QS Energy, Inc.

Regulatory Filings • Jun 7, 2004

10QSB 1 v97961e10qsb.htm FORM 10QSB - PERIOD ENDED JUNE 30,2003 SAVE THE WORLD AIR INC PAGEBREAK

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

FORM 10-QSB

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

Commission File Number 0-29185

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

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

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

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

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

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SAVE THE WORLD AIR, INC.

FORM 10-QSB

INDEX

PART I
ITEM 1	Financial
Statements	2
ITEM 2	Management’s
Discussion and Analysis	21
ITEM 3	Controls
and Procedures	27
PART II
ITEM 1	Legal
Proceedings	27
ITEM 2	Changes in
Securities	28
ITEM 6	Exhibits and Reports on Form 8-K	29
SIGNATURES		30
EXHIBIT
INDEX		31
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

/TOC

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PART I

Item 1. Financial Statements

CONTENTS

Financial statements
Balance
sheets	3-4
Statements
of operations	5
Statements
of stockholders’ deficiency	6-8
Statements
of cash flows	9-10
Notes
to financial statements	11-20

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

BALANCE SHEETS JUNE 30, 2003 AND DECEMBER 31, 2002

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

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

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

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

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

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

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

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SAVE THE WORLD AIR, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

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

share	Shares		Amount	Common stock — to be issued	Additional paid-in — capital	Deferred — compensation	Deficit accumulated during the — development stage	stage deficiency
Balance, February 18, 1998 (date of inception)		—	$ —	$ —	$ —	$ —	$ —	$	—
Issuance of common stock on April 18, 1998	.0015 – .01	10,030,000	10,030	—	14,270	—	—		24,300
Net loss		—	—	—	—	—	(21,307	)	(21,307	)
Balance, December 31, 1998 (as corrected, see Note 1)		10,030,000	10,030		14,270	—	(21,307	)	2,993
Issuance of common stock on May 18, 1999	1.00 – 6.40	198,003	198	—	516,738	—	—		516,936
Issuance of common stock for ZEFS on September 14, 1999	.001	5,000,000	5,000	—	—	—	—		5,000
Stock issued for professional services on May 18, 1999	0.88	69,122	69	—	49,444	—	—		49,513
Net loss		—	—	—	—	—	(1,075,264	)	(1,075,264	)
Balance, December 31, 1999 (as corrected, see Note 1)		15,297,125	15,297	—	580,452	—	(1,096,571	)	(500,822	)
Stock issued for employee compensation on February 8, 2000	1.03	20,000	20	—	20,580	—	—		20,600
Stock issued for consulting services on February 8, 2000	1.03	100,000	100	—	102,900	—	—		103,000
Stock issued for professional services on April 18, 2000	3.38	27,000	27	—	91,233	—	—		91,260
Stock issued for directors fees on April 18, 2000	3.38	50,000	50	—	168,950	—	—		169,000
Stock issued for professional services on May 19, 2000	4.06	5,000	5	—	20,295	—	—		20,300
Stock issued for directors fees on June 20, 2000	4.44	6,000	6	—	26,634	—	—		26,640
Stock issued for professional services on June 20, 2000	4.44	1,633	2	—	7,249	—	—		7,251
Stock issued for professional services on June 26, 2000	5.31	1,257	1	—	6,674	—	—		6,675
Stock issued for employee compensation on June 26, 2000	5.31	22,000	22	—	116,798	—	—		116,820
Stock issued for consulting services on June 26, 2000	5.31	9,833	10	—	52,203	—	—		52,213
Stock issued for promotional services on July 28, 2000	4.88	9,675	9	—	47,205	—	—		47,214
Stock issued for consulting services on July 28, 2000	4.88	9,833	10	—	47,975	—	—		47,985
Stock issued for consulting services on August 4, 2000	2.13	35,033	35	—	74,585	—	—		74,620
Stock issued for promotional services on August 16, 2000	2.25	25,000	25	—	56,225	—	—		56,250
Stock issued for consulting services on September 5, 2000	2.25	12,833	13	—	28,861	—	—		28,874
Stock issued for consulting services on September 10, 2000	1.50	9,833	10	—	14,740	—	—		14,750
Stock issued for consulting services on November 2, 2000	0.88	9,833	10	—	8,643	—	—		8,653
Stock issued for consulting services on November 4, 2000	0.88	9,833	10	—	8,643	—	—		8,653
Stock issued for consulting services on December 20, 2000	0.50	19,082	19	—	9,522	—	—		9,541

