amount is
deemed immaterial.




Inventories





Inventories
are valued at the lower of cost (first-in, first-out) or market and primarily
consist of finished goods.




Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Certain significant estimates were made in connection with preparing the
Company’s financial statements. Actual results could differ from those
estimates.




Fair
value of financial instruments
  Effective
January 1, 2008, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 157, Fair Value Measurements. This Statement defines fair value for
certain financial and nonfinancial assets and liabilities that are recorded at
fair value, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. This guidance applies to other
accounting pronouncements that require or permit fair value measurements. On
February 12, 2008, the FASB finalized FASB Staff Position (FSP) No.157-2,
Effective Date of FASB Statement No. 157. This Staff Position delays the
effective date of SFAS No. 157 for nonfinancial assets and liabilities to fiscal
years beginning after November 15, 2008 and interim periods within those fiscal
years, except for those items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually). The adoption
of SFAS No. 157 had no effect on the Company's consolidated financial position
or results of operations.


F-22




Recent
accounting pronouncements
  In March
2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments
and Hedging Activities, an amendment of FASB Statement No. 133" (SFAS 161). This
Statement requires enhanced disclosures about an entity's derivative and hedging
activities, including (a) how and why an entity uses derivative instruments, (b)
how derivative instruments and related hedged items are accounted for under SFAS
No. 133,  "Accounting for Derivative Instruments and Hedging
Activities" (SFAS 133), and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity's financial position,
financial performance, and cash flows. SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008.
 
 In
December 2007, the FASB issued FASB Statement No. 141 (R), "Business
Combinations" (FAS 141(R)), which establishes accounting principles and
disclosure requirements for all transactions in which a company obtains control
over another business.  Statement 141 (R) applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008.  Earlier adoption is prohibited.
 
 In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51".  SFAS
No. 160 establishes accounting and reporting standards that require that the
ownership interests in subsidiaries held by parties other than the parent be
clearly identified, labeled, and presented in the consolidated statement of
financial position within equity, but separate from the parent's equity; the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income; and changes in a parent's ownership interest
while the parent retains its controlling financial interest in its subsidiary be
accounted for consistently.  SFAS No. 160 also requires that any
retained noncontrolling equity investment in the former subsidiary be initially
measured at fair value when a subsidiary is deconsolidated.  SFAS No.
160 also sets forth the disclosure requirements to identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners.  SFAS No. 160 applies to all entities that prepare
consolidated financial statements, except not-for-profit organizations, but will
affect only those entities that have an outstanding noncontrolling interest in
one or more subsidiaries or that deconsolidate a subsidiary.  SFAS No.
160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  SFAS No. 160 must be applied prospectively as of the
beginning of the fiscal year in which it is initially applied, except for the
presentation and disclosure requirements.  The presentation and
disclosure requirements are applied retrospectively for all periods
presented.
 
 The
Company does not believe that the adoption of the above recent pronouncements
will have a material effect on the Company's consolidated results of operations,
financial position, or cash flows.
 
 Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the AICPA, and the SEC did not or are not believed by
management to have a material impact on the Company's present or future
consolidated financial statements.




F-23




3.    
Certain relationships and related transactions





Loans
from related parties





In May of
2007, a former officer and incumbent director of the Company loaned $31,404 to
pay a company obligation and in August 2007, the same party loaned $50,000 to
the Company so that it could pay certain operating expenses. These amounts are
unsecured, bear interest at 6% per annum and are due on demand.  At
December 31, 2008 and 2007, the balance of these loans including interest was
$78,280 and $83,596,.




Lease
agreement with related party




During
2003, the Company entered into a sublease agreement with Scottish Glen Golf
Company, Inc. (SGGC) to lease office space in North Hollywood, California for
its principal executive offices.  Bruce McKinnon, the former Chief
Executive Officer and former Director of the Company, is a beneficial owner of
the lessor.




In August
2005, the Company amended this sublease agreement. The original lease term was
from November 1, 2003 through October 16, 2005 and carried an option
to renew for two additional years with a 10 percent increase in the rental
rate. Monthly rent under this lease is $3,740 per month under this
lease.  The Company exercised its option to renew the lease through
October 15, 2007.





In
January 2006, the Company further amended this sublease agreement, as a result
of taking more space and obtaining expanded support services. The term of the
sublease was amended to July 31, 2007 and carries an option to renew for
two additional years with a 10 percent increase in the rental rate. Monthly
rent is $6,208 per month under this amended sublease agreement.
Additionally, the Company began leasing two additional office
spaces for $964 per month beginning July 2006 on a month-to-month
basis.  The Company did not exercise its option to renew this
sublease.





On July
12, 2007, SGGC presented to the Company a Three-Day Notice to Pay or Quit,
demanding payment of unpaid rent, additional rent and penalties.  On
July 19, 2007, SGGC sued the Company in Los Angeles Superior Court, alleging
unlawful detainer by the Company of its then-leased corporate offices at 5125
Lankershim Boulevard, North Hollywood, California, and failure to pay past due
rent and penalties in the aggregate amount of $104,413, of which $103,069 was
accrued by the Company at December 31, 2007.  The Company vacated the
premises on July 25, 2007.





On April
30, 2008 the Company and SGGC settled their pending litigation relating to the
Company’s prior offices.  The Company agreed to pay SGGC $51,000 in full
settlement of SGGC’s claims.  On May 28, 2008 the initial payment of
$34,000 was made and on July 9, 2008 the final payment of $17,000 was made and
the complaint was dismissed, with prejudice.   The Company
recorded $52,069 as other income and as a reduction of accounts payable that is
included in the settlement of litigation and debt in the accompanying Statement
of Operations for the year ending December 31, 2008.





Accounts
Payable to related parties




As
of December 31, 2008, the Company had accounts payable to related parties
in the amount of $93,003, which was composed of $59,705 in unpaid Directors
Fees, $33,298 in unreimbursed expenses incurred by Officers and
Directors.




Marketing
and promotional services agreement with related party




In July
2006, the Company entered into an agreement with SS Sales and Marketing Group
(“SS Sales”), to provide exclusive marketing and promotional services in the
western United States and western Canada  (the “Territory”) for the
Company’s products. SS Sales will also provide advice, assistance and
information on marketing the Company’s products in the automotive after-market,
and will seek to recruit and establish a market with distributors, wholesalers
and others. SS Sales will be paid a commission equal to 5% of the gross amount
actually collected on contracts the Company entered into during the term of the
agreement for existing or future customers introduced by SS Sales in the
Territory. The agreement has a term of five years unless sooner terminated by
either party on 30 days’ notice. In the event of termination, SS Sales will be
entitled to receive all commissions payable through the date of
termination.  SS Sales is owned by Nathan Shelton, who has served as
one of the directors of the Company since February 12, 2007.  There
were no payments made to SS Sales for the years ending December 31, 2008 and
2007.





F-24





4.   Property
and Equipment




At
December 31, 2008 and 2007, property and equipment consists of the
following:





December 31,2008
            
            
            2007Office
      equipment
            
            $
            31,966
            
            
            $
            53,043Delivery
      equipment
            
            
            —
            
            
            
            34,672Furniture
      and fixtures
            
            
            13,898
            
            
            
            18,957Machinery
      and equipment
            
            
            49,986
            
            
            
            54,161Dies
      and molds
            
            
            —
            
            
            
            3,000Testing
      equipment
            
            
            147,312
            
            
            
            147,312Leasehold
      improvements
            
            
            —
            
            
            
            245,512Subtotal
            
            
            243,162
            
            
            
            556,657Less
      accumulated depreciation
            
            
            (111,193
            )
            
            
            (355,599
            )Total
      current assets
            
            $
            131,969
            
            
            $
            201,058





Depreciation
expense for the years ended December 31, 2008 and 2007, was $37,530 and
$167,380, respectively.  Depreciation expense for the period from
inception February 18, 1998 through December 31, 2008 was
$393,129.





5.      Loans and other payable due to
Morale/Matthews





Loans and
other payable to Morale/Matthews consist of the following:





Maturity
      dates
            
            
            December
      31, 2008
            
            
            December
      31, 2007Note
      payable Morale Orchards, LLC, 2006 Note
            
            December
      5, 2006
            
            
            $
            —
            
            
            $
            671,992Note
      payable Morale Orchards, LLC, 2007 Note
            
            January
      10, 2007
            
            
            
            —
            
            
            
            601,250Discount
      on Morale Orchards, LLC 2007 Note
            
            —
            
            
            
            —
            
            
            
            (17,886
            )Loan
      payable to Morale Orchards, LLC
            
            Due
      on demand
            
            
            
            —
            
            
            
            20,334Fees
      due to Matthews & Partners
            
            —
            
            
            
            —
            
            
            
            472,762Total
            
            
            
            
            
            $
            —
            
            
            $
            1,748,452





Leodis
Matthews, through his law firm, Matthews & Partners, (“Matthews”) serves as
outside legal counsel to the Company.  Morale Orchards, LLC (“Morale”)
is owned by Jacqueline Alexander, the wife of Leodis Matthews.  Mr.
Matthews has no economic, voting, management or other interest, either directly
or indirectly, in Morale and disclaims any beneficial ownership in the common
stock and warrants of the Company held by Morale.




Morale
had previously purchased two convertible promissory notes.  Each note
was for $612,500.  One note was purchased December 5, 2006 (the “2006
Morale Note”) and another was purchased January 10, 2007 (the “2007 Morale
Note”).  The notes were unsecured, due one year from the date issued,
had an implied interest rate of 22.5%, and warrants were issued with the
notes.  The aggregate purchase price for the notes and warrants was
$1,000,000.





F-25





The 2006
Morale Note was convertible at the rate of $0.85 per share into 720,588 shares
of the Company’s common stock, and the 2007 Morale Note was convertible at the
rate of $0.70 per share into 875,000 shares of the Company’s common
stock.  The warrant issued with the 2006 Note was exercisable at $0.85
per share, for 360,294 shares of the Company’s common stock.  The
warrant issued with the 2007 Morale Note was exercisable at $.70 per share, for
437,500 shares of the Company’s common stock.





