QS Energy, Inc.

Regulatory Filings • Nov 14, 2005

10QSB 1 v14370e10qsb.htm SAVE THE WORLD AIR, INC. - SEPTEMBER 30, 2005 e10qsb PAGEBREAK

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

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

*For the quarterly period ended September 30, 2005.*

or

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

For the transition period from to

Commission File Number 0-29185

SAVE THE WORLD AIR, INC.

(Exact name of registrant as specified in its charter)

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

5125 Lankershim Boulevard North Hollywood, California 91601 (Address, including zip code, of principal executive offices) (818) 487-8000 (Registrant’s telephone number, including area code)

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The number of shares of the Registrant’s Common Stock outstanding as of September 30, 2005 was 39,354,821 shares.

Transitional Small Business Disclosure Format (Check one): Yes o No þ

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SAVE THE WORLD AIR, INC.

FORM 10-QSB INDEX

PART I
ITEM 1. Financial Statements	1
Condensed balance sheets	2
Condensed statements of operations (unaudited)	3
Condensed statements of changes in stockholders’ deficiency (unaudited)	4
Condensed statements of cash flows (unaudited)	9
Notes to condensed financial statements (unaudited)	11
ITEM 2. Management’s Discussion and Analysis or Plan of Operations	24
ITEM 3. Controls and Procedures	28
PART II
ITEM 1. Legal Proceedings	28
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds	30
ITEM 3. Defaults Upon Senior Securities	31
ITEM 4. Submission of Matters to a Vote of Security Holders	31
ITEM 5. Other Information	31
ITEM 6. Exhibits	31
SIGNATURES	32
EXHIBIT INDEX	33
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 10.4
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 31.1
Exhibit 31.2
Exhibit 32

/TOC

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PART I

Item 1. Financial Statements.

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

CONDENSED BALANCE SHEETS SEPTEMBER 30, 2005 (UNAUDITED) AND DECEMBER 31, 2004

	Sept. 30, 2005	December 31,
	(unaudited)	2004
ASSETS
Current assets
Cash	$ 429,754	$ 84,826
Other current assets	—	2,602
Total current assets	429,754	87,428
Property and equipment , net of accumulated depreciation	53,868	35,596
Other assets	4,500	—
	$ 488,122	$ 123,024

See notes to condensed financial statements.

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

CONDENSED BALANCE SHEETS — Continued SEPTEMBER 30, 2005 (UNAUDITED) AND DECEMBER 31, 2004

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

See notes to condensed financial statements.

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

CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 AND FOR THE PERIOD FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

	Three months ended				Nine months ended
	September 30,				September 30,				Cumulative
			2004				2004		since
	2005		(as restated)		2005		(as restated)		inception
Net sales	$ —		$ —		$ —		$ —		$ —
Operating expenses	759,087		864,653		1,983,186		2,362,205		14,848,556
Research and development expenses	452,571		162,458		1,066,068		1,565,177		3,719,293
Non-cash patent settlement costs	—		1,610,066		—		1,610,066		1,610,066
Loss before other income	(1,211,658	)	(2,637,177	)	(3,049,254	)	(5,537,448	)	(20,177,915	)
Other income
Interest income	—		—		—		514		954
Loss before provision for income taxes	(1,211,658	)	(2,637,177	)	(3,049,254	)	(5,536,934	)	(20,176,961	)
Provision (benefit) for income taxes	—		(4,063	)	1,976		(3,063	)	5,157
Net loss	$ (1,211,658	)	$ (2,633,114	)	$ (3,051,230	)	$ (5,533,871	)	$ (20,182,118	)
Net loss per share, basic and diluted	$ (0.03	)	$ (0.07	)	$ (0.08	)	$ (0.16	)
Weighted average shares outstanding, basic and diluted	39,115,886		36,599,887		38,564,191		35,328,591

See notes to condensed financial statements.

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

CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

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

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

CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

Price per					Common stock	paid -in		Deferred	during the		development
share	Shares		Amount		to be issued	capital		compensation	development stage		stage deficiency
Stock issued for consulting
services on November
4, 2000	0.88	9,833		10		—	8,643		—	—		8,653
Stock issued for consulting
services on December
20, 2000	0.50	19,082		19		—	9,522		—	—		9,541
Stock issued for filing
services on December
20, 2000	0.50	5,172		5		—	2,581		—	—		2,586
Stock issued for
professional services on
December 26, 2000	0.38	12,960		13		—	4,912		—	—		4,925
Other stock issuance on
August 24, 2000	2.13	2,000		2		—	4,258		—	—		4,260
Common shares cancelled		(55,000	)	(55	)	—	(64,245	)	—	—		(64,300	)
Net loss		—		—		—	—		—	(1,270,762	)	(1,270,762	)
Balance, December 31, 2000		15,645,935		15,646		—	1,437,873		—	(2,367,333	)	(913,814	)
Stock issued for consulting
services on January 8,
2001	0.31	9,833		10		—	3,038		—	—		3,048
Stock issued for consulting
services on February 1,
2001	0.33	9,833		10		—	3,235		—	—		3,245
Stock issued for consulting
services on March 1,
2001	0.28	9,833		10		—	2,743		—	—		2,753
Stock issued for legal
services on March 13,
2001	0.32	150,000		150		—	47,850		—	—		48,000
Stock issued for consulting
services on April 3, 2001	0.25	9,833		10		—	2,448		—	—		2,458
Stock issued for legal
services on April 4, 2001	0.25	30,918		31		—	7,699		—	—		7,730
Stock issued for
professional services on
April 4, 2001	0.25	7,040		7		—	1,753		—	—		1,760
Stock issued for consulting
services on April 5, 2001	0.25	132,600		132		—	33,018		—	—		33,150
Stock issued for filing fees
on April 30, 2001	1.65	1,233		1		—	2,033		—	—		2,034
Stock issued for filing fees
on September 19, 2001	0.85	2,678		2		—	2,274		—	—		2,276
Stock issued for
professional services on
September 28, 2001	0.62	150,000		150		—	92,850		—	—		93,000
Stock issued for directors
services on October 5,
2001	0.60	100,000		100		—	59,900		—	—		60,000
Stock issued for legal
services on October 17,
2001	0.60	11,111		11		—	6,655		—	—		6,666
Stock issued for consulting
services on October 18,
2001	0.95	400,000		400		—	379,600		—	—		380,000
Stock issued for consulting
services on October 19,
2001	1.25	150,000		150		—	187,350		—	—		187,500
Stock issued for exhibit fees
on October 22, 2001	1.35	5,000		6		—	6,745		—	—		6,751
Stock issued for directors
services on November
2, 2001	0.95	1,000,000		1,000		—	949,000		—	—		950,000
Stock issued for consulting
services on November
7, 2001	0.85	20,000		20		—	16,980		—	—		17,000

