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

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

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In December 2001, 75,000 shares of series 'B' preferred stock were converted into 75,000 shares of common stock.
In August 2002, 8,333 shares of series 'B' preferred stock were converted into 8,333 shares of common stock.
In August and October 2000, a significant shareholder converted the principal amount and all interest of a loan into 487,944 shares of common stock.

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 September 30, 2002, we have incurred losses from inception totalling $2,700,809, have a working capital deficiency of $478,694, 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.

2. Significant Accounting Policies

Basis Of Presentation

We prepared these consolidated financial statements in conformity with accounting principles generally accepted in the United States. While these financial statements reflect all normal recurring adjustments, which, in the opinion of our management, are necessary for fair presentation of the results of the interim period, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. For additional information, refer to the consolidated financial statements included in our annual report on form 10-K for our fiscal year ended December 31, 2001

The consolidated results of operations for the three- and nine-month interim periods ended September 30, 2002 included in these consolidated financial statements are not necessarily predictive of results to be expected for our full fiscal year ended December 31, 2002.

Consolidation

In the course of preparing these consolidated financial statements, we consolidated the accounts of our wholly-owned subsidiary, Clean Energy USA Inc. ("Clean Energy USA") with those of Clean Energy for the interim periods ended after December 31, 2001 included in these consolidated financial statements, and the accounts of our former wholly-owned subsidiary, Clean Energy Technologies (Canada) Inc. ("Clean Energy Technologies"), which we disposed of on December 31, 2001, with those of Clean Energy for the interim periods ended on or before December 31, 2001 included in these consolidated financial statements. All significant intercompany balances and transactions amongst Clean Energy and each of these subsidiaries were eliminated as a consequence of the consolidation process, and are therefore not reflected in these consolidated financial statements. Results of consolidated operations for the interim periods ended after December 31, 2001 included in these consol idated financial statements may not be comparable to results for the corresponding interim periods ended on or before December 31, 2001due to the divestiture of Clean Energy Technologies, although Clean Energy Technologies has continued to provide research and development services to our company on a contractual basis since December 31, 2001. See note 3.

Foreign Currency Translation

Clean Energy is a Delaware corporation and considers the United States dollar to be the appropriate functional currency for our operations and these financial statements, notwithstanding that we do business in Canada in transactions denominated in Canadian dollars. It is anticipated that the majority of our business will be conducted in United States dollars and our anticipated customer base will be within the United States. For purposes of preparing these financial statements, foreign currency monetary assets and liabilities are translated into U.S. dollars at the exchange rates in effect at the balance sheet date. Other balance sheet items and revenues and expenses are translated at the rates prevailing on the respective transaction dates. Translation gains and losses are included in operations.

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.

Basic And Diluted Loss Per Share

Our basic loss per share is computed in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", by dividing the net loss for the period attributable to holders of our common shares by the weighted average number of common shares outstanding for the period. Our diluted loss per share is computed, also in accordance with SFAS No. 128, by including the potential dilution that could occur if holders of our dilutive securities were to exercise or convert these securities into common shares. Common share equivalents are excluded from the computation if their effect is anti-dilutive. Common share equivalents consist of common shares issuable upon the conversion of the convertible loans, notes and special warrants (using the if-converted method) and incremental shares issuable upon the exercise of common share purchase options and warrants (using the treasury stock method).

Stock-Based Compensation

In accounting for the grant of common share purchase options to our employees and directors, we have elected to follow Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees", ("APB 25"), and related interpretations. Under APB 25, companies are not required to record any compensation expense relating to the grant of options to employees or directors where the awards are granted upon fixed terms with an exercise price equal to fair value and the only condition of exercise is continued employment. See note 7.

Comprehensive Income

Comprehensive income is reported and displayed in these consolidated financial statements in conformity with Statement of Financial Accounting Standards Statement ("SFAS") No. 130, Reporting Comprehensive Income, issued by the Financial Accounting Standards Board ("FASB"). SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements.

Accounting for Derivatives

SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, issued under U.S. GAAP and effective in 2001, establishes accounting standards for derivatives, and requires the reporting of derivative instruments information in annual and interim reports to shareholders. SFAS No. 133 did not have an impact on our consolidated financial position or results of operations.

Recent Accounting Pronouncements

In June 2001, the FASB introduced SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition of intangible assets acquired outside of a business combination whether acquired individually or with a group of other assets. These 

standards require all future business combinations to be accounted for using the purchase method of accounting. Goodwill will no longer be 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 and 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 nine-month period, the advances decreased by a net amount of $17,471, while the obligations decreased by $205,588. The total of these amounts, a decrease of $223,059, has been credited to the statement of operations as a reduction of provision related to the transfer of subsidiary.

