The information set forth in the section of this annual report captioned "Business" is current as of March 27, 2003, unless an earlier or later date is indicated in that section. The information set forth in the sections of this annual report other than "Business" is current as of December 31, 2002, unless an earlier or later date is indicated in those sections.

We conduct our transactions in the currency of both the United States and Canada, although we consider the United States dollar to be our functional and reporting currency. All references to "dollars" in this annual report refer to United States or U.S. dollars unless specific reference is made to Canadian or CDN dollars. For information relative to rates of exchange and currency conversion, see that section contained in explanatory note 2 to our consolidated financial statements captioned "Foreign Currency Translation".

In this annual report we make a number of statements, referred to as "forward-looking statements", which are intended to convey our expectations or predictions regarding the occurrence of possible future events or the existence of trends and factors that may impact our future plans and operating results. These forward-looking statements are derived, in part, from various assumptions and analyses we have made in the context of our current business plan and information currently available to us and in light of our experience and perceptions of historical trends, current conditions and expected future developments and other factors we believe to be appropriate in the circumstances. You can generally identify forward-looking statements through words and phrases such as "seek", "anticipate", "believe", "estimate", "expect", "intend", "plan", "budget", "project", "will be", "will continue", "will likely result", and similar expressions. Forward-looking statements contained in this report would, for example, include statements relating to the timing and completion of pending or prospective projects and contracts and receipt of revenues and various other statements generally contained in those sections of this annual report captioned "Business" and "Management's Discussion And Analysis Of Financial Condition And Results Of Operations".

When reading any forward looking statement you should remain mindful that actual results or developments may vary substantially from those expected as expressed in or implied by that statement for a number of reasons or factors including, by way of example and not limitation, (1) the various risks and uncertainties described in this special note or elsewhere in this annual report, and (2) our current and prospective financial requirements and current and prospective lack of capital; our inability to satisfactorily complete pending or new project proposals (including with prospective licensee or joint venture partners) and enter into binding revenue-producing contracts based upon those proposals; our overall inability or that of our licensees or joint venture partners, if any, to design, test, manufacture and sell pulse combustors on a profitable basis, including as a result of insufficient consumer acceptance of and demand for pulse combustors; regulatory constraints, and changes in our business plan and corporate strategies or those of our joint venture partners. Each forward-looking statement should be read in context with, and with an understanding of, the various other disclosures concerning our company and our business made elsewhere in this annual report as well as other pubic reports filed with the United States Securities and Exchange Commission (the "SEC"). You should not place undue reliance on any forward-looking statement as a prediction of actual results or developments.

We are not obligated to update or revise any forward-looking statement contained in this annual report to reflect new events or circumstances unless and to the extent required by applicable law. All forward-looking statements contained in this annual report constitute "forward-looking statements" within the meaning Section 21E of the United States Securities Exchange Act of 1934 and, to the extent it may be applicable by way of the incorporation of statements contained in this annual report by reference or otherwise, Section 27A of the United States Securities Act of 1933, each of which establishes a safe-harbor from private actions for forward-looking statements as defined in those statutes.

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Clean Energy Combustion Systems, Inc. ("we", "our company" or "Clean Energy") is a development stage enterprise formed and organized to market "burner units" based upon our patented high-frequency valveless "pulse combustion technology". Our principal focus to date has been to develop applications for our pulse combustion technology, which we believe has a wide variety of applications and competitive advantages. We have made significant progress in developing this technology, and a number of applications are now in a position to be introduced to the market having completed their primary development stage.

Our principal executive offices and research and development facilities are located at 7087 MacPherson Avenue, Burnaby, British Columbia, Canada, V5J 4N4, and our telephone number is (604) 435-9339.

We were formed and organized under the name Clean Energy Technologies, Inc. on March 1, 1999, and changed our corporate name to Clean Energy Combustion Systems, Inc. on May 20, 1999. We are authorized under our Certificate of Incorporation to issue common stock and preferred stock, with respect to the latter of which we have to date authorized the issuance of series 'A' convertible preferred stock, series 'B' convertible preferred stock and series 'C' convertible preferred stock (sometimes referred to in this annual report as "common shares", "preferred shares", "series 'A' preferred shares", "series 'B' preferred shares" and "series 'C' preferred shares", respectively).