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

CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

Price per	Common Stock		Common stock		paid-in	Deferred		during the		development
share	Shares	Amount	to be issued		capital	compensation		development stage		stage deficiency
Stock issued for consulting
services on November
20, 2001	0.98	43,000	43	—		42,097	—		—		42,140
Stock issued for consulting
services on November
27, 2001	0.98	10,000	10	—		9,790	—		—		9,800
Stock issued for consulting
services on November
28, 2001	0.98	187,000	187	—		183,073	—		—		183,260
Intrinsic value of options
issued to employees		—	—	—		2,600,000	(2,600,000	)	—		—
Fair value of options issued
to non-employees for
services		—	—	—		142,318	—		—		142,318
Amortization of deferred
compensation		—	—	—		—	191,667		—		191,667
Net loss		—	—	—		—	—		(2,735,013	)	(2,735,013	)
Balance, December 31, 2001		18,085,847	18,086	—		6,220,322	(2,408,333	)	(5,102,346	)	(1,272,271	)
Stock issued for directors
services on December
10, 2002	0.40	2,150,000	2,150	—		857,850	—		—		860,000
Common stock paid for, but
not issued (2,305,000
shares)	0.15 -0.25	—	—	389,875		—	—		—		389,875
Fair value of options issued
to non-employees for
services		—	—	—		54,909	(54,909	)	—		—
Amortization of deferred
compensation		—	—	—		—	891,182		—		891,182
Net loss for the year ended
December 31, 2002		—	—	—		—	—		(2,749,199	)	(2,749,199	)
Balance, December 31, 2002		20,235,847	20,236	389,875		7,133,081	(1,572,060	)	(7,851,545	)	(1,880,413	)
Common stock issued,
previously paid for	0.15	1,425,000	1,425	(213,750	)	212,325	—		—		—
Common stock issued,
previously paid for	0.25	880,000	880	(220,000	)	219,120	—		—		—
Stock issued for cash on
March 20, 2003	0.25	670,000	670	—		166,830	—		—		167,500
Stock issued for cash on
April 4, 2003	0.25	900,000	900	—		224,062	—		—		224,962
Stock issued for cash on
April 8, 2003	0.25	100,000	100	—		24,900	—		—		25,000
Stock issued for cash on
May 8, 2003	0.25	1,150,000	1,150	—		286,330	—		—		287,480
Stock issued for cash on
June 16, 2003	0.25	475,000	475	—		118,275	—		—		118,750
Stock issued for legal
services on June 27,
2003	0.55	83,414	83	—		45,794	—		—		45,877
Debt converted to stock on
June 27, 2003	0.25	2,000,000	2,000	—		498,000	—		—		500,000
Stock and warrants issued
for cash on July 11,
2003	0.25	519,000	519	—		129,231	—		—		129,750
Stock and warrants issued
for cash on September
29, 2003	0.25	1,775,000	1,775	—		441,976	—		—		443,751
Stock and warrants issued
for cash on October 21,
2003	0.25	1,845,000	1,845	—		459,405	—		—		461,250
Stock and warrants issued
for cash on October 28,
2003	0.25	1,570,000	1,570	—		390,930	—		—		392,500
Stock and warrants issued
for cash on November
19, 2003	0.25	500,000	500	—		124,500	—		—		125,000

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

CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

Price per	Common Stock		Common stock		paid-in		Deferred		during the		development
share	Shares	Amount	to be issued		capital		compensation		development stage		stage deficiency
Finders’ fees related to
stock issuances		—	—	43,875		(312,582	)	—		—		(268,707	)
Common stock paid for, but
not issued (25,000
shares)	0.25	—	—	6,250		—		—		—		6,250
Amortization of deferred
comp		—	—	—		—		863,727		—		863,727
Net loss for year ended
December 31, 2003		—	—	—		—		—		(2,476,063	)	(2,476,063	)
Balance, December 31, 2003		34,128,261	34,128	6,250		10,162,177		(708,333	)	(10,327,608	)	(833,386	)
Common stock issued,
previously paid for	0.25	25,000	25	(6,250	)	6,225		—		—		—
Stock issued for director
services on March 31,
2004	1.50	50,000	50	—		74,950		—		—		75,000
Stock issued for finders
fees on March 31, 2004	0.15	82,500	82	—		12,293		—		—		12,375
Stock issued for finders
fees on March 31, 2004	0.25	406,060	407	—		101,199		—		—		101,606
Stock issued for services
on
April 2, 2004	1.53	65,000	65	—		99,385		—		—		99,450
Debt converted to stock on
April 2, 2004	1.53	60,000	60	—		91,740		—		—		91,800
Stock issued upon exercise
of warrants on May 21,
2004	0.20	950,000	950	—		189,050		—		—		190,000
Stock issued for directors
services on June 8,
2004	1.70	600,000	600	—		1,019,400		—		—		1,020,000
Stock issued for cash on
August 25, 2004	1.00	550,000	550	—		549,450		—		—		550,000
Stock issued upon exercise
of options on August
30,
2004	0.40	4,000	4	—		1,596		—		—		1,600
Stock issued for cash on
September 8, 2004	1.00	25,000	25	—		24,975		—		—		25,000
Stock issued for consulting
services on September
15, 2004	1.31	50,000	49	—		65,451		—		—		65,500
Stock issued for patent
settlement on
September 22, 2004	1.24	20,000	20	—		24,780		—		—		24,800
Stock issued for research
and development on
October 6, 2004	1.40	65,000	65	—		90,935		—		—		91,000
Stock issued for cash on
October 6, 2004	1.00	25,000	25	—		24,975		—		—		25,000
Stock issued for cash on
October 15, 2004	1.00	150,000	150	—		149,850		—		—		150,000
Stock issued upon exercise
of stock options on
October 21, 2004	0.40	6,500	6	—		2,594		—		—		2,600
Stock issued for cash on
November 3, 2004	1.00	25,000	25	—		24,975		—		—		25,000
Stock issued for cash on
November 18, 2004	1.00	172,500	173	—		172,327		—		—		172,500
Stock issued for cash on
December 9, 2004	1.00	75,000	75	—		74,925		—		—		75,000
Stock issued for cash on
December 23, 2004	1.00	250,000	250	—		249,750		—		—		250,000
Finders fees related to
stock issuances	—	—	—	—		(88,384	)	—		—		(88,384	)
Common stock paid for, but
not issued (119,000
shares)	—	—	—	119,000		—		—		—		119,000

