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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
     
þ   QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005.
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. Employer
incorporation or organization)   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 þ No o
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
     The number of shares of the Registrant’s Common Stock outstanding as of September 30, 2005 was 39,354,821 shares.
     Transitional Small Business Disclosure Format (Check one): Yes o No þ
 
 

 


SAVE THE WORLD AIR, INC.
FORM 10-QSB
INDEX
         
    Page
       
 
       
    1  
    2  
    3  
    4  
    9  
    11  
    24  
    28  
 
       
       
 
       
    28  
    30  
    31  
    31  
    31  
    31  
 
       
    32  
 
       
    33  
EXHIBIT 10.1
       
EXHIBIT 10.2
       
EXHIBIT 10.3
       
EXHIBIT 10.4
       
EXHIBIT 31.1
       
EXHIBIT 31.2
       
EXHIBIT 32
       
 Exhibit 10.1
 Exhibit 10.2
 Exhibit 10.3
 Exhibit 10.4
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32

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PART I
Item 1. Financial Statements.
SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED BALANCE SHEETS
SEPTEMBER 30, 2005 (UNAUDITED) AND DECEMBER 31, 2004
                 
    Sept. 30, 2005     December 31,  
    (unaudited)     2004  
ASSETS
               
 
               
Current assets
               
Cash
  $ 429,754     $ 84,826  
Other current assets
          2,602  
 
           
 
               
Total current assets
    429,754       87,428  
 
           
 
               
Property and equipment, net of accumulated depreciation
    53,868       35,596  
 
           
 
               
Other assets
    4,500        
 
           
 
               
 
  $ 488,122     $ 123,024  
 
           
See notes to condensed financial statements.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED BALANCE SHEETS — Continued
SEPTEMBER 30, 2005 (UNAUDITED) AND DECEMBER 31, 2004
                 
    Sept. 30, 2005     December 31,  
    (unaudited)     2004  
LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
               
 
               
Current liabilities
               
Accounts payable
  $ 86,758     $ 64,089  
Accrued expenses
    80,669       84,420  
Accrued research and development fees
    705,000       50,000  
Accrued professional fees
    987,279       876,452  
Payable to shareholder
    20,000        
Payable to related parties
    179,561       36,478  
Finders fees payable
    1,000       1,521  
Convertible debentures, net
    22,066        
 
           
 
               
Total current liabilities
    2,082,333       1,112,960  
 
           
 
               
Advances from founding executive officer
    1,017,208       1,017,208  
 
           
 
               
Commitments and contingencies
               
 
               
Stockholders’ deficiency
               
Common stock, $.001 par value: 200,000,000 shares authorized, 39,354,821 and 37,784,821 shares issued and outstanding at September 30, 2005 and December 31, 2004, respectively
    39,355       37,784  
Common stock to be issued
    80,000       119,000  
Additional paid-in capital
    17,654,469       15,043,028  
Deferred compensation
    (203,125 )     (76,068 )
Deficit accumulated during the development stage
    (20,182,118 )     (17,130,888 )
 
           
 
               
Total stockholders’ deficiency
    (2,611,419 )     (2,007,144 )
 
           
 
               
 
  $ 488,122     $ 123,024  
 
           
See notes to condensed financial statements.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 AND FOR
THE PERIOD FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005
                                         
    Three months ended     Nine months ended        
    September 30,     September 30,     Cumulative  
            2004             2004     since  
    2005     (as restated)     2005     (as restated)     inception  
Net sales
  $     $     $     $     $  
 
                                       
Operating expenses
    759,087       864,653       1,983,186       2,362,205       14,848,556  
 
                                       
Research and development expenses
    452,571       162,458       1,066,068       1,565,177       3,719,293  
 
                                       
Non-cash patent settlement costs
          1,610,066             1,610,066       1,610,066  
 
                             
 
                                       
Loss before other income
    (1,211,658 )     (2,637,177 )     (3,049,254 )     (5,537,448 )     (20,177,915 )
 
                                       
Other income
                                       
Interest income
                      514       954  
 
                             
 
                                       
Loss before provision for income taxes
    (1,211,658 )     (2,637,177 )     (3,049,254 )     (5,536,934 )     (20,176,961 )
 
                                       
Provision (benefit) for income taxes
          (4,063 )     1,976       (3,063 )     5,157  
 
                             
 
                                       
Net loss
  $ (1,211,658 )   $ (2,633,114 )   $ (3,051,230 )   $ (5,533,871 )   $ (20,182,118 )
 
                             
 
                                       
Net loss per share, basic and diluted
  $ (0.03 )   $ (0.07 )   $ (0.08 )   $ (0.16 )        
 
                             
 
                                       
Weighted average shares outstanding, basic and diluted
    39,115,886       36,599,887       38,564,191       35,328,591          
 
                             
See notes to condensed financial statements.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY
FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005
                                                                 
                          Additional             Deficit accumulated     Total stockholders’  
    Price per     Common Stock     Common stock     paid -in     Deferred     during the     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
            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
            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  

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY
FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005
                                                                 
            Common Stock             Additional             Deficit accumulated     Total stockholders’  
    Price per                     Common stock     paid -in     Deferred     during the     development  
    share     Shares     Amount     to be issued     capital     compensation     development stage     stage deficiency  
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  
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
            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  

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY
FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005
                                                                 
                          Additional             Deficit accumulated     Total stockholders’  
    Price per     Common Stock     Common stock     paid-in     Deferred     during the     development  
    share     Shares     Amount     to be issued     capital     compensation     development stage     stage deficiency  
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 )            
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 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                   167,500  
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  
Stock and warrants issued for cash on July 11, 2003
    0.25       519,000       519             129,231                   129,750  
Stock and warrants issued for cash on September 29, 2003
    0.25       1,775,000       1,775             441,976                   443,751  
Stock and warrants issued for cash on October 21, 2003
    0.25       1,845,000       1,845             459,405                   461,250  
Stock and warrants issued for cash on October 28, 2003
    0.25       1,570,000       1,570             390,930                   392,500  
Stock and warrants issued for cash on November 19, 2003
    0.25       500,000       500             124,500                   125,000  

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Table of Contents

SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY
FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005
                                                                 