As of
January 31, 2008, both the 2006 and 2007 Morale Notes were in
default.  The note agreements provided if the notes are not paid when
due, the principal balance shall be increased by 10% and the Company shall pay
interest at 2.5% per month (30% per annum) until the note is paid.  At
January 31, 2008, the total amount due for the 2006 Morale Note and the 2007
Morale Note was $689,327 and $672,885 respectively.




In
addition to the 2006 and 2007 Morale Notes, the Company borrowed $20,000 from
Morale on October 30, 2007 (the “$20,000 Note”), at an interest rate of ten
percent (10%) per annum. Principal and accrued interest under the Morale Note is
due on demand, and no payments there under have been made by the Company. At
January 31, 2008, the Company was also indebted to Matthews $472,762 for past
legal fee.





Effective
January 31, 2008, the Company, Morale, and Matthews agreed to a settlement of
the Company’s loans due Morale and fees due Matthews.   Morale
agreed to waive all accrued interest on the notes after January 31, 2008, and
Morale and Matthews agreed to accept 7,421,896 shares of common stock of the
Company as payment of the notes payable and fees.





On March
10, 2008, the Company issued 5,530,848 shares of the Company’s common stock
valued at $2,101,722 to Morale for the conversion of the 2006 and 2007 Morale
Notes (totaling $1,362,212) and cancellation of $20,000
Note.   Also on March 10, 2008, the Company issued 1,891,048
shares of the Company’s common stock valued at $718,598 to Matthews in exchange
for settlement of the legal fees due Matthews of $472,762.





The fair
value of the shares of common stock issued was determined to be $0.38 per share,
based on the closing price of the Company’s common stock on January 31, 2008,
for a total settlement of $2,820,320.  As a result of the issuance of
shares of common stock, the Company incurred additional non-cash costs of
$927,903 that have been reflected as costs to settle outstanding debt in the
accompanying December 31, 2008 statement of operations.





6.           Convertible
notes and warrants





Convertible
debentures consist of the following:


Maturity
      dates
                  
                  December
      31,
                    2008
                  
                  
                  December
      31, 20072007
      Spring Offering
                  —
                  
                  $
                  —
                  
                  
                  $
                  341,0002007
      Summer Offering
                  —
                  
                  
                  —
                  
                  
                  
                  93,5002007
      Fall Offering
                  —
                  
                  
                  —
                  
                  
                  
                  622,6002007
      Winter Offering
                  February
      29, 2009
                  
                  
                  66,000
                  
                  
                  
                  —2008
      Summer Offering
                  August
      31, 2009
                  
                  
                  341,000
                  
                  
                  
                  —2008
      Fall Offering
                  October
      31, 2009
                  
                  
                  152,020
                  
                  
                  
                  —2008
      Winter Offering
                  December
      5, 2009
                  
                  
                  337,700
                  
                  
                  
                  —Sub-total
                  
                  
                  
                  896,,720
                  
                  
                  
                  1,057,100Less,
      remaining debt discount
                  
                  
                  
                  (593,595
                  )
                  
                  
                  (334,920
                  )Total
                  
                  
                  
                  303,125
                  
                  
                  
                  722,180Less:
      Convertible debentures, net, related parties
                  
                  
                  
                  (12,466
                  )
                  
                  
                  (227,136
                  )Convertible
      debentures, net, others
                  
                  
                  $
                  290,659
                  
                  
                  $
                  495,044




F-26





2007
Spring Offering





From
June 13, 2007 through June 26, 2007, the Company conducted a private
offering (the “2007 Spring Offering”) of up to $550,000 aggregate face amount of
its convertible notes (the “2007 Spring Notes”) with a small number of
accredited investors. Of this amount, $451,000 aggregate face amount of the 2007
Spring Notes were sold for an aggregate purchase price of $410,000 net proceeds.
Therefore, while the stated interest rate on the 2007 Spring Notes is 0%, the
implied interest rate on the 2007 Spring Notes is 10%. The 2007 Spring Notes
mature on the first anniversary of their date of issuance. The 2007 Spring Notes
are convertible, at the option of the noteholders, into shares of common stock
of the Company (the “Conversion Shares”) at an initial conversion price equal to
the average of the closing bid price of the Company’s common stock for the five
trading days preceding the closing dates of the 2007 Spring Offering (the
“Conversion Prices”). On the first closing, 1,002,941 Conversion Shares are
issuable at Conversion Price of $0.34 per share. On the second closing,
207,548 conversion shares are issuable at a conversion price of $0.53 per
share. The per share price of the Company’s common stock on the Pink Sheets
during this period ranged from a low bid price (intraday) of $0.35 to a high bid
price (intraday) of $0.59.





As of
December 31, 2008, investors have converted all $451,000 of the Convertible
Notes into 1,210,489 shares of the Company’s common stock (of which $344,546 of
notes and accrued interest were converted into 951,641 shares of common stock
during the year ended December 31, 2008).  There was no outstanding
balance at December 31, 2008 under these notes.





Each of
the investors in the 2007 Spring Offering also received a warrant (the
“2007 Spring Warrants”), entitling the holder to purchase a number of shares of
the Company’s common stock equal to 50% of the number of shares of common stock
into which the 2007 Spring Notes are convertible (the “Warrant Shares”). Each
Spring 2007 Warrant is exercisable on a cash basis only at an initial price of
$0.50 per share, and is exercisable immediately upon issuance and for a period
of two years from the date of issuance. A total of 605,242 Warrant Shares were
issued.





The
aggregate value of the 2007 Spring Offering Warrants issued in connection with
the June 13, 2007 closing were valued at $59, 296 using the Black-Scholes option
valuation model with the following assumptions; risk-free interest rate of
5.11%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 113.56%; and an expected life of two years (statutory term) and
vest immediately upon issuance.  The Company also determined that the
notes contained a beneficial conversion feature of $119,472.  The
value of the Spring 2007 Offering Warrants of $59,296, the conversion option of
$119,472, and the transaction fees of $31,000 are considered as debt discount
and are being amortized over the life of the Note.




The
aggregate value of the 2007 Spring Offering Warrants issued in connection with
the June 26, 2007 closing were valued at $19,580 using the Black-Scholes option
valuation model with the following assumptions; risk-free interest rate of
5.11%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 117.65%; and an expected life of two years (statutory term) and
vest immediately upon issuance.  The Company also determined that the
notes contained a beneficial conversion feature of $21,655.  The value
of the 2007 Spring Offering Warrants of $19,580, the conversion option of
$21,655 and the transaction fees of $112,500 are considered as debt discount and
are being amortized over the life of the Note.





F-27





2007
Summer Offering





From
August 8, 2007 through September 27, 2007, the Company conducted a private
offering (the "2007 Summer Offering") of up to $330,000 aggregate face amount of
its convertible notes (the "2007 Summer Notes") with a small number of
accredited investors. Of this amount, $309,980 aggregate face amount of the 2007
Summer Notes were sold for an aggregate purchase price of $281,800 net proceeds.
While the stated interest rate on the 2007 Summer Notes is 0%, the implied
interest rate on the 2007 Summer Notes is 10%. The 2007 Summer Notes mature on
the first anniversary of their date of issuance. The 2007 Summer Notes are
convertible, at the option of the noteholder, into shares of common stock of the
Company (the "Conversion Shares") at a conversion price equal to the average of
the closing bid price of the Company's common stock for the five trading days
preceding the closing date of the 2007 Summer Offering (the "Conversion
Prices"). Up to 837,784 Conversion Shares are issuable at a Conversion Price of
$0.37 per share.





As of
December 31, 2008, all investors have converted $309,980 Convertible Notes into
837,784 shares of the Company’s common stock  (of which $93,500 of
notes and accrued interest were converted into 252,702 shares of common stock
during the year ended December 31, 2008).  There was no outstanding
balance at December 31, 2008 under these notes.





Each of
the investors in the Summer 2007 Offering also received a warrant (the
"2007 Summer Warrants"), entitling the holder to purchase a number of shares of
the Company's common stock equal to 50% of the number of shares of common stock
into which the 2007 Summer Notes are convertible (the "Warrant Shares"). Each
2007 Summer Warrant is exercisable on a cash basis only at a price of $0.50 per
share, and is exercisable for a period of two years from the date of issuance. A
total of 418,892 Warrant Shares were issued.




The
aggregate value of the 2007 Summer Offering Warrants issued in connection with
the September 28, 2007 closing were valued at $60,678 using the Black-Scholes
option valuation model with the following assumptions; risk-free interest rate
of 4.87%; dividend yield of 0%; volatility factors of the expected market price
of common stock of 124.83%; and an expected life of two years (statutory term)
and vest immediately upon issuance.  The Company also determined that
the notes contained a beneficial conversion feature of $69,055.  The
value of the 2007 Summer Offering Warrants of $60,678, the conversion option of
$69,055 and the transaction fees of $28,180 are considered as debt discount and
are being amortized over the life of the Note.




2007
Fall Offering





From
November 14, 2007 through December 17, 2007, the Company conducted a private
offering (the "2007 Fall Offering") of up to $1,100,000 aggregate face amount of
its convertible notes (the "2007 Fall Notes") with a small number of accredited
investors. Of this amount, $622,600 aggregate face amount of the 2007 Fall Notes
were sold for an aggregate purchase price of $566,000 net proceeds. While the
stated interest rate on the 2007 Fall Notes is 0%, the implied interest rate on
the 2007 Fall Notes is 10%. The 2007 Fall Notes mature on the first anniversary
of their date of issuance. The 2007 Fall Notes are convertible, at the option of
the noteholder, into shares of common stock of the Company (the "Conversion
Shares") at a conversion price equal to the average of the closing bid price of
the Company's common stock for the five trading days preceding the closing date
of the 2007 Fall Offering (the "Conversion Prices"). Up to 1,596,410 Conversion
Shares are issuable at a Conversion Price of $0.39 per share.