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

CONDENSED STATEMENTS OF STOCKHOLDERS’ DEFICIENCY FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

Price per	Common Stock			Common stock	paid-in		Deferred			Deficit accumulated — during the		Total stockholders’ — development
share	Shares		Amount	to be issued	capital		compensation			development stage		stage deficiency
Intrinsic value of options
issued to employees	—	—	—	—		248,891		(248,891	)	—		—
Fair value of options issued
to non-employees for
services	—	—	—	—		55,381		(55,381	)	—		—
Fair value of warrants
issued for settlement
costs	—	—	—			1,585,266		—		—		1,585,266
Fair value of warrants
issued to non-
employees for services	—	—	—	—		28,872		—		—		28,872
Amortization of deferred
compensation	—	—	—	—		—		936,537		—		936,537
Net loss for year ended
December 31, 2004	—	—	—	—		—		—		(6,803,280	)	(6,803,280	)
Balance, December 31, 2004		37,784,821	37,784	119,000		15,043,028		(76,068	)	(17,130,888	)	(2,007,144	)
Common stock issued,
previously paid for	1.00	69,000	69	(69,000	)	68,931		—		—		—
Stock issued upon exercise
of warrants, previously
paid for	1.00	50,000	50	(50,000	)	49,950		—		—		—
Stock issued for cash on
January 20, 2005	1.00	25,000	25	—		24,975		—		—		25,000
Stock issued upon exercise
of warrants on January
31, 2005	0.40	500	1	—		199		—		—		200
Stock issued for cash on
February 17, 2005	1.00	325,000	325	—		324,675		—		—		325,000
Stock issued for cash on
March 31, 2005	1.00	215,000	215	—		214,785		—		—		215,000
Stock issued for cash on
May 17, 2005	1.00	5,000	5	—		4,995		—		—		5,000
Stock issued for cash on
June 7, 2005	1.00	300,000	300	—		299,700		—		—		300,000
Stock issued for cash on
August 5, 2005	1.00	480,500	481	—		480,019		—		—		480,500
Stock issued for cash on
August 9, 2005	1.00	100,000	100	—		99,900		—		—		100,000
Common stock paid for, but
not issued (80,000
shares)	—	—	—	80,000		—		—		—		80,000
Finders fees related to
stock issuances	—	—	—	—		(108,840	)	—		—		(108,840	)
Intrinsic value of options
issued to employees	—	—	—	—		243,750		(243,750	)	—		—
Fair value of options issued
for settlement costs	—	—	—	—		31,500		—		—		31,500
Fair value of warrants
issued for settlement
costs	—	—	—	—		4,957		—		—		4,957
Fair value of warrants
issued to non-
employees for services	—	—	—	—		13,505		—		—		13,505
Amortization of deferred
compensation	—	—	—	—		—		116,693		—		116,693
Warrants issued with
convertible debentures	—	—	—	—		427,703		—		—		427,703
Intrinsic value of beneficial
conversion associated
with convertible
debentures	—	—	—	—		430,737		—		—		430,737
Net loss for nine months
ended September 30,
2005	—	—	—	—		—		—		(3,051,230	)	(3,051,230	)
Balance, September 30, 2005
(unaudited)		39,354,821	$ 39,355	$ 80,000	$	17,654,469	$	(203,125	)	$ (20,182,118	)	$ (2,611,419	)

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

CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)

NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 AND FOR THE PERIOD FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

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

See notes to condensed financial statements.

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

CONDENSED STATEMENTS OF CASH FLOWS — Continued (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 AND FOR THE PERIOD FROM INCEPTION (FEBRUARY 18, 1998) TO SEPTEMBER 30, 2005

	September 30,	September 30,	Cumulative — since
	2005	2004	inception
Supplemental disclosures of cash flow
information
Cash paid during the year for
Interest	$ —	$ —	$ —
Income taxes	$ 1,976	$ —	$ 5,157
Non-cash investing and financing
activities
Acquisition of intangible asset through
advance from related party and issuance
of common stock	$ —	$ —	$ 505,000
Deferred compensation for stock options
issued for services	243,750	304,272	3,202,931
Purchase of property and equipment
financed by advance from related party	—	—	3,550
Conversion of related party debt to equity	—	15,000	515,000
Issuance of common stock in settlement of
payable	—	113,981	113,981
Common stock, previously paid for	119,000	6,250	119,000
Finders fees accrued for issuance of
common stock	1,000	64,928	1,000
Value of warrants and beneficial conversion
feature of convertible notes	858,440	—	858,440

See notes to condensed financial statements.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

1. Organization and basis of presentation

Basis of presentation

The accompanying interim condensed financial statements are unaudited, but in the opinion of management of Save the World Air, Inc. (the Company), contain all adjustments, which include normal recurring adjustments, necessary to present fairly the financial position at September 30, 2005, the results of operations for the three and nine months ended September 30, 2005 and 2004, and cash flows for the nine months ended September 30, 2005 and 2004. The balance sheet as of December 31, 2004 is derived from the Company’s audited financial statements.

Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, although management of the Company believes that the disclosures contained in these financial statements are adequate to make the information presented therein not misleading. For further information, refer to the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004, as filed with the Securities and Exchange Commission.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expense during the reporting period. Actual results could differ from those estimates. The results of operations for the nine months ended September 30, 2005 are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2005.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

1. Organization and basis of presentation — continued

Description of business

Save the World Air, Inc. (the “Company”) was incorporated in Nevada on February 18, 1998 under the name Mandalay Capital Corp. The Company changed its name to Save the World Air, Inc. on February 11, 1999 following the purchase of the worldwide exclusive manufacturing, marketing and distribution rights for the ZEFS device. ZEFS is a device which is fitted to an internal combustion engine and is expected to reduce carbon monoxide hydrocarbons and nitrous oxide emissions. During the past three years, the Company has been acquiring new technologies, developing prototype products using the Company’s technologies and conducting scientific tests regarding the technologies and prototype products. In 2003, the Company acquired worldwide intellectual property and patent rights to technologies which reduce carbon monoxide, hydrocarbons and nitrous oxide emissions in two- and four-stroke motorcycles, fuel-injection engines, generators and small engines. The Company has also developed prototype products and named them “CAT-MATE”.

Development stage enterprise

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

The Company’s primary historical focus has been on research and development of proprietary devices that are designed to reduce harmful emissions, and improve fuel efficiency and engine performance on equipment and vehicles driven by internal combustion engines and has not yet generated any revenues. The prototype devices are called “ZEFS” and “CAT-MATE.” Previously, the Company devoted the bulk of its efforts to complete the design, the development of production models and initial efforts for the promotion of products in the marketplace worldwide. The Company is currently in a transitional phase from research and development to initial marketing and early sales of its devices. Expenses have been funded primarily through the sale of company stock and debt. The Company has taken actions to secure the intellectual property rights to the ZEFS and CAT-MATE devices. In addition, the Company has initiated marketing efforts to international governmental entities in cooperation with the United Nations Environmental Programme (UNEP) and various original equipment manufacturers (OEMs), to eventually sell or license the ZEFS and CAT-MATE products and technology.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

2. Net loss per share

Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. In computing diluted earnings per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants. For the nine months ended September 30, 2005 and 2004, the dilutive impact of outstanding stock options of 16,508,561 and 14,422,652 respectively, and outstanding warrants of 19,095,728 and 14,973,414 have been excluded because their impact on the loss per share is antidilutive.

3. Recent accounting pronouncements

In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs”. This Statement amends the guidance in ARB No. 43 Chapter 4 Inventory Pricing, to require items such as idle facility costs, excessive spoilage, double freight and rehandling costs to be expensed in the current period, regardless if they are abnormal amounts or not. This Statement will become effective for us in the first quarter of 2006. The adoption of SFAS No. 151 is not expected to have a material impact on our financial condition, results of operations, or cash flows.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which revises SFAS No. 123. SFAS 123R also supersedes APB No. 25 and amends SFAS No. 95, “Statement of Cash Flows”. In general, the accounting required by SFAS 123R is similar to that of SFAS No. 123. However, SFAS No. 123 gave companies a choice to either recognize the fair value of stock options in their income statements or disclose the pro forma income statement effect of the fair value of stock options in the notes to the financial statements. SFAS 123R eliminates that choice and requires the fair value of all share-based payments to employees, including the fair value of grants of employee stock options, be recognized in the income statement, generally over the option vesting period. SFAS 123R must be adopted no later than July 1, 2005 (or December 31, 2005 for small business issuers). Early adoption is permitted.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

3. New accounting pronouncements — continued

The Company is currently evaluating the timing and manner in which it will adopt SFAS 123R. As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using APB 25’s intrinsic value method. Accordingly, adoption of SFAS 123R’s fair value method will have an effect on results of operations, although it will have no impact on overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had SFAS 123R been adopted in prior periods, the effect would have approximated the SFAS 123 pro forma net loss and loss per share disclosures as shown above. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required, thereby reducing net operating cash flows and increasing net financing cash flows in periods after adoption.

