Form: 10-Q

Quarterly report pursuant to sections 13 or 15(d)

November 16, 2009


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

FORM 10-Q
 
x
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2009
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
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
235 Tennant Avenue
Morgan Hill, California 95037
(Address, including zip code, of principal executive offices
(408) 778-0101
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Exchange Act: None.
 
Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, $0.001 par value.
 
Check whether the Registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x   No 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  o    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer  o
 
Non-accelerated filer  o  (Do not check if a smaller reporting company)
Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  x
 
The number of shares of the Registrant’s Common Stock outstanding as of  November 12, 2009 was 69,627,597 shares.
 
 
1

 
SAVE THE WORLD AIR, INC.
FORM 10-Q
 INDEX
 
       
  Page  
PART I
3    
       
ITEM 1. Financial Statements
3    
Condensed consolidated balance sheets (unaudited)
3    
Condensed consolidated statements of operations (unaudited)
4    
Condensed consolidated statement of changes in stockholders’ deficiency (unaudited)
5    
Condensed consolidated statements of cash flows (unaudited)
14    
Notes to condensed consolidated financial statements (unaudited)
16    
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
29    
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk
38    
ITEM 4. Controls and Procedures
38    
       
PART II
40    
       
ITEM 1. Legal Proceedings
40    
ITEM 1A. Risk Factors
41    
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
41    
ITEM 3. Defaults Upon Senior Securities
42    
ITEM 4. Submission of Matters to a Vote of Security Holders
42    
ITEM 5. Other Information
43    
ITEM 6. Exhibits
43    
       
SIGNATURES
44    
       
EXHIBIT INDEX
45    
       
EXHIBIT 31.1
     
EXHIBIT 31.2
     
EXHIBIT 32
     
 
 
2

 
PART I
Item 1. Financial Statements
SAVE THE WORLD AIR, INC. AND SUBSIDIARY
 (A DEVELOPMENT STAGE ENTERPRISE)

 CONDENSED CONSOLIDATED BALANCE SHEETS
   
   
September 30, 2009
(unaudited)
   
December 31,
2008
 
                 
ASSETS
               
                 
Current assets
               
Cash
 
$
8,378
   
$
59,346
 
Other current assets
   
13,195
     
33,275
 
Total current assets
   
21,573
     
92,621
 
Property and Equipment, net of accumulated depreciation and amortization of $136,149 and $111,193, respectively
   
107,013
     
131,969
 
Other assets
   
11,020
     
11,250
 
Total assets
 
$
139,606
   
$
235,840
 
                 
LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
               
Current liabilities
               
Accounts payable-related parties
 
$
170,750
   
$
93,003
 
Accounts payable-License Agreements
   
852,750
     
716,500
 
Accounts payable-other
   
497,269
     
384,467
 
Accrued expenses
   
1,126,119
     
803,795
 
Accrued professional fees
   
455,999
     
390,535
 
Loans payable-related parties and shareholders
   
102,628
     
78,280
 
Convertible debentures, net-related parties
   
56,832
     
12,466
 
Convertible debentures, net-others
   
898,545
     
290,659
 
Total current liabilities
 
4,160,892
     
2,769,705
 
                 
Commitments and contingencies
               
                 
Stockholders’ deficiency
               
Common stock, $.001 par value: 200,000,000 shares authorized, 65,959,620 and 62,940,891 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively
   
65,960
     
62,941
 
Common stock to be issued (97,059 shares at December 31, 2008)
   
-
     
16,500
 
Additional paid-in capital
   
41,938,994
     
40,129,758
 
Deficit accumulated during the development stage
   
(46,026,240)
     
(42,743,064
)
Total stockholders’ deficiency
   
(4,021,286)
     
(2,533,865
)
Total liabilities and stockholders’ deficiency
 
$
139,606
   
$
235,840
 

 
See notes to condensed consolidated financial statements.


3

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

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)


   
Three months ended
September 30,
   
Nine months ended
September 30,
   
For the Period From February 18, 1998 (Date of Inception) through
 
   
2009
   
2008
   
2009
   
2008
   
September 30, 2009
 
                               
Net sales
 
$
-
   
$
-
   
$
-
   
$
-
   
$
69,000
 
Cost of goods sold
   
-
     
-
     
-
     
-
     
24,120
 
Gross profit
   
-
     
-
     
-
     
-
     
44,880
 
                                         
Operating expenses
   
488,281
     
1,148,887
     
1,923,703
     
2,428,889
     
31,850,643
 
                                         
Research and development expenses
   
12,517
     
109,822
     
274,577
     
432,184
     
5,733,170
 
                                         
Non-cash patent settlement costs
     
-
   
                 -
       
-
   
-
     
1,610,066
 
                                         
Loss before other income (expense)
   
(500,798)
     
(1,258,709)
     
(2,198,280)
     
(2,861,073)
     
(39,148,999
)
                                         
Other income (expense)
                                       
Other income (expense)
   
-
     
(30)
     
-
     
          533
     
   (1,140
Interest income
   
-
     
-
     
-
     
              2
     
16,342
 
Interest expense
   
(250,616)
 
   
(220,400
)
   
(1,084,896)
     
(708,959)
     
(7,039,202
)
Loss on sale of equipment
   
-
     
-
             
       (9,683)
     
(14,426
)
Settlement of debt due Morale/Matthews
     
-
     
-
     
-
   
   (927,903)
     
(927,903
)
Settlement of litigation and debt
   
-
     
-
     
-
     
     52,070
     
1,089,088
 
                                         
Net loss
 
$
(751,414)
 
 
$
(1,4,79,139)
   
$
(3,283,176)
   
$
(4,455,013)
   
$
(46,026,240
)
                                         
Net loss per share, basic and diluted
 
$
(0.01)
 
 
$
(0.03)
   
$
(0.05)
   
$
(0.10)
         
                                         
Weighted average shares outstanding, basic and diluted
   
65,653,349
     
47,312,880
     
64,891,529
     
45,374,117
         

See notes to condensed consolidated financial statements.

 
4

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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
   
Price per
   
Common Stock
   
Common
Stock
to be
   
Additional
Paid-in
   
Deferred
   
Deficit
Accumulated
During the
Development
 
Total
Stockholders
 
   
Share
   
Shares
   
Amount
   
Issued
   
Capital
   
Compensation
   
Stage
 
Deficiency
 
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
)
 
 
(continued)
5


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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
 
Price per
 
Common Stock
 
Common
Stock
to be
 
Additional
Paid-in
 
Deferred
 
Deficit
Accumulated
During the
Development
 
Total
Stockholders
 
 
Share
 
Shares
   
Amount
 
Issued
 
Capital
 
Compensation
 
Stage
 
Deficiency
 
Balance, December 31, 1999
     
15,297,125
   
$
15,297
 
$
 
$
580,452
 
$
 
$
(1,096,571
$
(500,822
Issuance of common stock for services
$0.38 - $5.31
   
305,810
     
306
   
   
588,704
   
   
   
589,010
 
Stock issued for employee compensation on February 8, 2000
$1.03-$5.31
   
42,000
     
42
   
   
137,378
   
   
   
137,420
 
Stock issued for directors fees
$3.38-$4.44
   
56,000
     
56
   
   
195,584
   
   
   
195,640
 
Common stock 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
Issuance of common stock for services
$0.25-$1.65
   
1,339,912
     
1,340
   
   
1,031,231
   
   
   
1,032,571
 
Stock issued for directors fees
$0.60-$0.95
   
1,100,000
     
1,100
         
1,008,900
               
1,010,000
 
Intrinsic value of options issued to employees
                         
2,600,000
   
(2,600,000)
         
 
Fair value of options issued to non-employees
                         
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
 
 
(continued)
6


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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
   
Price per
   
Common Stock
 
Common
Stock
to be
   
Additional
Paid-in
   
Deferred
   
Deficit
Accumulated
During the
Development
   
Total
Stockholders
 
   
Share
   
Shares
   
Amount
 
Issued
   
Capital
   
Compensation
   
Stage
   
Deficiency
 
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 fees
   
0.40
     
2,150,000
     
2,150
   
     
857,850
     
     
     
860,000
 
Common stock sold (2,305,000 
shares)
   
0.15-0.25
     
     
   
389,875
     
     
     
     
389,875
 
Fair value of options issued to non-employees for services
           
     
   
     
54,909
     
(54,909
)
   
     
 
Amortization of deferred compensation
           
     
   
     
     
891,182
     
     
891,182
 
Net loss
           
     
   
     
     
     
(2,749,199
)
   
(2,749,199
)
Balance, December 31, 2002
           
20,235,847
     
20,236
   
389,875
     
7,133,081
     
(1,572,060)
     
(7,851,545
)
   
(1,880,413
)
Common stock issued previously paid for
   
0.15-0.25
     
2,305,000
     
2,305
   
(433,750
)
   
431,445
     
     
     
 
Sale of common stock
  $
0.25
     
9,504,000
     
9,504
           
2,366,439
     
     
     
2,375,943
 
Issuance of common stock for services
  $
0.55
     
83,414
     
83
   
     
45,794
     
     
     
45,877
 
Common stock issued for convertible debt
  $
0.25
     
2,000,000
     
2,000
           
498,000
     
     
     
500,000
 
Finders’ fees related to stock issuances
           
     
   
43,875
     
(312,582
)
   
     
     
(268,707
)
Common stock
sold (25,000 
shares)
   
0.25
     
     
   
6,250
     
     
     
     
6,250
 
Amortization of deferred comp
           
     
   
     
     
863,727
     
     
863,727
 
Net loss
                                                 
(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
)
 
 
(continued)
7


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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
   
Price per
   
Common Stock
 
Common
Stock
to be
 
Additional
Paid-in
   
Deferred
   
Deficit
Accumulated
During the
Development
   
Total
Stockholders
 
   
Share
   
Shares
   
Amount
 
Issued
 
Capital
   
Compensation
   
Stage
   
Deficiency
 
       
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
  $
.25
     
25,000
     
25
   
(6,250)
   
6,225
                     
 
Sale of common stock
  $
1.00
     
1,272,500
     
1,273
   
119,000
   
1,271,227
     
     
     
1,391,500
 
Stock issued for services
  $
 
.15-$1.70
     
1,268,560
1,
   
1,268
         
1,388,663
                     
1,389,931
 
Stock issued for directors fees
  $
1.50
     
50,000
     
50
   
   
74,950
     
     
     
75,000
 
Common stock issued for convertible debt
  $
1.53
     
60,000
     
60
         
91,740
     
     
     
91,800
 
Common stock issued upon exercise of warrants and options
  $
.20 -$.40
     
960,500
     
960
   
   
193,240
     
     
     
194,200
 
Common stock issued for patent settlement
  $
1.24
     
20,000
     
20
         
24,780
                     
24,800
 
Fair value of warrants issued
                               
1,614,138
                     
1,614,138
 
Fair value of options issued to employees
           
     
   
   
248,891
     
(248,891
)
   
     
 
Fair value of options issued to non-employees
           
     
   
   
55,381
     
(55,381
)
   
     
 
Amortization of deferred compensation
           
     
   
   
     
936,537
     
     
936,537
 
Finders’ fees related to stock issuances
                               
(88,384
                       
Net loss
           
     
   
   
     
     
(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
)
 
 
 
(continued)
8

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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
 
Price per
 
Common Stock
 
Common
Stock
to be
 
Additional
Paid-in
   
Deferred
   
Deficit
Accumulated
During the
Development
   
Total
Stockholders
 
 
Share
 
Shares
   
Amount
 
Issued
 
Capital
   
Compensation
   
Stage
   
Deficiency
 
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
   
119,000
     
119
   
(119,000
 
118,881
     
     
     
 
Sale of common stock
$1.00
   
1,530,500
     
1,530
         
1,528,970
     
     
     
1,530,500
 
Common stock issued upon exercise of warrants
$.40 - $1.00
   
500
     
1
   
   
199
     
     
     
200
 
Common stock to be issued for settlement of payables
                   
612,521
                           
612,521
 
Fair value of options issued for settlement costs
                         
31,500
                     
31,500
 
Fair value of warrants issued
                         
18,462
                     
18,462
 
Fair value of warrants issued and intrinsic value of beneficial conversion associated with convertible notes
                         
1,453,181
                     
1,453,181
 
Fair value of options issued to employees
     
     
   
   
243,750
     
(243,750
)
   
     
 
Amortization of deferred compensation
     
     
   
   
     
177,631
     
     
177,631
 
Finders’ fees related to stock issuances
                         
(109,840
                   
(109,840
Common stock cancelled
     
(8,047,403
   
(8,047
       
8,047
                     
 
Net loss
     
     
   
   
     
     
(3,115,186
)
   
(3,115,186
)
Balance, December 31, 2005
     
31,387,418
   
$
31,387
 
$
612,521
 
$
18,336,178
   
$
(142,187
 
$
(20,246,074
)
 
$
(1,408,175
)
 
 
(continued)
9


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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
 