4. Advances To Affiliated Company

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 September 30, 2002 and December 31, 2001:

	September 30, 2002	December 31, 2001
Advances from officers, directors and principal shareholders	$         459,278	$         190,729
Advances from shareholders	44,144	-
Total	$         503,422	$        190,729

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

The advances from officers, directors and principal shareholders include advances from the following: Mr. R. Dirk Stinson, a director and the current President of Clean Energy and an indirect principal shareholder of Clean Energy through Ravenscraig Properties; McSheahan Enterprises Ltd., a principal corporate shareholder of Clean Energy 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 of Clean Energy that is owned and controlled by John P. Thuot, a director of Clean Energy and its past President; and John D. Chato, Chairman of our board of directors and an indirect principal shareholder of Clean Energy 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. Interest of $43,029 as at September 30, 2002 ($8,084 as at December 31, 2001) has been accrued.

Pursuant to the loan agreements, each of the above parties has the right to convert any portion of outstanding indebtedness under their respective notes, 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 the result of the commencement of trading of common shares on the OTC Bulletin Board on June 17 2002, the conversion price has been fixed at $0.20 per share, representing the closing price as of August 16, 2002. No conversion rights have been exercised to date, and the parties to the loans are in discussions relative to effecting the conversion on terms more favorable to Clean Energy.

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 en titled 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.

During the year ended December 31, 2001, one of our shareholders converted 75,000 series 'B' preferred shares into 75,000 common shares, and in August, 2002 an additional 8,333 series 'B' preferred shares were converted to common shares, leaving 166,668 and 175,001 series 'B' preferred shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively.

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 September 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.

In 2001, we granted an additional 60,000 non-qualified common stock purchase options to each of Mr. L. Clive Boulton and Dr. William D. Jackson, in their capacity as directors, having identical terms and conditions as the previous grant, except that one grant vested one-third immediately upon grant.

Also during 2001, we granted additional common share purchase options as follows:

• Employee incentive options to key employees entitling them to purchase an aggregate of 101,305 common shares at an exercise price of $3 per share. These options vest one year after being granted and expire five years subsequent to the vesting date.

•  Management incentive options to JPT2 Holdings Ltd. and McSheahan Enterprise Ltd., management corporations controlled by Messrs. Thuot and Sheahan, respectively, entitling them to purchase an aggregate of 24,000 common shares at an exercise price of $2 per share. These options vest equally monthly over a one-year period, and each annual vesting portion expires five years subsequent to the vesting date.

In 2002, we granted non-qualified common stock purchase options to Mr. John L. Howard, 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.

Also during 2002, we granted management incentive options to JPT2 Holdings Ltd. and McSheahan Enterprise Ltd., management corporations controlled by Messrs. Thuot and Sheahan, respectively, entitling them to purchase an aggregate of 24,000 common shares at an exercise price of $2 per share. These options vest equally monthly over a one-year period, and each annual vesting portion expires five years subsequent to the vesting date.

At September 30, 2002, a total of 709,305 common share purchase options had been granted, and 429,305 options were vested. No common share purchase options have been exercised as at September 30, 2002.

Common Share Purchase Warrants

During 1999, we issued 36,000 common share purchase warrants as additional consideration pursuant to a public relations services agreement pursuant to which the holder is given the right to purchase 36,000 common shares at $2 per share. The right to exercise these warrants vests in equal monthly instalments over a twenty-four month period, and each instalments lapses five years after date of vesting. As at September 30, 2002, all of the 36,000 shares have vested and none have been exercised.

During 2000, we also issued 200,000 share purchase warrants as additional consideration pursuant to an investors and media relations services agreement pursuant to which the holder is given the right to purchase 200,000 common shares at prices between $2 to $5 per share. The right to exercise these warrants vests in equal quarterly instalments over a twelve-month period commencing July 27, 2000, and each instalment lapses twelve months after date of vesting. As at September 30, 2002, all 200,000 shares have vested and lapsed, and none of the warrants were exercised.

7. Related Party Transactions

Related party transactions and balances not disclosed elsewhere in these financial statements are as follows:

• As at December 31, 2001, we disposed of Clean Energy Technologies, our wholly-owned subsidiary, to Mr. John D. Chato. Mr. Chato is a director of our company, the inventor of our technologies, and a shareholder who indirectly holds greater than 10% of our issued common shares. Proceeds to Clean Energy were $1, however, net liabilities of Clean Energy Technologies exceeded assets by $294,521, resulting in Clean Energy recording an increase to additional paid-in capital of $294,522 in the financial statements for the fiscal year ended December 31, 2001 (see note 3). We have entered into a cost plus contract with Clean Energy Technologies to provide for our future research and development needs.

8. Financial Instruments

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.

9. Commitments And Contingencies