4. Certain relationships and related transactions

Advances from founding executive officer

All of the marketing and manufacturing rights for the ZEFS were acquired from Mr. Muller, for 5,000,000 shares of common stock, $500,000 and a $10 royalty for each unit sold (see discussion below), pursuant to the Agreement entered into in December 1998, by and between the Company and Mr. Muller. Working capital advances in the amount of $517,208 and payment in the amount of $500,000 for marketing and distribution rights of the ZEFS are due to Mr. Muller. Such amounts are interest free and do not have any due dates for payment.

In January 2000, the Company entered into an agreement offering Mr. Muller and Lynne Muller, Mr. Muller’s wife, the option to purchase 5,000,000 shares each at $0.10 per share as consideration for work performed for the Company. Mrs. Muller subsequently transferred her option to Mr. Muller.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

4. Certain relationships and related transactions — continued

Advances from founding executive officer — continued

In connection with the Company’s legal proceedings against Mr. Muller (see Note 9), the Company is attempting to obtain a judgment that will relieve the Company of $1,017,208, which represents all amounts due Mr. Muller. These amounts include the $500,000 due for the marketing and distribution rights of the ZEFS and the working capital advances of $517,208. The Company has been relieved of the $10 royalty interest that Mr. Muller held for each unit sold. In addition, the Company is also attempting to obtain a judgment that will divest and prevent any subsequent holders of the right to exercise options previously held by Mr. Muller for 10,000,000 shares of the Company’s common stock. Based on the status of current legal proceedings, the Company does not believe that it will have to pay Mr. Muller the $500,000 for the rights to the ZEFS device and the $517,208 of advances. The Company has not made any adjustments for the above in its financial statements as the matters have not yet been finalized.

Due to related parties

Masry & Vititoe, a law firm in which Edward Masry, the Company’s Chief Executive Officer, is a partner, has advanced $179,561 and $36,478 as of September 30, 2005 and 2004, respectively, to the Company for working capital purposes. Advances by Masry and Vititoe are unsecured, non-interest bearing, and are due on demand. In April 2004, the Company issued 60,000 shares of common stock to convert $15,000 of an outstanding loan made to the Company by the wife of Edward Masry. The shares issued are valued at the current market price at the date of issuance of $91,800 resulting in additional charge to expense of $76,800, which was reflected as consulting expense in the financial statements for the nine months ended September 30, 2004.

5. Convertible debentures and warrants

On September 23, 2005, the Company completed a private offering of an of its 9% Convertible Notes due July 31, 2006 (the “Notes”) and Warrants to purchase shares of the Company’s common stock which expire August 31, 2007 (the “Warrants”). The Notes are convertible at $0.70 per share of common stock and the Warrants entitle the holder to purchase a number of shares of the Company’s common stock equal to 150% of the number of shares of common stock into which the Note is convertible. The Warrants are exercisable at a price of $1.00 per share.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

5. Convertible debentures and warrants — continued

During the quarter ended September 30, 2005, the Company issued Notes totaling $904,720 and paid related transaction fees of $46,280, resulting in net proceeds to the Company of $858,440. In addition to the cash paid for transaction fees, 43,268 additional Warrants were issued to certain placement agents. These Warrants expire August 31, 2010 and are exercisable at a price of $1.00 per share.

The aggregate value of the Warrants issued in connection with the offering and to the finder were valued at $427,703 using the Black-Scholes option valuation model with the following assumptions; risk-free interest rate of 4.02%; dividend yield of 0%; volatility factors of the expected market price of common stock of 83.59%; and an expected life of two to five years. The company also determined that the notes contained a beneficial conversion feature of $430,737.

The value of the Warrants of $427,703, the conversion option of $430,737, and the transaction fees of $46,280 are considered as debt discount and are being amortized over the life of the Notes. $22,066 of such discount has been amortized and included in the accompanying statement of operations for the three and nine months ended September 30, 2005. The remaining unamortized debt discount of $882,654 has been netted against the $904,720 Convertible Debentures on the accompanying September 30, 2005 balance sheet.

Subsequent to September 30, 2005, the Company issued an additional $96,658 of these Notes.

6. Capital stock

Sale of equity securities

During the nine months ended September 30, 2005, the Company sold 1,451,000 units of common stock, of which 1,400,500 units consist of one share of common stock and one warrant to acquire a share of common stock at an exercise price of $1.50 per share, for net proceeds of $1,342,860. The 1,400,500 warrants were issued to investors as part of an equity agreement and were not ascribed any value in the accompanying financial statements.

In addition, the Company sold 80,000 units of common stock, of which 80,000 consist of one share of common stock and one warrant to acquire a share of common stock at an exercise price of $1.50 per share, for net proceeds of $73,600. The 80,000 warrants were issued to investors as part of an equity agreement and were not ascribed any value in the accompanying financial statements. As of September 30, 2005 the shares were not issued but the funds were received, and have been reflected as common stock issuable.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

6. Capital stock — continued

Sale of equity securities — continued

During the nine months ended September 30, 2005, the Company issued 119,000 shares (of which 50,000 relates to the exercise of warrants) of common stock for which payment was previously received.

Warrants

During the nine months ended September 30, 2005, the Company issued 10,000 warrants to an individual for settlement of a claim. The Company also issued 25,000 warrants to an individual in exchange for consulting services rendered. The warrants were valued at an aggregate amount of $18,462 using the Black Scholes pricing model and have been reflected in the accompanying statement of operations for the three and nine months ended September 30, 2005.

Intrinsic value of employee options

During the years ended December 31, 2004 and prior, certain employee options were granted with exercise prices less the than fair market value of the Company’s stock at the date of grant. As the grants were to employees, the intrinsic value method, as allowed under APB No. 25, was used to calculate the related compensation expense. For the nine months ended September 30, 2005, the Company granted 2,085,909 options to certain employees, exercisable at amounts ranging from $0.85 to $1.10, vested over one year with a ten-year life, and $116,693 and $789,636 of deferred compensation costs were amortized and recognized as expense in the nine months ended September 30, 2005 and 2004 respectively.