                                    Additional             Deficit accumulated     Total stockholders’  
    Price per     Common Stock     Common stock     paid-in     Deferred     during the     development  
    share     Shares     Amount     to be issued     capital     compensation     development stage     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                         6,250  
Amortization of deferred comp
                                    863,727             863,727  
Net 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                   75,000  
Stock issued for finders fees on March 31, 2004
    0.15       82,500       82             12,293                   12,375  
Stock issued for finders fees on March 31, 2004
    0.25       406,060       407             101,199                   101,606  
Stock issued for services on April 2, 2004
    1.53       65,000       65             99,385                   99,450  
Debt converted to stock on April 2, 2004
    1.53       60,000       60             91,740                   91,800  
Stock issued upon exercise of warrants on May 21, 2004
    0.20       950,000       950             189,050                   190,000  
Stock issued for directors services on June 8, 2004
    1.70       600,000       600             1,019,400                   1,020,000  
Stock issued for cash on August 25, 2004
    1.00       550,000       550             549,450                   550,000  
Stock issued upon exercise of options on August 30, 2004
    0.40       4,000       4             1,596                   1,600  
Stock issued for cash on September 8, 2004
    1.00       25,000       25             24,975                   25,000  
Stock issued for consulting services on September 15, 2004
    1.31       50,000       49             65,451                   65,500  
Stock issued for patent settlement on September 22, 2004
    1.24       20,000       20             24,780                   24,800  
Stock issued for research and development on October 6, 2004
    1.40       65,000       65             90,935                   91,000  
Stock issued for cash on October 6, 2004
    1.00       25,000       25             24,975                   25,000  
Stock issued for cash on October 15, 2004
    1.00       150,000       150             149,850                   150,000  
Stock issued upon exercise of stock options on October 21, 2004
    0.40       6,500       6             2,594                   2,600  
Stock issued for cash on November 3, 2004
    1.00       25,000       25             24,975                   25,000  
Stock issued for cash on November 18, 2004
    1.00       172,500       173             172,327                   172,500  
Stock issued for cash on December 9, 2004
    1.00       75,000       75             74,925                   75,000  
Stock issued for cash on December 23, 2004
    1.00       250,000       250             249,750                   250,000  
Finders fees related to stock issuances
                            (88,384 )                 (88,384 )
Common stock paid for, but not issued (119,000 shares)
                      119,000                         119,000  

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY
FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005
                                                                 
                                    Additional             Deficit accumulated     Total stockholders’  
    Price per     Common Stock     Common stock     paid-in     Deferred     during the     development  
    share     Shares     Amount     to be issued     capital     compensation     development stage     stage deficiency  
Intrinsic 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                   1,585,266  
Fair value of warrants issued to non- employees for services
                            28,872                   28,872  
Amortization of deferred compensation
                                  936,537             936,537  
Net 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                   25,000  
Stock issued upon exercise of warrants on January 31, 2005
    0.40       500       1             199                   200  
Stock issued for cash on February 17, 2005
    1.00       325,000       325             324,675                   325,000  
Stock issued for cash on March 31, 2005
    1.00       215,000       215             214,785                   215,000  
Stock issued for cash on May 17, 2005
    1.00       5,000       5             4,995                   5,000  
Stock issued for cash on June 7, 2005
    1.00       300,000       300             299,700                   300,000  
Stock issued for cash on August 5, 2005
    1.00       480,500       481             480,019                   480,500  
Stock issued for cash on August 9, 2005
    1.00       100,000       100             99,900                   100,000  
Common stock paid for, but not issued (80,000 shares)
                      80,000                         80,000  
Finders fees related to stock issuances
                            (108,840 )                 (108,840 )
Intrinsic value of options issued to employees
                            243,750       (243,750 )            
Fair value of options issued for settlement costs
                            31,500                   31,500  
Fair value of warrants issued for settlement costs
                            4,957                   4,957  
Fair value of warrants issued to non- employees for services
                            13,505                   13,505  
Amortization of deferred compensation
                                  116,693             116,693  
Warrants issued with convertible debentures
                            427,703                   427,703  
Intrinsic value of beneficial conversion associated with convertible debentures
                            430,737                   430,737  
Net loss for nine months ended September 30, 2005
                                        (3,051,230 )     (3,051,230 )
 
                                               
Balance, September 30, 2005 (unaudited)
            39,354,821     $ 39,355     $ 80,000     $ 17,654,469     $ (203,125 )   $ (20,182,118 )   $ (2,611,419 )
 
                                               

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 AND
FOR THE PERIOD FROM INCEPTION (FEBRUARY 18, 1998)
TO SEPTEMBER 30, 2005
                         
            September 30,     Cumulative  
    September 30,     2004     since  
    2005     (as restated)     inception  
Cash flows from operating activities
                       
Net loss
  $ (3,051,230 )   $ (5,533,871 )   $ (20,182,118 )
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
                171,190  
Issuance of common stock for services
          1,361,550       5,280,623  
Issuance of options for legal settlement
    31,500             31,500  
Issuance of warrants for legal settlement
    4,957             4,957  
Issuance of warrants for services
    13,505             13,505  
Patent acquisition cost
          1,585,266       1,610,066  
Amortization of issuance costs
    22,066             22,066  
Amortization of deferred compensation
    116,693       789,636       2,999,806  
Depreciation
    6,987       6,323       21,404  
Changes in operating assets and liabilities:
                       
Prepaid expenses and other
    (1,898 )     (50,000 )     (4,500 )
Income taxes payable
          (5,991 )      
Accounts payable and accrued expenses
    789,624       157,999       1,980,087  
 
                 
 
                       
Net cash used in operating activities
    (2,067,796 )     (1,689,088 )     (7,546,414 )
 
                 
 
                       
Cash flows from investing activities
                       
Purchase of property and equipment
    (25,259 )     (9,037 )     (71,722 )
 
                 
 
                       
Net cash used in investing activities
    (25,259 )     (9,037 )     (71,722 )
 
                 
 
                       
Cash flows from financing activities
                       
Increase (decrease) in payables to related parties and shareholder
    163,083       (6,425 )     711,011  
Advances from founding executive officer
                517,208  
Net proceeds from convertible debentures
    858,440             858,440  
Issuance of common stock for cash
    1,342,860       766,600       5,887,631  
Common stock issuable
    73,600       235,000       73,600  
 
                 
 
                       
Net cash provided by financing activities
    2,437,983       995,175       8,047,890  
 
