Table of Contents



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

FORM 10-QSB

     
[X]   QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the quarterly period ended June 30, 2003.
 
or
 
[   ]   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the transition period from ___________ to ___________

Commission File Number 0-29185

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

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

5125 Lankershim Boulevard
North Hollywood, California 91601

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

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

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

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

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

     The number of shares of the Registrant’s Common Stock outstanding as of June 30, 2003 was 27,919,261 shares.

DOCUMENTS INCORPORATED BY REFERENCE

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



 


SAVE THE WORLD AIR, INC.

FORM 10-QSB

INDEX

                 
            Page
           
  Financial Statements     2  
  Management’s Discussion and Analysis     21  
  Controls and Procedures     27  
  Legal Proceedings     27  
  Changes in Securities     28  
  Exhibits and Reports on Form 8-K     29  
 
SIGNATURES     30  
EXHIBIT INDEX     31  
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1

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Table of Contents

PART I

Item 1. Financial Statements

CONTENTS

         
    Page
Financial statements
       
    3-4  
    5  
    6-8  
    9-10  
    11-20  

2


Table of Contents

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

BALANCE SHEETS
JUNE 30, 2003 AND DECEMBER 31, 2002

                 
    June 30, 2003   December 31,
    (unaudited)
  2002
ASSETS
               
Current assets
               
Cash
  $ 611,514     $ 107,489  
 
   
 
     
 
 
Total current assets
    611,514       107,489  
 
   
 
     
 
 
Property and equipment, net of accumulated depreciation
    21,478       23,924  
 
   
 
     
 
 
 
  $ 632,992     $ 131,413  
 
   
 
     
 
 

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Table of Contents

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

BALANCE SHEETS — Continued
JUNE 30, 2003 AND DECEMBER 31, 2002

                 
    June 30, 2003   December 31,
    (unaudited)
  2002
LIABILITIES AND STOCKHOLDERS’ DEFICIT
               
Current liabilities
               
Income taxes payable
  $ 5,991     $ 4,927  
Payables to related parties
    172,258       553,022  
Accrued expenses
    515,955       436,669  
 
   
 
     
 
 
Total current liabilities
    694,204       994,618  
 
   
 
     
 
 
Due to founding executive officer
    1,017,208       1,017,208  
 
   
 
     
 
 
Commitments and contingencies
               
Stockholders’ deficit
               
Common stock, $.001 par value: 200,000,000 shares authorized, 27,919,261 and 20,235,847 shares issued and outstanding at June 30, 2003 and December 31, 2003, respectively
    27,919       20,236  
Common stock issuable, $.001 par value: 600,000 and 2,305,000 shares at June 30, 2003 and December 31, 2003, respectively
    150,000       389,875  
Additional paid-in capital
    8,775,208       7,133,081  
Deferred compensation
    (1,133,333 )     (1,572,060 )
Deficit accumulated during the development stage
    (8,898,215 )     (7,851,545 )
 
   
 
     
 
 
Total stockholders’ deficit
    (1,078,421 )     (1,880,413 )
 
   
 
     
 
 
 
  $ 632,992     $ 131,413  
 
   
 
     
 
 

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Table of Contents

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002 AND FOR THE PERIOD FROM INCEPTION
(FEBRUARY 18, 1998) TO JUNE 30, 2003

                                         
    Three months ended   Six months ended    
    June 30,
  June 30,
  Cumulative
since
    2003
  2002
  2003
  2002
  inception
Net sales
  $     $     $     $     $  
Expenses
    440,669       420,241       1,045,650       751,291       8,892,268  
 
   
 
     
 
     
 
     
 
     
 
 
Net loss before provision for income taxes
    (440,669 )     (420,241 )     (1,045,650 )     (751,291 )     (8,892,268 )
Provision for income taxes
                1,020       1,089       5,947  
 
   
 
     
 
     
 
     
 
     
 
 
Net loss
  $ (440,669 )   $ (420,241 )   $ (1,046,670 )   $ (752,380 )   $ (8,898,215 )
 
   
 
     
 
     
 
     
 
     
 
 
Net loss per share, basic and diluted
  $ (0.02 )   $ (0.02 )   $ (0.04 )   $ (0.04 )        
 
   
 
     
 
     
 
     
 
         
Weighted average shares outstanding, basic and diluted
    24,974,036       18,085,847       25,378,993       18,085,847          
 
   
 
     
 
     
 
     
 
         

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Table of Contents

SAVE THE WORLD AIR, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF STOCKHOLDERS’ DEFICIENCY
FROM INCEPTION (FEBRUARY 18, 1998) TO JUNE 30, 2003