Price per
 
Common Stock
 
Common
Stock
to be
 
Additional
Paid-in
   
Deferred
   
Deficit
Accumulated
During the
Development
   
Total
Stockholders
 
 
Share
 
Shares
   
Amount
 
Issued
 
Capital
   
Compensation
   
Stage
   
Deficiency
 
Balance, December 31, 2005
     
31,387,418
   
$
31,387
 
$
612,521
 
$
18,336,178
   
$
(142,187)
   
$
(20,246,074
)
 
$
(1,408,175
Common stock issued previously paid for
     
846,549
     
847
   
(612,521
 
611,674
     
     
     
 
Sale of common stock
$1.00 - $1.89
   
1,360,537
     
1,360
   
60,000
   
2,401,048
     
     
     
2,462,408
 
Common stock issued upon exercise of warrants
$.50 - $1.50
   
2,583,533
     
2,584
   
   
1,794,944
     
     
     
1,797,528
 
Common stock to be issued for convertible debt
$.70
   
3,416,186
     
3,417
         
2,356,449
                     
2,359,866
 
Common stock to be issued for  out of line of credit
$.55 - $1.22
   
487,483
 
   
487
         
379,610
                     
380,097
 
Fair value of options issued to employees
     
     
   
   
2,253,263
             
     
2,253,263
 
Fair value of options issued for settlement costs
                         
31,500
                     
31,500
 
Fair value of warrants issued for services
                         
463,627
                     
463,627
 
 Fair value of warrants issued and intrinsic value of beneficial conversion associated with convertible notes
                         
1,259.696
                     
1,259,696
 
Write off of  deferred compensation
     
     
   
   
(142,187
   
142,187
     
     
 
Finders’ fees related to stock issuances
                         
(284,579
                   
(284,579
Fees paid on equity line of credit
                         
(30,402
                   
(30,402
Net loss
     
     
   
   
     
     
(10,181,523
)
   
(10,181,523
)
Balance, December 31, 2006
     
40,081,757
   
$
40,082
 
$
60,000
 
$
29,430,821
   
$
   
$
(30,427,597
)
 
$
(896,694
)
 
(continued)
10


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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
 
Price per
 
Common Stock
   
Common
Stock
to be
   
Additional
Paid-in
   
Deficit
Accumulated
During the
Development
   
Total
Stockholders
 
 
Share
 
Shares
   
Amount
   
Issued
   
Capital
   
Stage
   
Deficiency
 
Balance, December 31, 2006
     
40,081,757
   
$
40,082
   
$
60,000
   
$
29,430,821
   
$
(30,427,597
)
 
$
(896,694
Common stock issued previously paid for
     
2,597,524
     
2,598
     
(60,000
   
57,402
     
     
 
Common stock to be issued for convertible debt
$.17 - $.53
   
1,910,711
     
1,911
             
524,569
             
526,480
 
Common stock  issued for  put of line of credit
$.27 - $.73
   
1,880,421
     
1,880
             
990,175
             
992,055
 
Common stock granted for services
                     
4,000
                     
4,000
 
Fair value of options issued to employees
     
     
     
     
67,592
     
     
67,592
 
Fair value of warrants issued for services
                             
35,340
             
35,340
 
 Fair value of warrants issued and intrinsic value of beneficial conversion associated with convertible notes
                             
1,253,548
             
1,253,548
 
Fees paid on equity line of credit
                             
(79,364
           
(79,364
Net loss
     
     
     
     
     
(6,262,743
)
   
(6,262,743
)
Balance, December 31, 2007
     
46,470,413
   
$
46,471
   
$
4,000
   
$
32,280,083
   
$
(36,690,340
)
 
$
(4,359,786
)
 
 
 
(continued)
11


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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
 
Price per
 
Common Stock
   
Common
Stock
to be
   
Additional
Paid-in
   
Deficit
Accumulated
During the
Development
   
Total
Stockholders
 
 
Share
 
Shares
   
Amount
   
Issued
   
Capital
   
Stage
   
Deficiency
 
Balance, December 31, 2007
     
46,470,413
   
$
46,471
   
$
4,000
   
$
32,280,083
   
$
(36,690,340
)
 
$
(4,359,786
)
Common stock issued for convertible debt
$.17 - $.53
   
5,575,082
     
5,574
     
16,500
     
1,936,171
     
     
1,958,245
 
Common stock issued for Morale/ Matthews settlement
$.38
   
7,421,896
     
7,422
     
     
2,776,289
     
     
2,783,711
 
Common stock issued for services
$.17 - $.49
   
2,398,850
     
2,399
     
     
516,230
     
     
518,629
 
Common stock issued upon exercise of warrants
$.50
   
1,064,650
     
1,065
     
     
531,260
     
     
532,325
 
Fair value of options issued as compensations
   
     
     
     
645,745
     
     
645,745
 
Fair value of warrants issued and intrinsic value of beneficial conversion associated with convertible notes
   
     
     
     
1,323,077
     
     
1,323,077
 
Fair value of warrants issued to PIPE holders
   
     
     
     
116,913
     
     
116,913
 
Common stock issued for services
0.17
   
10,000
     
10
     
(4,000
)
   
3,990
     
     
 
Net loss
   
     
     
     
     
(6,052,724
)
   
(6,052,724
 
Balance, December 31, 2008
     
62,940,891
   
$
62,941
   
$
16,500
   
$
40,129,758
   
$
(42,743,064
)
 
$
(2,533,865
)
 
 
 
(continued)
 
12


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

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIENCY (continued)
FROM FEBRUARY 18, 1998 (INCEPTION) TO SEPTEMBER 30, 2009
 
 
Price per
 
Common Stock
   
Common
Stock
to be
   
Additional
Paid-in
   
Deficit
Accumulated
During the
Development
   
Total
Stockholders
 
 
Share
 
Shares
   
Amount
   
Issued
   
Capital
   
Stage
   
Deficiency
 
Balance, December 31, 2008
     
62,940,891
   
$
62,941
   
$
16,500
   
$
40,129,758
   
$
(42,743,064
)
 
$
(2,533,865
)
Common stock issued for convertible debt
0.15 - 0.50
   
2,165,026
     
2,165
     
(16,500
)    
474,464
     
     
460,129
 
Common stock issued for services
0.17 - 0.49
   
340,000
     
340
     
     
137,160
     
     
137,500
 
Common stock issued for settlement of accounts payable
0.27
   
430,370
     
431
     
0
     
103,983
     
     
104,414
 
Common stock issued upon exercise of options
0.27    
83,333
     
83
     
0
     
22,417
     
     
22,500
 
Fair value of warrants issued for note payable
   
                     
 
1,248
             
1,248
 
Fair value of options issued as compensation
   
     
     
     
67,801
     
     
67,801
 
Fair value of warrants issued and intrinsic value of beneficial conversion associated with convertible notes
   
     
     
     
1,002,163
     
     
1,002,163
 
Net loss
   
     
     
     
     
(3,283,176
)
   
(3,283,176
)
Balance, September 30, 2009 (unaudited)
     
65,959,620
   
$
65,960
   
$
   
$
41,938,994
   
$
(46,026,240
)
 
$
(4,021,286
)
 
 
 
See notes to condensed consolidated financial statements.

13

 
SAVE THE WORLD AIR, INC. AND SUBSIDIARY
 (A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
             
   
Nine months ended
   
February 18, 1998
 
   
September 30,
   
September 30,
   
(inception) to
 
   
2009
   
2008
   
September 30, 2009
 
Cash flows from operating activities
                       
Net loss
 
$
(3,283,176
)
 
$
(4,455,013)
   
$
 (46,026,240
)
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Write off of intangible assets
   
-
     
-
     
505,000
 
Settlement of litigation and debt
   
-
     
-
     
(1,017,208
)
Settlement of debt due Morale/Matthews
   
-
     
927,903
     
927,903
 
Stock based compensation and warrant expense
   
67,801
     
599,754
     
3,682,723
 
Issuance of common stock for services
   
137,500
     
51,879
     
5,341,731
 
Issuance of options for legal settlement
   
-
     
-
     
31,500
 
Issuance of warrants for legal settlement
   
-
     
-
     
4,957
 
Issuance of warrants for financing fees
   
1,248
     
116,913
     
153,501
 
Non-cash increase in convertible notes recorded as expense
   
-
     
89,470
     
163,962
 
Patent acquisition cost
   
-
     
-
     
1,610,066
 
Addition of Interest Expense to Convertible Note Principal
   
58,100
     
-
     
58,100
 
Amortization of issuance costs and original issue debt discounts including beneficial conversion feature-part of interest expense
   
994,476
     
733,805
     
6,612,785
 
Amortization of deferred compensation
   
-
     
-
     
3,060,744
 
Loss on disposition of assets
   
-
     
9,683
     
14,426
 
Depreciation and amortization
   
24,956
     
28,551
     
418,085
 
Bad debt
   
-
     
1,380
     
1,380
 
Changes in operating assets and liabilities:
                       
Accounts receivable
   
-
     
-
     
(1,380
)
Other current assets
   
20,080
     
(14,292)
     
(13,195
)
Other assets
   
230
     
(6,750)
     
(11,020
)
Accounts payable and accrued expenses
   
841,501
     
430,111
     
4,529,111
 
Net cash used in operating activities
   
(1,137,284
)
   
(1,486,606
)    
(19,953,069
)
                   
Cash flows from investing activities
                       
Purchase of property and equipment
   
-
     
(345)
     
(553,452
)
Proceeds from sale of equipment
   
-
     
17,478
     
17,478
 
Net cash provided by (used in) investing activities
   
-
     
17,133
     
(535,974
)
                   
Cash flows from financing activities
                       
Net proceeds under equity line of credit
   
-
     
-
     
1,262,386
 
Increase (decrease) in payables to related parties and shareholder
   
24,348
     
(6,387)
     
634,412
 
Advances from founding executive officer
   
-
     
-
     
517,208
 
Net proceeds from issuance of convertible notes and warrants
   
1,107,320
     
974,000
     
7,567,743
 
Repayment of convertible notes
   
(45,352)
     
-
     
(271,602
)
Net proceeds from issuance of common stock
   
-
     
532,325
     
10,787,274
 
Net cash provided by financing activities
   
1,086,316
     
1,499,938
     
20,497,421
 
                   
Net increase (decrease) in cash
   
(50,968)
     
30,465
     
8,378
 
Cash, beginning of period
   
59,346
     
47,660
     
 
                         
Cash, end of period
 
$
8,378
   
$
78,125
   
$
8,378
 
 

 
(continued)
14

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

 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
 
   
Nine months ended
   
February 18, 1998
 
   
September 30,
   
September 30,
   
(inception) to
 
   
2009
   
2008
   
September 30, 2009
 
                   
Supplemental disclosures of cash flow information
                 
Cash paid during the period for
                 
Interest
  $ 9,736     $ 988     $ 146,135  
                         
Income taxes
  $ -     $ -     $ 5,882  
                         
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
    -       -       3,202,931  
Purchase of property and equipment financed by advance from related party
    -       -       3,550  
Conversion of related party debt to equity
    --       -       515,000  
Issuance of common stock in settlement of payable
    104,414       -       204,895  
Cancellation of stock
    -       -       8,047  
Conversion of accounts payable and accrued expenses to common stock issued
    -       -       612,521  
    Conversion of related party debt to convertible debentures
    -       -       45,000  
Conversion of convertible debentures to common stock
    460,129       -       5,391,808  
Issuance of shares for settlement of loans and other payable to Morale/Matthews
    -       2,783,711       2,783,711  
Write off of deferred compensation
    -               142,187  
Non-cash equity-warrant valuation and intrinsic value of beneficial conversion associated with convertible notes
    1,002,163       314,460       6,408,578  
Proceeds of exercise of options applied to accounts payable
    22,500       -       22,500  
 
 
See notes to condensed consolidated financial statements.

15


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

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NINE MONTHS ENDED SEPTEMBER 30, 2009 (UNAUDITED)
 


1.  Organization and basis of presentation

Basis of presentation

The accompanying unaudited condensed consolidated financial statements of Save the World Air, Inc. (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Regulation S-K for scaled disclosures for smaller reporting companies. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in United States of America for complete financial statements. However, such information reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for the fair presentation of the consolidated financial position and the consolidated results of operations. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full fiscal year.

The condensed consolidated balance sheet information as of December 31, 2008 was derived from the audited consolidated financial statements included in the Company's Annual Report on Form 10-K filed with the SEC. These interim financial statements should be read in conjunction with that report.
 
Going Concern
 
Since its inception, the Company has been primarily engaged in organizational and pre-operating activities. The Company has generated insignificant revenues and has incurred accumulated losses of  $46,026,240 from February 18, 1998 (Inception) through September 30, 2009. As reflected in the accompanying condensed consolidated financial statements, the Company had a net loss of $3,283,176 and a negative cash flow from operations of $1,137,284 for the nine months ended September 30, 2009, and had a working capital deficiency of $4,139,319 and a stockholders' deficiency of $4,021,286 at September 30, 2009.   The Company is currently unable to meet its cash obligations and is in default of certain of its convertible note agreements and its obligations under its license agreements with Temple University (see Note 8).   As a result, the Company's independent registered public accounting firm, in their report on the Company's 2008 consolidated financial statements, raised substantial doubt about the Company's ability to continue as a going concern.

