The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets

The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements of operations

The accompanying notes to consolidated financial statements are
an integral part of these consolidated statements of capital deficiency

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CLEAN ENERGY COMBUSTION SYSTEMS, INC.
(a development stage enterprise)
(expressed in U.S. dollars)
CONSOLIDATED OF CASH FLOW

The accompanying notes to consolidated financial statements are
an integral part of these consolidated statements of cash flows

CLEAN ENERGY COMBUSTION SYSTEMS, INC.
(a development stage enterprise)
(expressed in U.S. dollars)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Nature Of Business; Organization And Operations; Going Concern

Clean Energy Combustion Systems, Inc. ("we", "our company" or "Clean Energy") was incorporated under the laws of the State of Delaware and organized and commenced its operations on March 1, 1999. These financial statements also reflect select pre-organization transactions and commitments incurred between January 1, 1999 and the date of incorporation on March 1, 1999, that were accepted by our board of directors in connection with its organization as obligations of our company.

Clean Energy was formed for the specific purpose of acquiring exclusive world-wide license rights entitling us to design, engineer, manufacture, market, distribute, license and otherwise commercially exploit two "burner" technologies, our patented pulse blade combustion or "PBC" technology which we hold a license from one of our founding shareholders, Ravenscraig Properties Limited ("Ravenscraig Properties"), and our diesel fuel combustion technology which we hold a license from another of our founding shareholders, Mr.  John D. Chato.

Since we have not generated operating revenues to date, we should be considered a development stage enterprise. As of June 30, 2002, we have incurred losses from inception totaling $2,657,634, have a working capital deficiency of $313,624, and do not currently have the financial resources to complete our business plan. Our ability to continue as a going concern will be dependent upon our ability to attain future profitable operations and to obtain the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they come due. External financing, predominately in the short-term by loans from affiliated parties and in the longer-term through the issuance of equity or debt will be sought to finance development of our products; however, there can be no assurance that sufficient funds will be raised.

In the event that cash flow from our operations, if any, together with the proceeds of any future financings, are insufficient to meet our current operating expenses, Clean Energy will be required to reevaluate our planned expenditures and allocate our total resources in such manner as our board of directors and management deem to be in our best interest. This may result in a substantial reduction of the scope of our existing and planned operations.

Our objective is to enter into licensing, royalty, joint venture, or manufacturing agreements with established national and international heat transfer industry manufacturers.

We are authorized under our Certificate of Incorporation to issue shares of common stock, series 'A' preferred stock, series 'B' preferred stock and series 'C' preferred stock (sometimes referred to in our consolidated financial statements and this report as "common shares", "series 'A' preferred shares", "series 'B' preferred shares" and "series 'C' preferred shares", respectively). See note 7.

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CLEAN ENERGY COMBUSTION SYSTEMS, INC.
(a development stage enterprise)
(expressed in U.S. dollars)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. Significant Accounting Policies

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Estimates And Assumptions

The preparation of these consolidated financial statements in conformity with generally accepted accounting principles requires our 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 these consolidated financial statements and the reported amount of revenues and expenses during the reporting periods. Actual results may differ from those estimates

Cash And Cash Equivalents

Cash and cash equivalents consist of cash on hand, funds on deposit and short-term investments with an original maturity of ninety days or less.

Short-Term Investments

Short-term investments consist of term deposits with a one-year maturity. These investments are cashable and can be drawn on at any time.

Patents

Costs related to the acquisition of patents are capitalized in the accounts and are amortized on a straight-line basis, commencing upon the production of revenues from the patent, over the shorter of the duration of the patent, which is twenty years, or the estimated life of the technology. The costs of servicing our patents are expensed as incurred. Clean Energy assesses potential impairment of patents by measuring the expected net recovery based on cash flows from products based on these rights on an annual basis. These capitalized costs are valued at the lower of amortized cost and net recoverable amount.

Property And Equipment

We state property and equipment at cost, and then record amortization on these assets on a straight-line basis over their respective estimated service lives. Clean Energy holds no property or equipment at the date of these financials statements.

Impairment Of Long-Lived Assets And Long-Lived Assets To Be Disposed

We evaluate our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets or intangibles may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the assets. If any assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the net recoverable value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

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amortized but instead will be subject to impairment tests at least annually. We adopted SFAS No. 141 on a prospective basis as of July 2001, and SFAS No. 142 in January 2002. The adoption of SFAS No. 141 and SFAS No. 142 did not have an impact on our consolidated financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets to be held and used, to be disposed of other than by sale, and to be disposed of by sale. We adopted SFAS No. 144 in the first quarter of 2002 on a prospective basis. The adoption of SFAS No. 144 did have significant impact on our consolidated financial position or results of operations.

3. Disposition Of Subsidiary Company

On December 31, 2001, we sold all of the shares of Clean Energy Technologies to one of our directors, Mr. John D. Chato, for proceeds of $1. We have recorded increases to additional paid-in capital in connection with this transaction, calculated as follows:

Proceeds from disposition	$                   1
Net liabilities of Clean Energy Technologies on date of disposition	2,095,253
(Offset) recovery of provisions & liabilities related to transfer of ownership	(659,403)
Offset against amount due from Clean Energy Technologies related to research and development charges	(1,141,328)
Net increase in additional paid-in capital	$        294,522

Effective January 1, 2002, Clean Energy Technologies commenced invoicing our remaining subsidiary, Clean Energy USA, pursuant to a research and development contract which allows Clean Energy Technologies to invoice pre-approved research and development costs, related overhead and a 10% mark-up.

This reorganization has been undertaken with the long-term goal of reducing our research and development expenditures through the utilization of grants and tax-incentive programs both in the United States and Canada.

No pro forma disclosure has been provided, as Clean Energy will continue to incur research and development expenditures through our contract with Clean Energy Technologies, resulting in no significant change to our operating expenses.