                                                                 
    Price per   Common Stock
  Common stock   Additional
paid-in
  Deferred   Deficit accumulated
during the
  Total stockholders’
development
    share
  Shares
  Amount
  to be issued
  capital
  compensation
  development stage
  stage deficiency
Balance, February 18, 1998 (date of inception)
                $     $     $     $     $     $  
Issuance of common stock on April 18, 1998
    .0015 – .01       10,030,000       10,030             14,270                   24,300  
Net loss
                                          (21,307 )     (21,307 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Balance, December 31, 1998 (as corrected, see Note 1)
            10,030,000       10,030               14,270             (21,307 )     2,993  
Issuance of common stock on May 18, 1999
    1.00 – 6.40       198,003       198             516,738                   516,936  
Issuance of common stock for ZEFS on September 14, 1999
    .001       5,000,000       5,000                               5,000  
Stock issued for professional services on May 18, 1999
    0.88       69,122       69             49,444                   49,513  
Net loss
                                          (1,075,264 )     (1,075,264 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Balance, December 31, 1999 (as corrected, see Note 1)
            15,297,125       15,297             580,452             (1,096,571 )     (500,822 )
Stock issued for employee compensation on February 8, 2000
    1.03       20,000       20             20,580                   20,600  
Stock issued for consulting services on February 8, 2000
    1.03       100,000       100             102,900                   103,000  
Stock issued for professional services on April 18, 2000
    3.38       27,000       27             91,233                   91,260  
Stock issued for directors fees on April 18, 2000
    3.38       50,000       50             168,950                   169,000  
Stock issued for professional services on May 19, 2000
    4.06       5,000       5             20,295                   20,300  
Stock issued for directors fees on June 20, 2000
    4.44       6,000       6             26,634                   26,640  
Stock issued for professional services on June 20, 2000
    4.44       1,633       2             7,249                   7,251  
Stock issued for professional services on June 26, 2000
    5.31       1,257       1             6,674                   6,675  
Stock issued for employee compensation on June 26, 2000
    5.31       22,000       22             116,798                   116,820  
Stock issued for consulting services on June 26, 2000
    5.31       9,833       10             52,203                   52,213  
Stock issued for promotional services on July 28, 2000
    4.88       9,675       9             47,205                   47,214  
Stock issued for consulting services on July 28, 2000
    4.88       9,833       10             47,975                   47,985  
Stock issued for consulting services on August 4, 2000
    2.13       35,033       35             74,585                   74,620  
Stock issued for promotional services on August 16, 2000
    2.25       25,000       25             56,225                   56,250  
Stock issued for consulting services on September 5, 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                   14,750  
Stock issued for consulting services on November 2, 2000
    0.88       9,833       10             8,643                   8,653  
Stock issued for consulting services on November 4, 2000
    0.88       9,833       10             8,643                   8,653  
Stock issued for consulting services on December 20, 2000
    0.50       19,082       19             9,522                   9,541  

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Table of Contents

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF STOCKHOLDERS’ DEFICIENCY — Continued
FROM INCEPTION (FEBRUARY 18, 1998) TO JUNE 30, 2003

                                                                 
                                               
    Price per   Common Stock
  Common stock   Additional
paid-in
  Deferred   Deficit accumulated
during the
  Total stockholders’
development
    share
  Shares
  Amount
  to be issued
  capital
  compensation
  development stage
  stage deficiency
Stock issued for filing services on December 20, 2000
    0.50       5,172       5             2,581                   2,586  
Stock issued for professional services on December 26, 2000
    0.38       12,960       13             4,912                   4,925  
Other stock issuance on August 24, 2000
    2.13       2,000       2             4,258                   4,260  
Common shares cancelled
            (55,000 )     (55 )           (64,245 )                 (64,300 )
Net loss
                                          (1,270,762 )     (1,270,762 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Balance, December 31, 2000 (as corrected, see Note 1)
            15,645,935       15,646             1,437,873             (2,367,333 )     (913,814 )
Stock issued for consulting services on January 8, 2001
    0.31       9,833       10             3,038                   3,048  
Stock issued for consulting services on February 1, 2001
    0.33       9,833       10             3,235                   3,245  
Stock issued for consulting services on March 1, 2001
    0.28       9,833       10             2,743                   2,753  
Stock issued for legal services on March 13, 2001
    0.32       150,000       150             47,850                   48,000  
Stock issued for consulting services on April 3, 2001
    0.25       9,833       10             2,448                   2,458  
Stock issued for legal services on April 4, 2001
    0.25       30,918       31             7,699                   7,730  
Stock issued for professional services on April 4, 2001
    0.25       7,040       7             1,753                   1,760  
Stock issued for consulting services on April 5, 2001
    0.25       132,600       132             33,018                   33,150  
Stock issued for filing fees on April 30, 2001
    1.65       1,233       1             2,033                   2,034  
Stock issued for filing fees on September 19, 2001
    0.85       2,678       2             2,274                   2,276  
Stock issued for professional services on September 28, 2001
    0.62       150,000       150             92,850                   93,000  
Stock issued for directors services on October 5, 2001
    0.60       100,000       100             59,900                   60,000  
Stock issued for legal services on October 17, 2001
    0.60       11,111       11             6,655                   6,666  
Stock issued for consulting services on October 18, 2001
    0.95       400,000       400             379,600                   380,000  
Stock issued for consulting services on October 19, 2001
    1.25       150,000       150             187,350                   187,500  
Stock issued for exhibit fees on October 22, 2001
    1.35       5,000       6             6,745                   6,751  
Stock issued for directors services on November 2, 2001
    0.95       1,000,000       1,000             949,000                   950,000  
Stock 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                   42,140  
Stock issued for consulting services on November 27, 2001
    0.98       10,000       10             9,790                   9,800  
Stock issued for consulting services on November 28, 2001
    0.98       187,000       187             183,073                   183,260  
Intrinsic value of options issued to employees
                              2,600,000       (2,600,000 )            