Our operations to date have been funded through issuances of our common stock and convertible notes whereby we raised an aggregate $18,355,017 from February 18, 1998 (inception) through September 30, 2009. Based on our current operating plan, we believe that we do not have sufficient cash and cash equivalents to implement our operating plan. We will need to obtain additional financing in addition to the funds already raised through the sale of equity securities to fund our cash needs and continue our operations. Additional financing, whether through public or private equity or debt financing, arrangements with stockholders or other sources to fund operations, may not be available, or if available, may be on terms unacceptable to us. Our ability to maintain sufficient liquidity is dependent on our ability to raise additional capital. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of our common stock. Debt incurred by us would be senior to equity in the ability of debt holders to make claims on our assets. The terms of any debt issued could impose restrictions on our operations. If adequate funds are not available to satisfy either medium or long-term capital requirements, our operations and liquidity could be materially adversely affected and we could be forced to cut back our operations.
 
Description of business

Save the World Air, Inc. (“STWA”) designs, licenses and develops products to increase engine performance, reduce harmful emissions and increase fuel efficiency.  The Company is a green technology company that leverages a suite of patented, patent-pending and licensed intellectual properties related to the treatment of fuels. Technologies patented by or licensed to us utilize either magnetic or uniform electrical fields to alter physical characteristics of fuels and are designed to create cleaner combustion. Cleaner combustion has been shown to improve performance, enhance fuel economy and/or reduce harmful emissions in laboratory testing.
 
The Company has three product lines; MAG ChargR™ and ECO ChargR™, ELEKTRA™ and AOT (Applied Oil Technology).  The Company believes development of MAG ChargR is complete and it will be ready to be manufactured by the end of the fourth quarter 2009.  We believe the ELEKTRA is nearing the end of the product development cycle which we believe will culminate in an upcoming SAE (Society of Automotive Engineers) test to prove and certify the level of fuel savings.  AOT is in the research and development phase.
 
 
16

 
The Company was incorporated on February 18, 1998, as a Nevada corporation, under the name Mandalay Capital Corporation. The Company changed its name to Save the World Air, Inc. on February 11, 1999, following the acquisition of marketing and manufacturing rights of the ZEFS technologies.
 
 
2.  Summary of significant accounting policies

Development stage enterprise

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

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

Loss per share

Basic loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted loss per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the loss of the Company. In computing diluted loss per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants may have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. For the nine month periods ended September 30, 2009 and 2008, the dilutive impact of outstanding stock options of 4,851,225 and 4,301,225 respectively, and outstanding warrants of 11,847,436 and 11,676,034 have been excluded because their impact on the loss per share is anti-dilutive.
 
Stock-based compensation
 
The Company periodically issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing costs.  Stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period.  Options vest and expire according to terms established at the grant date.
 
Fair value of financial instruments

The Company uses various inputs in determining the fair value of its investments and measures these assets on a recurring basis.  Financial assets recorded at fair value in the consolidated balance sheets are categorized by the level of objectivity associated with the inputs used to measure their fair value.  Authoritative guidance provided by the FASB defines the following levels directly related to the amount of subjectivity associated with the inputs to fair valuation of these financial assets:
 
           *           Level 1 - quoted prices in active markets for identical investments
           *           Level 2 - other significant observable inputs (including quoted prices for similar investments, market corroborated inputs, etc.)
           *           Level 3 - significant unobservable inputs (including the Company’s own assumptions in determining the fair value of investments)
 
 
17

 
The inputs or methodology used for valuing securities are not necessarily an indication of the credit risk associated with investing in those securities.  The following table provides the fair value measurements of applicable Company financial assets that are measured at fair value on a recurring basis according to the fair value levels defined by authoritative guidance from the Financial Accounting Standards Board as of September 30, 2009 and December 31, 2008.
 
Recent accounting pronouncements
 
In June 2009, the FASB issued authoritative guidance on accounting standards codification and the hierarchy of generally accepted accounting principles.” The FASB Accounting Standards Codification™ (“Codification”) has become the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with GAAP. All existing accounting standard documents are superseded by the Codification and any accounting literature not included in the Codification will not be authoritative. However, rules and interpretive releases of the Securities Exchange Commission (“SEC”) issued under the authority of federal securities laws will continue to be sources of authoritative GAAP for SEC registrants. The FASB authoritative guidance is effective for interim and annual reporting periods ending after September 15, 2009. Therefore, beginning with our quarter ending September 30, 2009, all references made by it to GAAP in its consolidated financial statements now use the new Codification numbering system. The Codification does not change or alter existing GAAP and, therefore, it does not have an impact on our financial position, results of operations and cash flows.
 
On July 1, 2009, the Company adopted authoritative guidance issued by the FASB on business combinations. The guidance retains the fundamental requirements that the acquisition method of accounting (previously referred to as the purchase method of accounting) be used for all business combinations, but requires a number of changes, including changes in the way assets and liabilities are recognized and measured as a result of business combinations. It also requires the capitalization of in-process research and development at fair value and requires the expensing of acquisition-related costs as incurred. We have applied this guidance to business combinations completed since July 1, 2009.  Adoption of the new guidance did not have a material impact on our financial statements.
 
In October 2009, the FASB issued authoritative guidance on revenue recognition that will become effective for the Company beginning July 1, 2010, with earlier adoption permitted.  Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance.  We believe adoption of this new guidance will not have a material impact on our financial statements.
 
 In May 2009, the FASB issued new requirements for reporting subsequent events. These requirements set forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and disclosures that an entity should make about events or transactions that occurred after the balance sheet date. Disclosure of the date through which an entity has evaluated subsequent events and the basis for that date is also required.
 
Other recent accounting pronouncements issued by the FASB did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.

 
 3.  Certain relationships and related transactions

Loans from related parties and shareholders

In May 2007, August 2007 and May 2009, a former officer and incumbent director of the Company loaned $31,404, $50,000 and $5,000 to the Company. These amounts are unsecured, bear interest at 6% per annum and are due on demand.  At September 30, 2009 and December 31, 2008, the balance of these loans including interest was $81,583 and 78,280, respectively.
 
 
18


 
In April 2009, a shareholder loaned $47,000 to the Company.  The loan was unsecured; bears interest at 10% and matured on June 23, 2009.  The loan also included the issuance of a warrant to purchase 10,000 shares of the Company’s common stock.  The warrant is exercisable on a cash basis only at a price of $0.50 per share, and is exercisable for a period of two years from the date of issuance. The warrant was valued at $1,248 and was reflected as a financing cost in the accompanying statement of operations.  As of September 30, 2009 the loan and interest have been paid in full.

In April 2009, a shareholder loaned $25,000 to the Company.  The loan was unsecured, bears interest at 10%, per annum and is due on demand.  The balance owing at September 30, 2009 including interest was $21,045.

In June 2009 and August 2009 an officer and director of the Company advanced $17,100 to the Company.  As of September 30, 2009, these advances have been paid in full.

Accounts Payable to related parties
 
As of September 30, 2009 and December 31, 2008, the Company had accounts payable to related parties in the amount of $170,750, which was composed of $118,539 in unpaid Directors Fees and $52,211 in unreimbursed expenses incurred by Officers and Directors.  As of December 31, 2008, the Company had accounts payable to related parties in the amount of $93,003, which was composed of $59,705 in unpaid Directors Fees, $33,298 in unreimbursed expenses incurred by Officers and Directors.
 
Marketing and promotional services agreement with related party
 
In July 2006, the Company entered into an agreement with SS Sales and Marketing Group (“SS Sales”), to provide exclusive marketing and promotional services in the western United States and western Canada  (the “Territory”) for the Company’s products.  The agreement has a term of five years unless sooner terminated by either party on 30 days’ notice.  In the event of termination, SS Sales will be entitled to receive all commissions payable through the date of termination.  SS Sales is owned by Nathan Shelton, who has served as one of the directors of the Company since February 12, 2007.  There were no payments made to SS Sales for the nine month periods ending September 30, 2009 and 2008.


4.  Loans and other payables due to Morale/Matthews

Leodis Matthews, through his law firm, Matthews & Partners, (“Matthews”) serves as outside legal counsel to the Company.  Morale Orchards, LLC (“Morale”) is owned by Jacqueline Alexander, the wife of Leodis Matthews.  
 
In 2006 and 2007, Morale purchased two convertible promissory notes totaling $1,225,000.  The notes were unsecured; convertible into 1,595,588 shares of common stock, due one year from the date issued, and had an implied interest rate of 22.5%.  Warrants to purchase 797,794 shares of common stock were issued with the notes.  As of January 31, 2008, the notes were in default, and the total amount due for the notes was $1,362,212, including penalties and interest.  In addition to the two notes, the Company borrowed $20,000 from Morale on October 30, 2007.  At January 31, 2008, the Company was also indebted to Matthews $472,762 for past legal fee.

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

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

The fair value of the shares of common stock issued was determined to be $0.38 per share, based on the closing price of the Company’s common stock on January 31, 2008, for a total settlement of $2,820,320.  As a result of the issuance of shares of common stock, the Company incurred additional non-cash costs of $927,903 that have been reflected as costs to settle outstanding debt in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2008.


19

 
5.  Convertible Debentures

Convertible debentures consist of the following:
 
 
 
Maturity dates
 
September 30,
2009
   
December 31,
2008
 
               
2007 Winter Offering
February 29, 2009
  $     $ 66,000  
                   
2008 Summer Offering
August 31, 2009
    375,100       341,000  
                   
2008 Fall Offering
October 31, 2009
    127,820       152,020  
                   
2008 Winter Offering
December 5, 2009
    117,700       337,700  
                   
2009 Winter Offering – I
April 26, 2009
    202,148        
                   
2009 Winter Offering – II
March 12, 2010
    161,502        
                   
2009 Spring
April 30, 2010
    143,000        
                   
2009 Summer
September 29, 2012
    467,500        
                   
Sub-total 
      1,594,770       896,720  
                   
Less, remaining debt discount
      (639,393 )     (593,595 )
        955,377       303,125  
Less: Convertible debentures, net, related parties
      (56,832 )     (12,466 )
                   
Convertible debentures, net, others
    $ 898,545     $ 290,659  
 
 
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2008 Summer Offering

From July 17, 2008 to August 31, 2008,  the Company conducted an offering (the “2008 Summer Offering”) of up to $600,000 aggregate face amount of its convertible notes “the”2008 Summer Offering) with a small number of accredited investors. Of this amount $484,000 aggregate face amount of the 2008 Summer Notes were sold for an aggregate purchase price of $440,000 net proceeds.  Therefore, while the stated interest rate on the 2008 Summer Notes is 0%, the implied interest rate on the 2008 Summer Notes is 10%.  The 2008 Summer Notes will mature on the first anniversary of the date of issuance.  The 2008 Summer Notes are convertible, at the option of the noteholders, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2008 Summer Offering (the “Conversion Price”).  Up to 1,423,530 Conversion Shares are issuable at a Conversion Price of $0.34 per share.
 
Each of the investors in the 2008 Summer Offering received, for no additional consideration, a warrant (the “ 2008 Summer Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the ( 2008 Summer Notes) are convertible (the “2008 Summer Warrant Shares”). Each 2008 Summer Warrant is exercisable on a cash basis only at a price of $0.50 per share, and is exercisable for a period of two years from the date of issuance.  Up to 711,764, 2008 Summer Warrant Shares are initially issuable upon exercise of the 2008 Summer Warrants.  As of September 30, 2009, investors have converted $143,000 of the Convertible Notes into 420,589 shares of the Company’s common stock.  On September 2, 2009, the Company was in default on the outstanding notes of $341,000. The balance at September 30, 2009 was $375,100 which includes the 10% default penalty.

The aggregate value of the Summer 2008 Offering Warrants issued in connection with the August 31, 2008 closing were valued at $92,711 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 4.27%; dividend yield of 0%; volatility factors of the expected market price of common stock of 137.95%; and an expected life of two years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $179,416.  The value of the 2008 Summer Offering Warrants, the beneficial conversion feature, and the transaction fees of $44,000 are considered as debt discount and were amortized over the life of the Note.

2008 Fall Offering

From September 8, 2008 to October 31, 2008, the Company conducted an offering (the “2008 Fall Offering”) of up to $500,000 aggregate face amount of its Convertible Notes.  A total of $198,220 aggregate face amount of the 2008 Fall Notes were sold for an aggregate purchase price of $180,200 net proceeds.  Therefore, while the stated interest on the 2008 Fall Notes is 0%, the implied interest rate on the 2008 Fall Notes is 10%.  The 2008 fall notes will mature on the first anniversary of the date of issuance.  The 2008 Fall Notes are convertible, at the option of the noteholders, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2008 Fall Offering (the “Conversion Price”).  Up to 1,321,466 Conversion Shares are issuable at a Conversion Price of $0.15 per share.