A burner unit is a furnace, burner or other combustion chamber which uses the combustion process to convert the chemical energy contained in various fuel sources into heat energy measured in "British Thermal Units" or "BTUs". The use of a burner unit to create heat energy is typically the first of a number of steps in which the heat energy is generated for use in a multiplicity of residential, commercial, municipal or industrial settings, ranging from simple one-step residential and light commercial applications where the heat energy is used merely to heat air or water, such as the case of space or water heaters, to complicated industrial multi-step applications where the heat energy is subsequently converted into one or more other forms of energy. An illustration of a multi-step industrial application would be electricity generation, where a public utility company first burns oil, natural gas or coal to create heat energy, then uses this form of energy to heat water in a boiler system to create steam energy, then uses this form of energy to run a turbine to create mechanical energy, and ultimately uses this form of energy to create a magnetic field to generate electrical energy. Since the heat generated by the combustion of fuel in burner units is generally "transferred" for other purposes as the end result of the first step in a process, the industry in which we compete, namely, manufacturers and sellers of products incorporating burner units, is commonly referred to as the "heat transfer" industry.

Our "pulse combustion technology" is a high-frequency valveless pulse burner technology which can operate on a variety of carbon-based fuels, including natural gas, propane, powdered coal, as well as hydrogen, a non-carbon-based fuel. This design facilitates the manufacture of highly-compact burner units that are more energy-efficient, and emit significantly lower levels of pollutants, than conventional steady-state combustion designs. We believe that the reason for these results can be explained as follows:

Currently, there are a limited number of pulse combustion products on the market, all of which principally target premium-priced high-efficiency water heater and boiler applications. These designs utilize a "tubular" configuration, and operate in the range of 36 to 70 cycles per second depending upon the configuration and application. Our pulse combustion designs, on the other hand, utilize either an elongated or "linear" configuration or a "cylindrical" configuration, both of which operate at up to 350 to 1,600 cycles per second depending upon the configuration and application, or 6 to 22 times the rate of conventional tubular pulse combustion, leading to increased energy efficiencies and reduced emission levels. Due to the compactness, simplicity of design and lack of moving parts inherent in our pulse combustion technology, our designs also allow burner units to be more inexpensively, easily and quickly manufactured, installed and serviced than conventional steady-state and tubular pulse combustion designs.

We have developed or are currently working on production proto-types for the following applications of our pulse combustion technology:

• a large natural gas-fueled industrial dryer for tissue paper, which will act as a lead-in product for the broader industrial pulp and paper market;

• a residential natural gas-fueled water heater, which will act as a lead-in product for the broader industrial, commercial, and residential water heater and boiler market;

• natural gas-fueled burners for natural gas and oil transportation purposes, which will act as a lead-in product for a variety of specialty petroleum industry applications;

• a hydrogen-fueled burner to combine unwanted hydrogen with air and to then convert it into nitrogen and heat energy for natural gas and oil production and downstream processing purposes;

• natural gas-fueled burners units for a pollution control and fuel cell system;

• a diesel-based burner to be used for heavy-duty special-purpose vehicles heaters; and

• a small powdered coal-fired proto-type to be used to develop larger burners for commercial and municipal electricity generation purposes, which will act as a lead-in for larger industrial coal burning applications.

Most of the testing of our pulse combustion technology to date are fueled by natural gas, powdered coal and hydrogen, although our pulse combustion technology has the capability to use any carbon-based fuel as its energy source. We have, for example, successfully burned gasoline, diesel, propane, and a powdered coal and natural gas mix.

Natural gas is a logical fuel choice, particularly in North America, due to its relatively abundant supply and clean-burning characteristics when compared to other carbon-based fuels. The primary barrier to the greater use of natural gas has been transportation, as pipelines are generally required to convey natural gas from source to location of intended use.

We believe the demand for cleaning burning fuels will continue as clean air legislation and public environmental pressures increase, particularly in the industrial countries. The ability to efficiently burn fuel in order to conserve energy resources, while eliminating or minimizing the various pollutants resulting from the combustion process, has become worldwide economic and political issue as a result of increasing awareness and concerns over the past 25 years relative to energy conservation and the impact of pollution on our environment and health. One of the consequences of these concerns has been the imposition of ever increasing levels of regulatory restraints on emission levels and, to a lesser degree, fuel usage, particularly in the developing countries of the world. In the United States, for example, not only does the United States Environmental Protection Agency impose nationwide emission standards, but various states and their political subdivisions impose even more stringent emission standards. The most visible example of this is California, which imposes the most stringent automobile emission standards in the world, and the South Coast Air Quality Management District, a California regional governmental agency which imposes the strictest pollution control requirements in the world on a broad range of industrial, commercial or municipal emissions in the four counties comprising the Los Angeles metropolitan area.