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF STOCKHOLDERS’ DEFICIENCY — Continued
FROM INCEPTION (FEBRUARY 18, 1998) TO JUNE 30, 2003

                                                                 
                                               
    Price per   Common Stock
  Common stock   Additional
paid-in
  Deferred   Deficit accumulated
during the
  Total stockholders’
development
    share
  Shares
  Amount
  to be issued
  capital
  compensation
  development stage
  stage deficiency
Fair value of options issued to non-employees for services
                              142,318                   142,318  
Amortization of deferred compensation
                                    191,667             191,667  
Net 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                   860,000  
Common stock paid for, but not issued (2,305,000 shares)
    0.15-0.25                   389,875                         389,875  
Fair value of options issued to non-employees for services
                              54,909       (54,909 )            
Amortization of deferred compensation
                                    891,182             891,182  
Net loss
                                          (2,749,199 )     (2,749,199 )
 
   
 
     
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Balance, December 31, 2002
            20,235,847       20,236       389,875       7,133,081       (1,572,060 )     (7,851,545 )     (1,880,413 )
Common stock issued, previously paid for
    0.15       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                   167,500  
Stock issued for cash on April 4, 2003
    0.25       900,000       900             224,062                   224,962  
Stock issued for cash on April 8, 2003
    0.25       100,000       100             24,900                   25,000  
Stock issued for cash on May 8, 2003
    0.25       1,150,000       1,150             286,330                   287,480  
Stock issued for cash on June 16, 2003
    0.25       475,000       475             118,275                   118,750  
Stock issued for legal services on June 27, 2003
    0.55       83,414       83             45,794                   45,877  
Debt converted to stock on June 27, 2003
    0.25       2,000,000       2,000             498,000                   500,000  
Finders fees related to stock issuances
                        43,875       (153,509 )                 (109,634 )
Common stock paid for, but not issued
                        150,000                         150,000  
Amortization of deferred comp
                                    438,727             438,727  
Net loss for six months ended June 30, 2003
                                          (1,046,670 )     (1,046,670 )
 
           
 
     
 
     
 
     
 
     
 
     
 
     
 
 
Balance, June 30, 2003
            27,919,261     $ 27,919     $ 150,000     $ 8,775,208     $ (1,133,333 )   $ (8,898,215 )   $ (1,078,421 )
 
           
 
     
 
     
 
     
 
     
 
     
 
     
 
 

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Table of Contents

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2003 AND 2002 AND FOR THE
PERIOD FROM INCEPTION (FEBRUARY 18, 1998) TO
JUNE 30, 2003

                         
                    Cumulative
    June 30,   June 30,   since
    2003
  2002
  inception
Cash flows from operating activities
                       
Net loss
  $ (1,046,670 )   $ (752,380 )   $ (8,898,215 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Write off of intangible assets
                505,000  
Fair value of options issued for services
          54,909       642,318  
Issuance of common stock for services
    45,877             3,355,731  
Amortization of deferred compensation
    438,726       383,818       1,521,575  
Depreciation
    2,446       151       2,973  
Changes in operating liabilities:
                       
Income taxes payable
    1,064       1,089       5,991  
Accrued expenses
    (74,221 )     91,420       362,448  
 
   
 
     
 
     
 
 
Net cash used in operating activities
    (632,778 )     (220,993 )     (2,502,179 )
 
   
 
     
 
     
 
 
Cash flows from investing activities
                       
Purchase of property and equipment
          (1,989 )     (20,901 )
 
   
 
     
 
     
 
 
Net cash used in investing activities
          (1,989 )     (20,901 )
 
   
 
     
 
     
 
 
Cash flows from financing activities
                       
Increase in payables to related parties
    119,236       217,736       668,708  
Advances from founding executive officer
                517,208  
Issuance of common stock for cash
    867,567             1,798,678  
Common stock issuable
    150,000             150,000  
 
   
 
     
 
     
 
 
Net cash provided by financing activities
    1,136,803       217,736       3,134,594  
 
   
 
     
 
     
 
 
Net increase in cash
    504,025       (5,246 )     611,514  
Cash, beginning of period
    107,489       6,556        
 
   
 
     
 
     
 
 
Cash, end of period
  $ 611,514     $ 1,310     $ 611,514  
 
   
 
     
 
     
 
 

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Table of Contents

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

STATEMENTS OF CASH FLOWS — Continued
SIX MONTHS ENDED JUNE 30, 2003 AND 2002 AND FOR THE
PERIOD FROM INCEPTION (FEBRUARY 18, 1998) TO
JUNE 30, 2003

                         
                    Cumulative
    June 30,   June 30,   since
    2003
  2002
  inception
Supplemental disclosures of cash flow information
                       