During
the year ended December 31, 2008, 1,596,410 shares of the Company’s common stock
were issued to noteholders in the 2007 Fall Offering who converted Convertible
Notes in the amount of $622,600. There was no outstanding balance at December
31, 2008 under these notes.





F-28





Each of
the investors in the 2007 Fall Offering also received a warrant (the "2007
Fall Warrants"), entitling the holder to purchase a number of shares of the
Company's common stock equal to 50% of the number of shares of common stock into
which the (2007 Fall Notes) are convertible (the "Warrant Shares"). Each 2007
Fall Warrant is exercisable on a cash basis only at a price of $0.50 per share,
and is exercisable for a period of two years from the date of issuance. Up to
796,205 Warrant Shares are initially issuable on exercise of the 2007 Fall
Warrants.




2007-2008
Winter Offering





From
December 27, 2007 to February 29, 2008  the Company conducted an
offering (the “2008 Winter Offering”) of up to $1,000,000 aggregate face amount
of its convertible notes (the “ 2008 Winter Notes”) with a small number of
accredited investors.  Of this amount, $521,400 aggregate face amount
of the 2008 Winter Notes were sold for an aggregate purchase price of $474,000
net proceeds.  Therefore, while the stated interest rate on the 2008
Winter Notes is 0%, the implied interest rate on the 2008 Winter Notes is
10%.  The 2008 Winter Notes mature on the first anniversary of their
date of issuance.  The 2008 Winter Notes are convertible, at the
option of the noteholder, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Winter Offering (the “Conversion Price”).  Up
to $1,042,800 Conversion Shares are issuable at a Conversion Price of $0.50 per
share.





Each of
the investors in the 2008 Winter Offering received, for no additional
consideration, a warrant (the “ 2008 Winter Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Winter Notes) are
convertible (the “2008 Warrant Shares”)  Each  2008 Winter
Warrant is exercisable on a cash basis only at a Price of $0.50 per share, and
is exercisable for a period of two years from the date of
issuance.  Up to 521,400 2008 Warrant Shares are initially issuable on
exercise of the 2008 Winter Warrants.  As of December 31, 2008,
investors have converted $455,400 of the Convertible Notes into 910,800 shares
of the Company’s common stock.  The outstanding balance at December
31, 2008 is $66,000.





2008
Spring Offering





On May
27, 2008,  the Company made an offering (the “2008 Spring Offering”)
with a certain investor of which, $66,000 face amount of the 2008 Spring
Note was sold for $60,000 net proceeds.  Therefore, while the stated
interest rate on the 2008 Spring Note is 0%, the implied interest rate on the
2008 Spring Note is 10%. The 2008 Spring Note will mature on the first
anniversary of the date of issuance.  The 2008 Spring Note is
convertible, at the option of the noteholder, into shares of common stock of the
Company (the “Conversion Shares”) at a conversion price equal to the average of
the closing bid price of the Company’s common stock for the five trading days
preceding the closing date of the 2008 Spring Offering (the “Conversion
Price”).  The 132,000 Conversion Shares are issuable at a Conversion
Price of $0.50 per share.





The
investor in the 2008 Spring Offering received, for no additional consideration,
a warrant (the “ 2008 Spring Warrants”), entitling the holder to purchase a
number of shares of the Company’s common stock equal to 50% of the number of
shares of common stock into which the ( 2008 Spring Notes) are convertible (the
“2008 Spring Warrant Shares”).  The 2008 Spring Warrant Shares is
exercisable on a cash basis only at a Price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  The
66,000 2008 Spring Warrant Shares are initially issuable upon exercise of the
2008 Spring Warrants.  As of December 31, 2008, investors have
converted $66,000 of the Convertible Notes into 132,000 shares of the Company’s
common stock.  There was no outstanding balance at December 31,
2008.





F-29





2008
Summer Offering





From July
17, 2008 to August 31, 2008,  the Company conducted an offering (the
“2008 Summer Offering”) of up to $600,000 aggregate face amount of its
convertible notes “the”2008 Summer Offering) with a small number of accredited
investors. Of this amount $484,000 aggregate face amount of the 2008 Summer
Notes were sold for an aggregate purchase price of $440,000 net
proceeds.  Therefore, while the stated interest rate on the 2008
Summer Notes is 0%, the implied interest rate on the 2008 Summer Notes is
10%.  The 2008 Summer Notes will mature on the first anniversary of the
date of issuance.  The 2008 Summer Notes are convertible, at the
option of the noteholders, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Summer Offering (the “Conversion Price”).  Up
to 1,423,530 Conversion Shares are issuable at a Conversion Price of $0.34 per
share.




Each of
the investors in the 2008 Summer Offering received, for no additional
consideration, a warrant (the “ 2008 Summer Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Summer Notes) are
convertible (the “2008 Summer Warrant Shares”). Each 2008 Summer Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 711,764, 2008 Summer Warrant Shares are initially issuable upon exercise of
the 2008 Summer Warrants.  As of December 31, 2008, investors have
converted $143,000 of the Convertible Notes into 420,589 shares of the
Company’s common stock.  The outstanding balance at December 31, 2008
was $341,000.





2008
Fall Offering





From
September 8, 2008 to October 31, 2008, the Company conducted an offering (the
“2008 Fall Offering”) of up to $500,000 aggregate face amount of its Convertible
Notes.  A total of $198,220 aggregate face amount of the 2008 Fall
Notes were sold for an aggregate purchase price of $180,220 net
proceeds.  Therefore, while the stated interest on the 2008 Fall Notes
is 0%, the implied interest rate on the 2008 Fall Notes is 10%.  The
2008 fall notes will mature on the first anniversary of the date of
issuance.  The 2008 Fall Notes are convertible, at the option of the
noteholders, into shares of common stock of the Company (the “Conversion
Shares”) at a conversion price equal to the average of the closing bid price of
the Company’s common stock for the five trading days preceding the closing date
of the 2008 Fall Offering (the “Conversion Price”).  Up to 1,321,466
Conversion Shares are issuable at a Conversion Price of $0.15 per
share.





Each of
the investors in the 2008 Fall Offering received, for no additional
consideration, a warrant (the “ 2008 Fall Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Fall Notes) are
convertible (the “2008 Fall Warrant Shares”). Each 2008 Fall Warrant is
exercisable on a cash basis only at a price of $0.50 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 660,734 2008 Fall Warrant Shares are initially issuable upon exercise of the
2008 Fall Warrants.  As of December 31, 2008, investors have converted
$46,200 of the Convertible Notes into 308,000 shares of the Company’s common
stock.  The outstanding balance at December 31, 2008 was
$152,020.





2008
Winter Offering





From
November 24, 2008 to December 5, 2008, the Company conducted an offering (the
“2008 Winter Offering”) of up to $500,000 aggregate face amount of its
Convertible Notes.  A total of $524,700 aggregate face amount of the
2008 Winter Notes were sold for an aggregate purchase price of $477,000 net
proceeds.  Therefore, while the stated interest on the 2008 Winter
Notes is 0%, the implied interest rate on the 2008 Winter Notes is
10%.  The 2008 Winter Notes will mature on the first anniversary of
the date of issuance.  The 2008 Winter Notes are convertible, at the
option of the noteholders, into shares of common stock of the Company (the
“Conversion Shares”) at a conversion price equal to the average of the closing
bid price of the Company’s common stock for the five trading days preceding the
closing date of the 2008 Winter Offering (the “Conversion Price”).  Up
to 3,086,470 Conversion Shares are issuable at a Conversion Price of $0.17 per
share.








F-30





Each of
the investors in the 2008 Winter Offering received, for no additional
consideration, a warrant (the “ 2008 Winter Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the ( 2008 Winter Notes) are
convertible (the “2008 Winter Warrant Shares”). Each 2008 Winter Warrant is
exercisable on a cash basis only at a price of $0.30 per share, and is
exercisable for a period of two years from the date of issuance.  Up
to 1,543,235 2008 Winter Warrant Shares are initially issuable upon exercise of
the 2008 Winter Warrants.  As of December 31, 2008, investors have
converted $187,000 of the Convertible Notes into
1,099,999  shares of the Company’s common stock.  The
outstanding balance at December 31, 2008 was $337,700.




2007 PIPE
Offering. During
the year ended December 31, 2007, the Company conducted an offering (the “2007
PIPE Offering”), through Spencer Clarke LLC, as exclusive placement agent, of up
to $2,000,000 principal amount of its 10% convertible notes (the “2007 PIPE
Notes”).  Interest on the 2007 PIPE Notes, at a rate of 10% per annum,
is payable quarterly.  The Notes are due nine months from date of
issuance.  The 2007 PIPE Notes are convertible into shares of common
stock at an initial conversion price of $0.70 per share (the “Conversion
Shares”).  There is no reset to the conversion price for any
beneficial conversion feature.





The
Company has the right to redeem any or all of the outstanding 2007 PIPE Notes in
its sole discretion anytime after the termination of the 2007 PIPE Offering and
prior to the maturity date of the 2007 PIPE Notes. The redemption price shall be
the face amount of the redeemed 2007 PIPE Notes plus accrued and unpaid interest
thereon.  Subject to the following sentence, at any time prior to the
maturity date of the 2007 PIPE Notes, for each additional $1,000,000 of gross
proceeds raised from one or more offerings of the Company’s equity or
quasi-equity securities, the Company shall redeem 2007 PIPE Notes with a minimum
face value of $500,000 together with accrued and unpaid interest, until the
entire outstanding 2007 PIPE Note is redeemed. Certain financings that the
Company may conduct outside of North America are exempt from this provision to
redeem the 2007 PIPE Notes in whole or in part.




Investors
in the 2007 PIPE Offering also received a warrant (the “2007 PIPE
Warrant”), entitling the holder to purchase a number of shares of the Company’s
common stock equal to 150% of the number of shares of common stock into which
the 2007 PIPE Notes are convertible (the “Warrant Shares”). The 2007 PIPE
Warrant will be exercisable on a cash basis only and will have registration
rights.  The 2007 PIPE Warrant is exercisable at an initial price of
$1.00 per share, and is exercisable immediately upon issuance and for a period
of three years from the date of issuance.