At the date of this transaction, December 31, 2001, we made provisions and allowances of $659,403 related to amounts advanced to Clean Energy Technologies and amounts payable by Clean Energy Technologies which we may have to satisfy. During the current six-month period, the advances increased by a net amount of $98,022, while the obligations decreased by $199,813. The net of these amounts, a decrease of $101,791, has been credited to the statement of operations as a reduction of provision related to the transfer of subsidiary.

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4. Advances To Affiliated Company

As at June 30, 2002 and December 31, 2001, we had advanced $468,738 (CDN $732,761) and $370,716 (CDN $590,476), respectively, to Clean Energy Technologies. These advances are non-interest bearing, are repayable in Canadian dollars and have no specific terms of repayment.

As the repayment of these advances is primarily dependant upon Clean Energy acquiring sufficient funding to honor our research and development contract with Clean Energy Technologies, a valuation allowance equal to the full amount of the advances was set up and the net gain on disposition of Clean Energy Technologies was reduced accordingly (See note 3). This allowance has been increased to reflect the net increase in advances in the current period.

5. Property And Equipment

On December 31, 2001, Clean Energy disposed of all of our shares in Clean Energy Technologies, which reduced our property and equipment accounts to $0 as of that date (note 3).

6. Advances From Related Parties

Summarized below are our advances and borrowing from related parties as of June 30, 2002 and December 31, 2001:

	June 30, 2002	December 31, 2001
Advances from officers, directors and principal shareholders	$ 423,618	$ 190,729
Advances from shareholders Total	50,000	-
Total	$ 423,618	$ 190,729

The advances from officers, directors and principal shareholders include advances from the following: Mr. R. Dirk Stinson, a director and indirect principal shareholder through Ravenscraig Properties; McSheahan Enterprises Ltd., a principal corporate shareholder that is owned and controlled by Barry A. Sheahan, an executive officer and a director of Clean Energy; JPT2 Holdings Ltd., a principal corporate shareholder that is owned and controlled by John P. Thuot, an executive officer and a director of Clean Energy; and John D. Chato, Chairman of our board of directors and indirect principal shareholder through J9 Enterprises Ltd. These advances are unsecured, bear interest at the rate of 8.75% per annum, are repayable in Canadian dollars, and have no specific terms of repayment.

The advances from shareholders are unsecured, bear interest at the rate of 8.75% per annum, are repayable in Canadian dollars, and have no specific terms of repayment.

Pursuant to the loan agreements, each of the above parties has the right to convert any portion of outstanding indebtedness under the note, including accrued interest, that accrues on or prior to the date that occurs two months after the date of listing, at a conversion rate equal to 80% of the average market trading price for the 30 day period prior to conversion, but not to exceed $2 per share. As 

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the result of the commencement of trading of common shares on the OTC Bulletin Board on June 17 2002, this date has been fixed as of August 16, 2002. Interest of $35,782 as at June 30, 2002 ($8,084 as at December 31, 2001) has been accrued.

7. Share Capital and Stock Options

During 2001, our board of directors authorized the creation of an additional 500,000 preferred shares upon our filing of an amendment to our certificate of incorporation, bringing the authorized total at that time, including classes of preferred stock designated below, to 1,500,000 shares.

Series 'A' Preferred Stock

Our series 'A' preferred shares are non-voting and may be converted into one common share at the option of the holder at any time. The affirmative consent of a majority of all outstanding series 'A' preferred shares is required to liquidate or dissolve our company, to sell our principal assets, to merge or consolidate our company with another, to declare a dividend, to make any changes in our authorized capital stock, or to issue additional preferential preferred shares. Should our common shares be accepted for listing on The New York Stock Exchange or The American Exchange or accepted for quotation on Nasdaq, all outstanding series 'A' preferred shares will automatically convert into common shares on a one for one basis once our common shares have been actively traded on that exchange or market for a two year continuous period. In the event of the voluntary or involuntary liquidation, dissolution or winding up of our company, our series 'A' preferred shareholders will be entitled to an amount equal to $1 per share, but after payment has been made to all series 'B' preferred shareholders with respect to their liquidation preference.

Clean Energy designated and issued 1,000 series 'A' preferred shares upon our incorporation.

Series 'B' Preferred Stock

Our series 'B' preferred shares are voting and are entitled to participate in dividends with our common shares.

The affirmative consent of a majority of all outstanding series 'B' preferred shares is required to make any change in our authorized capital stock or to issue additional preferential preferred shares. Our series 'B' preferred shares may be converted at the option of the holder, at any time, into one common share. Should our common shares be accepted for listing on The New York Stock Exchange or The 

American Exchange or accepted for quotation on Nasdaq, all outstanding series 'B' preferred shares would automatically convert into common shares on a one for one basis. In the event of the voluntary or involuntary liquidation, dissolution or winding up of our company, our series 'B' preferred shareholders will be entitled to an amount equal to $2 per share before any payment will be made or any assets distributed to the holders of series 'A' preferred shares, common shares, or any other junior equity security.

During the period ended December 31, 1999, we designated 250,001 preferred shares as series 'B' preferred stock, and issued those shares pursuant to a private placement for gross proceeds of $500,002.

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During the year ended December 31, 2001, one of our shareholders converted 75,000 series 'B' preferred shares into 75,000 common shares, leaving 175,001 issued and outstanding at June 30, 2002 and December 31, 2001.

Series 'C' Preferred Stock

Our series 'C' preferred shares are voting and are entitled to participate in dividends with our common shares.

The affirmative consent of a majority of all outstanding series 'C' preferred shares is required to liquidate or dissolve our company, to sell our principal assets, to merge or consolidate our company with another, to declare a dividend, to make any changes in our authorized capital stock, to issue additional preferential preferred shares, to declare any dividends or to redeem or purchase any series 'C' preferred shares. Our series 'C' preferred shares may be converted at the option of the holder, at any time, into one common share. Should our common shares be accepted for listing on The New York Stock Exchange or The American Exchange or accepted for quotation on Nasdaq, all outstanding series 'C' preferred shares would automatically convert into one common share. In the event of our voluntary or involuntary liquidation, dissolution or winding up, our series 'C' preferred shareholders will be entitled to an amount equal to the stated value or issuance cost before any payment will be made or any assets distributed to the holders of our series 'A' preferred shares, series 'B' preferred shares, common shares, or any other junior equity security.