Cash paid during the year for
                       
Interest
  $     $     $  
 
   
 
     
 
     
 
 
Income taxes
  $     $     $  
 
   
 
     
 
     
 
 
Non-cash investing and financing activities
                       
Acquisition of intangible asset through advance from related party and issuance of common stock
  $     $     $ 505,000  
Deferred compensation for stock options issued for services
          54,909       2,654,909  
Purchase of property and equipment financed by advance from related party
          3,550       3,550  
Conversion of related party debt to equity
    500,000             500,000  

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS
QUARTER ENDED JUNE 30, 2003

1.   Organization and basis of presentation

    Basis of presentation

    The accompanying interim condensed financial statements are unaudited, but in the opinion of management of Save the World Air, Inc. (the Company), contain all adjustments, which include normal recurring adjustments, necessary to present fairly the financial position at June 30, 2003, the results of operations for the three and six months ended June 30, 2003 and 2002, and cash flows for the six months ended June 30, 2003 and 2002. The balance sheet as of December 31, 2002 is derived from the Company’s audited financial statements.
 
    Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although management of the Company believes that the disclosures contained in these financial statements are adequate to make the information presented therein not misleading. For further information, refer to the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2002, as amended, as filed with the Securities and Exchange Commission.
 
    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, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expense during the reporting period. Actual results could differ from those estimates.
 
    The results of operations for the six months ended June 30, 2003 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2003.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

1.   Organization and basis of presentation - Continued

    Description of business

    Save the World Air, Inc. (the “Company”) was incorporated in Nevada on February 18, 1998 under the name Mandalay Capital Corp. The Company changed its name to Save the World Air, Inc. on February 11, 1999 following the signing of an agreement by and between the Company and Jeffrey Alan Muller, the Company’s founding executive officer and director, with respect to the Company’s purchase of the Zero Emission Fuel-Saving Device (the “Agreement”). Under the terms of the Agreement, the Company issued 5,000,000 shares of its common stock to Mr. Muller and agreed to pay him a total of $500,000 for the marketing and distribution rights of the device, and a $10 royalty for every unit of the device sold (see additional discussion in the Significant Matters section of this note). The Company acquired the worldwide exclusive manufacturing, marketing and distribution rights for the Zero Emission Fuel-Saving Device (“ZEFS”) by entering into the Agreement. The ZEFS is a product, which is fitted to an internal combustion engine and is expected to reduce carbon monoxide hydrocarbons and toxic exhaust emissions. The ZEFS is currently undergoing testing to determine the achievable levels of reduced emissions and commercial viability.
 
    Significant matters
 
    On December 19, 2001, the Securities and Exchange Commission (“SEC”) filed civil charges in federal district court in New York, New York, against the Company, Mr. Muller, and Billy Blackwelder, a marketing consultant for the Company, alleging that they engaged in a fraudulent scheme to manipulate the market for the Company’s stock.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

1.   Organization and basis of presentation - Continued

    Significant matters — Continued

    The SEC’s complaint alleges that from at least February 1999 through at least April 2001, the Company and Mr. Muller carried out a fraudulent promotional campaign using press releases, Internet postings, an elaborate Internet website, and televised media events to disseminate false and materially misleading information about the Company’s product and commercial prospects. The complaint also alleges that the Company’s and Mr. Muller’s actions led to the artificial inflation of the price and trading volume of the Company stock, causing its market capitalization to be as much as $218,728,062. The promotional information distributed by the Company and Mr. Muller included: (1) announcements of significant licensing agreements and other important business developments, and (2) announcements concerning public automotive demonstrations that purportedly proved or would prove that the ZEFS materially reduces emissions and improves fuel economy in motor vehicles. The complaint further alleges that the purported licensing agreements and other purported business events simply did not exist, and the then current ZEFS demonstrations did not prove that the ZEFS actually worked as represented. At the same time that he publicly promoted the Company, Mr. Muller privately sold millions of shares of the Company’s restricted stock that, if sold at then-prevailing market prices, would have provided him with over $9 million in personal profits. He concealed these sales by failing to disclose in SEC filings, as required, any changes in his beneficial ownership in the Company. The SEC complaint also states that the Company and Mr. Muller made at least nine SEC filings that contain false financial statements and disclosures.
 
    In October 2001, Edward Masry became the Company’s new President and Chief Executive Officer. Because of the nature and scope of the SEC’s allegations regarding the Company’s financial statements and SEC filings, Masry has assembled a new management team and advisory board for the Company, in addition to selecting new independent auditors and corporate counsel.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

1.   Organization and basis of presentation - Continued

    Significant matters — Continued

    The Company entered into discussions with the SEC concerning the SEC’s complaint and negotiated a consent order in which it agreed, among other terms, to observe all securities laws. Based upon this consent order and related judgment, the proceedings against the Company were terminated. The Company has since caused an investigation into the facts and circumstances surrounding the allegations in the SEC’s complaint. Based upon review of the history leading to the filing of the complaint, the Company’s board of directors authorized the filing of cross-claims against Mr. Muller and others (including ten offshore companies) seeking disgorgement of stock obtained from the Company, to invalidate the transfer of several million shares to Mr. Muller and family members for inadequate or no consideration, rescission of stock options transferred to Mr. Muller and/or his family members, for the transfer of rights to patent claims from Mr. Muller to the Company and rescission of royalty rights held by Mr. Muller and/or his family members. Upon filing of the cross complaint, in July 2002, the Company obtained a temporary restraining order against Mr. Muller which, among other things, prohibits Mr. Muller from serving as an officer or director of the Company and enjoins Mr. Muller and others from selling, conveying, transferring or encumbering any shares which Mr. Muller controls or in which he has an interest. The Company believes the temporary restraining order may affect as many as seventeen million shares or more of the Company’s stock, in the form of issued shares and option rights.
 