Promptly,
but no later than 90 days following the closing date of the 2007 PIPE Offering,
the Company is required to file a Registration Statement with the SEC to
register the Conversion Shares and the Warrant Shares. The Company shall use its
best efforts to ensure that such Registration Statement is declared effective
within 120 days after filing.




Pursuant
to the terms of the PIPE Notes, if a Registration Statement is not filed on
the 91st day following the closing date, (i) the interest rate on the PIPE Notes
increased from 10% to 18% per annum until the event of default is cured and (ii)
the holders of the PIPE Notes became entitled to receive additional warrants in
an amount equal to 25% of the PIPE Warrants originally issued, for each 60-day
period that the Company remains in default.




During
the year ended December 31, 2007, the Company issued $400,000 of the PIPE Notes
which could be converted into 571,429 shares of the Company’s common stock and
2007 PIPE Warrants to purchase 857,144 shares of the Company’s common stock.
These warrants expire March 1, March 30 and April 2, 2010 and are exercisable at
a price of $1.00 per share. The Company had related transaction fees of $48,000,
resulting in net proceeds to the Company of $352,000. In addition to the
transaction fees, warrants to purchase 57,143 shares of the Company’s common
stock were issued to Spencer Clarke LLC, the Company’s exclusive placement agent
for the 2007 PIPE Offering. These warrants expire March 1, March 30 and April 2,
2010 and are exercisable at a price of $0.70 per share.







F-31





The
aggregate value of the 2007 PIPE Warrants issued in connection with this
offering and the warrants issued to the placement agent were valued at $256,533
using the Black-Scholes option valuation model with the following assumptions:
risk-free interest rate of 4.40% to 5.16%; dividend yield of 0%; volatility
factors of the expected market price of common stock of 100.28% to 114.98%; and
an expected life of two years (statutory term). The Company also determined that
the notes contained a beneficial conversion feature of $62,857.




The
Company was unable to meet its obligations to file the Registration Statement
required under the terms of the 2007 PIPE Offering in a timely manner. In early
July 2007, the Company began discussions with Spencer Clarke, acting on behalf
of the holders of the PIPE Notes and PIPE Warrants, for an extension of time to
file the Registration Statement. Notwithstanding such discussions, Spencer
Clarke issued a Notice of Default dated August 1, 2007 (the "Notice") to the
Company for its failure to file the Registration Statement in a timely
manner.




On August
29, 2007, the Company entered into a Modification Agreement with the 2007 PIPE
note holders. The Modification Agreement was entered into as a result of
negotiations between the Company and Spencer Clarke, LLC ("Spencer Clarke"), the
Company's exclusive placement agent for the 2007 PIPE Offering, after the
Company failed to file with the Securities and Exchange Commission (the "SEC")
in a timely manner a Registration Statement to register the shares of the
Company's common stock into which the PIPE Notes are convertible and for which
the PIPE Warrants may be exercised.





Pursuant
to the Modification Agreement, the parties have agreed as follows:




■
            Promptly,
      but no later than November 30, 2007 (instead of on or before July 2,
      2007), the Company shall file the Registration Statement with the SEC to
      register the Conversion Shares and the Warrant Shares.■
            Effective
      August 1, 2007, the interest rate on the PIPE Notes shall be increased
      from 10% per annum to 18% per annum until such time as the Registration
      Statement is declared effective by the SEC.■
            The
      price at which the PIPE Notes may be converted into Conversion Shares (the
      "Conversion Price") shall be reduced from $0.70 to $0.45 per
      share.■
            Each
      Investor shall receive, for no additional consideration, additional
      warrants ("Additional Warrants") in an amount equal to an additional 50%
      of the PIPE Warrants originally issued pursuant to the terms of the 2007
      PIPE Offering. These Additional Warrants total 428,575 and shall have the
      same registration rights as are described in the Private Placement
      Memorandum dated January 12, 2007 (the "Offering Memorandum") used in
      connection with the 2007 PIPE Offering applicable to the PIPE Warrants;
      shall be exercisable immediately upon issuance; shall remain exercisable
      for a period of five years from the date of the Modification Agreement, on
      a cash basis only, at an initial exercise price of $0.45 per share; and
      shall, in all other respects, have the same terms and conditions, and be
      in the same form, as the PIPE
Warrants.


■
            If
      the Company does not file the Registration Statement with the SEC by
      November 30, 2007, each Investor shall receive, for no additional
      consideration, warrants ("Delay Warrants") in an amount equal to an
      additional 50% of the PIPE Warrants originally issued pursuant to the
      terms of the Offering Memorandum. The Delay Warrants shall have the same
      registration rights as are described in the Offering Memorandum applicable
      to the PIPE Warrants; shall be exercisable immediately upon issuance;
      shall remain exercisable for a period of five years from the date of this
      Agreement, on a cash basis only, at an initial exercise price of $0.45 per
      share; and shall, in all other respects, have the same terms and
      conditions, and be in the same form, as the PIPE
  Warrants.





The terms
and conditions of the Offering Memorandum, the PIPE Notes and the PIPE Warrants,
to the extent not expressly amended in the Modification Agreement, remain in
full force and effect. The issuance of the Additional Warrants (“Delay
Warrants”), if any, and the reduction of the Conversion Price of the PIPE Notes,
has the potential to dilute the percentage ownership interest of the Company's
existing shareholders.





F-32





The
aggregate value of the 2007 PIPE Warrants issued in connection with this
Modification Agreement were valued at $138,107 using the Black-Scholes option
valuation model with the following assumptions: risk-free interest rate of
4.43%; dividend yield of 0%; volatility factors of the expected market price of
common stock of 113.55%; and an expected life of two years (statutory
term).




On
November 30, 2007, the Company and the Investors entered into the Second
Modification Agreement and pursuant to this agreement have agreed as
follows:




■
            The
      Investors have agreed to forgive all accrued interest on their PIPE Notes,
      from the date of issuance thereof through December 14,
      2007.■
            On
      December 14, 2007, the Company agreed to pay all Investors 50% of the
      principal amount of their original PIPE Notes which equals a total cash
      repayment of $200,000.  Additionally, in repayment of the other
      50% of the principal amount of the original PIPE Notes, the Company, on
      December 14, 2007, agreed to issue to Investors a total of 1,060,000
      shares of the Company’s common stock (the “Conversion
      Shares”).■
            Concurrently
      with the cash payment and the issuance of the Conversion Shares as noted
      in paragraph 2 above, the Investors agreed to deliver to the Company the
      original of the PIPE Notes, which will be marked and deemed cancelled and
      of no further force or effect.■
            In
      further consideration of the above terms and conditions, the Investors
      have agreed that the Company shall not be required to, and shall not, file
      a Registration Statement with the Securities and Exchange Commission or
      any state securities agency to register or qualify the PIPE Notes, the
      Conversion Shares, the PIPE Warrants, or any shares issuable pursuant to
      the PIPE Warrants (the Warrant Shares”).  The Conversion Shares
      and Warrant Shares when issued will be deemed restricted securities and
      bear appropriate legends.■
            The
      terms and conditions of the PIPE Warrants, to the extent not expressly
      amended in the Second Modification Agreement, shall remain in full force
      and effect in furtherance of the terms and conditions set forth in the
      Modification Agreement.




Payment
of $200,000 was made by the Company in accordance with the Second Modification
Agreement, the Original Notes were surrendered by the Investors and 1,060,000
shares of common stock were issued to the Investors on December 27,
2007.  Included in interest expense is the excess of the cost to
settle the obligation over the carrying value at the settlement date totaling
$222,368.





The
aggregate value of the 2007 PIPE warrants in connection with the Second
Modification Agreement were valued at $116,913 using the Black-Scholes valuation
model with the following assumptions: risk-free interest rate of 4.39%; dividend
yield of 0%; volatility factors of the expected market price of common stock of
116.75%; and an expected life of five years (statutory term).  The
Company recorded and issued these warrants in January 2008.





7.           Research
and Development





The
Company has research and development facilities in Morgan Hill, California. The
Company has tested products incorporating our ZEFS, MK IV and ELEKTRA
technologies for multiple makes and models diesel engines, motorbikes, boats,
generators, lawnmowers and other small engines.  The Company has
purchased test vehicles, test engines and testing equipment. The Company
incurred $652,363 and $600,816 for the years ended December 31, 2008 and 2007,
respectively, on its research and development activities.





F-33





Temple
University License Agreements





The
Company has entered into a research and development agreement (R&D
Agreement) with Temple University to conduct further research on the
ELEKTRA technology. Under the R&D Agreement Temple University will conduct a
24-month research project towards expanding the scope of, and developing
products utilizing, the technologies covered under the License Agreements,
including design and manufacture of prototypes utilizing electric fields to
improve diesel, gasoline and kerosene fuel injection in engines using such fuels
and a device utilizing a magnetic field to reduce crude oil viscosity for crude
oil (paraffin and mixed base) and edible oil flow in pipelines. If the research
project yields results within the scope of the technologies licensed pursuant to
the License Agreements, those results will be deemed included as rights licensed
to the Company pursuant to the License Agreements. If the research project
yields results outside of the scope of the technologies covered by the License
Agreements, the Company has a six-month right of first negotiation to enter into
a new worldwide, exclusive license agreement with Temple University for the
intellectual property covered by those results.