One of the tools being developed by governments world-wide to combat climate change is the concept of emission credits or allowances, based on pollution reductions. The development of a commodity trading system, based on lowering emission levels creates an economic value associated with pollution control.

We believe that our pulse combustion technology, in particular, has the potential to bring dramatic improvements in both efficiency and pollution control, particularly in view of the existing limitations of conventional steady-state combustion and pollution control technologies which we believe are approaching, if not at, their theoretical limits of effectiveness. We anticipate that the various advantages of our technologies will afford us the opportunity to ultimately develop and introduce a large variety of different burner units cutting across a broad number of diverse industrial, commercial, municipal and residential heat transfer markets through a variety of commercial arrangements with established heat transfer industry partners, including licensing, royalty, joint venture and manufacturing agreements.

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 or others over the next two to six months, and contract revenues after twelve months.

Conventional pulse combustion burner technology is a burner unit design comprised of two geometrically-configured adjoining channels and chambers-a combustion chamber and an exhaust channel or "tailpipe". As shown in the illustration below, most conventional pulse combustion burner units use a "tubular" configuration, similar to a bottle with an elongated neck. In operation, fuel and air are first injected from an intake channel into the combustion chamber (at the base

of the bottle) where they are ignited with an ignition rod and commence burning (in the bottom portion of the bottle). The heat created by the combustion process then generates a pressure wave which travels from the combustion chamber through the tailpipe (the elongated neck of the bottle), carrying with it various gases or "effluents" resulting from the combustion process. As the effluent gases exit the tailpipe, a partial vacuum is created within the combustion chamber which, in turn, pulls a new supply of air and fuel into the combustion chamber from the intake channel. This new fuel-air mixture is then compressed by effluent returning or "pulsing back" from the tailpipe, and ignites on its own without the need of the ignition rod as a result of this pressure increase and the remaining heat within the combustion chamber, causing the entire process to repeat. Most conventional pulse combustion technology, for example, operates at anywhere from 36 to 70 cycles per second depending upon the configuration and application. It is this oscillating or "pulsating" condition-hence, "pulse" combustion-which differentiates pulse combustion from conventional "steady-state" combustion, where combustion is provided through the steady or continuous burning of a flame, such as in the case of a kettle of water being heated on a gas stove.

The principal drawbacks of conventional pulse combustion technology has been noise and vibration and an inability to efficiently generate large quantities of BTUs through the combustion process. As discussed in greater detail below, the noise and vibration result from the operation of the conventional pulse combustion burner at relatively low frequencies of 36 to 70 cycles per second. The conventional pulse combustion burner's inability to efficiently generate large quantities of BTUs can be attributed to its geometries. Specifically, as the dimensions of the "bottle" are expanded or elongated in order to increase BTU production capacity, the heat output and heat transfer efficiency of the unit decreases, while emissions and noise and vibration levels increase.

BASED ON CLEAN ENERGY'S "LINEAR" PULSE COMBUSTION CONFIGURATION]

Pulse combustion technology is not a new development. It has been in the public domain since early in the twentieth century, and was used in World War II to power the infamous V-1 "buzz bombs". Until recently, however, its use for commercial heat transfer applications has been relatively limited.

Pulse combustion technology was first applied to the manufacture of boilers in the late 1950's by Lucas Rotax in its "Pulsamatic" boiler. The introduction of the technology was short-lived, though, due to lack of strong marketing and the absence of incentive to buy high-efficiency boilers when gas prices were low.

The technology was reactivated in 1979 when Hydrotherm Corporation introduced its high-efficiency residential "Hydropulse" series of residential water boilers. Lennox International, Inc., also incorporated pulse combustion technology into several of its products in 1976 through a collaborative working agreement with the American Gas Association and the Gas Research Institute, and introduced several models of an ultra-high efficiency pulse-forced-air furnace into the marketplace in 1992.

Even though the higher efficiencies afforded by pulse combustion over conventional steady-state combustion is a well known fact in the residential and commercial heating industry, pulse combustion products still have not been widely introduced, and have had limited penetration in the markets they have been introduced into. We believe the principal reasons for this limited market penetration are higher manufacturing and installation costs, which translate into higher sales prices, as well as noise considerations. Indeed, to our knowledge the only significant manufacturers and marketers of pulse combustion burner units within the United States today are:

• Hydrotherm Corporation, which markets a line of natural gas-fueled pulse water boiler systems rated at from 100,000 BTUs/hr to 300,000 BTUs/hr used principally for residential and commercial hydronic (radiant) space heating purposes. In hydronic space heating, hot water is circulated in an enclosed system through a series of interconnected pipes located within a concrete slab in a building. As the hot water circulates, the heat it emanates warms the air spaces above and below the slab.