    In the course of the legal proceedings, the Company has obtained complete control over all ownership claims to the ZEFS patent rights and all royalty interests previously held and claimed by Mr. Muller and certain others.
 
    The Company has continued to prosecute its claims and has substantially completed all pretrial procedures in preparation for the disposition of the case through dispositive pretrial motions and/or eventual trial on the merits of the claims. Based upon the substantial discovery completed and other evidence obtained to date, the Company believes there is very little risk of an adverse decision on the merits of its cross complaint.
 
    Based on the status of current legal proceedings, the Company believes it will not have to pay $1,017,208 of advances due to Mr. Muller. The Company also believes that the option Mr. Muller holds to purchase 10,000,000 shares of the Company’s stock will be cancelled.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

1.   Organization and basis of presentation - Continued

    Development stage enterprise

    The Company is a development stage enterprise as defined by Statement of Financial Accounting Standards (SFAS) No. 7, “Accounting and Reporting by Development Stage Enterprises.” All losses accumulated since the inception of the Company have been considered as part of the Company’s development stage activities.
 
    A team has been assembled for the research and development of the technology and potential markets for the ZEFS and to establish relationships with potential customers. Significant design work has been completed, and patent applications have been filed in 64 countries. There is no assurance that any of the filed patents will be granted. The Company is continuing in its product development efforts and several studies are underway to evaluate the effectiveness of the ZEFS in eliminating pollutants and emissions from internal combustion engines. The Company has had no sales to date. As such, the Company continues to remain a development stage enterprise. The ability of the Company to commercialize its products will depend on, among other things, the Company’s ability to demonstrate the merits of the ZEFS and develop markets and distribution channels.

2.   Net loss per share

    Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. In computing diluted earnings per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. For the six months ended June 30, 2003 and the year ended December 31, 2002, the dilutive impact of outstanding stock options of 14,000,000 and 14,000,000, respectively, and 7,808,414 warrants in 2003 has been excluded because their impact on the loss per share is antidilutive.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

3.   New accounting pronouncements

    In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. SFAS No. 146 nullifies Emerging Issues Task Force Issue No. 94-3: “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability be recognized for those costs only when the liability is incurred, that is, when it meets the definition of a liability in the FASB’s conceptual framework. SFAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with earlier adoption encouraged. Management does not expect the adoption of SFAS No. 146 will have a material impact on the Company’s financial position or results of operations.
 
    In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. It also amends the disclosure requirements of SFAS No. 123. If an entity elects to adopt the recognition provisions of the fair value based method of accounting for stock-based compensation in a fiscal year beginning before December 16, 2003, that change in accounting principle shall be reported using either the (i) prospective method, (ii) the modified prospective method, or (iii) the retroactive restatement method as defined in SFAS No. 148. SFAS No. 148 is effective for fiscal years ending after December 15, 2002. Since the Company has elected to continue accounting for stock-based compensation under APB No. 25, the adoption of SFAS No. 148 has had no impact to the Company’s financial position or results of operations. The Company’s financial statement disclosures have been designed to conform to the new disclosure requirements prescribed by SFAS No. 148.
 
    In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities, which are subject to the provisions of this statement for the first fiscal period beginning after December 15, 2004. The Company believes that the adoption of SFAS No. 150 will not have an impact on its financial position or results of operations.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

3.   New accounting pronouncements - Continued

    In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, “ which clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” relating to consolidation of certain entities. FIN 46 requires identification of a company’s participation in variable interest entities (VIEs), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit it to operate on a standalone basis. For entities identified as a VIE, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE (if any) bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 also sets forth certain disclosures regarding interests in VIEs that are deemed significant, even if consolidation is not required. The Company is not currently participating in, or invested in any VIEs, as defined in FIN 46.

4.   Certain relationships and related transactions

    Due to founding executive officer

    All of the marketing and manufacturing rights for the ZEFS were acquired from Mr. Muller, for 5,000,000 shares of common stock, $500,000 and a $10 royalty for each unit sold (see discussion below), pursuant to the Agreement entered into in December 1998, by and between the Company and Mr. Muller. Working capital advances in the amount of $517,208 and payment in the amount of $500,000 for marketing and distribution rights of the ZEFS are due to Mr. Muller. Such amounts are interest free and do not have any due dates for payment.
 