7. Research and development

The Company has established a research and development facility in Queensland, Australia. The Company has expanded research and development to include applications of the ZEFS and CAT-MATE technology to diesel engines, motorbikes, boats, generators, lawnmowers and other small engines. The Company has also purchased test vehicles, test engines and testing equipment. The Company completed testing on ZEFS and CAT-MATE devices for multiple automobiles, trucks, motorcycles, off-road vehicles and stationary engines, the results of which have been provided to RAND Corporation (RAND) for evaluation. During 2004, RAND expanded its role with the Company and now oversees the Company’s research and development facility in Australia. The Company also uses third party research and development facilities in Los Angeles and San Jose, California for the development of our ZEFS and CAT-MATE devices. For the nine months ended September 30, 2005 and 2004, the Company has spent $1,066,068 and $1,565,177, respectively, on research and development.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

8. Going concern

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. As reflected in the accompanying financial statements, the Company had a net loss of $3,051,230 and a negative cash flow from operations of $2,182,036 for the nine months ended September 30, 2005, and had a working capital deficiency of $1,652,579 and a stockholders’ deficiency of $2,611,419 at September 30, 2005. These factors raise substantial doubt about its ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon the Company’s ability to raise additional funds and implement its business plan. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

9. Commitments and contingencies

Legal matters

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

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

9. Commitments and contingencies — continued

Legal matters — continued

On July 2, 2002, after an investigation by the Company’s newly constituted board of directors, the Company filed a cross-complaint in the SEC action against Mr. Muller and others seeking injunctive relief, disgorgement of monies and stock and financial restitution for a variety of acts and omissions in connection with sales of the Company’s stock and other transactions occurring between 1998 and 2002. Among other things, the Company alleged that Mr. Muller and certain others sold company stock without providing adequate consideration to the Company; sold insider shares without making proper disclosures and failed to make necessary filings required under federal securities laws; engaged in self-dealing and entered into various undisclosed related-party transactions; misappropriated for their own use proceeds from sales of the Company’s stock; and entered into various undisclosed arrangements regarding the control, voting and disposition of their stock. The Company contends that it is entitled to a judgment canceling all of the approximately 8,716,710 shares of the Company’s common stock that were previously obtained and controlled, directly or indirectly, by Mr. Muller; divesting and preventing any subsequent holders of the right to exercise options previously held by Mr. Muller for 10,000,000 shares of the Company’s common stock, conversion of an existing preliminary injunction to a permanent injunction to prevent Mr. Muller from any involvement with the Company and a monetary judgment against Mr. Muller and others in the amount of several million dollars.

On July 30, 2002, the U.S. Federal District Court, Southern District of New York, granted the Company’s application for a preliminary injunction against Mr. Muller and others, which prevented Mr. Muller and other cross-defendants from selling, transferring, or encumbering any assets and property previously acquired from the Company, from selling or transferring any of the Company’s stock that they may own or control, or from taking any action to injure the business and from having any direct contact with the Company’s shareholders. The injunctive order also prevents Mr. Muller from engaging in any effort to exercise control over the Company and from serving as an officer or director of the Company. The Company believes that it has valid claims; however, there can be no assurance that an adverse result or settlement would not have a material adverse effect on the Company’s financial position or cash flow.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

9. Commitments and contingencies — continued

Legal matters — continued

In the course of the litigation, the Company has obtained ownership control over Mr. Muller’s claimed patent rights to the ZEFS device. Under a Buy-Sell Agreement between Mr. Muller and the Company dated December 29, 1998, Mr. Muller, who was listed on the ZEFS devise patent application as the inventor of the ZEFS device, purported to grant us all international marketing, manufacturing and distribution rights to the ZEFS device. Those rights were disputed because an original inventor of the ZEFS device contested Mr. Muller’s legal ability to have conveyed those rights.

In Australia, Mr. Muller entered into a bankruptcy action seeking to overcome the Company’s claims for ownership of the ZEFS device. In conjunction with these litigation proceedings, a settlement agreement was reached whereby the $10 per unit royalty previously due to Mr. Muller under his contested Buy-Sell Agreement was terminated and replaced with a $.20 per unit royalty payable to the bankruptcy trustee. On November 7, 2002, under a settlement agreement executed with the Mr. Muller’s bankruptcy trustee, the trustee transferred to the Company all ownership and legal rights to this international patent application for the ZEFS device.

Both the SEC and the Company have filed Motions for Summary Judgment contending that there are no material issues of fact in contention and as a matter of law, the Court should grant a judgment against Mr. Muller and the cross-defendants. Mr. Muller has filed a response contending the motions are without merit or substance. A final decision on these motions, which potentially would terminate the ongoing litigation, is still pending. Should the Court not grant summary judgment in favor of the Company, the case will be scheduled for final disposition in a trial.

Mr. Muller and several of the defendants filed a Motion to Dismiss the complaint filed by the Company and moved for summary judgment in their favor. On December 21, 2004, Judge George B. Daniels denied the cross-defendants’ motion to dismiss the Company’s cross-complaint, denied the request to vacate the July 2, 2002 preliminary injunction and denied the request for damages against the Company. The court also refused to grant a summary judgment in favor of the cross-defendants and dismissed Mr. Muller’s claims against the Company for indemnification for his legal costs and for damages resulting from the litigation. Neither Mr. Muller nor any of the cross-defendants have filed any cross-claims against the Company and the Company is not exposed to any liability as a result of the litigation, except for possibly incurring legal fees and expenses should the Company lose the litigation.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

9. Commitments and contingencies — continued

Legal matters — continued

Although the outcome of this litigation cannot be predicted with any degree of certainty, the Company is optimistic that the Court’s ruling will either significantly narrow the issues for any later trial or will result in a final disposition of the case in a manner favorable to the Company. The Company believes that they have valid claims; however, there can be no assurance that an adverse result or outcome on the pending motions or a trial of this case would not have a material adverse effect on the Company’s financial position or cash flow.

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

The Company was named as a defendant in a complaint filed before the Los Angeles Superior Court, Civ. No. BC 312401, by Terracourt Pty Ltd, an Australian corporation (“Terracourt”), claiming breach of contract and related remedies from promises allegedly made by the former president of the Company in 1999. Terracourt sought specific performance of the former president’s alleged promises to transfer to Terracourt an aggregate 480,000 shares of the Company’s common stock for office consultant and multimedia services. The complaint was filed on March 18, 2004. Terracourt also filed a Statement of Damages seeking costs of the lawsuit and general damages of $2 million. The case proceeded to trial in the Los Angeles Superior Court in May, 2005. In June, 2005, the Judge issued a statement of decision which denied Terracourt’s claims for 450,000 shares of stock, monetary damages, and costs of the lawsuit. The Court also ruled that Terracourt was entitled to receive an option exercisable for 30,000 shares of the Company’s common stock, exercisable at $.001 per share (par value). Both parties filed motions for a new trial on the issue of the opinion. Subsequently, the parties settled the lawsuit for a payment by the Company to Terracourt of $2,500 and asked the court to vacate the judgment and dismiss the lawsuit with prejudice, which action the court took on September 30, 2005.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

9. Commitments and contingencies — continued

Legal matters — continued

This recent lawsuit brought by Mr. Muller arises out of the same claims that are the subject of ongoing litigation in the Federal District Court for the Southern District of New York, in which the Company has previously obtained a preliminary injunction against Mr. Muller barring him from any involvement with the Company and preventing Mr. Muller, his agents or assigns, from exercising any claimed rights to the Company’s assets or stock. Mr. Muller previously filed the same complaint in the Federal District Court for the Southern District of New York, which claim is pending dismissal. On December 28, 2004, Federal District Court Judge George B. Daniels issued a decision dismissing motions filed by Mr. Muller against the Company’s cross-claims. The dismissal of those motions involved similar causes of action as those contained in Mr. Muller’s recent lawsuit commenced in the Federal District Court for the Central District of California. Since the case in New York is still pending, the filing of the new lawsuit in California is subject to various defenses which should result in the dismissal of the new lawsuit.