• Lennox International, Inc., which has marketed two natural gas-fueled forced-air pulse combustion furnaces for space heating, ranging from 50,000 BTUs/hr to 100,000 BTUs/hr output.

• Fulton Boiler Works, Inc., which markets:

• two lines of natural gas or propane fueled boilers for commercial and small business purposes, namely, a line of low pressure models rated at between 500,000 to 750,000 BTUs/hr input, and a line of high pressure models rated at between 500,000 to 700,000 BTUs/hr input; and

• a line of pulse boilers used for hydronic heating purposes and heat pump applications, rated at between 300,000 to 2,000,000 BTUs/hr input.

Each of these competitors positioned their pulse combustion products as premium-priced, "higher efficiency" alternatives to conventional steady-state combustion product lines.

All of Lennox's, Fulton's and Hydrotherm's pulse combustion products utilize conventional valved "tubular" designs. For example, in the case of the Lennox unit, the tube is approximately eight feet long and is looped or coiled vertically for space efficiency. The principal operational feature of the conventional tubular design is the low number of repetitive combustion pulses or cycles at which it operates, typically 36 to 70 cycles per second.

There are also numerous manufacturers and marketers of conventional steady-state combustion products within the United States that compete with pulse combustion products, including Cleaver Brooks, Raypack, Inc., AERCO International Inc. and Weben-Jarco, as well as Lennox, Fulton and Hydrotherm.

As discussed below in greater specificity, our pulse combustion technology affords the following principal competitive advantages over conventional steady-state combustion and conventional tubular pulse combustion technologies when burning carbon-based fuels:

• Our pulse combustion technology is highly efficiently, both in terms of ordinary operations as well as "on-off" efficiency. For example, our pulse combustion technology operates at over 95% heat transfer efficiency levels, as compared to the 75% to 85% levels attributable to traditional steady state combustion with comparable surface heating area. Our overall efficiency level is further enhanced by our rapid warm-up or ramp-up time, as compared to large conventional boiler systems that take some time to get up to temperature from cold start or turn down point. As a consequence, our pulse combustion typically displays three to five times the heat transfer rates of conventional steady-state combustion technologies, and up to three times the heat transfer rate of conventional tubular pulse combustion designs.

• Our pulse combustion technology enables very fast warm-up or ramp-up time to optimum efficiencies as compared to large conventional boiler systems that take some time to get up to temperature from cold start or turn down point.

• Our pulse combustion technology enables burner units to emit:

• significantly lower emissions than conventional steady-state combustion technology, and

• significantly lower NOx emission levels than conventional tubular pulse combustion technologies, and comparable or slightly lower emission levels than those technologies with respect to emissions other than NOx, such as CO and, in the case of "dirty" fuels such as coal or "heavy" oil, sulphur dioxide and particulates.

• Our pulse combustion technology allows unlimited size or output variations with our pulse blade design, while conventional "tubular" pulse burners which have limited scalability and thus are very restricted with respect to size and output.

• Our pulse combustion technology results in significantly smaller and lighter burner units and systems than allowed by both steady-state combustion and conventional tubular pulse combustion technologies due to our compact and simple designs, and the elimination of the need for an external primary heat exchanger. This advantage is compounded in multi-burner scale-up configurations. Moreover, our burner units are so much more compact in size that rather than performing complete boiler system replacements that it can actually be installed into the existing boiler unit thereby saving considerable capital cost. As a consequence, our technology can facilitate a burner unit retrofit at a fraction of the cost of a complete commercial or industrial boiler replacement.

• Our pulse combustion technology allows burner units to be designed for operation at optimum energy conversion efficiencies and low emission levels at differing pre-selected output levels due to our integrated modular design and resultant modular turn-down capability. While conventional steady-state combustion and tubular pulse combustion units can also operate on a similar modular basis, they can only do so when aligned in a bank of separate burner systems, while our design allows us to incorporate numerous combustion chambers within a single combustion system. This advantage allows us to compound the size and weight advantage which the compact size of our pulse burner technology already affords us on a unit-versus-unit comparison basis.

• Our pulse combustion technology allows burner units to be manufactured and installed at significantly lower costs than steady-state combustion and conventional tubular pulse combustion technologies due to our simplicity of design, compact size and lack of moving parts.