Each of the investors in the 2008 Fall Offering received, for no additional consideration, a warrant (the “ 2008 Fall Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the ( 2008 Fall Notes) are convertible (the “2008 Fall Warrant Shares”). Each 2008 Fall Warrant is exercisable on a cash basis only at a price of $0.50 per share, and is exercisable for a period of two years from the date of issuance.  Up to 660,734 2008 Fall Warrant Shares are initially issuable upon exercise of the 2008 Fall Warrants.  As of September 30, 2009, investors have converted $70,400 of the Convertible Notes into 469,333 shares of the Company’s common stock.  The outstanding balance at September 30, 2009 was $127,820.

The aggregate value of the Fall 2008 Offering Warrants issued in connection with the October 31, 2008 closing were valued at $53,320 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 4.68%; dividend yield of 0%; volatility factors of the expected market price of common stock of 145.98%; and an expected life of two years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $126,880.  The value of the Fall 2008 Offering Warrants, the beneficial conversion feature, and the transaction fees of $18,020 are considered as debt discount and are being amortized over the life of the Note.
 
2008 Winter Offering

From November 24, 2008 to December 5, 2008, the Company conducted an offering (the “2008 Winter Offering”) of up to $500,000 aggregate face amount of its Convertible Notes.  A total of $524,700 aggregate face amount of the 2008 Winter Notes were sold for an aggregate purchase price of $477,000 net proceeds.  Therefore, while the stated interest on the 2008 Winter Notes is 0%, the implied interest rate on the 2008 Winter Notes is 10%.  The 2008 Winter Notes will mature on the first anniversary of the date of issuance.  The 2008 Winter Notes are convertible, at the option of the noteholders, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2008 Winter Offering (the “Conversion Price”).  Up to 3,086,470 Conversion Shares are issuable at a Conversion Price of $0.17 per share.
 
 
21

 
Each of the investors in the 2008 Winter Offering received, for no additional consideration, a warrant (the “ 2008 Winter Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the ( 2008 Winter Notes) are convertible (the “2008 Winter Warrant Shares”). Each 2008 Winter Warrant is exercisable on a cash basis only at a price of $0.30 per share, and is exercisable for a period of two years from the date of issuance.  Up to 1,543,235 2008 Winter Warrant Shares are initially issuable upon exercise of the 2008 Winter Warrants.  As of September 30, 2009, investors have converted $407,000 of the Convertible Notes into 2,394,117 shares of the Company’s common stock.  The outstanding balance at September 30, 2009 was $117,700.

The aggregate value of the Winter 2008 Offering Warrants issued in connection with the December 5, 2008 closing were valued at $168,925 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 3.42%; dividend yield of 0%; volatility factors of the expected market price of common stock of 153.56%; and an expected life of two years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $308,075.  The value of the Winter 2008 Offering Warrants, the beneficial conversion feature, and the transaction fees of $47,700 are considered as debt discount and are being amortized over the life of the Note.

2009 Winter Offering I

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

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

The aggregate value of the Winter 2009 Offering Warrants issued in connection with the January 26, 2009 closing were valued at $66,178 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 0.85%; dividend yield of 0%; volatility factors of the expected market price of common stock of 151.42%; and an expected life of two years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $183,822.  The value of the Winter 2009 Offering Warrants and the beneficial conversion feature are considered as debt discount and were amortized over the life of the notes.

As of September 30, 2009, investors have converted $25,000 of the Convertible Notes into 69,444 shares of the Company’s common stock. As of April 26, 2009, the Company was in default in the amount of $225,000.  The Company has paid $45,352 as a partial redemption of the defaulted convertible notes.  The outstanding balance at September 30, 2009 was $202,148 which includes a 10% default penalty.  The Company is currently negotiating an extension of these outstanding notes.

2009 Winter Offering II

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

Each of the investors in the Winter 2009 #2 Offering received, for no additional consideration, a warrant (the “Winter 2009 #2 Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the Winter 2009 #2 Notes are convertible (the “Warrant Shares”). Each Winter 2009 #2 Warrant is exercisable on a cash basis only at an initial price of $0.50 per share, and is exercisable immediately upon issuance and for a period of two (2) years from the date of issuance. Up to 386,409 Warrant Shares are initially issuable on exercise of the Winter 2009 #2Warrants.
 
 
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The Company received $224,820 in net proceeds in the Winter 2009 #2 Offering which will be used for general corporate purposes and working capital. The aggregate value of the Winter 2009 #2 Offering Warrants issued in connection with the January 26, 2009 closing were valued at $62,028 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 1.03%; dividend yield of 0%; volatility factors of the expected market price of common stock of 156%; and an expected life of two years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $161,791.  The value of the Winter 2009 #2 Offering Warrants, the beneficial conversion feature, and the transaction fees of $22,482 are considered as debt discount and are being amortized over the life of the Note.

As of September 30, 2009, investors have converted $85,800 of the Convertible Notes into 268,124 shares of the Company’s common stock. The outstanding balance at September 30, 2009 was $161,502.
 
2009 Spring Offering

From March 17, 2009, through April 30, 2009, the Company conducted and concluded a private offering (the “Spring 2009 Offering”) of up to $300,000 aggregate face amount of its convertible notes (the “Spring 2009 Notes”) with 11 accredited investors. A total of $181,500 aggregate face amount of the Spring 2009 Notes were sold for an aggregate purchase price of $165,000.  The Spring 2009 Notes mature on the first anniversary of their date of issuance, are convertible, at the option of the noteholder, into up to 672,222 shares of common stock of the Company at a conversion price of $0.27 per share.

Each of the investors in the Spring 2009 Offering received, for no additional consideration, a warrant (the “Spring 2009 Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the Spring 2009 Notes are convertible (the “Warrant Shares”).  Each Spring 2009 Warrant is exercisable on a cash basis only at an initial price of $0.50 per share, and is exercisable for a period of two years.  Up to 336,111 Warrant Shares are initially issuable on exercise of the Spring 2009 Warrants.

The Company received $165,000 in net proceeds in the Spring 2009 Offering which will be used for general corporate purposes and working capital. The aggregate value of the Spring 2009 Offering Warrants issued in connection with the April 30, 2009 closing were valued at $39,994 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 0.94%; dividend yield of 0%; volatility factors of the expected market price of common stock of 156.39%; and an expected life of two years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $96,827.  The value of the Spring 2009 Offering Warrants, the beneficial conversion feature, and the transaction fees of $16,500 are considered as debt discount and are being amortized over the life of the Note.

As of September 30, 2009, investors have converted $38,500 of the Convertible Notes into 142,590 shares of the Company’s common stock. The outstanding balance at September 30, 2009 was $143,000.
 
2009 Summer Offering

From June 9, 2009, through September 28, 2009, the Company conducted and concluded a private offering (the “Summer 2009 Offering”) of up to $500,000 aggregate face amount of our convertible notes (the “Summer 2009 Notes”) with interest compounded quarterly at the annual rate of seven percent (7%) payable at maturity. A total of $467,500 Spring 2000 Notes were sold to 17 accredited investors. The Summer 2009 Notes mature on the third anniversary of the closing of this offering and will be convertible, at the option of the noteholder, into up to 1,870,000 shares of common stock of the Company at a conversion price of $0.25 per share.

Each of the investors in the Summer 2009 Offering will receive, for no additional consideration, a warrant (the “Summer 2009 Warrants”), entitling the holder to purchase a number of shares of our common stock equal to 100% of the number of shares of common stock into which the Summer 2009 Notes are convertible (the “Warrant Shares”).  Each Summer 2009 Warrant is exercisable on a cash basis only at an initial price of $0.30 per share, and is exercisable for a period of thirty six months.  Up to 1,870,000 Warrant Shares are initially issuable on exercise of the Summer 2009 Warrants.

The Company received $467,500 in net proceeds in the Summer 2009 Offering which will be used for general corporate purposes and working capital. The aggregate value of the Summer 2009 Offering Warrants issued in connection with the September 28, 2009 closing were valued at $269,543 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 1.00; dividend yield of 0%; volatility factors of the expected market price of common stock of 147.21%; and an expected life of three years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $197,957.  The value of the Summer 2009 Offering Warrants and the beneficial conversion feature are considered as debt discount and are being amortized over the life of the Note.

The outstanding balance as of September 30, 2009 was $467,500

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6. Capital stock

During the nine months ended September 30, 2009, the Company issued 2,165,026 shares of common stock in exchange for conversion of $460,129 of Convertible Notes.

During the nine months ended September 30, 2009, the Company granted 340,000 shares of common stock in exchange for consulting services in the amount of $137,500.

During the nine months ended September 30, 2009, the Company granted 430,370 shares of common stock in settlement of accounts payable of $104,414.

During the nine months ended September 30, 2009, the Company issued 83,333 shares of common stock upon exercise of stock options at $0.27 per share and valued at $22,500

7.  Stock options and warrants

The Company periodically issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing costs.  Stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period.  Options vest and expire according to terms established at the grant date.
 
Options
 
The Company currently issues stock options to employees, directors and consultants under the 2004 Stock Option Plan (the Plan). The Company could issue options under the Plan to acquire up to 5,000,000 shares of common stock. In February 2006, the board approved an amendment to the Plan (approved by the Shareholders in May 2006), increasing the authorized shares by 2,000,000 shares to 7,000,000 shares. At September 30, 2009, 2,398,775 were available to be granted under the Plan. Prior to 2004, the Company granted 3,250,000 options outside the Plan to officers of the Company of which 250,000 are still outstanding.
 
Employee options vest according to the terms of the specific grant and expire from 5 to 10 years from date of grant. Non-employee option grants to date are vested upon issuance. The weighted-average, remaining contractual life of employee options outstanding at September 30, 2009 was 7.6 years. Stock option activity for the period January 1, 2009 to September 30, 2009, was as follows:
 
   
Weighted Avg.
Options
   
Weighted Avg.
Exercise Price
 
             
Options outstanding, January 1, 2009
   
4,601,225
   
$
0.53
 
Options granted
   
             333,333
     
.30
 
Options exercised                                      
   
(83,333
)
   
0.27
 
Options forfeited 
   
     
 
Options cancelled 
   
     
 
Options outstanding, September 30, 2009
   
4,851,225
   
$
0.52
 

The weighted average exercise prices, remaining contractual lives for options granted, exercisable, and expected to vest under the Plan as of September 30, 2009 were as follows:
 
   
Outstanding Options
 
Exercisable Options
 
             
Weighted
     
Weighted
 
Option
       
Life
 
Average Exercise
     
Average Exercise
 
Exercise Price Per Share
 
Shares
 
(Years)
 
Exercise Price
 
Shares
 
Price
 
  $ 0.21 - $ 0.99
 
  4,463,679
   
7.8
 
$
0.45
     
4,130,346
   
$
0.46
   
  $ 1.00 - $ 1.99
 
  327,546
   
5.6
 
$
1.41
     
327,546
   
$
1.41
   
  $ 2.00 - $ 2.26
 
  60,000
   
1.9
 
$
2.26
     
60,000
   
$
2.26
   
   
  4,851,225
   
7.8
 
$
0.52
     
4,517,892
   
$
0.54
   

As of September 30, 2009 the market price of the Company’s stock was $0.41 per share. Future unamortized compensation expense on the outstanding options at September 30, 2009 is $72,110.  At September 30, 2009, the aggregate intrinsic value of the options outstanding and exercisable was $339,333.
 
 
24


 
Black-Scholes value of options
 
During the nine months ended September 30, 2009 and 2008, the Company valued options for pro-forma purposes at the grant date using the Black-Scholes pricing model with the following average assumptions:

   
September 30,
   
2009
 
2008
                 
Expected life (years)
   
5.5
     
5.5
 
Risk free interest rate
   
2.57
   
4.42
Volatility                     
   
129
%    
124.57
Expected dividend yield
   
0.00
   
0.00
%

The weighted average fair value for options granted in 2008 was $0.24.  The weighted average for options granted during the nine months ended September 30, 2009 was $0.27.
 
Warrants

The following table summarizes certain information about the Company’s stock purchase warrants from January 1, 2009 to September 30, 2009:
 
   
Warrants
   
Weighted Avg.
Exercise Price
 
Warrants outstanding, January 1, 2009
   
10,400,003
   
$
0.70
 
Warrants granted
   
2,949,743
     
0.37
 
Warrants exercised
   
     
 
Warrants cancelled
   
 (1,502,310
   
 
Warrants outstanding, June 30, 2009
   
11,847,436
   
$
0.55
 

 
   
Outstanding Warrants
   
Exercisable Warrants
 
Warrant
Exercise Price
Per Share
 
Shares
 
Life
(Years)
 
Weighted
Average Exercise
Price
   
Shares
   
Weighted
Average Exercise
Price
 
$ 0.30 - $ 0.99
   
9,702,168
 
 2.0
 
$
0.44
     
9,702,168
   
$
0.48
 
$ 1.00 - $ 1.99
   
2,057,966
 
 2.4
 
$
1.00
     
2,057,966
   
$
1.00
 
$ 2.00 - $ 2.70
   
87,302
 
1.9
 
$
2.70
     
87,302
   
$
2.70
 
     
11,847,436
 
2.0
 
$
0.55
     
11,847,436
   
$
0.60
 
 
As of September 30, 2009 the market value of the Company's stock was $0.41 per share, and the aggregate intrinsic value of the warrants outstanding was $-0-.
 