                 
 
                       
Net increase (decrease) in cash
    344,928       (702,950 )     429,754  
 
                       
Cash, beginning of period
    84,826       926,052        
 
                 
 
                       
Cash, end of period
  $ 429,754     $ 223,102     $ 429,754  
 
                 
See notes to condensed financial statements.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF CASH FLOWS — Continued (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 AND
FOR THE PERIOD FROM INCEPTION (FEBRUARY 18, 1998)
TO SEPTEMBER 30, 2005
                         
                    Cumulative  
    September 30,     September 30,     since  
    2005     2004     inception  
Supplemental disclosures of cash flow information
                       
 
                       
Cash paid during the year for
                       
 
Interest
  $     $     $  
 
                 
 
                       
Income taxes
  $ 1,976     $     $ 5,157  
 
                 
 
                       
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
    243,750       304,272       3,202,931  
 
                       
Purchase of property and equipment financed by advance from related party
                3,550  
 
                       
Conversion of related party debt to equity
          15,000       515,000  
 
                       
Issuance of common stock in settlement of payable
          113,981       113,981  
 
                       
Common stock, previously paid for
    119,000       6,250       119,000  
 
                       
Finders fees accrued for issuance of common stock
    1,000       64,928       1,000  
 
                       
Value of warrants and beneficial conversion feature of convertible notes
    858,440             858,440  
See notes to condensed financial statements.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
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 September 30, 2005, the results of operations for the three and nine months ended September 30, 2005 and 2004, and cash flows for the nine months ended September 30, 2005 and 2004. The balance sheet as of December 31, 2004 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, 2004, 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 nine months ended September 30, 2005 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2005.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
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 purchase of the worldwide exclusive manufacturing, marketing and distribution rights for the ZEFS device. ZEFS is a device which is fitted to an internal combustion engine and is expected to reduce carbon monoxide hydrocarbons and nitrous oxide emissions. During the past three years, the Company has been acquiring new technologies, developing prototype products using the Company’s technologies and conducting scientific tests regarding the technologies and prototype products. In 2003, the Company acquired worldwide intellectual property and patent rights to technologies which reduce carbon monoxide, hydrocarbons and nitrous oxide emissions in two- and four-stroke motorcycles, fuel-injection engines, generators and small engines. The Company has also developed prototype products and named them “CAT-MATE”.
     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 primary historical focus has been on research and development 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 any revenues. The prototype devices are called “ZEFS” and “CAT-MATE.” Previously, the Company devoted the bulk of its efforts to complete the design, the development of production models and initial efforts for the promotion of products in the marketplace worldwide. The Company is currently in a transitional phase from research and development to initial marketing and early sales of its devices. Expenses have been funded primarily through the sale of company stock and debt. The Company has taken actions to secure the intellectual property rights to the ZEFS and CAT-MATE devices. In addition, the Company has initiated marketing efforts to international governmental entities in cooperation with the United Nations Environmental Programme (UNEP) and various original equipment manufacturers (OEMs), to eventually sell or license the ZEFS and CAT-MATE products and technology.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
2. Net loss per share
Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. In computing diluted earnings per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. For the nine months ended September 30, 2005 and 2004, the dilutive impact of outstanding stock options of 16,508,561 and 14,422,652 respectively, and outstanding warrants of 19,095,728 and 14,973,414 have been excluded because their impact on the loss per share is antidilutive.
3. Recent accounting pronouncements
In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs”. This Statement amends the guidance in ARB No. 43 Chapter 4 Inventory Pricing, to require items such as idle facility costs, excessive spoilage, double freight and rehandling costs to be expensed in the current period, regardless if they are abnormal amounts or not. This Statement will become effective for us in the first quarter of 2006. The adoption of SFAS No. 151 is not expected to have a material impact on our financial condition, results of operations, or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which revises SFAS No. 123. SFAS 123R also supersedes APB No. 25 and amends SFAS No. 95, “Statement of Cash Flows”. In general, the accounting required by SFAS 123R is similar to that of SFAS No. 123. However, SFAS No. 123 gave companies a choice to either recognize the fair value of stock options in their income statements or disclose the pro forma income statement effect of the fair value of stock options in the notes to the financial statements. SFAS 123R eliminates that choice and requires the fair value of all share-based payments to employees, including the fair value of grants of employee stock options, be recognized in the income statement, generally over the option vesting period. SFAS 123R must be adopted no later than July 1, 2005 (or December 31, 2005 for small business issuers). Early adoption is permitted.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
3. New accounting pronouncements — continued
The Company is currently evaluating the timing and manner in which it will adopt SFAS 123R. As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using APB 25’s intrinsic value method. Accordingly, adoption of SFAS 123R’s fair value method will have an effect on results of operations, although it will have no impact on overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had SFAS 123R been adopted in prior periods, the effect would have approximated the SFAS 123 pro forma net loss and loss per share disclosures as shown above. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required, thereby reducing net operating cash flows and increasing net financing cash flows in periods after adoption.
4. Certain relationships and related transactions
     Advances from founding executive officer
All of the marketing and manufacturing rights for the ZEFS were acquired from Mr. Muller, for 5,000,000 shares of common stock, $500,000 and a $10 royalty for each unit sold (see discussion below), pursuant to the Agreement entered into in December 1998, by and between the Company and Mr. Muller. Working capital advances in the amount of $517,208 and payment in the amount of $500,000 for marketing and distribution rights of the ZEFS are due to Mr. Muller. Such amounts are interest free and do not have any due dates for payment.
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 CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
4. Certain relationships and related transactions — continued
     Advances from founding executive officer — continued