• Background: Among the principal considerations is evaluating a burner unit are its "energy conversion efficiencies", which simply refers to its overall ability to convert the maximum amount of chemical energy contained in the fuel into heat energy through the combustion process, and to then apply or transfer this heat for the intended purpose. The ultimate economic measure of energy conversion efficiencies is fuel savings. Essentially, a burner unit which has greater energy conversion efficiencies will use a lesser amount of fuel to generate and transfer a required level of heat than a less efficient combustion unit. The energy conversion efficiencies of a burner unit can be generally broken down into the following constituent elements:

• Energy Conversion Efficiency Advantages of Pulse Combustion Over Conventional Steady-State Combustion: Energy conversion efficiencies associated with pulse combustion are significantly higher than those of conventional steady-state combustion for the following reasons:

• Heat Output Efficiencies: Pulse combustion results in significantly higher heat output efficiencies than conventional steady-state combustion, since the more turbulent combustion environment and internal combustion pressures resulting from the repetitive pulse combustion cycles promote more thorough combustion. Consequently, a greater proportion of chemical energy per unit of fuel is converted into heat energy instead of being wasted or discharged as part of the exhaust stream.

• Heat Transfer Efficiencies: In conventional steady-state combustion, a zone of air called a "boundary layer" is created adjacent to the interior surfaces of the combustion unit, including those being used for heat transfer purposes. This layer acts as a barrier which essentially channels the heat energy generated by the combustion process away from the exterior surface areas and down the middle of the exhaust pathway, allowing a significant portion of the heat energy created to be wasted without application for heating purposes. This boundary layer affect is greatly reduced in pulse combustion, however, since the more turbulent combustion environment and internal combustion pressures resulting from the repetitive pulse 

combustion cycles forces a greater proportion of the heat energy to circulate against the heat transfer surfaces, resulting in less wasted heat energy than conventional steady-state combustion. As a consequence, burner units using pulse combustion will have a higher heat transfer efficiencies than conventional steady-state units when comparing burner units with equal heat surface areas. The only way to increase the relative heat transfer efficiency of the conventional steady-state burner would be to significantly increase its heat transfer surfaces at additional manufacturing costs For example, most conventional steady-state combustion units have a heat transfer efficiency rating in the 70% to 85% range, meaning that a corresponding percentage of the heat created is actually transferred to the targeted medium. By way of comparison, most conventional "tubular" pulse combustion units on the market today have a heat transfer efficiency rating in the range of 90% to 96%.

• Start-Up Efficiencies: As the result of its repetitive on-off cycling, pulse combustion can attain optimal combustion temperatures much more quickly than conventional steady-state combustion, which translates into both fuel savings and less operational downtime while the burner unit warms-up.

• Energy Conversion Efficiency Advantages of Our Pulse Combustion Technology Over Conventional "Tubular" Pulse Combustion: The various energy conversion efficiencies afforded by pulse combustion result from the more turbulent combustion environment and internal combustion pressures resulting from the repetitive pulse combustion cycles. Our pulse combustion design, as a consequence, can deliver greater energy conversion efficiencies than conventional tubular pulse combustion designs as a result of the greater number of burning cycles at which our design operates. Conventional tubular pulse combustion units, for instance, generally operate at only 36 to 70 cycles per second. Our pulse combustion technology, on the other hand, operates at anywhere from 350 to 1,600 cycles per second depending upon the configuration and application, or 6 to 22 times the rate of conventional tubular pulse combustion, leading to better heat output, heat transfer and start-up efficiencies.

Test evaluations by an independent engineering firm, for example, showed overall energy efficiency rates for our pulse combustion water heater in the order of 94%. An alternative method to calculate heat output efficiency is to evaluate emission levels, since lower emissions means more fuel is being converted into energy. As discussed in greater detail below, more recent emissions tests on our burners conducted through independent testing agencies show exhaust readings of less than 10 parts per million for both NOx and CO, meaning that almost all of the heat energy of the fuel was liberated in the combustion process.

In designing and operating burner units with an eye toward reducing emissions, manufacturers and operators must consider two inter-related variables, the "completeness" of the burning process as evidenced by its heat output efficiency, and the amount of so-called "excess air" required to maintain stable combustion based upon the fuel to be burned. Specifically:

• There is an inverse relationship between heat output efficiency and emission levels. As previously discussed, heat output efficiencies are a function of the completeness of the burning process. The more complete the process, the greater amount of the chemical components of the fuel will be converted into heat energy, and the less amount of unconverted fuel, in the form of various post-burn chemical gases, will be emitted as part of the exhaust stream.