The Company intends to vigorously defend against any bifurcation of the lawsuit that is ongoing in New York and will move to dismiss and/or to transfer the recently filed complaint to Judge Daniels in New York for any eventual decision. While the Company believes that it has valid claims, there can be no assurance that an adverse result or outcome on the pending motions or a trial of this case would not have a material adverse effect on the financial position or cash flow of the Company.

Employment agreements

In July 2005, the Company entered into an employment agreement with an individual to serve as a Vice President of Operations for the Company. The agreement expires December 31, 2005, with an automatic one-year extension and provides for annual base compensation of not less than $120,000 per year. During the employment term, the individual is eligible to participate in certain incentive plans, stock option plans and similar arrangements in accordance with the Company’s recommendations at award levels consistent and commensurate with the position and duties hereunder.

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

NOTES TO CONDENSED FINANCIAL STATEMENTS — Continued NINE MONTHS ENDED SEPTEMBER 30, 2005 (UNAUDITED)

10. Restatement

During the year ended December 31, 2004, the Company discovered an error in the previously reported September 30, 2004 financial statements related to the valuation of shares issued for services and options granted to employees and non-employees. These financial statements reflect the correction of the error in the September 30, 2004 amounts. The correction of this error resulted in an increase in net loss of $931,742, an increase in additional paid in capital of $977,070 and an increase in deferred compensation of $47,210.

The effect of this restatement on the September 30, 2004 financial statement is as follows:

	As previously — reported		As previously — reported
	Three months ending		Nine months ending
	Sept. 30, 2004	Restated	Sept. 30, 2004	Restated
Net loss	$ 2,661,971	$ 2,633,114	$ 4,602,129	$ 5,533,871
Paid in capital	$ 13,270,211	$ 14,247,281	$ 13,270,211	$ 14,247,281
Loss per share	$ 0.07	$ 0.07	$ 0.13	$ 0.16

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Item 2. Management’s Discussion and Analysis or Plan of Operations

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

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

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

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth elsewhere in this Report and under the heading “Risk Factors” in our Annual Report on Form 10-KSB for the year ended December 31, 2004. All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements.

Overview

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Financial Statements and notes thereto included in Part I, Item 1 of this Form 10-QSB and the Financial Statements and notes thereto contained in our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2004.

We are a development stage company that has not yet generated revenues. The company’s primary historical focus has been on research and development of proprietary devices that are designed to reduce harmful emissions, and improve fuel efficiency and engine performance on equipment and vehicles driven by internal combustion engines. We are currently in a transitional phase from research and development to initial marketing and early sales of our devices.

Our devices are called “ZEFS” and “CAT-MATE.” Previously, we devoted the bulk of our efforts to the completion of the design, the development of our production models and initial efforts for the promotion of our products in the marketplace worldwide. Expenses have been funded primarily through the sale of company stock and debt. We have taken actions to secure our intellectual property rights to the ZEFS and CAT-MATE devices.

During the third quarter of 2005, we established a product development and testing center in Morgan Hill, California, which we currently expect will be fully operational by December 2005. We are continuing our marketing efforts to international governmental entities in cooperation with the United Nations Environmental Programme (UNEP) and various original equipment manufacturers (OEMs), to eventually sell or license our ZEFS and CAT-MATE products and technology. We anticipate that these efforts will continue during the remainder of 2005. We sold our first devices early in the fourth quarter of 2005 and we

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will begin to generate revenue late in the fourth quarter of 2005 or early in 2006. We will need to raise additional capital in 2006, and possibly beyond, to fund our operational and other expenses until our revenue base grows sufficiently.

Results of Operations

To date, we have not generated any revenues and our business continues in the development stage. We have focused our efforts on verifying and developing our technologies and devices and commencing marketing efforts for their license or sale. We began selling our devices after the end of the three-month period ended September 30, 2005, and we expect to begin generating revenue in late 2005 or early 2006.

General and administrative expenses were $759,087 for the three-month period ended September 30, 2005, compared to $864,653 for the three-month period ended September 30, 2004 (as restated), a decrease of $105,566. This decrease is primarily attributable to a decrease in non-cash amortization of deferred compensation and corporate expenses, partially offset by increases in payroll expenses, professional fees, consulting fees, interest, office and computer expenses.

General and administrative expenses were $1,983,186 for the nine-month period ended September 30, 2005, compared to $2,362,205 for the nine-month period ended September 30, 2004 (as restated), a decrease of $379,019. This decrease is primarily attributable to a decrease in non-cash amortization of deferred compensation, partially offset by increases in payroll expenses, professional fees, consulting fees, travel expense, office expense, corporate, interest and advertising expenses.

Research and development expenses were $452,571 for the three-month period ended September 30, 2005, compared to $162,458 for the three-month period ended September 30, 2004 (as restated), an increase of $290,113. This increase is primarily attributable to an increase in research by RAND Corporation (“RAND”), product research, testing, product development and prototype expenses.

Research and development expenses were $1,066,068 for the nine-month period ended September 30, 2005, compared to $1,565,177 for the nine-month period ended September 30, 2004 (as restated), a decrease of $499,109. This decrease is primarily attributable to a decrease in non-cash research, partially offset by increases in research by RAND, product research, testing, product development and prototype expenses.

We expect our operating costs to increase during the balance of fiscal year 2005, primarily as a result of anticipated increases in research and development expenses, general and administrative expenses, and marketing expenses, as we continue production and sales activities during late 2005.

We had a net loss of $1,211,658 or $.03 per share for the three-month period ended September 30, 2005, compared to a net loss of $2,633,114 or $.07 per share for the three-month period ended September 30, 2004 (as restated). We had a net loss of $3,051,230 or $.08 per share for the nine-month period ended September 30, 2005, compared to a net loss of $5.533,871 or $.16 per share for the nine-month period ended September 30, 2004 (as restated). We have relied upon our 2004 Stock Option Plan to compensate consultants and employees who have assisted in developing and executing our business plan. This reliance, together with issuances of stock by us in connection with private offerings of our securities, has significantly narrowed the loss per share by increasing the amount of the Company’s outstanding common stock. See “Liquidity and Capital Resources” below. We expect to incur additional net loss in the fiscal year ending December 31, 2005, primarily attributable to continued general and administrative expenses and marketing-related expenditures without the benefit of any revenue for the remainder of the year.

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Liquidity and Capital Resources

We have incurred negative cash flow from operations in the development stage since our inception in 1998. As of September 30, 2005, we had cash of $429,754 and an accumulated deficit of $20,182,118. Our negative operating cash flow since inception has been funded primarily through the sale of common stock, issuance of convertible notes, and, to a lesser degree, by proceeds we received from the exercise of options and warrants.