The
Company has entered into three License Agreements with
Temple University covering Temple University’s current patent
applications concerning certain electric field effects on gasoline, kerosene and
diesel fuel particle size distribution, and concerning electric field effects on
crude oil and edible oil viscosity. Initially, the License Agreements are
exclusive and the territory licensed to the Company is worldwide. Pursuant to
the License Agreements, the Company will pay to Temple University
(i) license fees in the aggregate amount of $300,000.  A payment
of $50,000 was due on November 1, 2006; a payment of $100,000 was due on March
2, 2007; a payment of $75, 000 was due on February 2, 2008 and the final payment
is due on February 2, 2009.  Annual maintenance fees of $25,000 for the
first license were due on November 1, 2007 and November 1,
2008.  Annual maintenance payments of $125,000 for two of the licenses
were due January 1, 2008. In addition, each License Agreement separately
provides that the Company will pay royalties to Temple University on net sales
of products incorporating the technology licensed under that License Agreement
in an amount equal to 7% of the first $20 million of net sales, 6% of the
next $20 million of net sales and 5% of net sales in excess of
$40 million. Sales under the three License Agreements are not aggregated
for purposes of calculating the royalties payable to Temple University. In
addition, the Company has agreed to bear all costs of obtaining and maintaining
patents in any jurisdiction where the Company directs Temple University to
pursue a patent for either of the licensed technologies. Should the Company not
wish to pursue a patent in a particular jurisdiction, that jurisdiction would
not be included in the territory licensed to the Company.




At
December 31, 2008, the Company is in default in the amount of $300,000 in
connection with its payment obligations under the License Agreements and
maintenance payments.  On November 10, 2008, the Company received written
notice from Temple University of a material breach relating to required
payments under the License Agreements.  The notice provides the
Company with 60 days’ notice to cure the material breach.  The
Company’s failure to cure could result in a termination of the License
Agreements. If the termination occurs, the Company estimates this would have a
material adverse impact on the Company’s financial condition and
operations.  Under the License Agreements the Company is subject to a
penalty of 1% per month of the amounts due and unpaid under the License
Agreements.  As of December 31. 2008, the Company estimates the penalty to
be $40,250, and has accrued this in the accompanying financial
statements.




The
Company has also entered into a research and development agreement (R&D
Agreement) with Temple University to conduct further research on the
ELEKTRA technology. Under the R&D Agreement Temple University will conduct a
24-month research project towards expanding the scope of, and developing
products utilizing, the technologies covered under the License Agreements,
including design and manufacture of prototypes utilizing electric fields to
improve diesel, gasoline and kerosene fuel injection in engines using such fuels
and a device utilizing a magnetic field to reduce crude oil viscosity for crude
oil (paraffin and mixed base) and edible oil flow in pipelines. If the research
project yields results within the scope of the technologies licensed pursuant to
the License Agreements, those results will be deemed included as rights licensed
to the Company pursuant to the License Agreements. If the research project
yields results outside of the scope of the technologies covered by the License
Agreements, the Company has a six-month right of first negotiation to enter into
a new worldwide, exclusive license agreement with Temple University for the
intellectual property covered by those results. Pursuant
to the R&D Agreement, the Company will make payments to
Temple University in the aggregate amount of $500,000.





F-34





At
December 31, 2008, the Company is in default in the amount of $376,250 under the
R&D Agreement.  On November 10, 2008, the Company received written
notice of default from Temple University. The notice provides the Company
with 60 days to cure the material breach.  The Company’s failure to
cure the breach could result in the termination of the R&D
Agreement.  If the termination occurs, the Company estimates this
would have a material adverse impact on the Company’s financial condition and
operations.





At
November 30, 2008, the Company owed to Temple University a total of $716,500 for
the License Agreements, Maintenance Fees, R & D Agreement and
penalties.  On January 9, 2009, the Company entered into a Letter
Agreement with Temple University wherein Temple University granted to the
Company an extension of time to cure the above-referenced breaches until March
31, 2009.  The Letter Agreement provides for payments of $100,000 on
each of January 31, 2009, February 28, 2009 and March 31, 2009. The Company made
the January 31, 2009 payment but did not make the payment due on February 28,
2009. On March 26, 2009, the Company received a written extension for both the
February 28, 2009 payment and the March 31, 2009 payment until April 30,
2009. All additional amounts past due as of November 10, 2008 were to be
re-negotiated on or before March 31, 2009, however, this has now been extended
to April 30, 2009.  A penalty equal to 1% of the amount due and unpaid
on the first day of each calendar month will be added to the outstanding amount
due Temple University.





The
Company has provided for all past due amounts in the financial statements at
December 31, 2008.which is included in accounts payable-Temple University.
During the twelve months ended December 31, 2008 and December 31, 2007, the
Company recorded $480,250, and 186,250, respectively fees due to
Temple University.  Fees due Temple University as of
December 31, 2008 and 2007 were $716,500 and $161,250,
respectively.




Other




The
Company is also working with Temple and several domestic and international
corporations to develop the AOT (Applied Oil Technology) product line for oil
refineries and pipelines.  The AOT product line uses the same
dynamically-controlled strong electrical field concepts to reduce viscosity as
ELEKTRA but is designed for pipeline applications that use thicker, more viscous
fuels than the ELEKTRA market.  The AOT product is intended to improve
the speed of highly viscous fluids such as crude oil traveling through
pipelines.





8.    
Common Stock Transactions





Issuances
of Common Stock - 2008





During
the year ended December 31, 2008, the Company issued an aggregate of 2,398,850
of shares of its common stock for an aggregate value of $518,629.  The
shares were valued based upon the trading price of the common stock at the date
of the agreement.  The agreements entered into during the year
included the following





●
            On
      November 17, 2008, the Company entered into a Consultant Agreement with
      Core Consulting Group to advise the Company regarding Public and Investor
      Relations concerning various Company business and public
      disclosures.  Core shall be paid $2,500 a month for six (6)
      months and 1,000,000 non-refundable restricted shares of common
      stock.  The Company valued the shares at $170,000 based upon the
      trading price of the common stock at the date of the
      agreement.





●
            On
      November 17, 2008, the Company entered into a Service Agreement with IRTH
      Communications,IRTH will perform certain IR/PR services, internet development,
      communications, and business consulting services to private and publicly
      held companies. Compensation for services will be $7,500 for the following
      12 months.  IRTH will receive 625,000 non-refundable restricted
      shares of common stock. The Company valued the shares at $106,250 based
      upon the trading price of the common stock at the date of the
      agreement.





F-35





●
            During
      2008, the Company issued 238,850 shares of its common stock for services
      valued in the aggregate at $81,879. The Company valued the shares at
      prices ranging from $0.16 to $0.49 per share based upon the trading price
      of the common stock at the date of the
  agreements.





●
            During
      2008, the Company issued 535,000 shares of its common stock to settle
      $160,500 of outstanding accounts
payable.





During
the year ended December 31, 2008, the Company issued 5,575,082 shares of common
stock in exchange for conversion of  $1,958,245 of Convertible
Notes.





During
the year ended December 31, 2008, the Company issued 7,421,896 shares of its
common stock valued at $2,783,711 stock in settlement of certain loans and other
amounts due Morale/ Matthews (See Note 5).





During
the year ended December 31, 2008, the Company issued 1,064,650 shares of common
stock in exchange upon the exercise of outstanding warrants and options,
resulting in net proceeds to the Company of  $532,325.





Issuance
of common stock – 2007





In August
2007, the Company issued 2,597,524 shares in connection with the exercise of
options that were originally granted to the late Edward L. Masry.




During
the year ended December 31, 2007 the Company issued 1,880,421 shares of common
stock under the equity line of credit.  Gross proceeds received of
$992,055 and net proceeds received of $912,683.




During
the year ended December 31, 2007, the Company issued 1,910,711 shares of common
stock in exchange for conversion of  $526,480 of Convertible
Notes.





9.    
Stock options and warrants





The
Company currently issues stock options to employees, directors and consultants
under the 2004 Stock Option Plan (the Plan). The Company could issue options
under the Plan to acquire up to 5,000,000 shares of common stock. In
February 2006, the board approved an amendment to the Plan (approved by the
Shareholders in May 2006), increasing the authorized shares by
2,000,000 shares to 7,000,000 shares. At December 31, 2008,
2,648,775 were available to be granted under the Plan. Prior to 2004, the
Company granted 3,250,000 options outside the Plan to officers of the Company of
which 250,000 are still outstanding.





F-36




Employee
options vest according to the terms of the specific grant and expire from 5 to
10 years from date of grant. Non-employee option grants to date are vested
upon issuance. The weighted-average, remaining contractual life of employee
options outstanding at December 31, 2008 was 8.18 years. Stock option
activity for the years ended December 31, 2008 and 2007, which includes
3,250,000 options granted outside and prior to the adoption of the Plan, was as
follows:


Weighted
      Avg.
                Options
              
              
              Weighted
      Avg.
                Exercise
      PriceOptions,
      January 1, 2004
              
              
              13,250,000
              
              
              $
              0.11Options
      granted
              
              
              1,172,652
              
              
              
              1.03Options
      exercised
              
              
              —
              
              
              
              —Options
      cancelled
              
              
              —
              
              
              
              —Options,
      December 31,
      2004
              
              
              14,422,652
              
              
              
              0.18Options
      granted
              
              
              2,085,909
              
              
              
              0.92Options
      exercised
              
              
              —
              
              
              
              —Options
      cancelled
              
              
              (10,000,000
              )
              
              
              0.10Options,
      December 31,
      2005
              
              
              6,508,561
              
              
              
              0.53Options
      granted
              
              
              1,313,605
              
              
              
              1.21Options
      exercised
              
              
              (2,860,000
              )
              
              
              0.10Options
      forfeited
              
              
              (962,607
              )
              
              
              0.84Options
      cancelled
              
              
              —
              
              
              
              —Options,
      December 31,
      2006
              
              
              3,999,559
              
              
              
              0.99Options
      granted
              
              
              238,679
              
              
              
              0.55Options
      exercised
              
              
              —
              
              
              
              —Options
      forfeited
              
              
              (49,793
              )
              
              
              1.96Options
      cancelled
              
              
              —
              
              
              
              —Options,
      December 31,
      2007
              
              
              4,188,445
              
              
              $
              0.95Options
      granted
              
              
              2,700,000
              
              
              
              0.28Options
      exercised
              
              
              —
              
              
              
              —Options
      forfeited
              
              
              (2,287,220
              )
              
              
              1.00Options
      cancelled
              
              
              —
              
              
              
              —Options,
      December 31,
      2008
              
              
              4,601,225
              
              
              $
              0.53





The
weighted average exercise prices, remaining contractual lives for options
granted, exercisable, and expected to vest under the Plan as of
December 31, 2008 were as follows:




Outstanding
      Options
              
              
              Exercisable
      OptionsWeightedOption
              
              
              
              
              
              Life
              
              
              
              
              
              
              
              
              Average
      ExerciseExercise Price Per Share
              
              
              Shares
              
              
              (Years)
              
              
              Exercise Price
              
              
              Shares
              
              
              Price$ 0.21 - $ 0.99
              
              
              
              4,213,679
              
              
              8.4
              
              
              $
              0.45
              
              
              
              3,963,679
              
              
              $
              0.46$ 1.00 - $ 1.99
              
              
              
              327,546
              
              
              5.8
              
              
              $
              1.41
              
              
              
              327,546
              
              
              $
              1.41$ 2.00 - $ 2.26
              
              
              
              60,000
              
              
              2.6
              
              
              $
              2.26
              
              
              
              60,000
              
              
              $
              2.264,601,225
              
              
              
              
              
              $
              0.53
              
              
              
              4,351,225
              
              
              $
              0.54




As
of December 31, 2008 the market price of the Company’s stock was $0.40 per
share. Future compensation expense on the options which were not
exercisable at December 31, 2008 is $51,914.