• The amount of pollutants is also a function of the level of "excess air" used in the combustion process, as measured as a percentage of oxygen contained in the exhaust stream. Simply put, the combustion process requires, at a minimum, two quantities of oxygen-the first quantity of oxygen representing that amount necessary to bond and chemically react with the fuel as part of the combustion process in order to convert its chemical energy into heat energy, and the second quantity of oxygen representing an additional amount necessary to maintain a "stable" combustion environment. If there are insufficient quantities of this latter amount of additional oxygen in the combustion environment, referred to as "excess air", then the combustion process will sputter or be "unstable", resulting in reduced combustion system efficiencies. By way of example, natural gas-fueled water heaters typically operate with excess air rates of 30% to 40%, which constitutes approximately 30% to 40% of additional oxygen over that required to burn the natural gas and convert it into heat energy and 30% to 40% more heated nitrogen out of the vent stack.

From an emission control standpoint, the greater amount of excess air the better. Specifically, the excess air promotes the re-burning of the various post-burn chemical gases from the primary combustion process, and consequentially lowers emissions. Excess air is not beneficial, however, from a heat transfer efficiency standpoint, since the excess air captures or "steals" the heat generated by the primary combustion process, which makes it unavailable for the intended heat transfer purposes. The more excess air-the greater the loss in heat transfer efficiency. As a consequence of this dynamic, operators of burner units are faced with the following "no-win" choice: if their primary requirement is pollution control-they must operate their burner unit at "richer" oxygen levels and bear the attendant greater fuel costs due to the resulting loss of heat transfer efficiency; and if their primary requirement is lower fuel costs-they must operate their burner unit at increased emission levels.

• Emission Control Advantages of Pulse Combustion Over Conventional Steady-State Combustion: As previously discussed, if the pulses occur at a fast enough rate, the chemical byproducts created through the kinetic combustion process are reduced due to the accelerated completion of the heat conversion process as well as the more complete conversion of chemical energy into heat energy, thereby leading to reduced exhaust emissions. The NOx emission levels for our current water heater prototype, for example, test at less than 10 parts per million, which is less than one-tenth of conventional steady-state combustors. We believe based upon early testing that our pulse combustion technology will lead to similar reductions with respect to other unwanted byproducts of the combustion process, such as CO and other hydrocarbons, and we are conducting characterization tests to confirm these early observations. Of equal importance, pulse combustion can maintain stable combustion at significantly lower excess air rates than conventional steady-state combustion as a result of its combustion dynamics. As a result, higher heat transfer efficiencies can be maintained with pulse combustion as compared to conventional steady-state combustion, resulting in improved fuel savings, while at the same time lowering emission levels.

• Emission Control Advantages of Our Pulse Combustion Technology Over The Conventional "Tubular" Pulse Combustion: The ability of the pulse combustion unit to completely burn fuel results from the more turbulent combustion environment and internal combustion pressures resulting from the repetitive pulse combustion cycles. Our pulse combustion design, as a consequence, has demonstrated significantly reduced NOx emissions than conventional tubular pulse combustion designs, and also shows reduced amounts of CO as a result of the turbulent environment's effective mixing of the hydrocarbons in the fuel and oxygen in the air. As previously noted, pulse burner units using the conventional tubular pulse combustion configuration typically operate at 36 to 70 cycles per second. Our pulse combustion technology, on the other hand, operates at anywhere from 350 to 1,600 cycles per second depending upon the configuration and application, which translates into significantly lower emissions.

Our pulse combustion burner units are significantly smaller than conventional steady-state and tubular pulse combustion units of equivalent output due to the following considerations:

• Our burner units require a smaller combustion chamber to generate equivalent heat output and heat transfer capabilities than conventional steady-state and tubular pulse combustion units due to the geometric configuration of our design as well as the higher number of pulse cycles at which our unit operates.

• Conventional steady-state and tubular pulse combustion units require separate, large external heat exchangers to transfer heat energy, regardless of application, while the walls of our burner design act as primary heat exchange surfaces. This dramatically decreases the size requirement for secondary heat exchange, which is one of the largest cost elements of conventional designs.

This size advantage is extremely important where limited floor or room space considerations apply. For instance, the core of a 150,000 BTU/hr low pressure boiler system utilizing our pulse combustion configuration is approximately the size of a briefcase, and weighs approximately 50 pounds, exclusive of the jacketing, muffler and a secondary heat exchanger connected to the tailpipe. By way of comparison, a low pressure boiler system utilizing a conventional pulse combustion tubular design contains a combustion chamber, tailpipes, and decoupler combination that is approximately one foot in diameter and three feet in height, and weighs in excess of 200 pounds. The size of conventional steady-state combustion units, in turn, which consist of a burner and an external heat exchanger, equal or exceed that of conventional tubular combustion units of comparable output. 