During the period ended December 31, 1999, we designated 500,000 preferred shares as series 'C' preferred stock. As at June 30, 2002, there were no series 'C' preferred shares.

Common Stock

During 2001, our board of directors authorized the creation of an additional 10,000,000 common shares, which will increase our total authorized common shares to 25,000,000 shares upon our filing of an amendment to our certificate of incorporation.

Common Share Purchase Options

In 1999, we granted non-qualified common stock purchase options to executive officers and key employees entitling them to purchase an aggregate of 320,000 common shares at an exercise price of $2 per share, including an aggregate 260,000 options granted to Messrs. Chato, Thuot and Sheahan. These options vest equally annually over a five-year period, and each annual vesting portion expires five years subsequent to the vesting date. The $2 exercise price was determined to be fair market value, based on the concurrent sale of convertible series 'B' preferred shares to non-related parties.

Also in 1999, we granted non-qualified common stock purchase options to Mr. R. Dirk Stinson, in his capacity as a director, entitling him to purchase an aggregate of 60,000 common shares at an exercise price of $2 per share. These options vest equally annually over a three-year period, and each annual vesting portion expires five years subsequent to the vesting date.

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8. Related Party Transactions

Our financial instruments consist of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, accrued liabilities, current payroll taxes, advances from affiliated companies and a loan payable. The fair value of these financial instruments approximates our carrying values due to the short-term to maturity of these financial instruments and similarity to current market rates.

It is management's opinion that Clean Energy is not exposed to significant interest, currency or credit risks arising from these financial instruments.

10. Commitments And Contingencies

Ravenscraig Properties, the licensor of our pulse combustion technology, has the right to terminate the license if we do not obtain a listing of our common shares on The New York Stock Exchange, The American Stock Exchange or Nasdaq by March 5, 2004. Ravenscraig Properties also has the right to reacquire the pulse combustion technology if Clean Energy is declared insolvent or bankrupt. Should Ravenscraig Properties exercise its termination right, we can purchase full title to the pulse combustion technology by paying CDN $525,000 within ten business days of the ninety day termination period, plus interest on such amount at the rate of 13% per annum, accruing as of January 1, 1999. On the purchase, Clean Energy will also be entitled to receive the return of 593,750 common shares as well as all outstanding series 'A' preferred shares. If Ravenscraig Properties is unable to deliver the full number of shares, the cash payment will be reduced pro-rata. Should the pulse combustion technology license terminate without our acquisition of full ownership of that technology, then our diesel fuel combustion technology license with Mr. John D. Chato shall expire concurrently.

We have entered into management services agreements with to JPT2 Holdings Ltd. and McSheahan Enterprise Ltd., management corporations controlled by Messrs. Thuot and Sheahan, respectively, providing for total annual payments of $120,000 (CDN $192,000), commencing April, 2001, plus additional common share purchase options as detailed in note 7. Each agreement provides for a one-year initial term, renewed automatically for successive one-year terms. This agreement was renewed for an additional year, commencing April 1, 2002, with annual payments of $130,000 (CDN $200,000).

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We have entered into a consulting agreement with the HMJ Corporation, a company owned and controlled by William D. Jackson, a director of our company. The agreement obligates HMJ to provide the services of Dr. Jackson for a stipulated number of hours monthly and requires Clean Energy to pay a retainer of US$5,000 monthly, plus out-of-pocket travel costs associated with the contract work. This agreement commenced April, 2001 and expired March 31, 2002. A renewal of the agreement is currently under review with Dr. Jackson.

We have entered into a consulting agreement with an engineer with respect to our residential hot water heater project to provide a stipulated number of hours monthly. The agreement requires Clean Energy to pay a retainer of US$2,000 monthly, plus out-of-pocket travel costs associated with the contract work.

We have entered into a public relations services agreement whereby Clean Energy was obligated to pay a monthly fee of CDN $6,000 for a period of thirty-six months, commencing April 1999. Either party can terminate the agreement after one year. In April, 2001, the parties agreed to amend this agreement to reduce the monthly fee to CDN $3,000.

We have entered into an investor relations and communications services agreement whereby Clean Energy is obligated to pay a monthly fee of CDN $2,275 for a one-year period, commencing June 2001. The agreement may be cancelled upon sixty days written notice.

 

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Clean Energy was formed on March 1, 1999, for the principal purpose of acquiring exclusive world-wide license rights entitling us to design, engineer, manufacture, market, distribute, license and otherwise commercially exploit our pulse blade combustion technology. This technology has completed the primary development stage and is in a position to be commercially exploited. Our objective is to enter into licensing, royalty, joint venture or manufacturing agreements with established national and international heat transfer industry manufacturers which will result in the introduction of a variety of different burner units based upon this technology into various selected market segments. We have no revenues to date, nor have we entered into any revenue producing contracts to date, although we are currently working on a number of proto-types under several proposal requests which could lead to development grants by manufacturers over the next four to six months, and contract revenues after twelve months. Since we have not generated operating revenues to date, we should be considered a development stage enterprise. For additional and more detailed background information relating to our company and our business, see our annual report on form 10-K for our fiscal year ended December 31, 2001.

The consolidated results of operations for the three- and six-month interim periods ended June 30, 2002 included in this report are not necessarily predictive of results to be expected for our full fiscal year ended December 31, 2002. Results of consolidated operations for the interim periods ended after December 31, 2001 included in this report may not be comparable to results for corresponding interim periods ended on or before December 31, 2001 due to the divestiture on December 31, 2001 of our research and development subsidiary, Clean Energy Technologies, to Mr. John D. Chato, the inventor of our technologies, our head of our research and development, and a director and principal shareholder of our company. As a part of that divestiture, Clean Energy Technologies entered into an agreement to provide continued research and development services to our company on a cost plus 10% contractual basis since December 31, 2001. See explanatory note 3 to our consolidated financial statements.