F-37




Black-Scholes
value of options




During
the years ended December 31, 2008 and 2007, the Company valued options for
pro-forma purposes at the grant date using the Black-Scholes pricing model with
the following average assumptions:





2008
            
            
            2007Expected
      life (years
            
            
            5.05
            
            
            
            
            5.06Risk
      free interest rate
            
            
            4.37
            %
            
            
            
            4.42
            %Volatility
            
            
            124.05
            %
            
            
            
            116.82
            %Expected
      dividend yield
            
            
            0.00
            %
            
            
            
            0.00
            %





The
weighted average fair value for options granted in 2008 and 2007 were $0.24 and
$0.89, respectively.




During
the year ended December 31, 2008, the Company granted 2,700,000 options
exercisable at amounts ranging from $0.21 to $0.40, vested immediately or over
one year with a one to ten year life. The options were valued at an aggregate
amount of $$648,570 (or $0.24 per share on average) using the Black Scholes
pricing model using a 5.0 to 5.5 year expected term, 123% to 131% volatility, no
annual dividends, and a discount rate of 4.34% to 4.64%.  During the
year ended December 31, 2008, the Company recognized compensation expense of
$645,745 relating to the vesting of these options.  As of December 31,
2008, there was unamortized compensation of $51,914 that will be amortized as
compensation cost in 2009.





Warrants





The
following table summarizes certain information about the Company’s stock
purchase warrants (including the warrants discussed in Note 8).


Warrants
                              
                              
                              Weighted
      Avg.
                                Exercise
      PriceWarrants
      outstanding, January 1, 2004
                              
                              
                              14,252,414
                              
                              
                              
                              0.48Warrants
      granted
                              
                              
                              2,372,500
                              
                              
                              
                              1.27Warrants
      exercised
                              
                              
                              (960,500
                              )
                              
                              
                              0.20Warrants
      cancelled
                              
                              
                              —
                              
                              
                              
                              —Warrants
      outstanding, December31, 2004
                              
                              
                              15,664,414
                              
                              
                              
                              0.62Warrants
      granted
                              
                              
                              5,198,574
                              
                              
                              
                              1.16Warrants
      exercised
                              
                              
                              (50,500
                              )
                              
                              
                              0.99Warrants
      cancelled
                              
                              
                              (20,000
                              )
                              
                              
                              1.50Warrants
      outstanding, December31, 2005
                              
                              
                              20,792,488
                              
                              
                              
                              0.75Warrants
      granted
                              
                              
                              3,624,894
                              
                              
                              
                              1.28Warrants
      exercised
                              
                              
                              (2,328,452
                              )
                              
                              
                              0.68Warrants
      cancelled
                              
                              
                              (1,191,619
                              )
                              
                              
                              1.46Warrants
      outstanding, December 31, 2006
                              
                              
                              20,897,311
                              
                              
                              $
                              0.81Warrants
      granted
                              
                              
                              3,602,701
                              
                              
                              
                              0.64Warrants
      exercised
                              
                              
                              —
                              
                              
                              
                              —Warrants
      cancelled
                              
                              
                              (6,580,984
                              )
                              
                              
                              1.06Warrants
      outstanding, December 31, 2007
                              
                              
                              17,919,028
                              
                              
                              $
                              0.67Warrants
      granted
                              
                              
                              3,931,708
                              
                              
                              
                              0.42Warrants
      exercised
                              
                              
                              (1,064,650
                              )
                              
                              
                              0.50Warrants
      cancelled
                              
                              
                              (10,386,083
                              )
                              
                              
                              0.56Warrants
      outstanding, December 31, 2008
                              
                              
                              10,400,003
                              
                              
                              $
                              0.70




At
December 31, 2008 the price of the Company’s common stock was $0.40 per share
which is less than the exercise price of all of the warrants, and therefore
there was no intrinsic value.




F-38




Outstanding
      Warrants
              
              
              Exercisable
      WarrantsWeightedWarrant
              
              
              
              
              
              Life
              
              
              
              
              
              
              
              
              Average
      ExerciseExercise Price Per Share
              
              
              Shares
              
              
              (Years)
              
              
              Exercise Price
              
              
              Shares
              
              
              Price$ 0.30 - $ 0.99
              
              
              
              7,776,559
              
              
              2.0
              
              
              $
              0.47
              
              
              
              7,776,559
              
              
              $
              0.47$ 1.00 - $ 1.99
              
              
              
              2,057,966
              
              
              2.8
              
              
              $
              1.00
              
              
              
              2,057,966
              
              
              $
              1.00$ 2.00 - $ 2.70
              
              
              
              565,478
              
              
              0.7
              
              
              $
              2.67
              
              
              
              565,478
              
              
              $
              2.6710,400,003
              
              
              
              
              
              $
              0.70
              
              
              
              10,400,003
              
              
              $
              0.70


10.  Commitments
and contingencies





Legal matters




On
December 19, 2001, the SEC filed civil charges in the United States Federal
District Court, Southern District of New York, against the Company, the
Company’s former President and then sole director Jeffrey A. Muller, and others,
alleging that the Company and the other defendants were engaged in a fraudulent
scheme to promote the Company’s stock. The SEC complaint alleged the existence
of a promotional campaign using press releases, Internet postings, an elaborate
website, and televised media events to disseminate false and materially
misleading information as part of a fraudulent scheme to manipulate the market
for stock in the Company which was then controlled by Mr. Muller. On
March 22, 2002, the Company signed a Consent to Final Judgment of Permanent
Injunction and Other Relief in settlement of this action as against the
corporation only, which the Court approved on July 2, 2002. Under this
settlement, the Company was not required to admit fault and did not pay any
fines or restitution.




On
July 2, 2002, after an investigation by the Company’s newly constituted
board of directors, the Company filed a cross-complaint in the SEC action
against Mr. Muller and others seeking injunctive relief, disgorgement of
monies and stock and financial restitution for a variety of acts and omissions
in connection with sales of the Company’s stock and other transactions occurring
between 1998 and 2002.  Among other things, the Company alleged that
Mr. Muller and certain others sold Company stock without providing adequate
consideration to the Company; sold insider shares without making proper
disclosures and failed to make necessary filing required under federal
securities laws; engaged in self-dealing and entered into various
undisclosed  related-party transactions; misappropriated for their own
use proceeds from sales of the Company’ stock; and entered into various
undisclosed arrangement regarding the control, voting and disposition of their
stock.




On
July 30, 2002, the U.S. Federal District Court, Southern District of New
York, granted the Company’s application for a preliminary injunction against
Mr. Muller and others, which prevented Mr. Muller and other
cross-defendants from selling, transferring, or encumbering any assets and
property previously acquired from the Company, from selling or transferring any
of the Company’s stock that they may have owned or controlled, or from taking
any action to injure the Company or the Company’s business and from having any
direct contact with the Company’s shareholders. The injunctive order also
prevented Mr. Muller or his nominees from engaging in any effort to
exercise control over the Company’s corporation and from serving as an officer
or director of the Company.




In the
course of the litigation, the Company has obtained ownership control over all
patent rights to the ZEFS device.




On
January 4, 2007, the Court entered a final judgment against Jeffrey Muller which
barred Mr. Muller from serving as an officer or director of a public
company for a period of 20 years, ordered Mr. Muller to disgorge any
shares of the Company’s stock that he still owns and directed the Company to
cancel any issued and outstanding shares of the Company’s stock still owned by
Mr. Muller. Mr. Muller was also ordered to disgorge unlawful profits
in the amount of $7.5 million and to pay a civil penalty in the amount of
$100,000.  Acting in accordance with the ruling and decision of the
Court, the Company has canceled (i) 8,047,403 shares of common stock that
had been held by Mr. Muller and/or his affiliates, (ii) options to
acquire an additional 10,000,000 shares of the Company’s common stock held by
Mr. Muller personally and (iii) $1,017,208 of debt which Mr. Muller
claimed was owed to him by the Company.  After an appeal filed by Mr.
Muller was dismissed the Judgment against him is considered final.