In connection with the Company’s legal proceedings against Mr. Muller (see Note 9), 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. The Company has 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 divest and prevent any subsequent holders of the right to exercise options previously held by Mr. Muller for 10,000,000 shares of the Company’s common stock. 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 has not made any adjustments for the above in its financial statements as the matters have not yet been finalized.
     Due to related parties
Masry & Vititoe, a law firm in which Edward Masry, the Company’s Chief Executive Officer, is a partner, has advanced $179,561 and $36,478 as of September 30, 2005 and 2004, respectively, to the Company for working capital purposes. Advances by Masry and Vititoe are unsecured, non-interest bearing, and are due on demand. In April 2004, the Company issued 60,000 shares of common stock to convert $15,000 of an outstanding loan made to the Company by the wife of Edward Masry. The shares issued are valued at the current market price at the date of issuance of $91,800 resulting in additional charge to expense of $76,800, which was reflected as consulting expense in the financial statements for the nine months ended September 30, 2004.
5. Convertible debentures and warrants
On September 23, 2005, the Company completed a private offering of an of its 9% Convertible Notes due July 31, 2006 (the “Notes”) and Warrants to purchase shares of the Company’s common stock which expire August 31, 2007 (the “Warrants”). The Notes are convertible at $0.70 per share of common stock and the Warrants entitle 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 Note is convertible. The Warrants are exercisable at a price of $1.00 per share.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
5. Convertible debentures and warrants — continued
During the quarter ended September 30, 2005, the Company issued Notes totaling $904,720 and paid related transaction fees of $46,280, resulting in net proceeds to the Company of $858,440. In addition to the cash paid for transaction fees, 43,268 additional Warrants were issued to certain placement agents. These Warrants expire August 31, 2010 and are exercisable at a price of $1.00 per share.
The aggregate value of the Warrants issued in connection with the offering and to the finder were valued at $427,703 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 4.02%; dividend yield of 0%; volatility factors of the expected market price of common stock of 83.59%; and an expected life of two to five years. The company also determined that the notes contained a beneficial conversion feature of $430,737.
The value of the Warrants of $427,703, the conversion option of $430,737, and the transaction fees of $46,280 are considered as debt discount and are being amortized over the life of the Notes. $22,066 of such discount has been amortized and included in the accompanying statement of operations for the three and nine months ended September 30, 2005. The remaining unamortized debt discount of $882,654 has been netted against the $904,720 Convertible Debentures on the accompanying September 30, 2005 balance sheet.
Subsequent to September 30, 2005, the Company issued an additional $96,658 of these Notes.
6. Capital stock
     Sale of equity securities
During the nine months ended September 30, 2005, the Company sold 1,451,000 units of common stock, of which 1,400,500 units consist of one share of common stock and one warrant to acquire a share of common stock at an exercise price of $1.50 per share, for net proceeds of $1,342,860. The 1,400,500 warrants were issued to investors as part of an equity agreement and were not ascribed any value in the accompanying financial statements.
In addition, the Company sold 80,000 units of common stock, of which 80,000 consist of one share of common stock and one warrant to acquire a share of common stock at an exercise price of $1.50 per share, for net proceeds of $73,600. The 80,000 warrants were issued to investors as part of an equity agreement and were not ascribed any value in the accompanying financial statements. As of September 30, 2005 the shares were not issued but the funds were received, and have been reflected as common stock issuable.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
6. Capital stock — continued
     Sale of equity securities — continued
During the nine months ended September 30, 2005, the Company issued 119,000 shares (of which 50,000 relates to the exercise of warrants) of common stock for which payment was previously received.
     Warrants
During the nine months ended September 30, 2005, the Company issued 10,000 warrants to an individual for settlement of a claim. The Company also issued 25,000 warrants to an individual in exchange for consulting services rendered. The warrants were valued at an aggregate amount of $18,462 using the Black Scholes pricing model and have been reflected in the accompanying statement of operations for the three and nine months ended September 30, 2005.
     Intrinsic value of employee options
During the years ended December 31, 2004 and prior, certain employee options were granted with exercise prices less the than fair market value of the Company’s stock at the date of grant. As the grants were to employees, the intrinsic value method, as allowed under APB No. 25, was used to calculate the related compensation expense. For the nine months ended September 30, 2005, the Company granted 2,085,909 options to certain employees, exercisable at amounts ranging from $0.85 to $1.10, vested over one year with a ten-year life, and $116,693 and $789,636 of deferred compensation costs were amortized and recognized as expense in the nine months ended September 30, 2005 and 2004 respectively.
7. Research and development
The Company has established a research and development facility in Queensland, Australia. The Company has expanded research and development to include applications of the ZEFS and CAT-MATE technology to diesel engines, motorbikes, boats, generators, lawnmowers and other small engines. The Company has also purchased test vehicles, test engines and testing equipment. The Company completed testing on ZEFS and CAT-MATE devices for multiple automobiles, trucks, motorcycles, off-road vehicles and stationary engines, the results of which have been provided to RAND Corporation (RAND) for evaluation. During 2004, RAND expanded its role with the Company and now oversees the Company’s research and development facility in Australia. The Company also uses third party research and development facilities in Los Angeles and San Jose, California for the development of our ZEFS and CAT-MATE devices. For the nine months ended September 30, 2005 and 2004, the Company has spent $1,066,068 and $1,565,177, respectively, on research and development.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
8. 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 $3,051,230 and a negative cash flow from operations of $2,182,036 for the nine months ended September 30, 2005, and had a working capital deficiency of $1,652,579 and a stockholders’ deficiency of $2,611,419 at September 30, 2005. 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 financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
9. Commitments and contingencies
     Legal matters
On December 19, 2001, the SEC filed civil charges in the United States Federal District Court, Southern District of New York, against its 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 for 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. The SEC’s charges of fraud and stock manipulation continue against Mr. Muller and others.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
9. Commitments and contingencies — continued
     Legal matters — continued