We had no revenues for our six-month and three-month interim fiscal periods ended June 30, 2002 and June 30, 2001, respectively.

We incurred an operating loss of $297,959 for our six-month interim period ended June 30, 2002, as compared to $431,371 for the corresponding interim period in fiscal 2001, representing a $133,412 or 30.9% overall decrease. For our three-month interim period ended June 30, 2002, we incurred an operating loss of $181,008, as compared to $195,883 for the corresponding interim period in fiscal 2001, representing a decrease of $14,875 or 7.6%.

The 30.9% overall decrease in our operating loss for our six-month interim period ended June 30, 2002 over the corresponding interim period in fiscal 2001 was primarily attributable to:

 

• a $117,940, or 45.0%, decrease in administration expense from $262,034 to $144,094; and

• a $101,791 reduction of provision related to transfer of subsidiary which occurred in 2002 but not in 2001;

   

partially offset by

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• an $86,319, or 51.0%, increase in research and development expense from $169,337 to $255,656.

For our three-month interim period ended June 30, 2002, the 7.6% overall decrease in our operating loss over the corresponding interim period in fiscal 2001 was primarily attributable to:

• a $46,533, or 35.5%, decrease in administration expense from $130,956 to $84,423; and

• a $23,481 reduction of provision related to transfer of subsidiary which occurred in 2002 but not in 2001;

partially offset by

• a $55,139, or 84.9%, increase in research and development expense from $64,927 to $120,066.

The decrease in administration expense for our six-month and three-month interim periods ended June 30, 2002 over the corresponding interim periods in fiscal 2001, respectively, and the increase in our research and development expense over the same periods, respectively, were both primarily attributable to the divestiture of our research and development subsidiary, Clean Energy Technologies, and our subsequent contracting of research and development services on a cost-plus 10% contract basis. Specifically, in divesting Clean Energy Technologies and its attendant research and development personnel and activities, we effectively shifted a portion of our wages and benefits, marketing expense, amortization expense and occupancy costs included in administration expense from that aggregate expense grouping to the research and development expense grouping, insofar as these costs are now indirectly recorded by us under the monthly cost plus 10% research and development fee that is charged to us under the research and development contract we entered into with Clean Energy Technologies..

As a consequence of this divestiture, we recorded a $31,621 overall net reduction in combined administration and research and development expense over our six-month interim periods ended June 30, 2002, reflecting an overall reduction in our research and development activities and attendant decreases in materials and labor costs for this period as compared to the corresponding prior period, and a$8,606 overall net increase in combined administration and research and development expense over our three-month interim periods ended June 30, 2002, reflecting an overall increase in our research and development activities and attendant decreases in materials and labor costs for this period as compared to the corresponding prior period.

We have not entered into any transactions during our six-month interim period ended June 30, 2002 with any parties that are not clearly independent on terms that might not be available from other clearly independent third parties related parties.

Our cash flow requirements from our inception through June 30, 2002 were principally funded by:

Included in the $785,187 in accounts payable, accrued liabilities and short-term advances by shareholders noted above are short-term advances by shareholders and other creditors in the aggregate amount of $473,618 relating to both cash advances and unpaid wages and fees. Pursuant to the terms of the underlying notes or agreements, these obligations are payable, together with interest accrued at prime plus 2%, upon demand or, at the option of the noteholder, convertible into common shares at a conversion rate determined at the time of conversion based on a 20% discount to average market trading price for the prior twenty business days, or $2 per share if our common shares are not trading at the time of conversion.

There are no guarantees, commitments, lease and debt agreements or other agreements that could trigger adverse change in our credit rating, earnings, cash flows or stock price, including requirements to perform under standby agreements, other than the following:

• Defaults in the notes described above.

• Contingent liabilities of Clean Energy Technologies as of June 30, 2002 in the amount of $88,873 which arise from contracts previously entered into by Clean Energy either jointly with, or on behalf of, Clean Energy Technologies before our divestiture of that company on December 31, 2001. These contingent liabilities are included as part of liabilities relating to Clean Energy Technologies in our consolidated balance sheet.

Our cash and cash equivalents position as of June 30, 2002 and December 31, 2001 was $0. Our cash and cash equivalents position as of June 30, 2001 was $1,192, as compared to $2,122 as of December 31, 2000.

In the six month period ended June 30, 2002, we generated $184,867 in cash from financing activities, partially offset by $183,589 in cash used in operating activities and $1,278 used in investing activities. The $930 decrease in our cash position for our six-month interim period ended June 30, 2001 as compared to December 31, 2000 was attributable to $142,722 used in operating activities and $13,338 used in investing activities, partially offset by $132,885 realized from financing activities.

Our operating activities required cash in the amount of $183,589 for our six-month period ended June 30, 2002, as compared to cash requirements of $142,722 for the corresponding interim period in fiscal 2001. The $183,589 of cash used in operating activities for our six-month interim period ended June 30, 2002 reflected our net loss of $297,959 for that period, as decreased for non-cash deductions and a net increase in non-cash working capital balances. The $930 decrease in our cash position for our six-month interim period ended June 30, 2001 as compared to December 31, 2000 was attributable to $142,722 in cash used in operating activities, partially offset by $8,907 realized from investing activities and $132,885 realized from financing activities

We used cash in the amount of $1,278 for investing activities which was comprised of additions to patents for our six-month interim period ended June 30, 2002, as compared to $8,907 of cash used in investing activities for the corresponding interim period in fiscal 2001. There were no purchases of property or equipment, or investment in patents for our six-month interim period ended June 30, 2002, as compared to additions to patents of $4,252 and purchases of property and equipment of $179 for the corresponding interim period in fiscal 2001.