As previously discussed, one of the principal advantages of our pulse design is that it lends itself readily to the joining together on a side by side basis of separate but integrated operating "modules", each module containing one or more combustion units that work in concert. This modular design affords the following advantages over both conventional steady-state combustion and tubular pulse combustion designs:

• Modular Turn-down Capability: All conventional and pulse burners operate at optimum energy conversion efficiencies and emission levels based upon their design, measured in terms of BTU output. A 100,000 BTU/hour conventional steady-state furnace, for example, is designed to operate most efficiently at a level of fuel-mixture, which would generate 100,000 BTUs of heat energy per hour after taking into consideration the inefficiencies inherent in that particular design. If the unit is operated at levels above or below the rated optimum output in order to regulate or adjust heat output by either increasing or decreasing the amount of incoming air and fuel, then the heat output and heat transfer efficiencies will vary and emission levels could increase.

As discussed earlier, one of the principal advantages of our pulse combustion designs over both conventional steady-state combustion and tubular pulse combustion designs is that our burner units can be designed to incorporate numerous combustion chambers aligned on a side-by-side basis within a single combustion unit. These combustion chambers can then be engineered to operate together in separate "modules" consisting of one or more combustion chambers. This modular configuration is important since it allows us to regulate or adjust heat output while maintaining maximum heat transfer efficiencies and lower emissions levels, which we refer to as "modular turn-down capability", by simply turning one or more modules contained in a combustion unit on or off. Moreover, he combustion units' overall output ability may be increased simply by attaching a new module to the system.

While conventional steady-state combustion and tubular pulse combustion units can also operate on a similar modular basis, they can only do so when aligned in a bank of separate burner systems, while our designs allow us to incorporate numerous combustion chambers within a single combustion system. This advantage allows us to compound the size advantage which the compact size of our pulse burner technology already affords us on a unit versus unit comparison basis.

• Reduced Downtime For Maintenance and Repair: The modular design of our pulse combustion technology also allows for easy assembly and disassembly, enabling the operator to repair or replace sections of the burner unit in most configurations. This feature is particularly important in commercial and industrial applications such as hospitals and schools, where the significant costs incurred in repairs and routine maintenance of the heating system and, in some cases, the cost of backup units, are virtually eliminated.

Conventional tubular pulse designs employ mechanical flapper valves on the air and natural gas intakes. A mechanical valve, i.e., one that mechanically opens and closes, is limited in speed of operation by the flexibility and durability of the valve material. Moreover, the maximum speed of operation of a valve operated mechanically is limited to approximately 150 cycles per second. Our pulse combustion design, on the other hand, is aerodynamically valved and has no moving parts. As such, our design affords increased operating reliability and reduced manufacturing, maintenance and repair costs, principally because there are no valves to wear out and the design hardware is simpler and less costly to produce.

Our pulse combustion burner unit has the capability to use any carbon-based fuel as its energy source. Although most of our testing to date has been done with natural gas and powdered coal, we have also successfully burned gasoline, diesel, propane, and a powdered coal and natural gas mix.

Excess air is defined as the amount of air that is in excess of that needed for the total combustion of a given amount of fuel. Stable operation at "zero" and "sub zero" excess air is important because it affords our pulse combustion technology access to application conditions that cause instability in conventional combustion devices. These applications, such as horizontal down-hole petroleum drilling, methane reforming for the production of hydrogen and industrial catalytic regeneration, require an inert, oxygen free (stoichiometric) or fuel rich (sub-stoichiometric) exhaust stream for their process requirements. Our technology is extremely stable at these conditions.

One of the principal drawbacks of conventional tubular pulse combustion is the cost and effort required to dampen its operating noise to levels commensurate with conventional steady-state combustion units in situations where noise reduction is important, such as commercial and residential applications.. As previously discussed, conventional tubular pulse combustion units operate at approximately 36 to 70 cycles per second due to their configuration. The oscillating pressure 

waves from these cycles create a corresponding low frequency standing sound wave, resulting in a very loud, continuous and deep level of operating noise. Due to the relatively long length of this sound wavelength, technically complicated and expensive dampening technology is required in order to mute the operating noise to levels commensurate with conventional steady-state combustion.