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8.  Research and development


The Company has research and development facilities in Morgan Hill, California. The Company has tested products incorporating our ZEFS, MK IV and ELEKTRA technologies for multiple makes and models diesel engines, motorbikes, boats, generators, lawnmowers and other small engines.  The Company has purchased test vehicles, test engines and testing equipment. The Company incurred $274,577 and $432,184 for the nine months ended September 30, 2009 and 2008, respectively, on its research and development activities.

Temple University License Agreements

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

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

The Company has also entered into a research and development agreement (R&D Agreement) with Temple University to conduct further research on the ELEKTRA technology. Under the R&D Agreement Temple University will conduct a 24-month research project towards expanding the scope of, and developing products utilizing, the technologies covered under the License Agreements, including design and manufacture of prototypes utilizing electric fields to improve diesel, gasoline and kerosene fuel injection in engines using such fuels and a device utilizing a magnetic field to reduce crude oil viscosity for crude oil (paraffin and mixed base) and edible oil flow in pipelines. If the research project yields results within the scope of the technologies licensed pursuant to the License Agreements, those results will be deemed included as rights licensed to the Company pursuant to the License Agreements. If the research project yields results outside of the scope of the technologies covered by the License Agreements, the Company has a six-month right of first negotiation to enter into a new worldwide, exclusive license agreement with Temple University for the intellectual property covered by those results.  Pursuant to the R&D Agreement, the Company will make payments to Temple University in the aggregate amount of $500,000
 
At December 31, 2008, the Company was in default in the amount of $300,000 in connection with its payment obligations under the License Agreements and maintenance payments.  On November 10, 2008, the Company received written notice from Temple University of a material breach relating to required payments under the License Agreements.  The notice provides the Company with 60 days’ notice to cure the material breach.  The Company’s failure to cure could result in a termination of the License Agreements. If the termination occurs, the Company estimates this would have a material adverse impact on the Company’s financial condition and operations.  Under the License Agreements the Company is subject to a penalty of 1% per month of the amounts due and unpaid under the License Agreements.
 

26


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

On January 9, 2009, the Company entered into a Letter Agreement with Temple University wherein Temple University granted to the Company an extension of time to cure the above-referenced breaches until March 31, 2009.  The Letter Agreement provides for payments of $100,000 on each of January 31, 2009, February 28, 2009 and March 31, 2009. The Company made the January 31, 2009 payment but did not make the payment due on February 28, 2009. On March 26, 2009, the Company received a written extension for both the February 28, 2009 payment and the March 31, 2009 payment until April 30, 2009.  All additional amounts past due as of December 31, 2008 and additional License and Maintenance Fees of $200,000 which became due the first quarter of 2009  were to be re-negotiated on or before April, 2009, however, this has now been extended to December 31, 2009. (See Note 10) 

At September 30, 2009, the Company owed to Temple University $400,000 for the License Agreements and Maintenance Fees; $376,250 for the R&D Agreement and $76,500 in penalties for a total of $852,750. A penalty equal to 1% of the amount due and unpaid on the first day of each calendar month will be added to the outstanding amount due Temple University.

The Company has provided for all past due amounts in the financial statements at September 30, 2009 and December 31, 2008.  Fees due Temple University as of September 30, 2009 and December 31, 2008 were $852,750 and $716,500, respectively, and are included in accounts payable to Temple University in the accompanying condensed consolidated financial statements.  During the nine months ended September 30, 2009 and 2008, the Company recorded $236,250 and $376,500, respectively, of fees and penalties due to Temple University.  
 
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 the Company, the Company’s former President and then sole director Jeffrey A. Muller, and others, alleging that the Company and the other defendants were engaged in a fraudulent scheme to promote the Company’s stock. The SEC complaint alleged the existence of a promotional campaign using press releases, Internet postings, an elaborate website, and televised media events to disseminate false and materially misleading information as part of a fraudulent scheme to manipulate the market for stock in the Company which was then controlled by Mr. Muller. On March 22, 2002, the Company signed Consent to Final Judgment of Permanent Injunction and Other Relief in settlement of this action as against the corporation only, which the Court approved on July 2, 2002. Under this settlement, the Company was not required to admit fault and did not pay any fines or restitution.
 
On July 2, 2002, after an investigation by the Company’s newly constituted board of directors, the Company filed a cross-complaint in the SEC action against Mr. Muller and others seeking injunctive relief, disgorgement of monies and stock and financial restitution for a variety of acts and omissions in connection with sales of the Company’s stock and other transactions occurring between 1998 and 2002.  Among other things, the Company alleged that Mr. Muller and certain others sold Company stock without providing adequate consideration to the Company; sold insider shares without making proper disclosures and failed to make necessary filing required under federal securities laws; engaged in self-dealing and entered into various undisclosed  related-party transactions; misappropriated for their own use proceeds from sales of the Company’ stock; and entered into various undisclosed arrangement regarding the control, voting and disposition of their stock.
 
On July 30, 2002, the U.S. Federal District Court, Southern District of New York, granted the Company’s application for a preliminary injunction against Mr. Muller and others, which prevented Mr. Muller and other cross-defendants from selling, transferring, or encumbering any assets and property previously acquired from the Company, from selling or transferring any of the Company’s stock that they may have owned or controlled, or from taking any action to injure the Company or the Company’s business and from having any direct contact with the Company’s shareholders. The injunctive order also prevented Mr. Muller or his nominees from engaging in any effort to exercise control over the Company’s corporation and from serving as an officer or director of the Company.  In the course of the litigation, the Company has obtained ownership control over all patent rights to the ZEFS device.
 

27


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

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

The Company has been involved in a dispute with its former Corporate Officer concerning claims in connection with his departure from the Company.  Although the matter is ongoing, the Company has consulted with legal counsel concerning its rights and obligations in responding to the claims.


10.  Subsequent events

The Company has evaluated subsequent events occurring between the end of our fiscal quarter, September 30, 2009 and November 12, 2009.

On November 11, 2009, the Company received from Temple University a written extension of the January 9, 2009 Letter Agreement.  The agreement provides an extension of the $100,000 due to Temple on February 28, 2009 and $100,000 due March 30, 2009 to December 31, 2009.  The Company expects that all payments regarding past due amounts will be renegotiated on or before December 31, 2009.

From October 1, through November 12, 2009, the Company issued 3,667,977 shares of common stock in exchange for the conversion of $847,497 Convertible Notes.


28


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
    
This Quarterly Report on Form 10-Q contains forward-looking statements. These forward-looking statements include predictions regarding our future:
 
revenues and profits;
 
customers;
 
research and development expenses and efforts;
 
scientific and other third-party test results;
 
sales and marketing expenses and efforts;
 
liquidity and sufficiency of existing cash;
 
technology and products;
 
the outcome of pending or threatened litigation; and
 
the effect of recent accounting pronouncements on our financial condition and results of operations
         
You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “expects,” “anticipates,” “believes,” “estimates,” “continues,” or the negative of such terms, or other comparable terminology.

Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2008. 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 condensed consolidated financial condition and condensed consolidated results of operations should be read in conjunction with the condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Form 10-Q and the condensed consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

We are a green technology company that leverages a suite of patented, patent-pending and licensed intellectual properties related to the treatment of fuels. Technologies patented by, or licensed to, us utilize either magnetic or uniform electrical fields to alter physical characteristics of fuels and are designed to create a cleaner combustion. Cleaner combustion has been shown to improve performance, enhance fuel economy and/or reduce harmful emissions in laboratory testing.


29


Our ECO ChargR™ and MAG ChargR™ products use fixed magnetic fields to alter some physical properties of fuel, by incorporating our patented and patent-pending ZEFS and MK IV technologies.  We differentiate ECO ChargR and MAG ChargR products based on their differing attributes and marketing focus. ECO ChargR products are primarily designed to reduce harmful emissions and MAG ChargR products are primarily designed to enhance performance and fuel economy. Our ECO ChargR product is intended to reduce exhaust emissions in vehicle and small utility motors.  ECO ChargR will be marketed primarily to original equipment manufacturers (“OEMs”) as well as to pilot and government-mandated emissions programs.  Our MAG ChargR product is intended to increase power and improve mileage. MAG ChargR will be marketed primarily to the specialty consumer accessories market for many types of vehicles, including but not limited to cars, trucks, motorcycles, scooters, all terrain vehicles (“ATVs”), snowmobiles, personal watercraft and small utility motors.  Because our ECO ChargR and MAG ChargR products are customized to specific brands, models and engine sizes, these products ultimately will require individually developed parts, which can be expensive and time-consuming to produce.  See “Our Technologies and Products” below.

Our first revenues have come from initial sales in Asia for our ECO ChargR product in the motorcycle industry. We plan on commencing sales of ECO ChargR to customers in the United States in the motorcycle industry in the fourth quarter of 2009. We also plan on commencing initial sales of our MAG ChargR product in the United States in the automobile and motorcycle industry in the fourth quarter of 2009.  See “Recent Developments” and “Sales and Marketing” below.
 
We have obtained a license from Temple University for their patent-pending uniform electric field technology, tentatively called ELEKTRA™. The ELEKTRA technology consists of passing fuel through a specific strong electrical field.  Although ELEKTRA has a similar effect on fuels as our ZEFS and MK IV technologies, ELEKTRA incorporates a uniform electrical field principle.  Based on our early research and product development, we believe that ELEKTRA carries certain advantages over our ZEFS and MK IV technologies, primarily not requiring as many variations for products incorporating the ELEKTRA technology compared to products incorporating the ZEFS or MK IV technologies. Preliminary testing conducted in Europe by an outside research and development facility indicates that ELEKTRA causes a significant change in some of the physical characteristics of the fuel, resulting in better atomization of the fuel and improved combustion.

We have also entered into a research and development agreement with Temple University to conduct further research on the ELEKTRA technology and magnetic technologies in general.  Together with Temple University, we have developed prototype products using the ELEKTRA technology and we are continuing testing, and research and development. We are in the early stages of developing ELEKTRA products that, based on the previously mentioned preliminary testing, is intended to improve fuel economy and change fuel viscosity, and may improve performance and reduce emissions, depending upon the specific application. We are also working with Temple and several domestic and international corporations investigating applications of this technology to the transportation industry, oil refineries and pipelines, and OEMs. See “Our Technologies and Products” below.
 
We operate in a highly competitive industry.  Many of our activities may be subject to governmental regulation.  We have taken aggressive steps to protect our intellectual property.
 
There are significant risks associated with our business, our company and our stock. 
 
We are a development stage company that generated its first initial revenues in the fourth quarter of 2006. Our expenses to date have been funded primarily through the sale of stock and convertible debt, as well as proceeds from the exercise of stock purchase warrants. We raised capital in 2008 and the first nine months of 2009 and will need to raise substantial additional capital in the balance of 2009, and possibly beyond, to fund our sales and marketing efforts, continuing research and development, and certain other expenses, until our revenue base grows sufficiently.  
 
Our company was incorporated on February 18, 1998, as a Nevada corporation, under the name Mandalay Capital Corporation. We changed our name to Save the World Air, Inc. on February 11, 1999, following the acquisition of marketing and manufacturing rights of the ZEFS technologies. Our mailing address is 235 Tennant Avenue, Morgan Hill, California 95037. Our telephone number is (408)-778-0101. Our corporate website is www.stwa.com.  Information contained on the website is not deemed part of this Annual Report.
 
Our common stock is quoted on the Over-the-Counter Bulletin Board under the symbol “ZERO.OB”.

Results of Operations

We did not generate any revenue for the three-month period and nine month periods ended September 30, 2009 and 2008.

Operating expenses were $488,281 for the three-month period ended September 30, 2009, compared to $1,148,887 for the three-month period ended September 30, 2008, a decrease of $660,606. This decrease is attributable to decreases in non-cash expenses of $533,238 and cash expenses of $127,368. Specifically, the decrease in non-cash expense is attributable to decreases in valuation of options given as compensation $532,814 and depreciation $424. Specifically, the cash expense decrease is attributable to decreases in consulting and professional fees $107,787, corporate expenses $17,711 and travel expenses $5,608, offset by increases in salaries and benefits $3,335 and miscellaneous office expenses $403.
 
 
30

 
Operating expenses were $1,923,703 for the nine-month period ended September 30, 2009, compared to $2,428,889 for the nine-month period ended September 30, 2008, a decrease of $505,186. This decrease is attributable to a decrease in non-cash expenses of $634,751, offset by an increase in cash expenses of $129,565.  The increase in cash expenses is attributable to increases in salaries and benefits $66,235, consulting and professional fees $56,673 and office and other expenses $31,527, offset by decreases in travel expense $18,437 and corporate expense $6,433.