We raised $184,867 in cash from financing activities for our six-month interim period ended June 30, 2002, as compared to $132,885 in cash raised from financing activities for the corresponding interim period in fiscal 2001. The $184,867 in cash raised through financing activities for our six-month interim period ended June 30, 2002 was principally comprised of $282,889 in funds advanced by shareholders and related parties, and 

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$98,022 net additional advances to an affiliated company. The $132,885 in cash raised through financing activities for our six-month interim period ended June 30, 2001, was principally comprised of $132,398 in funds advanced by shareholders, related parties and consultants.

Our ability to continue as a going concern will be dependent upon our entering into revenue producing contracts and raising additional working capital to fund these contracts, conduct addition research and development activities through our contract with Clean Energy Technologies and fully implement our longer-term business plan and marketing strategies. We anticipate that we will need to raise at least $850,000 to fund our projected operating, research and development and project costs over the next twelve months assuming we continue to stay our China coal project, and at least $5,000,000 in working capital (including the $850,000 noted above) to fully implement our business plan and marketing strategies including the acquisition of the necessary plant, equipment and personnel to pursue larger scale research & development projects as identified in our business plan. These estimates will be subject to significant change based upon any contracts we may enter into and/or additional capital we may raise, including any grant monies we receive.

Our operating expenses are currently being funded primarily through:

Mr. Stinson has indicated that he would be willing to continue to make advances on these terms for the indefinite future, should his personal financial situation permit it. We cannot give you any assurance that Mr. Stinson will remain in a position to fund our operations notwithstanding his desire to do so. We have made no binding arrangements or received binding commitments to obtain additional working capital as of the date of this report other than the advances described above which Mr. Stinson may make.

Our research and development contractor, Clean Energy Technologies, has received or is entitled to receive CDN $60,000 to date in matching grants with respect to our Canadian natural gas-fueled industrial dryer project, and is filing grant applications for the purpose of funding an additional CDN $193,000 in project costs. Should it raise this capital, our industry partner has committed to fund the balance of the project costs of approximately CDN $193,000. These amounts, if and when received, will reduce or lever our research and development costs for the project.

We have also filed grant applications with government funding programs in Canada and in California to provide matching funds for our natural gas-fueled water heater project, and are currently in negotiations with prospective industry partners relative to advancing this project.

Our intent is to raise additional working capital to fund our ongoing capital and operational requirements in one or more increments through grants, contract advances, public or private sales of debt or equity securities, debt financing or short-term loans, or a combination of the foregoing. We currently are in contact with, and over the past year have also been in contact with, a number of financing sources, including investors, lenders and finders, relative to funding our ongoing capital requirements. With the exception of the grant applications described above, we have not to date, however, received significant commitments from any of these sources on terms our board deems acceptable. Our ability to raise monies has also been adversely affected in part by general poor economic conditions and enhanced risks associated in investing in development stage ventures.

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In view of our limited operating history and lack of revenues and profits to date, we cannot give you any assurance that we will be able to secure the additional capital we require at all, or on terms which will not be objectionable to our company or our shareholders, including substantial dilution or the sale or licensing of our technologies. Our failure or inability under these circumstances to obtain additional capital on acceptable terms or at all would have a material adverse effect on our company and our business, which would result in our being forced to materially scale back or even suspend our operations, or even force us to seek a merger with or to sell our business to a third party. In view of these considerations, note 1 of our financial statements states that if we do not raise sufficient capital there is substantial doubt as to our ability to continue as a going concern.

Research and development expenditures are expensed as incurred.

We recorded no foreign currency translation gain or loss for our six-month period ended June 30, 2002. We anticipate that our exposure to significant foreign currency gains or losses on our accounting records will decrease as the result of the disposition of Clean Energy Technologies. We cannot give you any assurance that our future operating results will not be adversely affected by currency exchange rate fluctuations. See that section of this report captioned "Quantitative and Qualitative Disclosure About Market Risk" for a description of other aspects of our company that may be potentially affected by foreign exchange fluctuations.

We do not believe that our operating results were adversely affected during the first six months of fiscal 2002 or fiscal 2001 by inflation or changing prices.

Our consolidated financial condition and results of operations are not currently subject to or impacted by critical accounting policies involving areas in which subjective or complex judgments are made in connection with methods, assumptions or estimates concerning the effect of matters that are inherently uncertain.

For a summary of the effect of recent accounting pronouncements on our company, see that section in explanatory note 2 to our consolidated financial statements included with this report captioned "Recent Accounting Pronouncements".

One market risk that affects our company relates to foreign currency fluctuations between United States and Canadian dollars. To the extent we maintain our accounts in Canadian funds or enter into transactions denominated in Canadian currency, our financial position could be adversely affected by United States-Canadian currency fluctuations. We have not previously engaged in activities to mitigate the effects of foreign currency fluctuations due to the absence of Canadian revenues to date, and we anticipate that the exchange rate between the United States and Canadian dollar will remain fairly stable.

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If earnings from our Canadian operations were to increase, our exposure to fluctuations in the United States-Canadian exchange rate would also increase, and we would have to consider utilizing forward exchange rate contracts or engage in other efforts to mitigate these foreign currency risks. We cannot give you any assurance that the use of exchange rate contracts or other mitigation efforts would effectively limit any adverse effects of foreign currency fluctuations on our Company's international operations and our overall results of operations.

It is our policy to maintain the bulk of our available cash in U.S. dollar-denominated money-market accounts. Our interest income from these short-term investments could be adversely affected by any material changes in interest rates within the United States.

Our future results of operations or financial condition may be affected by the uncertainties and other risk factors enumerated below as well as those presented elsewhere in this report and in other reports we periodically file with the SEC, including our annual report on form 10-K for the fiscal year ended December 31, 2001, and should be considered in context with the various disclosures concerning our company presented elsewhere herein and therein.