The financial statements accompanying this report have been prepared on a going concern basis, which contemplates the realization of assets and settlement of liabilities and commitments in the normal course of our business. As reflected in the accompanying financial statements, we had a net loss of $3,051,230 and a negative cash flow from operations of $2,182,036 for the nine-month period ended September 30, 2005 and had a working capital deficiency of $1,652,579 and a stockholders’ deficiency of $2,611,419 as of September 30, 2005. These factors raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to raise additional funds and implement our business plan. The financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

From July 24, 2004 through July 22, 2005, we engaged in a private offering (the “Stock Offering”) of units comprised of shares of our common stock and one-year warrants to purchase an equal number of shares of common stock at an exercise price of $1.50 per share. The Stock Offering terminated on July 22, 2005. From July 1, 2005 through July 22, 2005, we received aggregate gross proceeds of $199,500 and aggregate net proceeds of $183,540 in connection with the sale of 199,500 shares of our common stock to nine purchasers. The total amount raised during the Stock Offering was $2,872,000 gross proceeds and $2,659,044 net proceeds. See Notes 5 and 10 to Notes to Financial Statements and Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds”.

As disclosed in our Current Report on Form 8-K, filed with the Securities and Exchange Commission on July 28, 2005, on July 25, 2005 we extended the expiration date of each of the warrants issued in the Stock Offering by 180 days from its original expiration date. No additional consideration was paid by the purchasers of the units for such extension.

Between August 1, and September 23, 2005, we conducted a new offering (the “Interim Offering”) of our 9% convertible notes due July 31, 2006 and warrants. The notes are convertible into shares of our common stock at an initial conversion price of $.70 per share, anytime prior to maturity at the election of the noteholder and may be converted at our election under certain circumstances. The warrants are convertible, at $1.00 per share, for 150% of the number of shares into which the notes are convertible and may be exercised until August 31, 2007. The Interim Offering was made to the purchasers of the units in the Stock Offering and a limited number of individuals who are not “U.S. persons” as that term is defined in Rule 902 of Regulation S promulgated under the Securities Act of 1933, as amended. The total amount subscribed for in the Interim Financing was $1,501,378 gross proceeds ($1,428,432 net proceeds). Of this amount, $904,720 gross proceeds ($858,440 net proceeds) was received by the Company during the three-month period ended September 30, 2005, and the balance of $596,658 gross proceeds ($569,992 net proceeds) is expected to be received by the Company during the fourth quarter of 2005.

We are relying on the proceeds of the Stock Offering and the Interim Offering to provide additional working capital for our needs for the next several months. We believe that we have sufficient cash to fund our operations through the remainder of 2005.

We have also retained the services of an exclusive placement agent to work with us from September 1, 2005, to provide additional capital that we need to continue to execute on our business plan. In this regard, on October 10, 2005, we commenced an offering (the “Bridge Financing”) of our 9% subordinated convertible promissory notes and warrants. The Bridge Financing is being made exclusively through our placement agent. The Bridge Financing is ongoing and, as of the date of the filing of this Report, no sales have been consummated under the Bridge Financing.

We believe that exercises of in-the-money options and warrants, with various expiration dates through 2007, may also provide some of the proceeds needed to meet our capital requirements, together with sales of our securities in connection with the efforts of our placement agent in the Bridge Financing and other financings we may undertake. However, there can be no assurance that

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additional equity or debt financing will be available or available on terms favorable to us. If we are unable to obtain additional capital, we may be required to delay, reduce the scope of, or eliminate, our research and development programs, reduce any marketing activities or relinquish rights to technologies that we might otherwise seek to develop or commercialize.

Critical Accounting Policies and Estimates

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

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

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

Stock-Based Compensation

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

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

New Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 151, “Inventory Costs”. This Statement amends the guidance in APB No. 43 Chapter 4 Inventory Pricing, to require items such as idle facility costs, excessive spoilage, double freight and rehandling costs to be expensed in the current period, regardless if they are abnormal amounts or not. This Statement will become effective for us in the first quarter of 2006. The adoption of SFAS No. 151 is not expected to have a material impact on our financial condition, results of operations, or cash flows.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R), which revises SFAS No. 123. SFAS 123R also supersedes APB No. 25 and amends SFAS No. 95, “Statement of Cash Flows”. In general, the accounting required by SFAS 123R is similar to that of SFAS

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No. 123. However, SFAS No. 123 gave companies a choice to either recognize the fair value of stock options in their income statements or disclose the pro forma income statement effect of the fair value of stock options in the notes to the financial statements. SFAS 123R eliminates that choice and requires the fair value of all share-based payments to employees, including the fair value of grants of employee stock options, be recognized in the income statement, generally over the option vesting period. SFAS 123R must be adopted no later than July 1, 2005 (December 15, 2005 for small business filers). Early adoption is permitted.

The Company is currently evaluating the timing and manner in which it will adopt SFAS 123R. As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using APB 25’s intrinsic value method. Accordingly, adoption of SFAS 123R’s fair value method will have an effect on results of operations, although it will have no impact on overall financial position. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had SFAS 123R been adopted in prior periods, the effect would have approximated the SFAS 123 pro forma net loss and loss per share disclosures as shown above. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as currently required, thereby reducing net operating cash flows and increasing net financing cash flows in periods after adoption.

Item 3. Controls and Procedures

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

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

PART II

Item 1. Legal Proceedings

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

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On July 2, 2002, after an investigation by our newly constituted board of directors, we filed a cross-complaint in the SEC action against Mr. Muller and others seeking injunctive relief, disgorgement of monies and stock and financial restitution for a variety of acts and omissions in connection with sales of our stock and other transactions occurring between 1998 and 2002. Among other things, we alleged that Mr. Muller and certain others sold Company stock without providing adequate consideration to us; sold insider shares without making proper disclosures and failed to make necessary filing required under federal securities laws; engaged in self-dealing and entered into various undisclosed related-party transactions; misappropriated for their own use proceeds from sales of our stock; and entered into various undisclosed arrangement regarding the control, voting and disposition of their stock. We contend that we are entitled to a judgment canceling all of the approximately 8,716,710 shares of our common stock that was previously obtained and controlled, directly or indirectly, by Mr. Muller; divesting and preventing any subsequent holders of the right to exercise options previously held by Mr. Muller for 10,000,000 shares of our common stock, conversion of an existing preliminary injunction to a permanent injunction to prevent Mr. Muller from any involvement with the Company and a monetary judgment against Mr. Muller and others in the amount of several million dollars.

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

In the course of the litigation, we have obtained ownership control over Mr. Muller’s claimed patent rights to the ZEFS device. Under a Buy-Sell Agreement between Mr. Muller and dated December 29, 1998, Mr. Muller, who was listed on the ZEFS devise patent application as the inventor of the ZEFS device, purported to grant us all international marketing, manufacturing and distribution rights to the ZEFS device. Those rights were disputed because an original inventor of the ZEFS device contested Mr. Muller’s legal ability to have conveyed those rights.

In Australia, Mr. Muller entered into a bankruptcy action seeking to overcome our claims for ownership of the ZEFS device. In conjunction with these litigation proceedings, a settlement agreement was reached with the bankruptcy trustee whereby the $10 per unit royalty previously due to Mr. Muller under his contested Buy-Sell Agreement was terminated and replaced with a $.20 per unit royalty payable to the bankruptcy trustee. On November 7, 2002, under a settlement agreement executed with Mr. Muller’s bankruptcy trustee, the trustee transferred to us all ownership and legal rights to this international patent application for the ZEFS device.