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

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

share	Shares		Amount		to be issued	capital		compensation		development stage		stage deficiency
Stock issued for filing services on December 20, 2000	0.50	5,172		5		—	2,581		—		—		2,586
Stock issued for professional services on December 26, 2000	0.38	12,960		13		—	4,912		—		—		4,925
Other stock issuance on August 24, 2000	2.13	2,000		2		—	4,258		—		—		4,260
Common shares cancelled		(55,000	)	(55	)	—	(64,245	)	—		—		(64,300	)
Net loss		—		—		—	—		—		(1,270,762	)	(1,270,762	)
Balance, December 31, 2000 (as corrected, see Note 1)		15,645,935		15,646		—	1,437,873		—		(2,367,333	)	(913,814	)
Stock issued for consulting services on January 8, 2001	0.31	9,833		10		—	3,038		—		—		3,048
Stock issued for consulting services on February 1, 2001	0.33	9,833		10		—	3,235		—		—		3,245
Stock issued for consulting services on March 1, 2001	0.28	9,833		10		—	2,743		—		—		2,753
Stock issued for legal services on March 13, 2001	0.32	150,000		150		—	47,850		—		—		48,000
Stock issued for consulting services on April 3, 2001	0.25	9,833		10		—	2,448		—		—		2,458
Stock issued for legal services on April 4, 2001	0.25	30,918		31		—	7,699		—		—		7,730
Stock issued for professional services on April 4, 2001	0.25	7,040		7		—	1,753		—		—		1,760
Stock issued for consulting services on April 5, 2001	0.25	132,600		132		—	33,018		—		—		33,150
Stock issued for filing fees on April 30, 2001	1.65	1,233		1		—	2,033		—		—		2,034
Stock issued for filing fees on September 19, 2001	0.85	2,678		2		—	2,274		—		—		2,276
Stock issued for professional services on September 28, 2001	0.62	150,000		150		—	92,850		—		—		93,000
Stock issued for directors services on October 5, 2001	0.60	100,000		100		—	59,900		—		—		60,000
Stock issued for legal services on October 17, 2001	0.60	11,111		11		—	6,655		—		—		6,666
Stock issued for consulting services on October 18, 2001	0.95	400,000		400		—	379,600		—		—		380,000
Stock issued for consulting services on October 19, 2001	1.25	150,000		150		—	187,350		—		—		187,500
Stock issued for exhibit fees on October 22, 2001	1.35	5,000		6		—	6,745		—		—		6,751
Stock issued for directors services on November 2, 2001	0.95	1,000,000		1,000		—	949,000		—		—		950,000
Stock issued for consulting services on November 7, 2001	0.85	20,000		20		—	16,980		—		—		17,000
Stock issued for consulting services on November 20, 2001	0.98	43,000		43		—	42,097		—		—		42,140
Stock issued for consulting services on November 27, 2001	0.98	10,000		10		—	9,790		—		—		9,800
Stock issued for consulting services on November 28, 2001	0.98	187,000		187		—	183,073		—		—		183,260
Intrinsic value of options issued to employees		—		—		—	2,600,000		(2,600,000	)	—		—