F-39





On
February 8, 2007, Federal Magistrate Judge Maas issued a post-judgment order, at
the Company’s request, which further concluded that all of the shares of the
Company’s stock held by Mr. Muller or any of his nominees directly or indirectly
owned or controlled were to be recaptured by the Company and were subject to
disgorgement and forfeiture.  The ruling provided that all shares,
options and any other obligations allegedly owed by the Company to Mr. Muller
were to be disgorged in our favor and confirmed the earlier judgment holding
Mr. Muller liable for $7.5 million in actual damages, imposing a
$100,000 fine and barring Mr. Muller from any involvement with a publicly traded
company for 20 years.  With prejudgment interest, this ruling
brings the actual damages against Muller to over
$11 million.  Additionally, the Court clarified that the order
required the disgorgement of any shares of the Company’s stock that
Mr. Muller or any of his nominees directly or indirectly owned or
controlled.  In furtherance of this order, the Company has taken
action to cancel over 3.6 million shares which had been issued to offshore
companies.  The Order also confirmed the appropriateness of actions
previously taken by the Company to acquire the patent rights and to consolidate
the manufacturing, marketing and distribution rights with its ownership of all
rights to the existing patents. On February 11, 2009, Judge Maas confirmed that
his previous decision was modified and Save the World Air’s Motion for Summary
Judgment was granted in favor of Save the World Air as set forth in his order of
February 8, 2007.  A proposed Final Judgment in favor of Save the
World air is pending before the United States District Court, Southern District
of New York





Patent
Infringement Claims by Jeffrey A. Muller




In
April 2005, Jeffrey A. Muller, the Company’s former sole director and
executive officer, filed a complaint against the Company in the Federal District
Court for the Central District of California, seeking declaratory and injunctive
relief and alleging unfair competition in connection with a claimed prior patent
interest in the ZEFS device and stock option rights. In seeking declaratory
relief, Mr. Muller is seeking to have the patent rights in the ZEFS device
that were previously transferred to the Company by Mr. Muller’s bankruptcy
trustee declared null and void.




This
lawsuit brought by Mr. Muller arose out of the same claims that were the
subject of litigation in the Federal District Court for the Southern District of
New York, in which the Court entered judgment against Mr.
Muller.  Those claims are pending further
proceedings.  While the Company believes that the Company has valid
claims and defenses, there can be no assurance that an adverse result or outcome
on the pending motions or a trial of this case would not have a material adverse
effect on the Company’s financial position or cash flow. Muller’s claims for
patent infringement against Save The World Air were dismissed and the case was
closed on October 15, 2008, by order of George B. Daniels, United States
District Judge, Southern District of New York.




Litigation
Involving Scottish Glen Golf Company




We were
involved in litigation with Scottish Glen Golf Company, Inc. (SGGC) doing
business as KZ Golf, Inc., the Company’s previous landlord on claims in the
aggregate amount of $104,413.   The Company did not dispute the
fact that certain amounts of unpaid past rent are due but did dispute that it
owes the aggregate of $104,413 demanded by SGGC; more than half of which are
purported “late fees” which was assessed at the rate of $100 per
day.  It was the Company’s position that the late fees are void and
unenforceable and that the Company is entitled to a set-off for office space
that reverted back to SGGC.





On April
30, 2008 the Company and SGGC settled their pending litigation relating to the
Company’s prior offices.  The Company agreed to pay SGGC $51,000 in full
settlement of SGGC’s claims.  On May 28, 2008 the initial payment of
$34,000 was made and on July 9, 2008 the final payment of $17,000 was made and
the Complaint was dismissed, with prejudice.   The Company
recorded $52,069 as other income and as a reduction of accounts
payable.





F-40




Employment
agreements





John
Bautista




In July
2005, the Company entered into an employment agreement with John Bautista to
serve as a Vice President of Operations for the Company. The agreement
expired December 31, 2005, with an automatic one-year extension and
provided for annual base salary of not less than $120,000 per
year.  Effective February 21, 2006, the individual was promoted to
Executive Vice President, his annual base salary was increased from $120,000 per
year to $150,000 per year and the term of his employment agreement was extended
to December 31, 2007.  Effective August 8, 2006, the individual was
promoted to Chief Operating Officer and his annual base salary was increased
from $150,000 per year to $200,000 per year.  During the employment
term, the individual is eligible to participate in certain incentive plans,
stock option plans and similar arrangements in accordance with the Company’s
recommendations at award levels consistent and commensurate with the position
and duties hereunder.  Effective March 21, 2008, the employment
relationship between the Company and John Bautista, Chief Operating Officer, was
terminated.





Eugene
E. Eichler





On
November 9, 2006, Eugene Eichler, who served as the Company’s Chief Executive
Officer and Chief Financial Officer, resigned due to a medical disability. His
resignation as Chief Executive Officer took effect on November 20, 2006 and his
resignation as Chief Financial Officer took effect on January 8,
2007.  Mr. Eichler did not stand for reelection as a director at the
December 13, 2007 Shareholder Meeting.




Under the
terms of the separation agreement as an officer of the Company, Mr. Eichler is
entitled to be paid out the remainder of the cash portion of his employment
agreement, at a rate of $300,000 per annum, through December 31, 2007, in
accordance with the Company’s normal pay policies. Options granted to him in
February 2006 have been accelerated, fully vested on November 20, 2006
and the related compensation was expensed.  Additionally, Mr. Eichler
will have until November 20, 2007 to exercise such options. Mr. Eichler is also
entitled to receive a stock option grant in 2007 equal to the lesser of (i) the
number of stock options he was granted in 2006 or (ii) the highest number of
options granted to any of the then Chief Executive Officer, President or Chief
Financial Officer on an annualized basis, on terms no less favorable as granted
to such person; provided, however, that such options to be granted to the former
officer shall be fully vested upon grant and shall be exercisable for one year
from the date of grant. The Company and the former officer have waived any
claims they may have against each other and have agreed to mutual
indemnification.  The Company expensed $345,000 for the remaining term
of Mr. Eichler’s employment agreement and benefits for the year ended December
31, 2006.





As an
interim matter, on July 18, 2007, the Board of Directors appointed incumbent
director and former President and Chief Executive Officer of the Company Eugene
E. Eichler as Interim President and Chief Executive Officer of the
Company.  Mr. Eichler served without cash compensation and resigned on
July 25, 2007 at which time Charles Blum assumed the positions of President and
Chief Executive Officer. On October 18, 2007, the Board appointed Mr. Eichler as
Interim Chief Financial Officer to serve in this capacity at no salary until a
replacement is appointed and extended the expiration date of Mr. Eichler’s
options to November 20, 2009.  These options would have expired on
November 20, 2007.  On April 1, 2008, Mr. Eichler entered into a month
to month arrangement at a salary of $10,000 per month.





Bruce
H. McKinnon




On
June 15, 2007, the Company and Bruce H. McKinnon agreed and entered into an
agreement that Mr. McKinnon would resign as Chief Executive Officer of the
Company effective on the first to occur of (i) the appointment of a new
Chief Executive Officer by the Board of Directors and (ii) July 31,
2007.  It was intended that Mr. McKinnon would continue to serve as
President of the Company and would continue to receive the compensation provided
for in accordance with the provisions of the employment agreement dated as of
October 5, 2005 between the Company and Mr. McKinnon, through
December 31, 2007, the end of the term of that agreement. Additionally,
Mr. McKinnon will continue to serve as a director of the Company, until Mr.
McKinnon has resigned, been removed by the stockholders or not been re-elected
to the Board. The Company and Mr. McKinnon have waived any claims the
Company and Mr. McKinnon may have against each other and have agreed to mutual
indemnification.





F-41





On July
18, 2007, Bruce H. McKinnon was removed by the Board of Directors as President
and Chief Executive Officer of the Company and its wholly-owned subsidiary, STWA
Asia, effective immediately.  Mr. McKinnon also was removed by the
Board of Directorsas a director of STWA
Asia, effective immediately.  Mr. McKinnon continued to serve as
a director of the Company, until Mr. McKinnon resigned in November 2007. The
Company expensed $111,381 for the remaining term of Mr. McKinnon’s employment
agreement and benefits for the year ended December 31, 2007.




Charles
R. Blum




EffectiveJuly 18, 2007, the
Company entered into an employment agreement with Mr. Charles R. Blum to serve
as the Company’s President and Chief Executive Officer.  Pursuant to
the Employment Agreement, Mr. Blum’s employment is for a one-year term, subject
to automatic one-year extensions and provides for annual base compensation of
$200,000 per year, subject to periodic review and adjustment.  In
addition, Mr. Blum will receive an automobile allowance of $900 per month and
four weeks of paid vacation annually.  Also, Mr. Blum is entitled to
participate in all employee benefit plans that the Company makes available to
the Company’s employees generally; provided that if Mr. Blum elects not to
participate in the Company’s group medical insurance plan, Mr. Blum will be
reimbursed in an amount equal to the lesser of (i) the premium the Company would
have paid to include Mr. Blum as a participant in that group health insurance
plan and (ii) the sums paid by Mr. Blum in connection with maintaining Mr.
Blum’s private health insurance.  The Company will also reimburse Mr.
Blum the reasonable costs paid by Mr. Blum for maintaining DSL Internet
access and other direct costs of maintaining an office at Mr. Blum’s home, but
only until such time as the Company shall provide Mr. Blum with an office at a
location reasonably acceptable to Mr. Blum.




Leases




In
September 2005, the Company entered into a lease agreement for a testing
facility located in Morgan Hill, California. The term of the lease was from
September 1, 2005 through August 31, 2007 and carried an option to
renew for two additional years at the then prevailing market rate. The rent was
$2,240 per month under this lease. The lease was amended in February 2006
for additional space. The rent under the amended lease was $4,160 per
month.  The Company renewed this lease on August 9, 2007 for an
additional two-year term.  The rent is $4,640 per month for the first
six months of the new term of the lease and $5,480 per month for the remaining
eighteen months of the new term of the lease which expires on August 31,
2009.




In May
2008, the Company entered into a lease agreement for its administrative offices
in Los Angeles, California. The term of the lease was for $3,000 per month from
June 1, 2008 through November 30, 2008. From that point on, the lease is
due on a month to month basis with rent payment increasing to
$3,750.





Total
rent expense under this leases for the year ended December 31, 2008 and 2007, is
$85,980 and $59,640, respectively.  The following is a schedule by
years of future minimum rental payments required under the non-cancellable
operating leases as of December 31, 2008.