Both the SEC and we have filed Motions for Summary Judgment contending that there are no material issues of fact in contention and as a matter of law, the Court should grant a judgment against Mr. Muller and the cross-defendants. Mr. Muller has filed a response contending the motions are without merit or substance. A final decision on these motions, which potentially would terminate the ongoing litigation, is still pending. Should the Court not grant summary judgment in our favor, the case will be scheduled for final disposition in a trial.

Mr. Muller and several of the defendants filed a Motion to Dismiss the complaint filed by us and moved for summary judgment in their favor. On December 28, 2004, Judge George B. Daniels, denied the cross-defendants’ motion to dismiss our cross-complaint, denied the defendants’ request to vacate the July 2, 2002 preliminary injunction and denied their request for damages against us. The court also refused to grant a summary judgment in favor of the cross-defendants and dismissed Mr. Muller’s claims against us for indemnification for his legal costs and for damages resulting from the litigation. Neither Mr. Muller nor any of the cross-defendants have filed any cross-claims against us and we are not exposed to any liability as a result of the litigation, except for possibly incurring legal fees and expenses should we lose the litigation.

Although the outcome of this litigation cannot be predicted with any degree of certainty, we are optimistic that the Court’s ruling will either significantly narrow the issues for any later trial or will result

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in a final disposition of the case in a manner favorable to us. While we believe that we have valid claims, there can be no assurance that an adverse result or outcome on the pending motions or a trial of this case would not have a material adverse effect on our financial position or cash flow.

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

This recent lawsuit brought by Mr. Muller arises out of the same claims that are the subject of ongoing litigation in the Federal District Court for the Southern District of New York, in which we have previously obtained a preliminary injunction against Mr. Muller barring him from any involvement with the Company and preventing Mr. Muller, his agents or assigns, from exercising any claimed rights to our assets or stock. Mr. Muller previously filed the same complaint in the Federal District Court for the Southern District of New York, which claim is still pending. On December 28, 2004, Federal District Court Judge George B. Daniels issued a decision dismissing motions filed by Mr. Muller against our cross-claims. The dismissal of those motions involved similar causes of action as those contained in Mr. Muller’s recent lawsuit commenced in the Federal District Court for the Central District of California. Since the case in New York is still pending, we believe that the filing of the new lawsuit in California is subject to various defenses which should result in the dismissal of the new lawsuit.

We have filed a Motion to Dismiss this new complaint or alternatively, to transfer this action to the Federal District Court in New York for disposition by the same Federal District Judge handling the New York litigation. While we believe that we have valid claims and defenses, there can be no assurance that an adverse result or outcome on the pending motions or a trial of this case would not have a material adverse effect on our financial position or cash flow.

We were named as a defendant in a complaint filed before the Los Angeles Superior Court, Civ. No. BC 312401, by Terracourt Pty Ltd, an Australian corporation (“Terracourt”), claiming breach of contract and related remedies from promises allegedly made by the former president of the Company in 1999. Terracourt sought specific performance of the former president’s (Jeffrey Muller) alleged promises to transfer to Terracourt an aggregate 480,000 shares of our common stock for office consultant and multimedia services. The complaint was filed on March 18, 2004. Terracourt also filed a Statement of Damages seeking costs of the lawsuit and general damages of $2 million. The case proceeded to trial in the Los Angeles Superior Court in May, 2005. In June, 2005, the judge issued a decision which denied Terracourt’s claims for 450,000 shares of stock, monetary damages and costs of the lawsuit. The Court also ruled that Terracourt was entitled to receive an option exercisable for 30,000 shares of the Company’s common stock, exercisable at $.001 per share (par value). Both parties filed motions for a new trial on the issue of the option. Subsequently, the parties settled the lawsuit for a payment by the Company to Terracourt of $2,500 and asked the court to vacate the judgment and dismiss the lawsuit with prejudice, which action the court took on September 30, 2005.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the three-month period ended September 30, 2005, the Company sold an aggregate 199,500 shares of common stock and warrants to purchase 199,500 additional shares of common stock at $1.00 per share, to certain investors in connection with the Company’s Stock Offering. Gross proceeds to the Company in connection with these issuances were $199,500 and net proceeds were $183,540.

Between August 1, and September 23, 2005, we conducted the Interim Offering of our 9% convertible notes due July 31, 2006 and warrants. The notes are convertible into shares of our common stock at an initial conversion price of $.70 per share, anytime prior to maturity at the election of the noteholder and may be converted at our election under certain circumstances. The warrants are convertible, at $1.00 per share, for 150% of the number of shares into which the notes are convertible and may be exercised until August 31, 2007. The Interim Offering was made to the purchasers of the units in the Stock Offering and a limited number of individuals who are not “U.S. persons” as that term is defined in Rule 902 of Regulation S promulgated under the Securities Act of 1933, as amended. The total amount subscribed

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for in the Interim Financing was $1,501,378 gross proceeds ($1,428,432 net proceeds). Of this amount, $904,720 gross proceeds ($858,440 net proceeds) was received by the Company during the three-month period ended September 30, 2005, and the balance of $596,658 gross proceeds ($569,992 net proceeds) is expected to be received by the Company during the fourth quarter of 2005. Of the total number of warrants issued by the Company, warrants exercisable for 53,627 shares of the Company’s common stock were issued to the Company’s placement agent. If all of the warrants issued in the Interim Offering were exercised by all the warrant holders, the Company would be obligated to issue an additional 3,270,859 shares of its common stock to such persons.

The issuances of shares, convertible notes and warrants described above were made in reliance on the exemptions from registration set forth in Section 4(2) of the Securities Act of 1933, as amended, or Regulations D or S promulgated thereunder.

Item 3. Defaults Upon Senior Securities

None

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

None

Item 5. Other Information

None

Item 6. Exhibits

Exhibit No.	Description
10.1	Employment Agreement dated July 1, 2005 between the Company and John R. Bautista.
10.2	Lease dated August 15, 2005 between the Company and Thomas L. Jackson.
10.3	Form of the Company’s 9% convertible note issued in the Interim Financing.
10.4	Form of the Company’s stock purchase warrant issued in the Interim Financing.
31.1	Certification of Chief Executive Officer of Quarterly Report
Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
31.2	Certification of Chief Financial Officer of Quarterly Report
Pursuant to 18 U.S.C. Section 1350
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)

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SIGNATURES

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

Date: November 11, 2005
By:	/s/ EUGENE E. EICHLER
	Eugene E. Eichler
	Chief Executive Officer

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EXHIBIT INDEX

Exhibit No.	Description
10.1	Employment Agreement dated July 1, 2005 between the Company and John R. Bautista.
10.2	Lease dated August 15, 2005 between the Company and Thomas L. Jackson.
10.3	Form of 9% convertible note issued in the Company’s Interim Financing.
10.4	Form of stock purchase warrant issued in the Company’s Interim Financing.
31.1	Certification of Chief Executive Officer of Quarterly Report
Pursuant to Rule 13(a)-15(e) or Rule 15(d)-15(e)
31.2	Certification of Chief Financial Officer of Quarterly Report
Pursuant to 18 U.S.C. Section 1350
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)

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