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

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

| share | Shares | | Amount | Common stock — to be issued | capital | | compensation | | | Deficit accumulated during the — development stage | | Total
stockholders’ development — stage deficiency | |
| --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- | --- |
| Fair value of options issued to non-employees for services | | — | — | — | | 142,318 | | — | | — | | 142,318 | |
| Amortization of deferred compensation | | — | — | — | | — | | 191,667 | | — | | 191,667 | |
| Net loss | | — | — | — | | — | | — | | (2,735,013 | ) | (2,735,013 | ) |
| Balance, December 31, 2001 | | 18,085,847 | 18,086 | — | | 6,220,322 | | (2,408,333 | ) | (5,102,346 | ) | (1,272,271 | ) |
| Stock issued for directors services on December 10, 2002 | 0.40 | 2,150,000 | 2,150 | — | | 857,850 | | — | | — | | 860,000 | |
| Common stock paid for, but not issued (2,305,000 shares) | 0.15-0.25 | — | — | 389,875 | | — | | — | | — | | 389,875 | |
| Fair value of options issued to non-employees for services | | — | — | — | | 54,909 | | (54,909 | ) | — | | — | |
| Amortization of deferred compensation | | — | — | — | | — | | 891,182 | | — | | 891,182 | |
| Net loss | | — | — | — | | — | | — | | (2,749,199 | ) | (2,749,199 | ) |
| Balance, December 31, 2002 | | 20,235,847 | 20,236 | 389,875 | | 7,133,081 | | (1,572,060 | ) | (7,851,545 | ) | (1,880,413 | ) |
| Common stock issued, previously paid for | 0.15 | 1,425,000 | 1,425 | (213,750 | ) | 212,325 | | — | | — | | — | |
| Common stock issued, previously paid for | 0.25 | 880,000 | 880 | (220,000 | ) | 219,120 | | — | | — | | — | |
| Stock issued for cash on March 20, 2003 | 0.25 | 670,000 | 670 | — | | 166,830 | | — | | — | | 167,500 | |
| Stock issued for cash on April 4, 2003 | 0.25 | 900,000 | 900 | — | | 224,062 | | — | | — | | 224,962 | |
| Stock issued for cash on April 8, 2003 | 0.25 | 100,000 | 100 | — | | 24,900 | | — | | — | | 25,000 | |
| Stock issued for cash on May 8, 2003 | 0.25 | 1,150,000 | 1,150 | — | | 286,330 | | — | | — | | 287,480 | |
| Stock issued for cash on June 16, 2003 | 0.25 | 475,000 | 475 | — | | 118,275 | | — | | — | | 118,750 | |
| Stock issued for legal services on June 27, 2003 | 0.55 | 83,414 | 83 | — | | 45,794 | | — | | — | | 45,877 | |
| Debt converted to stock on June 27, 2003 | 0.25 | 2,000,000 | 2,000 | — | | 498,000 | | — | | — | | 500,000 | |
| Finders fees related to stock issuances | | — | — | 43,875 | | (153,509 | ) | — | | — | | (109,634 | ) |
| Common stock paid for, but not issued | | — | — | 150,000 | | — | | — | | — | | 150,000 | |
| Amortization of deferred comp | | — | — | — | | — | | 438,727 | | — | | 438,727 | |
| Net loss for six months ended June 30, 2003 | | — | — | — | | — | | — | | (1,046,670 | ) | (1,046,670 | ) |
| Balance, June 30, 2003 | | 27,919,261 | $ 27,919 | $ 150,000 | $ | 8,775,208 | $ | (1,133,333 | ) | $ (8,898,215 | ) | $ (1,078,421 | ) |

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

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

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

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

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

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

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

NOTES TO FINANCIAL STATEMENTS QUARTER ENDED JUNE 30, 2003

1. Organization and basis of presentation

Basis of presentation

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

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

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

1. Organization and basis of presentation - Continued

Description of business

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

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

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

1. Organization and basis of presentation - Continued

Significant matters — Continued

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

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

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

1. Organization and basis of presentation - Continued

Significant matters — Continued

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

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

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

1. Organization and basis of presentation - Continued

Development stage enterprise

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

1. Net loss per share

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

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

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

1. New accounting pronouncements

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

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

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

1. New accounting pronouncements - Continued

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

1. Certain relationships and related transactions

Due to founding executive officer

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

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

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

1. Certain relationships and related transactions - Continued

Due to founding executive officer — Continued

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

Due to related parties

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

1. Stockholders’ deficiency

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

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

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

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

1. Stock warrants

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

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

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

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

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

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

1. Going concern

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying financial statements, the company has a net loss of $1,046,670, a negative cash flow from operations of $632,778 and a stockholders’ deficiency of $1,078,421. These factors raise substantial doubt about its ability to continue as a going concern. The ability to the Company to continue as a going concern is dependent on the company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the company is unable to continue as a going concern.