Years Ending
      December 31,2009
              
              $
              43,840Total
              
              $
              43,840




F-42





11.           Income
taxes





Income
tax provision consists of the following:





For the years ended
              December 31,2008
            
            
            2007Current:Federal
            
            $
            —
            
            
            $
            —State
            
            
            800
            
            
            
            800Total
      current
            
            
            800
            
            
            
            800Deferred:Federal
            
            
            —
            
            
            
            —State
            
            
            —
            
            
            
            —Total
      deferred
            
            
            —
            
            
            
            —Total
      income tax provision
            
            $
            800
            
            
            $
            800





As of
December 31, 2008, the Company has recorded a $13,876,336 valuation allowance
against a portion of its deferred tax assets, since at that time it was believed
that such assets did not meet the more likely than not criteria to be
recoverable through projected future profitable operations in the foreseeable
future.





Failure
by the Company to successfully maintain improved margins, grow revenues and/or
maintain anticipated savings on future interest costs, and maintain profitable
operating results in the near term, could adversely affect the Company's
expected realization of some or all of its deferred tax assets and could require
the Company to record a valuation allowance against some or all of such assets,
which could adversely affect the Company's financial position and results of
operations.





The total
income tax provision (benefit) was 0% of pretax income (loss) for the years
ended December 31, 2008 and 2007, respectively. A reconciliation of income taxes
with the amounts computed at the statutory federal rate follows:





December 31,2008
            
            
            2007Computed
      tax provision (benefit) at federal statutory rate (34%)
            
            $
            (2,062,414
            )
            
            $
            (2,129,061
            )State
      income taxes, net of federal benefit
            
            
            (257,605
            )
            
            
            (268,524
            )Permanent
      items
            
            
            558,142
            
            
            
            561,162Credits
            
            
            —
            
            
            
            —Valuation
      allowance
            
            
            1,762,677
            
            
            
            1,837,223Income
      tax provision
            
            $
            800
            
            
            $
            800





The
deferred tax assets and deferred tax liabilities recorded on the balance sheet
are as follows:




December 31,
      2008
                
                
                December 31,
      2007Deferred
      tax
                
                
                Deferred
      tax
                
                
                Deferred
      tax
                
                
                Deferred
      taxassets
                
                
                liabilities
                
                
                assets
                
                
                liabilitiesCurrent:Accrued
      liabilities
                
                $
                419,138
                
                
                $
                ---
                
                
                $
                538,747
                
                
                $
                —Other
                
                
                272
                
                
                
                ---
                
                
                
                272
                
                
                
                —419,41
                
                
                
                
                
                
                
                539,019
                
                
                
                —Noncurrent:Net
      operating loss carry forwards
                
                
                12,326,918
                
                
                
                ---
                
                
                
                10,122,130
                
                
                
                —Unexercised
      stock options and warrants
                
                
                815,781
                
                
                
                ---
                
                
                
                1,133,210
                
                
                
                —Credit
      carryovers
                
                
                256,757
                
                
                
                ---
                
                
                
                256,757
                
                
                
                —Depreciation
                
                
                57,470
                
                
                
                ---
                
                
                
                62,543
                
                
                
                —Valuation
      allowance
                
                
                (13,876,336
                )
                
                
                ---
                
                
                
                (12,113,659
                )
                
                
                —Total
      deferred taxes net of valuation allowance
                
                $
                —
                
                
                $
                —
                
                
                $
                —
                
                
                $
                —




F-43





As of
December 31, 2008, the Company had net operating losses available for carry
forward for federal tax purposes of approximately $31.2 million expiring
beginning in 2018. These carryforward benefits may be subject to annual
limitations due to the ownership change limitations imposed by the Internal
Revenue Code and similar state provisions. The annual limitation, if imposed,
may result in the expiration of net operating losses before
utilization.




Effective
January 1, 2007, the Company adopted Financial Accounting Standards Board
Interpretation No 48, “Accounting for Uncertainty in Income Taxes — an
interpretation of FASB Statement No 109, “Accounting for Income Taxes (“FIN
48”).” FIN 48 addresses the determination of whether tax benefits claimed or
expected to be claimed on a tax return should be recorded in the financial
statements. Under FIN 48, the Company may recognize the tax benefit from an
uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based on the
technical merits of the position. The tax benefits recognized in the financial
statements from such a position should be measured based on the largest benefit
that has a greater than 50% likelihood of being realized upon ultimate
settlement. FIN 48 also provides guidance on de-recognition,
classification, interest and penalties on income taxes, accounting in interim
periods and requires increased disclosures. At the date of adoption, and as of
December 31, 2008, the Company does not have a liability for unrecognized tax
benefits.




The
Company files income tax returns in the U.S. federal jurisdiction and the state
of California. The Company is subject to U.S. federal or state income tax
examinations by tax authorities for years after 2002. During the periods open to
examination, the Company has net operating loss and tax credit carry forwards
for U.S. federal and state tax purposes that have attributes from closed
periods. Since these net operating losses and tax credit carry forwards may be
utilized in future periods, they remain subject to examination. The Company’s
policy is to record interest and penalties on uncertain tax provisions as income
tax expense. As of December 31, 2008, The Company has no accrued interest or
penalties related to uncertain tax positions. The Company believes that it has
not taken any uncertain tax positions that would impact its condensed
consolidated financial statements as of December 31, 2008. Also as of the date
of adoption, and as of December 31, 2008, the Company does not have a liability
for unrecognized tax benefits.





12.  Subsequent
events





On
January 9, 2009, the Company entered into an Agreement with (Endeavor Group, LLC). The
Company has retained Endeavor Group, LLC as its non-exclusive financial advisor
and investment banking advisor to provide general financial advisory and
investment banking service to the Company. The Company shall pay $10,000 upon
execution of the agreement and additional fees relating to capital investments
to be received by the Company.  The Company shall issue to Endeavor
stock certificates representing an aggregate of 500,000 shares of common stock
of which 250,000 shares shall be issued upon execution of this Agreement, with
remaining 250,000 shares, issued as compensation for investment funds, advisors
etc. when certain goals are met.





On
January 28, 2009, the Company entered into an Agreement with a consultant to
provide services prepare a five year business plan including detailed income,
balance and cash flow statements; capital requirements; use of proceeds;
competition analysis and an AOT market analysis.  Consultant is to be
paid $7,000 for the first month and $5,000 for the second and third months for a
total of $17,500.  Consultant will receive 30,000 restricted shares of
common stock upon execution of the Agreement.





F-44





From
January 13, 2009, through January 26, 2009, Save the World Air, Inc. (the
“Company”) conducted and concluded a private offering (the “Winter 2009
Offering”) of up to $250,000 aggregate face amount of its convertible notes (the
“Winter 2009 Notes”) with 8 accredited investors. A total of $250,000 aggregate
face amount of the Winter 2009 Notes were sold for an aggregate purchase price
of $250,000.  The Winter 2009 Notes bear interest at 10% per annum,
payable at maturity. The Winter 2009 Notes mature three months from their date
of issuance. The Winter 2009 Notes are convertible, at the option of the
noteholder, into shares of common stock of the Company (the “Conversion Shares”)
at an initial conversion price equal to the average of the closing bid price of
the Company’s common stock for the five trading days preceding the closing dates
of the Winter 2009 Offering (the “Conversion Price”). Up to 694,444 Conversion
Shares are initially issuable at a Conversion Price of $0.36 per
share.





Each of
the investors in the Winter 2009 Offering received, for no additional
consideration, a warrant (the “Winter 2009 Warrants”), entitling the holder to
purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Winter 2009 Notes are
convertible (the “Warrant Shares”).  Each Winter 2009 Warrant is
exercisable on a cash basis only at an initial price of $0.50 per share, and is
exercisable immediately upon issuance and for a period of two (2) years from the
date of issuance. Up to 347,722 Warrant Shares are initially issuable on
exercise of the Winter 2009 Warrants.





The
Company received $250,000 in net proceeds in the Winter 2009 Offering which will
be used for general corporate purposes and working capital.




On
January 30, 2009, Cecil Bond Kyte was appointed Chief Executive Officer of the
Company, replacing Charles R. Blum.  Mr. Blum continues to serve as
President of the Company.





From
February 4, 2009, through March 11, 2009, Save the World Air, Inc. (the
“Company”) conducted and concluded a private offering (the “Winter 2009 #2
Offering”) of up to $250,000 aggregate face amount of its convertible notes (the
“Winter 2009  #2 Notes”) with 17 accredited investors. A total of
$247,302 aggregate face amount of the Winter 2009 #2 Notes were sold for an
aggregate purchase price of $224,820.  While the stated interest rate
on the Winter 2009#2 Notes is 0%, the actual interest rate on the Winter 2009 #2
Notes is 10% per annum. The Winter 2009 #2 Notes mature on the first anniversary
of their date of issuance. The Winter 2009 #2 Notes are convertible, at the
option of the noteholder, into shares of common stock of the Company (the
“Conversion Shares”) at an initial conversion price equal to the average of the
closing bid price of the Company’s common stock for the five trading days
preceding the closing dates of the Winter 2009 #2 Offering (the “Conversion
Price”). Up to 772,818 Conversion Shares are initially issuable at a Conversion
Price of $0.32 per share.





Each of
the investors in the Winter 2009 #2 Offering received, for no additional
consideration, a warrant (the “Winter 2009 #2 Warrants”), entitling the holder
to purchase a number of shares of the Company’s common stock equal to 50% of the
number of shares of common stock into which the Winter 2009 #2 Notes are
convertible (the “Warrant Shares”). Each Winter 2009 #2 Warrant is exercisable
on a cash basis only at an initial price of $0.50 per share, and is exercisable
immediately upon issuance and for a period of two (2) years from the date of
issuance. Up to 386,409 Warrant Shares are initially issuable on exercise of the
Winter 2009 #2Warrants.





The
Company received $224,820 in net proceeds in the Winter 2009 #2 Offering which
will be used for general corporate purposes and working capital.






F-45