We were only recently organized, on March 1, 1999, and have a limited operating history. We have not yet introduced our products commercially to the markets or entered into binding contracts to do so. We are, as a consequence, subject to all the risks and issues inherent in the establishment and expansion of a new business enterprise. Our failure to successfully address these risks would adversely affect our ability to:

Our activities through the date of this report have been limited to:

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Risks and issues inherent in the establishment and expansion of a new business enterprise which we face include, among others, problems of entering new markets, marketing new technologies, hiring and training personnel, acquiring reliable facilities and equipment, and implementing operational controls. In general, startup businesses are subject to risks and or levels of risk that are often greater than those encountered by companies with established operations and relationships. Startups often require significant capital from sources other than operations. The management and employees of startup business shoulder the burdens of the business operations and a workload associated with company growth and capitalization that is disproportionately greater than that for an established business. Our limited operating history makes it difficult, if not impossible, to predict future operating results. We cannot give you any assurance that we will successfully address these risks.

We are a developmental stage company since we have not commenced commercial sales of our burner technologies and have no revenues to date. Our failure to generate revenues and ultimately profits would:

We do not anticipate that we will generate revenues for at least twelve months at the earliest, assuming that one or more of our pending projects lead to a commercial contract. We have, as a result of our lack of revenues, incurred operating losses in the amount of $2,657,634 from our inception through June 30, 2002, and we anticipate that we will continue to incur substantial operating losses for the foreseeable future, despite any revenues we may receive in the short-term from any of our pending projects, due to the significant costs associated with the development and marketing of our burner technologies. We cannot give you any assurance that we will generate revenues or profits in the near future or at all.

We currently have insufficient working capital to fund our projected operating and project costs for more than one month. Our inability to raise sufficient additional working capital in the near future would likely force us to suspend our operations, and possibly even liquidate our assets and wind-up and dissolve our company.

Our operating expenses are currently being primarily funded for the indefinite future through advances made by one of our directors and principal shareholders, Mr. R. Dirk Stinson. We cannot give you any assurance that Mr. Stinson will remain in a position to fund our operations notwithstanding his desire to do so.

We anticipate that we will need to raise at least $850,000 to fund our projected operating and project costs over the next twelve months, and at least $5,000,000, including the $850,000 noted above, in additional working capital to fully implement our longer-term business plan and marketing strategies. We have no current arrangements for obtaining this additional capital other than our current relationship with Mr. Stinson, 

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and will seek to raise this amount in one or more increments through grants, Canadian research and development tax credits, contract advances, public or private sales of debt or equity securities, debt financing or short-term loans, or a combination of the foregoing. We cannot give you any assurance that we will be able to secure the additional capital we require to continue our operation at all, or on terms which will not be objectionable to our company or our shareholders, including substantial dilution or the sale or licensing of our technologies.

Explanatory note 1 to our financial statements states that if we do not raise sufficient capital there is a substantial doubt as to our ability to continue as a going concern. Our independent auditors expressed a going concern opinion in their report accompanying our financial statements for the fiscal year ended December 31, 2001 .

Although we are working on proto-types under several pending proposals, we have not entered into any revenue-generating contracts to date, and our ability to do so will be dependent in primary part upon our ability to satisfactorily complete the proto-types, to raise sufficient capital to fund these efforts, and to otherwise successfully implement our various market strategies under our business plan. Our failure to enter into any revenue-generating contracts would:

Even if we enter into revenue-generating contracts, we cannot give you any assurance that we will attain or sustain operating profitability as a result of these contracts.

The failure of our burner products to achieve or sustain market acceptance would likely force us to suspend our operations, liquidate our assets, and wind-up and dissolve our company. Products using our burner technologies must compete with established conventional steady-state burner technologies and conventional "tubular" pulse combustion technologies which have already achieved market acceptance. The design for our burner technologies is new and unique, and no products based upon our technologies and configurations have been commercially produced or sold to date, either by our company or by any of our competitors. Additionally, although there is a market for pulse combustion burner products using differently configured pulse burner technology designs, these products are not widely accepted by the market, and therefore not particularly useful as a precedent for the introduction of our pulse combustion burner technology.

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As is typical in the case of any new technology, demand and market acceptance for products based upon new technologies are subject to a high level of uncertainty and risk, including the risk that the marketplace may not accept, or be receptive to, the potential benefits of these new products. The extent and pace of market acceptance of new burner products based upon our burner technologies will ultimately be a function of many variables, including the following:

The extent and pace of market acceptance of products based upon our burner technologies will also depend upon general economic conditions affecting customers' purchasing patterns. Because the market for our burner technologies is new and evolving, it is difficult, if not impossible, to predict the future growth rate, and the size of the potential market. We cannot give you any assurance that a market for our burner technologies will develop or, if developed, will be sustainable.

We currently have no internal sales, marketing and distribution capabilities, and will likely be forced to rely extensively on strategic partners or third party marketing and distribution companies. Our failure to generate substantial sales through any strategic partners or distribution arrangements we procure or to otherwise develop our own internal sales, marketing and distribution capabilities would:

As a consequence of our prospective reliance upon strategic partners or third party marketing and distribution partners, our ability to effectively market and distribute our burner products will be dependent in large part on the strength and financial condition of others, the expertise and relationships of our strategic partners or distributors and marketers with customers, and the interest of these parties in selling and marketing our products. Our prospective strategic partners and marketing and distribution parties may also market and distribute the products of other companies. If our relationships with any strategic partners or third party marketing and distribution partners were to terminate, we would need to either develop alternative relationships or develop our own internal sales and marketing forces to continue to sell our products. Even if we are 

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able to develop our internal sales, marketing and distribution capabilities, these efforts would require significant cash and other resources that would be diverted from other uses, if available at all, and could cause delays or interruptions in our product supply to customers, which could result in the loss of significant sales or customers. We can give you no assurance that we will be successful in our efforts to engage strategic partners or third party marketing and distribution companies to meet our sales, marketing and distribution requirements.