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Item 2. Management’s Discussion and Analysis

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

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

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

Such statements, which include statements concerning future revenue sources and concentration, selling, general and administrative expenses, research and development expenses, capital resources, additional financings and additional losses, are subject to risks and uncertainties, including, but not limited to, those discussed elsewhere in this Form 10-QSB, that could cause actual results to differ materially from those projected.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the heading “Risk Factors.” In our Annual Report on Form 10-KSB for the year ended December 31, 2002. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements.

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

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Overview

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

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

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

Results of Operation

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

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

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

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

Liquidity and Capital Resources

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

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

Capitalization

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

Critical Accounting Policies

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

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

Stock-Based Compensation

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

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

Estimates

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

New Accounting Pronouncements

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

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

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Item 3. Controls and Procedures

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

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

PART II

Item 1. Legal Proceedings

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

On July 2, 2002, after an investigation by our newly constituted board of directors, we filed a cross-complaint in the SEC action against Mr. Muller and others seeking injunctive relief, disgorgement and financial restitution for a variety of acts and omissions in connection with sales of our stock and other transactions occurring between 1998 and 2002. We are also seeking cancellation of such shares and Mr. Muller’s stock option agreement and royalty arrangement. Among other things, we allege that Mr. Muller and certain others sold stock without consideration and without registration under federal securities laws; engaged in self-dealing and entered into various undisclosed related-party transactions; misappropriated for their own use proceeds from sales of our stock; and entered into various undisclosed arrangements regarding the control, voting and disposition of their stock.

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

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

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

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Item 2. Changes in Securities

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

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Item 6. Exhibits and Reports on Form 8-K

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

Exhibit No.	Description
3.1(1)	Articles of Incorporation, as amended, of the Registrant.
3.2(1)	Bylaws of the Registrant.
10.1(4)	Commercial Sublease between the Registrant and KZ Golf, Inc., dated October 16, 2003.
10.2(4)	General Tenancy Agreement between the Registrant and Autumlee Pty Ltd., dated November 15, 2003.
10.3(2)	Agreement between the Registrant and RAND, dated December 13, 2002.
10.4(4)*	Agreement between the Registrant and RAND, dated May 7, 2003.
10.5(3)	Deed and Document Conveyance between the Trustee of the Property of Jeffrey Ann Muller and Lynette Anne Muller (Bankrupts).
10.5(3)	Assignment and Bill of Sale between Pro Hart and the Registrant dated May 28, 2002.
31.1	Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).
31.2	Certification of Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C. Section 1350.
32	Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).

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

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

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

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SIGNATURES

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

/s/ Edward L. Masry
Edward L. Masry Chief Executive Officer

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Table of Contents

EXHIBIT INDEX

Exhibit No.	Description
3.1(1)	Articles of Incorporation, as amended, of the Registrant.
3.2(1)	Bylaws of the Registrant.
10.1(4)	Commercial Sublease between the Registrant and KZ Golf, Inc., dated October 16, 2003.
10.2(4)	General Tenancy Agreement between the Registrant and Autumlee Pty Ltd., dated November 15, 2003.
10.3(2)	Agreement between the Registrant and RAND, dated December 13, 2002.
10.4(4)*	Agreement between the Registrant and RAND, dated May 7, 2003.
10.5(3)	Deed and Document Conveyance between the Trustee of the Property of Jeffrey Ann Muller and Lynette Anne Muller (Bankrupts).
10.6(3)	Assignment and Bill of Sale between Pro Hart and the Registrant dated May 28, 2002.
31.1	Certification of Chief Executive Officer of Quarterly Report Pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).
31.2	Certification of Chief Financial Officer of Quarterly Report Pursuant to 18 U.S.C. Section 1350.
32	Certification of Chief Executive Officer and Chief Financial Officer of Quarterly Report pursuant to Rule 13(a)–15(e) or Rule 15(d)–15(e).

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

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