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 filings 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’s stock; and entered into various undisclosed arrangements regarding the control, voting and disposition of their stock. The Company contends that it is entitled to a judgment canceling all of the approximately 8,716,710 shares of the Company’s common stock that were previously obtained and controlled, directly or indirectly, by Mr. Muller; divesting and preventing any subsequent holders of the right to exercise options previously held by Mr. Muller for 10,000,000 shares of the Company’s common stock, conversion of an existing preliminary injunction to a permanent injunction to prevent Mr. Muller from any involvement with the Company and a monetary judgment against Mr. Muller and others in the amount of several million dollars.
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 own or control, or from taking any action to injure the business and from having any direct contact with the Company’s shareholders. The injunctive order also prevents Mr. Muller from engaging in any effort to exercise control over the Company and from serving as an officer or director of the Company. The Company believes that it has valid claims; however, there can be no assurance that an adverse result or settlement would not have a material adverse effect on the Company’s financial position or cash flow.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
9. Commitments and contingencies — continued
     Legal matters — continued
In the course of the litigation, the Company has obtained ownership control over Mr. Muller’s claimed patent rights to the ZEFS device. Under a Buy-Sell Agreement between Mr. Muller and the Company dated December 29, 1998, Mr. Muller, who was listed on the ZEFS devise patent application as the inventor of the ZEFS device, purported to grant us all international marketing, manufacturing and distribution rights to the ZEFS device. Those rights were disputed because an original inventor of the ZEFS device contested Mr. Muller’s legal ability to have conveyed those rights.
In Australia, Mr. Muller entered into a bankruptcy action seeking to overcome the Company’s claims for ownership of the ZEFS device. In conjunction with these litigation proceedings, a settlement agreement was reached whereby the $10 per unit royalty previously due to Mr. Muller under his contested Buy-Sell Agreement was terminated and replaced with a $.20 per unit royalty payable to the bankruptcy trustee. On November 7, 2002, under a settlement agreement executed with the Mr. Muller’s bankruptcy trustee, the trustee transferred to the Company all ownership and legal rights to this international patent application for the ZEFS device.
Both the SEC and the Company have filed Motions for Summary Judgment contending that there are no material issues of fact in contention and as a matter of law, the Court should grant a judgment against Mr. Muller and the cross-defendants. Mr. Muller has filed a response contending the motions are without merit or substance. A final decision on these motions, which potentially would terminate the ongoing litigation, is still pending. Should the Court not grant summary judgment in favor of the Company, the case will be scheduled for final disposition in a trial.
Mr. Muller and several of the defendants filed a Motion to Dismiss the complaint filed by the Company and moved for summary judgment in their favor. On December 21, 2004, Judge George B. Daniels denied the cross-defendants’ motion to dismiss the Company’s cross-complaint, denied the request to vacate the July 2, 2002 preliminary injunction and denied the request for damages against the Company. The court also refused to grant a summary judgment in favor of the cross-defendants and dismissed Mr. Muller’s claims against the Company for indemnification for his legal costs and for damages resulting from the litigation. Neither Mr. Muller nor any of the cross-defendants have filed any cross-claims against the Company and the Company is not exposed to any liability as a result of the litigation, except for possibly incurring legal fees and expenses should the Company lose the litigation.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
9. Commitments and contingencies — continued
     Legal matters — continued
Although the outcome of this litigation cannot be predicted with any degree of certainty, the Company is optimistic that the Court’s ruling will either significantly narrow the issues for any later trial or will result in a final disposition of the case in a manner favorable to the Company. The Company believes that they have valid claims; however, 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.
In April 2005, Jeffrey A. Muller, the Company’s former sole director and executive officer, filed a lawsuit 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.
The Company was named as a defendant in a complaint filed before the Los Angeles Superior Court, Civ. No. BC 312401, by Terracourt Pty Ltd, an Australian corporation (“Terracourt”), claiming breach of contract and related remedies from promises allegedly made by the former president of the Company in 1999. Terracourt sought specific performance of the former president’s alleged promises to transfer to Terracourt an aggregate 480,000 shares of the Company’s common stock for office consultant and multimedia services. The complaint was filed on March 18, 2004. Terracourt also filed a Statement of Damages seeking costs of the lawsuit and general damages of $2 million. The case proceeded to trial in the Los Angeles Superior Court in May, 2005. In June, 2005, the Judge issued a statement of decision which denied Terracourt’s claims for 450,000 shares of stock, monetary damages, and costs of the lawsuit. The Court also ruled that Terracourt was entitled to receive an option exercisable for 30,000 shares of the Company’s common stock, exercisable at $.001 per share (par value). Both parties filed motions for a new trial on the issue of the opinion. Subsequently, the parties settled the lawsuit for a payment by the Company to Terracourt of $2,500 and asked the court to vacate the judgment and dismiss the lawsuit with prejudice, which action the court took on September 30, 2005.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
9. Commitments and contingencies — continued
     Legal matters — continued
This recent lawsuit brought by Mr. Muller arises out of the same claims that are the subject of ongoing litigation in the Federal District Court for the Southern District of New York, in which the Company has previously obtained a preliminary injunction against Mr. Muller barring him from any involvement with the Company and preventing Mr. Muller, his agents or assigns, from exercising any claimed rights to the Company’s assets or stock. Mr. Muller previously filed the same complaint in the Federal District Court for the Southern District of New York, which claim is pending dismissal. On December 28, 2004, Federal District Court Judge George B. Daniels issued a decision dismissing motions filed by Mr. Muller against the Company’s cross-claims. The dismissal of those motions involved similar causes of action as those contained in Mr. Muller’s recent lawsuit commenced in the Federal District Court for the Central District of California. Since the case in New York is still pending, the filing of the new lawsuit in California is subject to various defenses which should result in the dismissal of the new lawsuit.
The Company intends to vigorously defend against any bifurcation of the lawsuit that is ongoing in New York and will move to dismiss and/or to transfer the recently filed complaint to Judge Daniels in New York for any eventual decision. While the Company believes that it has valid claims, 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 financial position or cash flow of the Company.
     Employment agreements
In July 2005, the Company entered into an employment agreement with an individual to serve as a Vice President of Operations for the Company. The agreement expires December 31, 2005, with an automatic one-year extension and provides for annual base compensation of not less than $120,000 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.