    In January 2000, the Company entered into an agreement offering Mr. Muller and Lynne Muller, Mr. Muller’s wife, the option to purchase 5,000,000 shares each at $0.10 per share as consideration for work performed for the Company. Mrs. Muller subsequently transferred her option to Mr. Muller.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

4.   Certain relationships and related transactions - Continued

    Due to founding executive officer — Continued

    In connection with the Company’s legal proceedings against Mr. Muller, the Company is attempting to obtain a judgment that will relieve the Company of $1,017,208, which represents all amounts due Mr. Muller. These amounts include the $500,000 due for the marketing and distribution rights of the ZEFS and the working capital advances of $517,208. As described in the Significant Matters section of Note 1, the Company has already been relieved of the $10 royalty interest that Mr. Muller held for each unit sold. In addition, the Company is also attempting to obtain a judgment that will cancel the options to purchase 10,000,000 shares granted to Mr. and Mrs. Muller, collectively. Based on the status of current legal proceedings, the Company does not believe that it will have to pay Mr. Muller the $500,000 for the rights to the ZEFS device and the $517,208 of advances. The Company also believes that the option Mr. Muller holds to purchase 10,000,000 shares of the Company’s stock will be cancelled and no longer valid.

    Due to related parties

    Masry & Vititoe, a law firm in which Edward Masry is a partner, has advanced $172,248 and $553,022 as of June 30, 2003 and December 31, 2002 to the Company for working capital purposes. The advances payable to Masry & Vititoe were allocations to the Company for shared expenses, primarily payroll. These advances are unsecured, non-interest bearing, and are due on demand. In June 2003, $500,000 of debt was converted to 2,000,000 shares of common stock.

5.   Stockholders’ deficiency

    As of June 30, 2003, the Company has authorized 200,000,000 shares of its common stock and 27,919,261 shares were issued and outstanding, and 600,000 shares were issuable. As described in Note 1, estimates and judgments were used by management to determine the fair value for certain issuances of the outstanding shares.
 
    The Company’s significant stockholders are as follows:

                 
    Number   Percentage
    of shares
  ownership
Mr. Jeffrey Muller and controlled by Mr. Muller through beneficial ownership
    8,716,710       31.2 %
Mr. Edward Masry
    3,000,000       10.7 %
Remaining stockholders
    16,202,551       58.0 %
 
   
 
     
 
 
 
    27,919,261       100.0 %
 
   
 
     
 
 

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

6.   Stock warrants

    The following table summarizes certain information about the company’s stock purchase warrants.

                 
    Weighted   Avg.
    Warrants
  Exercise Price
Warrants outstanding, January 1, 2002
        $  
Warrants granted
    1,850,000       0.35  
Warrants exercised
           
Warrants cancelled
           
 
   
 
     
 
 
Warrants outstanding, December 31, 2002
    1,850,000       0.35  
Warrants granted
    5,958,414       0.50  
Warrants exercised
           
Warrants cancelled
           
 
   
 
     
 
 
Warrants outstanding, June 30, 2003
    7,808,414     $ 0.46  
 
   
 
     
 
 

    The Company has elected to account for stock-based compensation using the intrinsic value method prescribed in APB No. 25 and related interpretations, and follow the pro forma disclosure requirements of SFAS No. 123. Accordingly, no compensation expense has been recognized related to the granting of stock options, except as noted above. The following table illustrates the effect on net income as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

                         
                    Cumulative
    June 30,   December 31,   since
    2003
  2002
  inception
Net loss, as reported
  $ (1,046,670 )   $ (2,749,199 )   $ (8,898,215 )
Less: total fair value method stock-based employee compensation expense
    (474,989 )     (949,977 )     (1,733,314 )
Add: deferred compensation amortization for below market employee options
    425,000       850,000       1,466,667  
 
   
 
     
 
     
 
 
Pro forma net loss
  $ (1,096,659 )   $ (2,849,176 )   $ (9,164,862 )
 
   
 
     
 
     
 
 
Pro forma loss per share
  $ (0.04 )   $ (0.15 )        
 
   
 
     
 
         

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)

NOTES TO FINANCIAL STATEMENTS — Continued
SIX MONTHS ENDED JUNE 30, 2003

7.   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 has a net loss of $1,046,670, a negative cash flow from operations of $632,778 and a stockholders’ deficiency of $1,078,421. These factors raise substantial doubt about its ability to continue as a going concern. The ability to the Company to continue as a going concern is dependent on 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.

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Item 2. Management’s Discussion and Analysis

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

 
          research and development expenses;
 
          scientific test results;
 
          general and administrative expenses;
 
          liquidity and sufficiency of existing cash;
 
          technology; and
 
          the outcome of pending or threatened litigation;

     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.

     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 elsewhere in this Form 10-QSB, that could cause actual results to differ materially from those projected.

     Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the heading “Risk Factors.” In our Annual Report on Form 10-KSB for the year ended December 31, 2002. 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.

     The forward-looking statements set forth in this Form 10-QSB are as of June 30, 2003, and we undertake no duty to update this information.

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Overview

     The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Financial Statements and notes thereto included in Part I, Item 1 of this Form 10-QSB and the Financial Statements and notes thereto contained in our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2002.