Research and development expenses were $12,517 for the three-month period ended September 30, 2009, compared to $109,822 for the three-month period ended September 30, 2008, a decrease of $97,305. This decrease is mainly attributable to decreases in product testing, research and supplies $49,555 and contract fees $47,750.

Research and development expenses were $274,577 for the nine-month period ended September 30, 2009, compared to $432,184 for the nine-month period ended September 30, 2008, a decrease of $157,607. This decrease is attributable to decreases in contract fees $140,250 and product testing, research and supplies $17,357.
 
Other expense for the three-month period ended September 30, 2009 were $250,616, compared to $220,430 for the three-month period ended September 30, 2008, an increase of $30,186. This increase is attributable to an increase in non-cash interest expense $22,466 and cash interest expense $7,720.

Other expense for the nine-month period ended September 30, 2009 were $1,084,896, compared to $1,593,940 for the nine-month period ended September 30, 2008, a decrease of $509,044. This decrease is attributable to decreases in non-cash interest expense $559,662 and loss on sale of equipment $9,683, offset by an increase in cash interest expense $7,695 and a   decrease in other income $52,606.
 
We had a net loss of $751,414, or $0.01 per share, for the three-month period ended September 30, 2009, compared to a net loss of $1,479,139, or $0.03 per share, for the three-month period ended September 30, 2008. We had a net loss of $3,283,176, or $0.05 per share, for the nine-month period ended September 30, 2009, compared to a net loss of $4,455,013, or $0.10 per share, for the nine-month period ended September 30, 2008. We expect to incur additional net loss in the fiscal year ending December 31, 2009, primarily attributable to continued operating and marketing-related expenditures without the benefit of any significant revenue for the remainder of the year.
 
Liquidity and Capital Resources

General
 
Since its inception, the Company has been primarily engaged in organizational and pre-operating activities. The Company has generated insignificant revenues and has incurred accumulated losses of $46,026,240 from February 18, 1998 (Inception) through September 30, 2009. As reflected in the accompanying condensed consolidated financial statements, the Company had a net loss of $3,283,176 and a negative cash flow from operations of $1,137,284 for the nine months ended September 30, 2009, and had a working capital deficiency of $4,139,319 and a stockholders' deficiency of $4,021,286 at September 30, 2009.   The Company is currently unable to meet its cash obligations and is in default of certain of its convertible note agreements and its obligations under its license agreements with Temple University.   As a result, the Company's independent registered public accounting firm, in their report on the Company's 2008 consolidated financial statements, raised substantial doubt about the Company's ability to continue as a going concern.

Our operations to date have been funded through issuances of our common stock and convertible notes whereby we raised an aggregate $18,355,017 from February 18, 1998 (inception) through September 30, 2009. Based on our current operating plan, we believe that we do not have sufficient cash and cash equivalents to implement our operating plan. We will need to obtain additional financing in addition to the funds already raised through the sale of equity securities to fund our cash needs and continue our operations. Additional financing, whether through public or private equity or debt financing, arrangements with stockholders or other sources to fund operations, may not be available, or if available, may be on terms unacceptable to us. Our ability to maintain sufficient liquidity is dependent on our ability to raise additional capital. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of our common stock. Debt incurred by us would be senior to equity in the ability of debt holders to make claims on our assets. The terms of any debt issued could impose restrictions on our operations. If adequate funds are not available to satisfy either medium or long-term capital requirements, our operations and liquidity could be materially adversely affected and we could be forced to cut back our operations.


31

 
Details of Recent Financing Transactions

Morale Orchards, LLC and Leodis Matthews

Leodis Matthews, through his law firm, Matthews & Partners, (“Matthews”) serves as outside legal counsel to the Company.  Morale Orchards, LLC (“Morale”) is owned by Jacqueline Alexander, the wife of Leodis Matthews.  
 
In 2006 and 2007, Morale purchased two convertible promissory notes totaling $1,225,000.  The notes were unsecured; convertible into 1,595,588 shares of common stock, due one year from the date issued, and had an implied interest rate of 22.5%.  Warrants to purchase 797,794 shares of common stock were issued with the notes.  As of January 31, 2008, the notes were in default, and the total amount due for the notes was $1,362,212, including penalties and interest.  In addition to the two notes, we borrowed $20,000 from Morale on October 30, 2007.  At January 31, 2008, we were also indebted to Matthews $472,762 for past legal fee.

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

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

The fair value of the shares of common stock issued was determined to be $0.38 per share, based on the closing price of the Company’s common stock on January 31, 2008, for a total settlement of $2,820,320.  As a result of the issuance of shares of common stock, the we incurred additional non-cash costs of $927,903 that have been reflected as costs to settle outstanding debt in the accompanying condensed consolidated statement of operations.
 
2007 Winter Offering.  From December 27, 2007 to February 29, 2008 we conducted an offering (the “2007 Winter Offering”) of up to $1,000,000 aggregate face amount of its convertible notes (the “ 2008 Winter Notes”) with a small number of accredited investors.  Of this amount, $521,400 aggregate face amount of the 2007 Winter Notes were sold for an aggregate purchase price of $474,000 net proceeds.  Therefore, while the stated interest rate on the 2007 Winter Notes is 0%, the implied interest rate on the 2007 Winter Notes is 10%.  The 2007 Winter Notes mature on the first anniversary of their date of issuance.  The 2007 Winter Notes are convertible, at the option of the noteholder, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2007 Winter Offering (the “Conversion Price”).  Up to $1,042,800 Conversion Shares are issuable at a Conversion Price of $0.50 per share.

Each of the investors in the 2007 Winter Offering received, for no additional consideration, a warrant (the “ 2007 Winter Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the (2007 Winter Notes) are convertible (the “2007 Warrant Shares”)  Each  2007 Winter Warrant is exercisable on a cash basis only at a Price of $0.50 per share, and is exercisable for a period of two years from the date of issuance.  Up to 521,400 2008 Warrant Shares are initially issuable on exercise of the 2007 Winter Warrants.  

As of September 30, 2009, investors have converted $521,400 of the Convertible Notes into 1,042,800 shares of the Company’s common stock.  There was no outstanding balance at September 30, 2009.

2008 Spring Offering. On May 27, 2008,  we made an offering (the “2008 Spring Offering”) with a certain investor of which, $66,000 face amount of the 2008 Spring Note was sold for $60,000 net proceeds.  Therefore, while the stated interest rate on the 2008 Spring Note is 0%, the implied interest rate on the 2008 Spring Note is 10%. The 2008 Spring Note will mature on the first anniversary of the date of issuance.  The 2008 Spring Note is convertible, at the option of the noteholder, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2008 Spring Offering (the “Conversion Price”).  The 132,000 Conversion Shares are issuable at a Conversion Price of $0.50 per share.
 
The investor in the 2008 Spring Offering received, for no additional consideration, a warrant (the “ 2008 Spring Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the ( 2008 Spring Notes) are convertible (the “2008 Spring Warrant Shares”).  The 2008 Spring Warrant Shares is exercisable on a cash basis only at a Price of $0.50 per share, and is exercisable for a period of two years from the date of issuance.  The 66,000 2008 Spring Warrant Shares are initially issuable upon exercise of the 2008 Spring Warrants.  

As of September 30, 2009, the investor converted $66,000 of the Convertible Notes into 132,000 shares of the Company’s common stock.  There was no outstanding balance at September 30, 2009.
 
 
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2008 Summer Offering.  From July 17, 2008 to August 31, 2008,  we conducted an offering (the “2008 Summer Offering”) of up to $600,000 aggregate face amount of its convertible notes “the”2008 Summer Offering) with a small number of accredited investors. Of this amount $484,000 aggregate face amount of the 2008 Summer Notes were sold for an aggregate purchase price of $440,000 net proceeds.  Therefore, while the stated interest rate on the 2008 Summer Notes is 0%, the implied interest rate on the 2008 Summer Notes is 10%.  The 2008 Summer Notes will mature on the first anniversary of the date of issuance.  The 2008 Summer Notes are convertible, at the option of the noteholders, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2008 Summer Offering (the “Conversion Price”).  Up to 1,423,530 Conversion Shares are issuable at a Conversion Price of $0.34 per share.

Each of the investors in the 2008 Summer Offering received, for no additional consideration, a warrant (the “ 2008 Summer Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the ( 2008 Summer Notes) are convertible (the “2008 Summer Warrant Shares”). Each 2008 Summer Warrant is exercisable on a cash basis only at a price of $0.50 per share, and is exercisable for a period of two years from the date of issuance.  Up to 711,764, 2008 Summer Warrant Shares are initially issuable upon exercise of the 2008 Summer Warrants.  As of September 30, 2009, investors have converted $143,000 of the Convertible Notes into 420,589 shares of the Company’s common stock.  On September 2, 2009, the Company was in default on the outstanding notes of $341,000. The balance at September was $375,100 which includes the 10% default penalty

2008 Fall Offering.  From September 8, 2008 to October 31, 2008, we conducted an offering (the “2008 Fall Offering”) of up to $500,000 aggregate face amount of its Convertible Notes.  A total of $198,220 aggregate face amount of the 2008 Fall Notes were sold for an aggregate purchase price of $180,200 net proceeds.  Therefore, while the stated interest on the 2008 Fall Notes is 0%, the implied interest rate on the 2008 Fall Notes is 10%.  The 2008 fall notes will mature on the first anniversary of the date of issuance.  The 2008 Fall Notes are convertible, at the option of the noteholders, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2008 Fall Offering (the “Conversion Price”).  Up to 1,321,466 Conversion Shares are issuable at a Conversion Price of $0.15 per share.

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

As of September 30, 2009, investors have converted $70,400 of the Convertible Notes into 469,333 shares of the Company’s common stock.  The outstanding Convertible Note balance at September 30, 2009 was $127,820.

2008 Winter Offering.  From November 24, 2008 to December 5, 2008, we conducted an offering (the “2008 Winter Offering”) of up to $500,000 aggregate face amount of its Convertible Notes.  A total of $524,700 aggregate face amount of the 2008 Winter Notes were sold for an aggregate purchase price of $477,000 net proceeds.  Therefore, while the stated interest on the 2008 Winter Notes is 0%, the implied interest rate on the 2008 Winter Notes is 10%.  The 2008 Winter Notes will mature on the first anniversary of the date of issuance.  The 2008 Winter Notes are convertible, at the option of the noteholders, into shares of common stock of the Company (the “Conversion Shares”) at a conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing date of the 2008 Winter Offering (the “Conversion Price”).  Up to 3,086,470 Conversion Shares are issuable at a Conversion Price of $0.17 per share.
 
Each of the investors in the 2008 Winter Offering received, for no additional consideration, a warrant (the “ 2008 Winter Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the ( 2008 Winter Notes) are convertible (the “2008 Winter Warrant Shares”). Each 2008 Winter Warrant is exercisable on a cash basis only at a price of $0.30 per share, and is exercisable for a period of two years from the date of issuance.  Up to 1,543,235 2008 Winter Warrant Shares are initially issuable upon exercise of the 2008 Winter Warrants.  

As of September 30, 2009, investors have converted $407,000 of the Convertible Notes into 2,394,117 shares of the Company’s common stock.  The outstanding Convertible Note balance at September 30, 2009 was $117,700.

2009 Winter Offering #1.  From January 13, 2009, through January 26, 2009, we conducted and concluded a private offering (the “Winter 2009 Offering”) of up to $250,000 aggregate face amount of its convertible notes (the “Winter 2009 Notes”) with 8 accredited investors. A total of $250,000 aggregate face amount of the Winter 2009 Notes were sold for an aggregate purchase price of $250,000.  The Winter 2009 Notes bear interest at 10% per annum, payable at maturity. The Winter 2009 Notes mature three months from their date of issuance. The Winter 2009 Notes are convertible, at the option of the noteholder, into shares of common stock of the Company (the “Conversion Shares”) at an initial conversion price equal to the average of the closing bid price of the Company’s common stock for the five trading days preceding the closing dates of the Winter 2009 Offering (the “Conversion Price”). Up to 694,444 Conversion Shares are initially issuable at a Conversion Price of $0.36 per share.
 
 
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Each of the investors in the Winter 2009 Offering received, for no additional consideration, a warrant (the “Winter 2009 Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the Winter 2009 Notes are convertible (the “Warrant Shares”).  Each Winter 2009 Warrant is exercisable on a cash basis only at an initial price of $0.50 per share, and is exercisable immediately upon issuance and for a period of two (2) years from the date of issuance. Up to 347,722 Warrant Shares are initially issuable on exercise of the Winter 2009 Warrants.

The aggregate value of the Winter 2009 Offering Warrants issued in connection with the January 26, 2009 closing were valued at $66,178 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 0.85%; dividend yield of 0%; volatility factors of the expected market price of common stock of 151.42%; and an expected life of two years  (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $183,822.  The value of the Winter 2009 Offering Warrants and the beneficial conversion feature are considered as debt discount and were amortized over the life of the notes.