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SAVE THE WORLD AIR, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued
NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)
10. Restatement
During the year ended December 31, 2004, the Company discovered an error in the previously reported September 30, 2004 financial statements related to the valuation of shares issued for services and options granted to employees and non-employees. These financial statements reflect the correction of the error in the September 30, 2004 amounts. The correction of this error resulted in an increase in net loss of $931,742, an increase in additional paid in capital of $977,070 and an increase in deferred compensation of $47,210.
The effect of this restatement on the September 30, 2004 financial statement is as follows:
                                 
    As previously             As previously        
    reported             reported        
    Three months ending             Nine months ending        
    Sept. 30, 2004     Restated     Sept. 30, 2004     Restated  
Net loss
  $ 2,661,971     $ 2,633,114     $ 4,602,129     $ 5,533,871  
Paid in capital
  $ 13,270,211     $ 14,247,281     $ 13,270,211     $ 14,247,281  
Loss per share
  $ 0.07     $ 0.07     $ 0.13     $ 0.16  

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Item 2. Management’s Discussion and Analysis or Plan of Operations
     This Quarterly Report on Form 10-QSB contains forward-looking statements. These forward-looking statements include predictions regarding our future:
    revenues and profits;
 
    customers;
 
    research and development expenses and efforts;
 
    scientific test results;
 
    sales and marketing expenses and efforts;
 
    liquidity and sufficiency of existing cash;
 
    pending and future financings;
 
    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 elsewhere in this Report and under the heading “Risk Factors” in our Annual Report on Form 10-KSB for the year ended December 31, 2004. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements.
Overview
     The following discussion and analysis of our 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, 2004.
     We are a development stage company that has not yet generated revenues. The company’s primary historical focus has been on research and development 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. We are currently in a transitional phase from research and development to initial marketing and early sales of our devices.
     Our devices are called “ZEFS” and “CAT-MATE.” Previously, we devoted the bulk of our efforts to the completion of the design, the development of our production models and initial efforts for the promotion of our products in the marketplace worldwide. Expenses have been funded primarily through the sale of company stock and debt. We have taken actions to secure our intellectual property rights to the ZEFS and CAT-MATE devices.
     During the third quarter of 2005, we established a product development and testing center in Morgan Hill, California, which we currently expect will be fully operational by December 2005. We are continuing our marketing efforts to international governmental entities in cooperation with the United Nations Environmental Programme (UNEP) and various original equipment manufacturers (OEMs), to eventually sell or license our ZEFS and CAT-MATE products and technology. We anticipate that these efforts will continue during the remainder of 2005. We sold our first devices early in the fourth quarter of 2005 and we

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will begin to generate revenue late in the fourth quarter of 2005 or early in 2006. We will need to raise additional capital in 2006, and possibly beyond, to fund our operational and other expenses until our revenue base grows sufficiently.
Results of Operations
     To date, we have not generated any revenues and our business continues in the development stage. We have focused our efforts on verifying and developing our technologies and devices and commencing marketing efforts for their license or sale. We began selling our devices after the end of the three-month period ended September 30, 2005, and we expect to begin generating revenue in late 2005 or early 2006.
     General and administrative expenses were $759,087 for the three-month period ended September 30, 2005, compared to $864,653 for the three-month period ended September 30, 2004 (as restated), a decrease of $105,566. This decrease is primarily attributable to a decrease in non-cash amortization of deferred compensation and corporate expenses, partially offset by increases in payroll expenses, professional fees, consulting fees, interest, office and computer expenses.
     General and administrative expenses were $1,983,186 for the nine-month period ended September 30, 2005, compared to $2,362,205 for the nine-month period ended September 30, 2004 (as restated), a decrease of $379,019. This decrease is primarily attributable to a decrease in non-cash amortization of deferred compensation, partially offset by increases in payroll expenses, professional fees, consulting fees, travel expense, office expense, corporate, interest and advertising expenses.
     Research and development expenses were $452,571 for the three-month period ended September 30, 2005, compared to $162,458 for the three-month period ended September 30, 2004 (as restated), an increase of $290,113. This increase is primarily attributable to an increase in research by RAND Corporation (“RAND”), product research, testing, product development and prototype expenses.
     Research and development expenses were $1,066,068 for the nine-month period ended September 30, 2005, compared to $1,565,177 for the nine-month period ended September 30, 2004 (as restated), a decrease of $499,109. This decrease is primarily attributable to a decrease in non-cash research, partially offset by increases in research by RAND, product research, testing, product development and prototype expenses.
     We expect our operating costs to increase during the balance of fiscal year 2005, primarily as a result of anticipated increases in research and development expenses, general and administrative expenses, and marketing expenses, as we continue production and sales activities during late 2005.
     We had a net loss of $1,211,658 or $.03 per share for the three-month period ended September 30, 2005, compared to a net loss of $2,633,114 or $.07 per share for the three-month period ended September 30, 2004 (as restated). We had a net loss of $3,051,230 or $.08 per share for the nine-month period ended September 30, 2005, compared to a net loss of $5.533,871 or $.16 per share for the nine-month period ended September 30, 2004 (as restated). We have relied upon our 2004 Stock Option Plan to compensate consultants and employees who have assisted in developing and executing our business plan. This reliance, together with issuances of stock by us in connection with private offerings of our securities, has significantly narrowed the loss per share by increasing the amount of the Company’s outstanding common stock. See “Liquidity and Capital Resources” below. We expect to incur additional net loss in the fiscal year ending December 31, 2005, primarily attributable to continued general and administrative expenses and marketing-related expenditures without the benefit of any revenue for the remainder of the year.