     The company is a development stage company that has not yet commenced operations and does not generate revenue. The company’s current focus is on research and development of proprietary devices that can be installed on motor vehicles and which are designed to reduce harmful emissions, improve fuel efficiency and improve performance. Our prototype device is called “ZEFS”. We have devoted the bulk of our efforts to complete the design and development of our production models and raise the financing required to do so and fund our expenses.

     We anticipate that these research and development efforts will continue for at least the remainder of 2003. We do not envision generating any revenue in 2003. We will need to complete the current round of financing that began in November 2002, in order to raise the additional capital needed to find continuing research and development activities and meet our operating expenses for the remainder of 2003.

Results of Operation

     To date, we have not generated any revenues and our business is in the development stage. We have focused our efforts on verifying and developing the ZEFS device.

     Our operating costs and expenses consist primarily of research and development expenses and general and administrative expenses. We expect our operating costs to increase once we begin to manufacture and market the ZEFS device, which we do not expect to occur earlier than the fourth quarter of 2004. Our research and development expenses include contractual payments to RAND Corporation, consultants’ fees, capital expenditures, cost of services and supplies We expect our research and development costs to increase as we continue to develop the ZEFS device and develop new applications of our technology.

     Our general and administrative expenses include compensation expenses related to executive and other administrative personnel, facility lease, the costs of our insurance and legal and accounting support. We expect our general and administrative expenses to increase as we expand our infrastructure in support of our anticipated increased operations, which we do not expect to occur earlier than the fourth quarter of 2004.

     We had a net loss of $440,669 and $1,046,670 for the three months and six months ended June 30, 2003, respectively. This compares to a loss of $420,241 and $752,380 for the three and six months ended June 20, 2002, respectively. The increase in loss is primarily attributable to an increase in research and development expenses as a result of the agreement we entered into with RAND Corporation in December 2002. We expect an increase in net loss through 2003 attributable to increased general and administrative expenses and commencement of marketing.

Liquidity and Capital Resources

     We have incurred negative cash flow from operations in the developmental stage since our inception in 1998. As of June 30, 2003 we had cash of $611,514 and an accumulated deficit of $8,898,215. Our 2003 negative operating cash flows were funded primarily through Masry & Vititoe, a law firm in which our Chief Executive Officer and President, Edward Masry, is a member, and a private financing that we commenced in November 2002 and is ongoing. We anticipate additional operating losses, which may increase, through at least the remainder of 2003 as we expand our research and development program without the benefit of revenue.

     We believe that we have sufficient cash to fund our operations for at least the next 12 months. To the extent our capital resources are insufficient to meet our future capital requirements, we will need to raise additional capital or incur new debt to fund our operations. However, there can be no assurance that additional equity or debt financing will be available. If we are unable to obtain additional capital, we may be required to delay, reduce the scope of, or eliminate our research and development programs or relinquish rights to technologies that we might otherwise seek to develop or commercialize.

Capitalization

     In the action by the Securities and Exchange Commission (the “SEC”) against Jeffrey Muller, the founder and former sole director of the Company, and others, we seek, among other relief, the cancellation of all shares of our common stock controlled, directly or indirectly, by Mr. Muller and his affiliates, options to purchase an additional 10,000,000 shares of our common stock, and Mr. Muller’s original royalty agreement. See “Part II, Item 1, Legal Proceedings.” The cancellation of these shares and options would have a significant positive effect on our capitalization.

Critical Accounting Policies

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

     The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report in our Financial Statements. The SEC considers an entity’s most critical accounting policies to be those policies that are both most important to the portrayal of a company’s financial condition and results of operations and those that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain at the time of estimation. We believe the following critical accounting policies, among others, require significant judgments and estimates used in the preparation of our Financial Statements:

Stock-Based Compensation

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

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

Estimates

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

New Accounting Pronouncements

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

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

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Item 3. Controls and Procedures

     (a) Evaluation of disclosure controls and procedures: Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-QSB. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

     (b)  Changes in internal control over financial reporting: There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-QSB that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1. Legal Proceedings

     On December 19, 2001, the SEC filed civil charges in the United States Federal District Court, Southern District of New York, against us, our former President and then sole director Jeffrey 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 pay any fines or restitution. The SEC’s action continues against Mr. Muller and others.

     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 and financial restitution for a variety of acts and omissions in connection with sales of our stock and other transactions occurring between 1998 and 2002. We are also seeking cancellation of such shares and Mr. Muller’s stock option agreement and royalty arrangement. Among other things, we allege that Mr. Muller and certain others sold stock without consideration and without registration under federal securities laws; engaged in self-dealing and entered into various undisclosed related-party transactions; misappropriated for their own use proceeds from sales of our stock; and entered into various undisclosed arrangements regarding the control, voting and disposition of their stock.

     On July 30, 2002, the U.S. Federal District Court, Southern District of New York, granted our application for a preliminary injunction against Mr. Muller and others, which prevents Mr. Muller and other cross-defendants from selling, transferring, or encumbering any of our assets and property, from selling or transferring any of our stock that they may own or control, or from taking any action to injure us or our business and shareholders. The order also prevents Mr. Muller from exercising any control over our corporation and serving as an officer or director of our company. While we believe that we have valid claims, there can be no assurance that an adverse result or settlement would not have a material adverse effect on our financial position or cash flow.