We currently have no internal manufacturing capability, and will likely be forced to rely extensively on strategic partners or third party contract manufacturers or suppliers. A delay or interruption in the supply of components or finished products would:

•  introduce burner products using our technologies onto the market and to compete, with consequential delays in our ability to generate revenues and profits; and

•  raise additional working capital; and

Should we be forced to manufacture our burner products, we cannot give you any assurance that we will be able to develop or internal manufacturing capability or procure third party suppliers. Moreover, we cannot give you any assurance that any contract manufacturers or suppliers we procure will be able to supply our product in a timely or cost effective manner or in accordance with applicable regulatory requirements or our specifications.

Due to the early developmental stage of our business, we have expended only limited amounts on research and development of our burner products to date, including development of project proto-types, and currently have very limited resources to devote to future research and development. Unless we are able to obtain and devote resources to our research and development efforts, including project proto-types, we may only be able to develop limited product offerings in the future and our ability to procure contracts or otherwise achieve market acceptance for our burner products will be limited. As a result, we may fail to achieve significant growth in revenues or profitability in the future.

Products based upon our burner technologies will face intense domestic and foreign competition in all markets in which they are introduced from conventional products and technologies already being sold in these markets. The failure of our burner products to achieve or sustain market acceptance would likely force us to suspend our operations, liquidate our assets, and wind-up and dissolve our company. Additionally, many of our prospective competitors have significantly greater financial, technical and marketing resources and trade name recognition than ours, which may enable them to successfully develop and market products based 

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on technologies or approaches similar to ours, or develop products based on other technologies or approaches which are, or may be, competitive with our burner technologies. The development by our competitors new or improved products, processes or technologies may make our burner technologies less competitive or obsolete. We will be required to devote significant financial and other resources to continue to develop our burner technologies in view of potential competition. We cannot give you any assurance that we will be able to initially penetrate or compete successfully within the heat transfer industry.

The licensors of our pulse combustion and diesel fuel combustion technologies reserved several termination rights as a condition for their licensing these technologies to our company. The loss of either of our technology licenses would likely force us to suspend our operations, liquidate our assets, and wind-up and dissolve our company. Specifically:

We can give you no assurance in the event of the potential termination of either of our technology licenses that we will be able to preserve the license through the exercise of any cures or other protective rights available to us under the applicable technology license.

Our success depends to a significant extent on the continued efforts of our research and development and senior management team, which currently is composed of a small number of individuals, including Mr. John D. Chato, the inventor of our licensed technologies who heads our research and development efforts on a contract basis through Clean Energy Technologies, Mr. John P. Thuot, our President, and Mr. Barry A. Sheahan, our Chief Financial Officer. The loss of any of these management personnel would:

Although Messrs. Chato, Thuot and Sheahan have signed research and development or management services agreements, we cannot give you any assurance that one or more of these employees will not leave our company. We also do not carry key person life insurance on any of our key management personnel.

Our ability to implement our growth strategies will be dependent upon our continuing ability to attract and retain highly qualified engineering, managerial, sales and marketing and administrative personnel. Our inability to attract and retain the necessary personnel would impede our growth. Competition for the type of personnel we require is intense and we cannot give you any assurance that we will be able to retain our key managerial and technical employees, or that we will be able to attract and retain additional highly qualified managerial and technical personnel in the future

Our success will depend upon the rapid expansion of our business. Our inability to effectively manage our growth, or the failure of our new personnel to achieve anticipated performance levels, would adversely affect our ability to:

Expansion will place a significant strain on our financial, management and other resources, and will require us, among other things, to:

We cannot give you any assurance that our efforts to hiring or retain these personnel will be successful, or that we will be able to manage the expansion of our business effectively.

Our ability to compete effectively will be materially dependent upon the proprietary nature of our designs, processes, technologies and materials. The invalidation or circumvention of key patents or proprietary rights which we own or license would likely force us to suspend our operations, liquidate our assets, and wind-up and dissolve our company.

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Although we protect our proprietary property, technologies and processes through a combination of patent law, trade secrets and non-disclosure agreements, we cannot give you any assurance that these measures will prove to be effective. For example, in the case of patents, we cannot give you any assurance that our or our licensors' existing patents will not be invalidated, that any patents that we or our licensors' currently or prospectively apply for will be granted, or that any of these patents will ultimately provide significant commercial benefits. Moreover, it is possible that competing companies may circumvent any patents that we or our licensors may hold by developing products which closely emulate but do not infringe our or our these patents, and accordingly market products that compete with our products without obtaining a license from us.

In addition to patented or potentially patentable designs, technologies, processes and materials, we also rely on proprietary designs, technologies, processes and know-how not eligible for patent protection. We cannot give you any assurance that our competitors will not independently develop the same or superior designs, technologies, processes and know-how as we possess.

We believe that the international market for our products and technologies is as important as the domestic market, and we will therefore seek patent protection for our products and technologies or those of our licensors in selected foreign countries. Because of the differences in foreign patent and other laws concerning proprietary rights, our products and technologies may not receive the same degree of protection in a number of foreign countries as they would in the United States.

We cannot give you any assurance that we will be able to successfully defend our patents and proprietary rights. We also cannot give you any assurance that we will not be required to defend against litigation involving the patents or proprietary rights of others, or that we will be able to obtain licenses for these rights. Legal and accounting costs relating to prosecuting or defending patent infringement litigation may be substantial.

We intend to sell our products and technologies internationally as well as to the United States and within Canada. This will subject us to various risks associated with international transactions that may adversely effect our results of operations, including risks associated with:

We do not currently engage in activities to mitigate the effects of foreign currency fluctuations, and we anticipate we will be paid in U.S. dollars with respect to any international transactions we may enter into. If earnings from international operations increase, our exposure to fluctuations in foreign currencies may increase, and we may utilize forward exchange rate contracts or engage in other efforts to mitigate foreign currency risks. We can give no you assurance as to the effectiveness of these efforts in limiting any adverse effects of foreign currency fluctuations on our international operations and our overall results of operations.