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Liquidity and Capital Resources
     We have incurred negative cash flow from operations in the development stage since our inception in 1998. As of September 30, 2005, we had cash of $429,754 and an accumulated deficit of $20,182,118. Our negative operating cash flow since inception has been funded primarily through the sale of common stock, issuance of convertible notes, and, to a lesser degree, by proceeds we received from the exercise of options and warrants.
     The financial statements accompanying this report have been prepared on a going concern basis, which contemplates the realization of assets and settlement of liabilities and commitments in the normal course of our business. As reflected in the accompanying financial statements, we had a net loss of $3,051,230 and a negative cash flow from operations of $2,182,036 for the nine-month period ended September 30, 2005 and had a working capital deficiency of $1,652,579 and a stockholders’ deficiency of $2,611,419 as of September 30, 2005. These factors raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to raise additional funds and implement our business plan. The financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.
     From July 24, 2004 through July 22, 2005, we engaged in a private offering (the “Stock Offering”) of units comprised of shares of our common stock and one-year warrants to purchase an equal number of shares of common stock at an exercise price of $1.50 per share. The Stock Offering terminated on July 22, 2005. From July 1, 2005 through July 22, 2005, we received aggregate gross proceeds of $199,500 and aggregate net proceeds of $183,540 in connection with the sale of 199,500 shares of our common stock to nine purchasers. The total amount raised during the Stock Offering was $2,872,000 gross proceeds and $2,659,044 net proceeds. See Notes 5 and 10 to Notes to Financial Statements and Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds”.
     As disclosed in our Current Report on Form 8-K, filed with the Securities and Exchange Commission on July 28, 2005, on July 25, 2005 we extended the expiration date of each of the warrants issued in the Stock Offering by 180 days from its original expiration date. No additional consideration was paid by the purchasers of the units for such extension.
     Between August 1, and September 23, 2005, we conducted a new offering (the “Interim Offering”) of our 9% convertible notes due July 31, 2006 and warrants. The notes are convertible into shares of our common stock at an initial conversion price of $.70 per share, anytime prior to maturity at the election of the noteholder and may be converted at our election under certain circumstances. The warrants are convertible, at $1.00 per share, for 150% of the number of shares into which the notes are convertible and may be exercised until August 31, 2007. The Interim Offering was made to the purchasers of the units in the Stock Offering and a limited number of individuals who are not “U.S. persons” as that term is defined in Rule 902 of Regulation S promulgated under the Securities Act of 1933, as amended. The total amount subscribed for in the Interim Financing was $1,501,378 gross proceeds ($1,428,432 net proceeds). Of this amount, $904,720 gross proceeds ($858,440 net proceeds) was received by the Company during the three-month period ended September 30, 2005, and the balance of $596,658 gross proceeds ($569,992 net proceeds) is expected to be received by the Company during the fourth quarter of 2005.
     We are relying on the proceeds of the Stock Offering and the Interim Offering to provide additional working capital for our needs for the next several months. We believe that we have sufficient cash to fund our operations through the remainder of 2005.
     We have also retained the services of an exclusive placement agent to work with us from September 1, 2005, to provide additional capital that we need to continue to execute on our business plan. In this regard, on October 10, 2005, we commenced an offering (the “Bridge Financing”) of our 9% subordinated convertible promissory notes and warrants. The Bridge Financing is being made exclusively through our placement agent. The Bridge Financing is ongoing and, as of the date of the filing of this Report, no sales have been consummated under the Bridge Financing.
     We believe that exercises of in-the-money options and warrants, with various expiration dates through 2007, may also provide some of the proceeds needed to meet our capital requirements, together with sales of our securities in connection with the efforts of our placement agent in the Bridge Financing and other financings we may undertake. However, there can be no assurance that

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additional equity or debt financing will be available or available on terms favorable to us. If we are unable to obtain additional capital, we may be required to delay, reduce the scope of, or eliminate, our research and development programs, reduce any marketing activities or relinquish rights to technologies that we might otherwise seek to develop or commercialize.
Critical Accounting Policies and Estimates
     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:
     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 to Notes to Financial Statements. See Item 7, “Financial Statements”. Actual results could differ from those estimates.
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.
New Accounting Pronouncements
     In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 151, “Inventory Costs”. This Statement amends the guidance in APB No. 43 Chapter 4 Inventory Pricing, to require items such as idle facility costs, excessive spoilage, double freight and rehandling costs to be expensed in the current period, regardless if they are abnormal amounts or not. This Statement will become effective for us in the first quarter of 2006. The adoption of SFAS No. 151 is not expected to have a material impact on our financial condition, results of operations, or cash flows.
     In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which revises SFAS No. 123. SFAS 123R also supersedes APB No. 25 and amends SFAS No. 95, “Statement of Cash Flows”. In general, the accounting required by SFAS 123R is similar to that of SFAS

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No. 123. However, SFAS No. 123 gave companies a choice to either recognize the fair value of stock options in their income statements or disclose the pro forma income statement effect of the fair value of stock options in the notes to the financial statements. SFAS 123R eliminates that choice and requires the fair value of all share-based payments to employees, including the fair value of grants of employee stock options, be recognized in the income statement, generally over the option vesting period. SFAS 123R must be adopted no later than July 1, 2005 (December 15, 2005 for small business filers). Early adoption is permitted.
     The Company is currently evaluating the timing and manner in which it will adopt SFAS 123R. As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using APB 25’s intrinsic value method. Accordingly, adoption of SFAS 123R’s fair value method will have an effect on results of operations, although it will have no impact on overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had SFAS 123R been adopted in prior periods, the effect would have approximated the SFAS 123 pro forma net loss and loss per share disclosures as shown above. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required, thereby reducing net operating cash flows and increasing net financing cash flows in periods after adoption.
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 Quaterly 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 inadequate 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. We are developing a plan to ensure that all information will be recorded, processed, summarized and reported on a timely basis. This plan is dependent, in part, upon reallocation of responsibilities among various personnel, possibly hiring additional personnel and additional funding. It should also 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 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. The SEC’s charges of fraud and stock manipulation continue against Mr. Muller and others.

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     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. We contend that we are entitled to a judgment canceling all of the approximately 8,716,710 shares of our common stock that was previously obtained and controlled, directly or indirectly, by Mr. Muller; divesting and preventing any subsequent holders of the right to exercise options previously held by Mr. Muller for 10,000,000 shares of our common stock, conversion of an existing preliminary injunction to a permanent injunction to prevent Mr. Muller from any involvement with the Company and a monetary judgment against Mr. Muller and others in the amount of several million dollars.
     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 own or control, or from taking any action to injure us or our business and from having any direct contact with our shareholders. The injunctive order also prevents Mr. Muller from engaging in any effort to exercise control over our corporation and from 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 ownership control over Mr. Muller’s claimed patent rights to the ZEFS device. Under a Buy-Sell Agreement between Mr. Muller and dated December 29, 1998, Mr. Muller, who was listed on the ZEFS devise patent application as the inventor of the ZEFS device, purported to grant us all international marketing, manufacturing and distribution rights to the ZEFS device. Those rights were disputed because an original inventor of the ZEFS device contested Mr. Muller’s legal ability to have conveyed those rights.
     In Australia, Mr. Muller entered into a bankruptcy action seeking to overcome our claims for ownership of the ZEFS device. In conjunction with these litigation proceedings, a settlement agreement was reached with the bankruptcy trustee whereby the $10 per unit royalty previously due to Mr. Muller under his contested Buy-Sell Agreement was terminated and replaced with a $.20 per unit royalty payable to the bankruptcy trustee. On November 7, 2002, under a settlement agreement executed with Mr. Muller’s bankruptcy trustee, the trustee transferred to us all ownership and legal rights to this international patent application for the ZEFS device.
     Both the SEC and we have filed Motions for Summary Judgment contending that there are no material issues of fact in contention and as a matter of law, the Court should grant a judgment against Mr. Muller and the cross-defendants. Mr. Muller has filed a response contending the motions are without merit or substance. A final decision on these motions, which potentially would terminate the ongoing litigation, is still pending. Should the Court not grant summary judgment in our favor, the case will be scheduled for final disposition in a trial.
     Mr. Muller and several of the defendants filed a Motion to Dismiss the complaint filed by us and moved for summary judgment in their favor. On December 28, 2004, Judge George B. Daniels, denied the cross-defendants’ motion to dismiss our cross-complaint, denied the defendants’ request to vacate the July 2, 2002 preliminary injunction and denied their request for damages against us. The court also refused to grant a summary judgment in favor of the cross-defendants and dismissed Mr. Muller’s claims against us for indemnification for his legal costs and for damages resulting from the litigation. Neither Mr. Muller nor any of the cross-defendants have filed any cross-claims against us and we are not exposed to any liability as a result of the litigation, except for possibly incurring legal fees and expenses should we lose the litigation.
     Although the outcome of this litigation 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