     In the course of the litigation, we have obtained control over Mr. Muller’s patent rights to the ZEFS device. Under a Buy-Sell Agreement between Jeffrey Muller and us dated December 29, 1998, Mr. Muller, who was listed on the ZEFS devise patent application as the inventor of the ZEFS device, granted us the marketing, manufacturing and distribution rights to the ZEFS device. In conjunction with these proceedings, a settlement agreement was reached whereby the $ 10 per unit royalty previously due to Mr. Muller was terminated and replaced with a $.20 per unit royalty payable to the bankruptcy trustee. On November 7, 2002, under our settlement with the Muller bankruptcy trustee, the trustee transferred all ownership and legal rights to this international patent application for the ZEFS device to us.

     The litigation against Mr. Muller and others has been pending before the Court and will be scheduled for further proceedings and final disposition by summary judgment motions within the near future. Although the outcome of these motions cannot be predicted with any degree of certainty, we are optimistic that the Court’s ruling will either significantly narrow the issues for any later trial or will result in a disposition of the case in a manner favorable to the company. We contend that we are entitled to a judgment canceling all of the approximately 8,716,710 shares of our common stock which we believe are controlled, directly or indirectly, by Mr. Muller, divesting Mr. Muller of any right to exercise options for 10,000,000 shares of our stock, the entry of an existing preliminary injunction to prevent Mr. Muller from any involvement with the company and a monetary judgment against Muller and others in the amount of several million dollars. While we believe that we have valid claims, there can be no assurance that an adverse result or settlement would not have a material adverse effect on our financial position or cash flow.

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Item 2. Changes in Securities

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

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Item 6. Exhibits and Reports on Form 8-K

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

     
Exhibit No.   Description

 
3.1(1)   Articles of Incorporation, as amended, of the Registrant.
3.2(1)   Bylaws of the Registrant.
10.1(4)   Commercial Sublease between the Registrant and KZ Golf, Inc., dated October 16, 2003.
10.2(4)   General Tenancy Agreement between the Registrant and Autumlee Pty Ltd., dated November 15, 2003.
10.3(2)   Agreement between the Registrant and RAND, dated December 13, 2002.
10.4(4)*   Agreement between the Registrant and RAND, dated May 7, 2003.
10.5(3)   Deed and Document Conveyance between the Trustee of the Property of Jeffrey Ann Muller and Lynette Anne Muller (Bankrupts).
10.5(3)   Assignment and Bill of Sale between Pro Hart and the Registrant dated May 28, 2002.
31.1   Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).
31.2   Certification of Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C. Section 1350.
32   Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).


*   Confidential Treatment Requested.
(1)   Incorporated by reference from Registrant’s Registration Statement on Form 10-SB (Registration Number 000-29185), as amended, filed on March 2, 2000.
(2)   Incorporated by reference from Registrant’s Form 8-K filed on December 30, 2002.
(3)   Incorporated by reference from Registrant’s Form 8-K filed on November 12, 2002.
(4)   Incorporated by reference from Registrant’s Form 10-KSB for fiscal year ended December 31, 2002.

     No reports were filed on Form 8-K during the quarterly period ending March 31, 2003.

     Items 3, 4 and 5 are not applicable and have been omitted.

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SIGNATURES

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

         
    SAVE THE WORLD AIR, INC.
 
Date: June 6, 2004   By:   /s/ Edward L. Masry
       
        Edward L. Masry
Chief Executive Officer

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EXHIBIT INDEX

     
Exhibit No.   Description

 
3.1(1)   Articles of Incorporation, as amended, of the Registrant.
3.2(1)   Bylaws of the Registrant.
10.1(4)   Commercial Sublease between the Registrant and KZ Golf, Inc., dated October 16, 2003.
10.2(4)   General Tenancy Agreement between the Registrant and Autumlee Pty Ltd., dated November 15, 2003.
10.3(2)   Agreement between the Registrant and RAND, dated December 13, 2002.
10.4(4)*   Agreement between the Registrant and RAND, dated May 7, 2003.
10.5(3)   Deed and Document Conveyance between the Trustee of the Property of Jeffrey Ann Muller and Lynette Anne Muller (Bankrupts).
10.6(3)   Assignment and Bill of Sale between Pro Hart and the Registrant dated May 28, 2002.
31.1   Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).
31.2   Certification of Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C. Section 1350.
32   Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).


*   Confidential Treatment Requested.
(1)   Incorporated by reference from Registrant’s Registration Statement on Form 10-SB (Registration Number 000-29185), as amended, filed on March 2, 2000.
(2)   Incorporated by reference from Registrant’s Form 8-K filed on December 30, 2002.
(3)   Incorporated by reference from Registrant’s Form 8-K filed on November 12, 2002.
(4)   Incorporated by reference from Registrant’s Form 10-KSB for fiscal year ended December 31, 2002.

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