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There is only a limited public market for the common shares on the OTC Electronic Bulletin Board, and we cannot give you any assurance that a broader or more active public trading market for the common shares will develop or be sustained, or that current trading levels will be sustained.

The market price for the common shares on the OTC Bulletin Board has been and we anticipate will continue to be extremely volatile and subject to significant price and volume fluctuations in response to a variety of external and internal factors. This is especially true with respect to emerging companies such as ours. Examples of external factors, which can generally be described as factors that are unrelated to the operating performance or financial condition of any particular company, include changes in interest rates and worldwide economic and market conditions, as well as changes in industry conditions, such as changes in the cost of components and energy, regulatory and environment rules, announcements of technology innovations or new products by other companies, and quarterly fluctuation in our or in our competitors' operating results. Examples of internal factors, which can generally be described as factors that are directly related to our operating performance or financial condition, would include release of reports by securities analysts and announcements we may make from time-to-time relative to our ability to enter into contracts or other arrangement, our operating performance, advances in our technology or other business developments specific to our company. Any of these external or internal factors could have a significant impact on the price of our common shares or other securities on the public market.

Because we are a development stage enterprise with a limited operating history and no revenues or profits to date, the market price for the common shares is more volatile than that of a seasoned issuer. Changes in the market price of the common shares, for example, may have no connection with our operating results or business prospects. No predictions can be made as to what the prevailing market price for the common shares will be at any time, or as to what effect, if any, that the sale of shares or the availability of common shares for sale at any time will have on the prevailing market price.

Sales of substantial amounts of the common shares on the public market, or the perception that substantial sales could occur, could adversely affect the prevailing market prices for those shares and also, to the extent the prevailing market price for the common shares is reduced, adversely impact our ability to raise additional capital in the equity markets. In addition, employees, directors and consultants of Clean Energy currently hold vested options entitling them to acquire 459,305 common shares. Should these persons exercise these options, it is likely they would sell some or all of the underlying common shares on the public markets in order to procure liquidity to pay taxes as well as other reasons they may deem pertinent.

Since the common shares are not listed on a national stock exchange or quoted on the Nasdaq Market within the United States, trading in the common shares on the OTC Electronic Bulletin Board is subject, to the extent the market price for the common shares is less than $5 per share, to a number of regulations known as the "penny stock rules". The penny stock rules require a broker-dealer to deliver a standardized risk disclosure document prepared by the SEC, to provide the customer with additional information including current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, monthly account statements showing the market value of each penny stock held in the customer's account, and to make a special written determination that the penny stock is a suitable 

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investment for the purchaser and receive the purchaser's written agreement to the transaction. To the extent these requirements may be applicable they will reduce the level of trading activity in the secondary market for the common shares and may severely and adversely affect the ability of broker-dealers to sell the common shares.

If you hold common shares and were we to wind-up and dissolve our company and liquidate and distribute our assets, you would share ratably with our other common shareholders in our assets only after we satisfy the following obligations calculated as of December 31, 2001:

If our liquidation were attributable to our inability to profitably operate our business, then it is likely that we would have material liabilities at the time of liquidation or dissolution. We cannot give you any assurance that sufficient assets will remain available after the payment of our creditors and preferred shareholders to enable you to receive any liquidation distribution with respect to any common shares or other securities of our company you may hold. Our current principal shareholders will continue to control our company, and will accordingly retain the power to substantially influence corporate actions that conflict with the interests of public shareholders

While our series 'A' preferred shareholders generally do not have the right to vote, we cannot effectuate any of the following transactions or actions without their consent and approval:

An investment in our common shares or other securities will entail you entrusting these and similar decisions to our present management and principal shareholders subject, of course, to their fiduciary duties and the business judgment rule.

Our Certificate of Incorporation currently authorizes us to issue 15,000,000 common shares, and 1,000,000 preferred shares, including 248,999 serial or "blank check" preferred shares that will contain rights, preferences and privileges to be prospectively fixed by our board of directors at the time of issuance-without shareholder consent or approval-based upon any factors our board of directors may deem relevant at that time. Our board of directors and shareholders have also recently approved an increase in our authorized capital to 25,000,000 common shares and 1,500,000 preferred shares. It is likely that we will be required to issue a large amount of additional securities to raise capital to further our development and marketing plans, particularly our coal project. If you are a common shareholder, your proportionate ownership and voting rights could be adversely effected by the issuance of additional common, series 'C' convertible or "blank check" preferred shares, depending on their rights, preferences and privileges, including a substantial dilution in your net tangible book value per share. We cannot give you any assurance that we will not issue shares of capital stock under circumstances we may deem appropriate at the time.

Some of the provisions contained in our charter documents and Delaware corporate law may discourage transactions involving an actual or potential change in control of our company, and may limit the ability of our shareholders to approve these transactions should they deem them to be in their best interests. For example, our Certificate of Incorporation and Bylaws:

We are also subject to section 203 of the Delaware General Corporation Law which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any ''interested shareholder'' for a period of three years following the date that shareholder became an interested shareholder.

Our Board of Directors also has the authority to fix the rights and preferences of and issue our "blank check" preferred shares without the approval of our common shareholder and, in some cases, our series 'B' and series 'C' preferred shareholders. Any "blank check" preferred shares we issue could also be utilized as a method for raising additional capital or discouraging, delaying or preventing a change in control of our company. We cannot give you any assurance that we will not issue "blank check" preferred shares under circumstances we may deem appropriate at the time.

As of the date of this report, there are:

Not Applicable

Not Applicable

Not Applicable

Not Applicable

None

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Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this quarterly report on form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated at Burnaby, British Columbia, this 11th day of August, 2002.

	Clean Energy Combustion Systems, Inc.
	By: /s/ John P. Thuot
		John P. Thuot President (principal executive officer)
	By: /s/ Barry A. Sheahan
		Barry A. Sheahan, C.A. Chief Financial Officer (principal accounting officer