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in a final disposition of the case in a manner favorable to us. While we believe that we have valid claims, 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.
     In April 2005, Jeffrey A. Muller, the Company’s former sole director and executive officer, filed a lawsuit 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 recent lawsuit brought by Mr. Muller arises out of the same claims that are the subject of ongoing litigation in the Federal District Court for the Southern District of New York, in which we have previously obtained a preliminary injunction against Mr. Muller barring him from any involvement with the Company and preventing Mr. Muller, his agents or assigns, from exercising any claimed rights to our assets or stock. Mr. Muller previously filed the same complaint in the Federal District Court for the Southern District of New York, which claim is still pending. On December 28, 2004, Federal District Court Judge George B. Daniels issued a decision dismissing motions filed by Mr. Muller against our cross-claims. The dismissal of those motions involved similar causes of action as those contained in Mr. Muller’s recent lawsuit commenced in the Federal District Court for the Central District of California. Since the case in New York is still pending, we believe that the filing of the new lawsuit in California is subject to various defenses which should result in the dismissal of the new lawsuit.
     We have filed a Motion to Dismiss this new complaint or alternatively, to transfer this action to the Federal District Court in New York for disposition by the same Federal District Judge handling the New York litigation. 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.
     We were named as a defendant in a complaint filed before the Los Angeles Superior Court, Civ. No. BC 312401, by Terracourt Pty Ltd, an Australian corporation (“Terracourt”), claiming breach of contract and related remedies from promises allegedly made by the former president of the Company in 1999. Terracourt sought specific performance of the former president’s (Jeffrey Muller) alleged promises to transfer to Terracourt an aggregate 480,000 shares of our common stock for office consultant and multimedia services. The complaint was filed on March 18, 2004. Terracourt also filed a Statement of Damages seeking costs of the lawsuit and general damages of $2 million. The case proceeded to trial in the Los Angeles Superior Court in May, 2005. In June, 2005, the judge issued a decision which denied Terracourt’s claims for 450,000 shares of stock, monetary damages and costs of the lawsuit. The Court also ruled that Terracourt was entitled to receive an option exercisable for 30,000 shares of the Company’s common stock, exercisable at $.001 per share (par value). Both parties filed motions for a new trial on the issue of the option. Subsequently, the parties settled the lawsuit for a payment by the Company to Terracourt of $2,500 and asked the court to vacate the judgment and dismiss the lawsuit with prejudice, which action the court took on September 30, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
     During the three-month period ended September 30, 2005, the Company sold an aggregate 199,500 shares of common stock and warrants to purchase 199,500 additional shares of common stock at $1.00 per share, to certain investors in connection with the Company’s Stock Offering. Gross proceeds to the Company in connection with these issuances were $199,500 and net proceeds were $183,540.
     Between August 1, and September 23, 2005, we conducted the Interim Offering of our 9% convertible notes due July 31, 2006 and warrants. The notes are convertible into shares of our common stock at an initial conversion price of $.70 per share, anytime prior to maturity at the election of the noteholder and may be converted at our election under certain circumstances. The warrants are convertible, at $1.00 per share, for 150% of the number of shares into which the notes are convertible and may be exercised until August 31, 2007. The Interim Offering was made to the purchasers of the units in the Stock Offering and a limited number of individuals who are not “U.S. persons” as that term is defined in Rule 902 of Regulation S promulgated under the Securities Act of 1933, as amended. The total amount subscribed

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for in the Interim Financing was $1,501,378 gross proceeds ($1,428,432 net proceeds). Of this amount, $904,720 gross proceeds ($858,440 net proceeds) was received by the Company during the three-month period ended September 30, 2005, and the balance of $596,658 gross proceeds ($569,992 net proceeds) is expected to be received by the Company during the fourth quarter of 2005. Of the total number of warrants issued by the Company, warrants exercisable for 53,627 shares of the Company’s common stock were issued to the Company’s placement agent. If all of the warrants issued in the Interim Offering were exercised by all the warrant holders, the Company would be obligated to issue an additional 3,270,859 shares of its common stock to such persons.
     The issuances of shares, convertible notes and warrants described above were made in reliance on the exemptions from registration set forth in Section 4(2) of the Securities Act of 1933, as amended, or Regulations D or S promulgated thereunder.
Item 3. Defaults Upon Senior Securities
     None
Item 4. Submission of Matters to a Vote of Security Holders
     None
Item 5. Other Information
     None
Item 6. Exhibits
     
Exhibit No.   Description
10.1
  Employment Agreement dated July 1, 2005 between the Company and John R. Bautista.
 
   
10.2
  Lease dated August 15, 2005 between the Company and Thomas L. Jackson.
 
   
10.3
  Form of the Company’s 9% convertible note issued in the Interim Financing.
 
   
10.4
  Form of the Company’s stock purchase warrant issued in the Interim Financing.
 
   
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
 
   
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  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)

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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.
         
Date: November 11, 2005  SAVE THE WORLD AIR, INC.
 
 
  By:   /s/ EUGENE E. EICHLER    
    Eugene E. Eichler   
    Chief Executive Officer   

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EXHIBIT INDEX
     
Exhibit No.   Description
10.1
  Employment Agreement dated July 1, 2005 between the Company and John R. Bautista.
 
   
10.2
  Lease dated August 15, 2005 between the Company and Thomas L. Jackson.
 
   
10.3
  Form of 9% convertible note issued in the Company’s Interim Financing.
 
   
10.4
  Form of stock purchase warrant issued in the Company’s Interim Financing.
 
   
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
 
   
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  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)

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