As of September 30, 2009, investors have converted $25,000 of the Convertible Notes into 69,444 shares of the Company’s common stock. As of April 26, 2009, the Company was in default in the amount of $225,000.  The Company has paid $45,352 as a partial redemption of the defaulted convertible notes.  The outstanding balance at September 30, 2009 was $202,148 which includes a 10% default penalty.  The Company is currently negotiating an extension of these outstanding notes.

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

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

 We received $224,820 in net proceeds in the Winter 2009 #2 Offering which will be used for general corporate purposes and working capital.  The aggregate value of the Winter 2009 #2 Offering Warrants issued in connection with the January 26, 2009 closing were valued at $62,028 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 1.03%; dividend yield of 0%; volatility factors of the expected market price of common stock of 156%; and an expected life of two years (statutory term) and vest immediately upon issuance.  We also determined that the notes contained a beneficial conversion feature of $161,792.  The value of the Winter 2009 Offering Warrants, the beneficial conversion feature, and the transaction fees of $22,482 are considered as debt discount and are being amortized over the life of the Note.

As of September 30, 2009, investors have converted $85,800 of the Convertible Notes into 268,125 shares of the Company’s common stock. The outstanding Convertible Note balance at September 30, 2009 was $161,502.

2009 Spring Offering.  From March 17, 2009 through April 30, 2009, we conducted and concluded a private offering (the “Spring 2009 Offering”) of up to $300,000 aggregate face amount of its convertible notes (the “Spring 2009 Notes”) with 11 accredited investors. A total of $181,500 aggregate face amount of the Spring 2009 Notes were sold for an aggregate purchase price of $165,000.  The Spring 2009 Notes mature on the first anniversary of their date of issuance, are convertible, at the option of the noteholder, into up to 672,222 shares of common stock of the Company at a conversion price of $0.27 per share.

Each of the investors in the Spring 2009 Offering received, for no additional consideration, a warrant (the “Spring 2009 Warrants”), entitling the holder to purchase a number of shares of the Company’s common stock equal to 50% of the number of shares of common stock into which the Spring 2009 Notes are convertible (the “Warrant Shares”).  Each Spring 2009 Warrant is exercisable on a cash basis only at an initial price of $0.50 per share, and is exercisable for a period of two years.  Up to 336,111 Warrant Shares are initially issuable on exercise of the Spring 2009 Warrants.
 
 
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We received $165,000 in net proceeds in the Spring 2009 Offering which will be used for general corporate purposes and working capital. The aggregate value of the Spring 2009 Offering Warrants issued in connection with the April 30, 2009 closing were valued at $39,994 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 0.94%; dividend yield of 0%; volatility factors of the expected market price of common stock of 156.39%; and an expected life of two years (statutory term) and vest immediately upon issuance.  We also determined that the notes contained a beneficial conversion feature of $96,827.  The value of the Spring 2009 Offering Warrants, the beneficial conversion feature, and the transaction fees of $16,500 are considered as debt discount and are being amortized over the life of the Note.

As of September 30, 2009, investors have converted $38,500 of the Convertible Notes into 142,590 shares of the Company’s common stock. The outstanding balance at September 30, 2009 was $143,000.

2009 Summer Offering

From June 9, 2009, through September 28, 2009, we conducted and concluded a private offering (the “Summer 2009 Offering”) of up to $500,000 aggregate face amount of our convertible notes (the “Summer 2009 Notes”) with interest compounded quarterly at the annual rate of seven percent (7%) payable at maturity. A total of $467,500 Spring 2000 Notes were sold to 17 accredited investors. The Summer 2009 Notes mature on the second anniversary of the closing of this offering and will be convertible, at the option of the noteholder, into up to 1,870,000 shares of our common stock at a conversion price of $0.25 per share.

Each of the investors in the Summer 2009 Offering will receive, for no additional consideration, a warrant (the “Summer 2009 Warrants”), entitling the holder to purchase a number of shares of our common stock equal to 100% of the number of shares of common stock into which the Summer 2009 Notes are convertible (the “Warrant Shares”).  Each Summer 2009 Warrant is exercisable on a cash basis only at an initial price of $0.30 per share, and is exercisable for a period of thirty six months.  Up to 1,870,000 Warrant Shares are initially issuable on exercise of the Summer 2009 Warrants.

The Company received $467,500 in net proceeds in the Summer 2009 Offering which will be used for general corporate purposes and working capital. The aggregate value of the Summer 2009 Offering Warrants issued in connection with the September 28, 2009 closing were valued at $245,825 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 1.00; dividend yield of 0%; volatility factors of the expected market price of common stock of 147.21%; and an expected life of three years (statutory term) and vest immediately upon issuance.  The Company also determined that the notes contained a beneficial conversion feature of $221,675.  The value of the Summer 2009 Offering Warrants and the beneficial conversion feature are considered as debt discount and are being amortized over the life of the Note.

The outstanding balance at September 30, 2009 was $467,500

Contractual Obligations

The following table discloses our contractual commitments for future periods. Long-term commitments are comprised of operating leases and minimum guaranteed compensation payments under employment and other agreements. (See Note 9 in Notes to Condensed Consolidated Financial Statements).
 
Year ending December 31,
   
Operating
Leases (1)
     
Guaranteed
Payments
     
2009
  $ 10,560     $ 80,400   (2)  
2010
  $ 43,560     $ 207,200   (3)  
2011
  $     $      
                     
    $ 54,120     $ 287,600      

(1) Consists of rent for our Santa Barbara office expiring on December 31, 2010
(2) Consists of total compensation, including base salary and certain contractually-provided benefits, to   two executive officers, pursuant to employment agreements that expire on July 25, 2009 and January 30, 2010.
(3) Consists of an aggregate of $82,200 in total compensation, including base salary and certain contractually provided benefits to one executive officer, pursuant to employment agreement that expires on January 30, 2010 and $125,000 of license and maintenance fees due to Temple University.
 
 
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License agreements with Temple University

In 2007, we entered into three License Agreements with Temple University covering Temple University’s current patent applications concerning certain electric field effects on gasoline, kerosene and diesel fuel particle size distribution, and concerning electric field effects on crude oil and edible oil viscosity.  Initially, the License Agreements are exclusive and the territory licensed to us is worldwide.  Pursuant to the License Agreements, we agreed to pay Temple University license fees in the aggregate amount of $300,000 as follows: $50,000 was due November 1, 2006, $100,000 was due on March 2, 2007, $75, 000 was due February 2, 2008 and $75,000 was due on February 2, 2009.  Annual maintenance fees of $25,000 for the first license were due on November 1, 2007 and November 1, 2008.  Annual maintenance payments of $125,000 for two of the licenses were due January 1, 2008.  In addition, each License Agreement provides that we will pay royalties to Temple University on net sales of products incorporating such licensed technology.
 
We have also entered into a research and development agreement (R&D Agreement) with Temple University to conduct further research on the ELEKTRA technology.  Under the R&D Agreement Temple University will conduct a 24-month research project towards expanding the scope of, and developing products utilizing, the technologies covered under the License Agreements.  Pursuant to the R&D Agreement, we will make payments to Temple University in the aggregate amount of $500,000.

At December 31, 2008, we were in default in the amount of $716,500 under the License Agreements, maintenance fees, R & D Agreement and related penalties.  On January 9, 2009, we entered into a Letter Agreement with Temple University wherein Temple University granted to us an extension of time to cure the above-referenced breaches until March 31, 2009.  The Letter Agreement provides for payments of $100,000 on January 31, 2009, $100,000 on February 28, 2009 and $100,000 on March 31, 2009.  We made the January 31, 2009 payment but did not make the payment due on February 28, 2009.  On March 26, 2009, we received a written extension for both the February 28, 2009 payment and the March 31, 2009 payment until April 30, 2009. All additional amounts past due as of November 10, 2008 were to be re-negotiated on or before March 31, 2009, however, this was   been extended to April 30, 2009. All additional amounts past due as of December 31, 2008 and additional License and Maintenance Fees of $200,000 which became due in the first quarter of 2009 were to be re-negotiated on or before April 30, 2009, however, this has now been extended to December 31, 2009.  A penalty equal to 1% of the amount due and unpaid on the first day of each calendar month will be added to the outstanding amount due Temple University.

Fees due Temple University as of September 30, 2009 and 2008 were $852,750 and $537,750, respectively, and include all past due amounts and related penalties.  During the nine months ended September 30, 2009 and 2008, the Company recorded $236,250, and $376,500, respectively, of fees due to Temple University.  

Critical Accounting Policies and Estimates

Our discussion and analysis of our condensed consolidated 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 condensed consolidated financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going basis, our estimates and judgments, including those related to the useful life of the assets. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the condensed consolidated 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.. For a more detailed discussion of the accounting policies of the Company, see Note 2 of Notes to the condensed consolidated financial statements.

We believe the following critical accounting policies, among others, require significant judgments and estimates used in the preparation of our condensed consolidated 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 condensed consolidated financial statements as described in Note 1 to Notes to condensed consolidated financial statements. Actual results could differ from those estimates

Revenue Recognition
 
The Company recognizes revenue based upon meeting the four criteria pursuant to the authoritative guidance issued by the FASB:

Persuasive evidence of an arrangement exists;
 
Delivery has occurred or services rendered;
 
The seller’s price to the buyer is fixed or determinable; and
 
Collectability is reasonably assured.
   
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We contract with manufactures of fixed magnetic field products and sell them to various original equipment manufacturers in the motor vehicle and small utility motor markets. We negotiate an initial contract with the customer fixing the terms of the sale and then receives a letter of credit or full payment in advance of shipment. Upon shipment, we recognize the revenue associated with the sale of the products to the customer.
 
Estimates

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

Impairment of long-lived assets

Our long-lived assets, such as property and equipment, are reviewed for impairment when events and circumstances indicate that depreciable or amortizable long lived assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of those assets. When specific assets are determined to be unrecoverable, the cost basis of the asset is reduced to reflect the current value.

We use various assumptions in determining the current fair value of these assets, including future expected cash flows and discount rates, as well as other fair value measures. Our impairment loss calculations require us to apply judgment in estimating future cash flows, including forecasting useful lives of the assets and selecting the discount rate that reflects the risk inherent in future cash flows.

If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to future impairment losses that could be material to our results.  No impairments were recorded for the nine months ended September 30, 2009.  We recorded an impairment of approximately $505,000 during the period from inception (February 18, 1998) through September 30, 2009.

Stock-Based Compensation

The Company periodically issues stock options and warrants to employees and non-employees in capital raising transactions, for services and for financing costs.  Stock-based compensation is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period.  Options vest and expire according to terms established at the grant date.

Recent Accounting Pronouncements

In June 2009, the FASB issued authoritative guidance on accounting standards codification and the hierarchy of generally accepted accounting principles.” The FASB Accounting Standards Codification™ (“Codification”) has become the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with GAAP. All existing accounting standard documents are superseded by the Codification and any accounting literature not included in the Codification will not be authoritative. However, rules and interpretive releases of the Securities Exchange Commission (“SEC”) issued under the authority of federal securities laws will continue to be sources of authoritative GAAP for SEC registrants. The FASB authoritative guidance is effective for interim and annual reporting periods ending after September 15, 2009. Therefore, beginning with our quarter ending September 30, 2009, all references made by it to GAAP in its consolidated financial statements now use the new Codification numbering system. The Codification does not change or alter existing GAAP and, therefore, it does not have an impact on our financial position, results of operations and cash flows.
 
On July 1, 2009, the Company adopted authoritative guidance issued by the FASB on business combinations. The guidance retains the fundamental requirements that the acquisition method of accounting (previously referred to as the purchase method of accounting) be used for all business combinations, but requires a number of changes, including changes in the way assets and liabilities are recognized and measured as a result of business combinations. It also requires the capitalization of in-process research and development at fair value and requires the expensing of acquisition-related costs as incurred. We have applied this guidance to business combinations completed since July 1, 2009.  Adoption of the new guidance did not have a material impact on our financial statements.
 
 
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In October 2009, the FASB issued authoritative guidance on revenue recognition that will become effective for the Company beginning July 1, 2010, with earlier adoption permitted.  Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance.  We believe adoption of this new guidance will not have a material impact on our financial statements.
 
In May 2009, the FASB issued new requirements for reporting subsequent events. These requirements set forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and disclosures that an entity should make about events or transactions that occurred after the balance sheet date. Disclosure of the date through which an entity has evaluated subsequent events and the basis for that date is also required.
 
Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed by management to have a material impact on the Company's present or future consolidated financial statements.


Item 3. Quantitative and Qualitative Disclosure about Market Risk

The Company is a smaller reporting company and is not required to provide the information required by this.
 
 
Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management evaluated, with the participation of our Chief Executive Officer and Interim Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Interim Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)  were ineffective as of September 30, 2009, due to the material weaknesses in our internal control over financial reporting described below.
 
Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.  Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including our Chief Executive Officer and Interim Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.  Internal control consists of procedures which are designed with the objective of providing reasonable assurance that our transactions are properly authorized, recorded and reported and our assets are safeguarded against unauthorized or improper use, to permit the preparation of our financial statements in conformity with generally accepted accounting principles.
 
We identified certain matters that constitute material weakness (as defined under the Public Company Accounting Oversight Board Auditing Standard No. 2) in our internal control over financial reporting as discussed on Management’s Annual Report on Internal Control Over Financial Reporting below.
 
In light of the material weaknesses in internal control over financial reporting described below, we performed additional analysis and other post-closing procedures to ensure that our financial statements were prepared in accordance with generally accepted accounting principles.  Despite material weaknesses in our internal control over financial reporting, we believe that the financial statements included in our Form 10-Q for the period ended September 30, 2009 fairly present, in all material respects, our financial condition, results of operations, changes in shareholder’s equity and cash flows for the periods presented.
 
Management’s Annual Report on Internal Control over Financial Reporting.
 
 
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Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transaction and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. 
 
Because of its inherent limitation, internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives. 
 
Our Chief Executive Officer, Interim Chief Financial Officer and Controller conducted an assessment of the effectiveness of our internal control over financial reporting as of September 30, 2009 based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).  A material weakness is a deficiency or a combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
 
Based on that assessment, we have identified the following material weaknesses and have implemented the following remediation of material weaknesses in internal control over financial reporting:
 
Lack of segregation of duties
 
We have limited staff in our corporate offices and, as such, there is a lack of segregation of duties.  In December 2006 our Controller retired and in January 2007 our Chief Financial officer retired due to medical problems.  We have subsequently hired an Interim Chief Financial Officer and a full-time Controller and our former Controller provides certain financial consulting services.
 
Lack of documented and reviewed system of internal control
 
We have an internal control weakness due to the lack of a documented and reviewed system of internal control.  We have determined that to perform the processes and remediate this internal control deficiency, we will either need to engage an internal control consultant or reassign existing personnel.  We have started to enhance some of our key internal control systems surrounding inventory purchasing and control, and to document those changes; however, this process is on-going and the implementation of policies and procedures may take several quarters.
 
As a result of the material weaknesses described above, management concluded that, as of September 30, 2009, we did not maintain effective internal control over financial reporting based on the criteria established in Internal Control – Integrated Framework, issued by COSO.
 
We have retained a consulting firm and are conducting an evaluation to design and implement adequate systems of accounting and financial statement disclosure controls. We expect to complete a review during 2009 to comply with the requirements of the SEC, which as required by SEC rules, will include an opinion from our auditors regarding management’s report on internal control over financial reporting for our fiscal year ending 2010.  We believe that the ultimate success of our plan to improve our internal control over financial reporting will require a combination of additional financial resources, outside consulting services, legal advice, additional personnel, further reallocation of responsibility among various persons, and substantial additional training of those of our officers, personnel and others, including certain of our directors such as our Chairman of the Board and committee chairs, who are charged with implementing and/or carrying out our plan.  It should also be noted that the design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. 
 
In addition, our management with the participation of our Chief Executive Officer and Interim Chief Financial Officer have determined that no change in our internal control over financial reporting (as that term is defined in Rules 13(a)-15(f) and 15(d)-15(f) of the Securities Exchange Act of 1934) occurred during or subsequent to the quarter ended September 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
 
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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 the Company, the Company’s former President and then sole director Jeffrey A. Muller, and others, alleging that the Company and the other defendants were engaged in a fraudulent scheme to promote the Company’s stock. The SEC complaint alleged the existence of a promotional campaign using press releases, Internet postings, an elaborate website, and televised media events to disseminate false and materially misleading information as part of a fraudulent scheme to manipulate the market for stock in the Company which was then controlled by Mr. Muller. On March 22, 2002, the Company signed a Consent to Final Judgment of Permanent Injunction and Other Relief in settlement of this action as against the corporation only, which the Court approved on July 2, 2002. Under this settlement, the Company was not required to admit fault and did not pay any fines or restitution.
 
On July 2, 2002, after an investigation by the Company’s newly constituted board of directors, the Company filed a cross-complaint in the SEC action against Mr. Muller and others seeking injunctive relief, disgorgement of monies and stock and financial restitution for a variety of acts and omissions in connection with sales of the Company’s stock and other transactions occurring between 1998 and 2002.  Among other things, the Company alleged that Mr. Muller and certain others sold Company stock without providing adequate consideration to the Company; sold insider shares without making proper disclosures and failed to make necessary filing required under federal securities laws; engaged in self-dealing and entered into various undisclosed  related-party transactions; misappropriated for their own use proceeds from sales of the Company’ stock; and entered into various undisclosed arrangement regarding the control, voting and disposition of their stock.
 
On July 30, 2002, the U.S. Federal District Court, Southern District of New York, granted the Company’s application for a preliminary injunction against Mr. Muller and others, which prevented Mr. Muller and other cross-defendants from selling, transferring, or encumbering any assets and property previously acquired from the Company, from selling or transferring any of the Company’s stock that they may have owned or controlled, or from taking any action to injure the Company or the Company’s business and from having any direct contact with the Company’s shareholders. The injunctive order also prevented Mr. Muller or his nominees from engaging in any effort to exercise control over the Company’s corporation and from serving as an officer or director of the Company.
 
In the course of the litigation, the Company has obtained ownership control over all patent rights to the ZEFS device.
 
On January 4, 2007, the Court entered a final judgment against Jeffrey Muller which barred Mr. Muller from serving as an officer or director of a public company for a period of 20 years, ordered Mr. Muller to disgorge any shares of the Company’s stock that he still owns and directed the Company to cancel any issued and outstanding shares of the Company’s stock still owned by Mr. Muller. Mr. Muller was also ordered to disgorge unlawful profits in the amount of $7.5 million and to pay a civil penalty in the amount of $100,000.  Acting in accordance with the ruling and decision of the Court, the Company has canceled (i) 8,047,403 shares of common stock that had been held by Mr. Muller and/or his affiliates, (ii) options to acquire an additional 10,000,000 shares of the Company’s common stock held by Mr. Muller personally and (iii) $1,017,208 of debt which Mr. Muller claimed was owed to him by the Company.  After an appeal filed by Mr. Muller was dismissed the Judgment against him is considered final.

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

The Company has been involved in a dispute with it’s former Corporate Officer concerning claims in connection with his departure from the Company.  Although the matter is ongoing, the Company has consulted with legal counsel concerning its rights and obligations in responding to the claims


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Item 1A.  Risk Factors
 
There have been no material changes in the risk factors previously disclosed in Form 10-K for the period ended December 31, 2008, we filed with the SEC on March 31, 2009.
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

Morale Orchards Transaction
 
On December 5, 2006, we entered into a Note Purchase Agreement (the “Note Purchase Agreement”) with Morale Orchards, LLC (“Morale”). The Note Purchase Agreement provides that Morale will purchase the Company’s one-year Convertible Promissory Notes in the aggregate face amount of $1,225,000 (the “Morale Notes”), and five-year Warrants (the “Morale Warrants”) to purchase shares of our Common Stock at prices ranging from $0.70 to $0.85 per share. The aggregate purchase price for the Morale Notes and Morale Warrants is $1,000,000. Therefore, while the stated interest on the Morale Notes is 0%, the actual interest rate is 22.5% because the Morale Notes are being purchased at a discount from their face amount.

Pursuant to the terms of the Note Purchase Agreement, Morale purchased one Morale Note in the principal amount of $612,500 on December 5, 2006, for which it paid $500,000 and purchased the other Morale Note in the principal amount of $612,500 on January 10, 2007, for which it paid $500,000.  The December 5, 2006 Note is convertible into 720,588 shares of our common stock and 360,294 Warrants to purchase our common stock were issued.  The January 10, 2007 Note is convertible into 875,000 shares of our common stock and 437,500 Warrants to purchase our common stock were issued.  (See “Details of Recent Financing Transactions”).
 
On January 31, 2008, a Modification and Satisfaction Agreement was entered into between the Company, Morale Orchards, LLP and Matthews & Partners.  (See “Details of Recent Financing Transactions”).
 
2007 Winter Offering

From December 27, 2008 through February 29, 2008, we conducted a private offering (the “2007 Winter Offering”) and issued Convertible Notes in the aggregate face amount of $521,400.  These Notes were sold for an aggregate purchase price of $474,000 net proceeds.  The Notes are convertible into 1,042,800 shares of our common stock and in addition, investors received warrants entitling the holders to purchase up to 521,400 shares of our common stock.  (See “Details of Recent Financing Transactions”).

2008 Spring Offering

On May 27, 2008 we conducted a private offering (the “2008 Spring Offering”) and issued a Convertible Note in the aggregate face amount of $66,000.  This note was sold for an aggregate purchase price of $60,000 net proceeds.  The Note is convertible in to 132,000 shares of our common stock and in addition, the investor received warrants entitling the holder to purchase up to 66,000 shares of our common stock.  (See “Details of Recent Financing Transactions”).

2008 Summer Offering

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


2008 Winter Offering

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

2009 Winter Offering I

From January 13, 2009 through January 26, 2009, we conducted a private offering (the “2009 Winter Offering I”) and issued Convertible Notes in the aggregate face amount of $250,000.  These Notes were sold for an aggregate purchase price of $250,000 net proceeds.  The Notes are convertible into 699,444 shares of our common stock and in addition, investors received warrants entitling the holders to purchase up to 347,722 shares of our common stock.  (See “Details of Recent Financing Transactions”).
 
 
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2009 Winter Offering II

From February 4, 2009 through March 11, 2009, we conducted a private offering (the “2009 Winter Offering  II”) and issued Convertible Notes in the aggregate face amount of $247,302.  These Notes were sold for an aggregate purchase price of $224,820 net proceeds.  The Notes are convertible into 772,818 shares of our common stock and in addition, investors received warrants entitling the holders to purchase up to 386,409 shares of our common stock.  (See “Details of Recent Financing Transactions”).

2009 Spring Offering

From March 17, 2009 through April 30, 2009, we conducted a private offering (the “2009 Spring”) and issued Convertible Notes in the aggregate face amount of $181,500.  These Notes were sold for an aggregate purchase price of $165,000 net proceeds.  The Notes are convertible into 672,222 shares of our common stock and in addition, investors received warrants entitling the holders to purchase up to 336,111 shares of our common stock.  (See “Details of Recent Financing Transactions”).

2009 Summer Offering

From June 9, 2009 through September 28, 2009, we conducted a private offering (the “2009 Summer”) and issued Convertible Notes in the aggregate face amount of $467,500.  These Notes were sold for an aggregate purchase price of $467,500 net proceeds.  The Notes are convertible into 1,870,000 shares of our common stock and in addition, investors received warrants entitling the holders to purchase up to 1,870,000 shares of our common stock.  (See “Details of Recent Financing Transactions”).

The sales of the securities 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 (the “Act”), or Regulations D or S promulgated thereunder.

Other Issuances.

During the nine months ended September 30, 2009, we issued 2,165,026 shares of common stock in exchange for conversion of $460,129 of Convertible Notes.

During the nine months ended September 30, 2009, we granted 340,000 shares of common stock in exchange for consulting services in the amount of $137,500.

During the nine months ended September 30, 2009, we granted 430,370 shares of common stock in settlement of accounts payable of $104,414.

During the nine months ended September 30, 2009, we issued 83,333 shares of common stock upon exercise of options @ $0.27 per share and valued at $22,500.


Item 3. Defaults Upon Senior Securities

None
 
 
Item 4. Submission of Matters to a Vote of Security Holders

None
 
 
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Item 5. Other Information

We have evaluated subsequent events occurring between the end of our fiscal quarter, September 30, 2009 and November 12, 2009.

On November 11, 2009, we received from Temple University a written extension of the January 9, 2009 Letter Agreement.  The agreement provides an extension of the $100,000 due to Temple on February 28, 2009 and $100,000 due March 30, 2009 to December 31, 2009.  We expect that all payments regarding past due amounts will be renegotiated on or before December 31, 2009.

From October 1, through November 12, 2009, we issued 3,667,977 shares of common stock in exchange for the conversion of $847,497 Convertible Notes.

 
Item 6. Exhibits
 
Exhibit No.
 
 
Description
       
 
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 Interim Chief Financial Officer of Quarterly Report pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
 
 
32
 
Certification of Chief Executive Officer and Interim Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C. Section 1350
 
 
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SIGNATURES
 
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this Report to be signed on its behalf by the undersigned, hereunto duly authorized.
 
 
 
SAVE THE WORLD AIR, INC.  
 
     
     
Date: November 14, 2009 
By:
/s/ EUGENE E. EICHLER
 
   
Eugene E. Eichler 
 
   
Interim Chief Financial Officer 
 
 
 

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EXHIBIT INDEX
 
 
 
 
Exhibit No.
 
 
Description
       
 
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 Interim Chief Financial Officer of Quarterly Report Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
       
 
32
 
Certification of Chief Executive Officer and Interim Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C. Section 1350
 
 
45