The noise generated by our pulse combustion technology, on the other hand, operates at between 350 and 1,600 cycles per second depending upon the configuration, and can be "tuned" to create a standing sound wave in that frequency range. Although this continuous sound wave is equally loud, albeit at a higher pitch, than that associated with conventional tubular pulse combustion, it nevertheless lends itself to relatively simple and inexpensive dampening technologies due to the short longitudinal length of its wavelength, which affords it significant competitive advantages over conventional tubular pulse combustion technology.

Due to the simplicity and compact size of our design, including the lack of moving parts and a reduction in or elimination of the amount of materials needed for heat exchange, including refractory bricks, finned copper tubing and cast iron headers, we believe that we can design, manufacture and install a pulse combustion boiler system with comparable output at a significantly lower cost, and a significantly shorter design-through-installation period.

The principal competitive disadvantage of our pulse combustion technology is that our design is new and unique, and no products based upon our pulse combustion technologies and configurations have been commercially produced or sold to date, either by our company or by any of our competitors. Moreover, while the higher efficiencies afforded by pulse combustion are well known in the residential and commercial heating industry, we believe that conventional pulse combustion products have not been widely accepted in this market segment due to their higher product cost, noise and vibration, limitation in BTU generation capacity, and technical performance issues relating to their tubular design. In order to establish market acceptance, we will need to both satisfactorily educate prospective purchasers of our products, including burner manufacturers and retailers, relating to the benefits of our technology over both conventional pulse and steady state combustion technologies. We will also have to develop internal and external manufacturing, sales, marketing and distribution capabilities. For a more comprehensive description of these issues, see that section of this annual report captioned "Uncertainties And Risk Factors-Uncertainties And Risks Generally relating To Our Company And Our Business".

Burner units are used worldwide for numerous commercial, municipal, industrial, residential and specialty heat transfer applications. The following list of heat transfer markets applications is instructive:

Our pulse combustion technology has completed its research and development stage, and the next step in exploiting this technology is to introduce it to the various markets in order to build market penetration and share and product knowledge and acceptance. Given the broad range of potential applications and markets for pulse combustion technologies, we anticipate that we will introduce our technologies to these potential markets through a number of different strategies and approaches, including the following types of arrangements:

Our natural gas- and hydrogen-fueled burner designs have completed their primary development stage and are now in a position to be introduced to the market. We are currently working on a variety of projects using these and other fuel sources. Described below are some of the projects which we which we are currently or have recently worked on which could lead to the initial introduction of burner units using our technologies:

Our research and development activities are currently centered on the full commercialization of our technology under the auspices of Dr. William Jackson, one of our directors and a consultant to our company and our recently appointed Vice President of Research and Engineering, and Mr. Denver Collins, a consultant to our company and our recently appointed Chief Product Development Engineer. Dr. Jackson also heads our grant procurement activities.

The bulk of our research and development activities are currently conducted through McSheahan Enterprises Ltd. ("McSheahan Enterprises"), a personal service corporation owned and controlled by Mr. Barry A. Sheahan, our Chief Financial Officer and a director, pursuant to a  cost plus research and development agreement entered into effective January 1, 2003.  Under that agreement, McSheahan Enterprises agreed to provide pre-approved budgeted pulse combustion research and development services to Clean Energy USA, and to invoice the latter company for its budgeted costs, related overhead and a 10% mark-up.   The purpose of entering into a research and development arrangement with McSheahan Enterprises on the noted arms-length basis was to continue to preserve our ability to indirectly benefit from certain grants and tax-incentive programs offered in both the United States and Canada, which we could not otherwise directly utilize by reason of our becoming a public company whose stock was publicly traded.

Our gross research and development expenses, including amounts paid to Clean Energy Technologies under our pulse combustion research and development contract with that company, amounted to $455,018, $397,006 and $400,377 for our 2002, 2001 and 2000 fiscal periods, respectively. Our research and development budget for fiscal 2003 is budgeted at $400,000.

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One of our objectives in meeting our research and development and commercialization costs is to fund a significant portion of those expenditures through either direct grants or indirect grants through our research and development affiliates.  We have, for example, directly or indirectly through Clean Energy Technologies, funded a total of CDN $56,600 in grants for developmental purposes of our pulse combustion technology from the date of our inception, and our predecessors to this technology funded a total of CDN $1,785,000 in developmental grants prior to our acquisition of that technology.

In late 2001, the Industrial Research Assistance Program of the Canadian federal government's National Resource Counsel approved a CDN $90,000 grant to fund our phase I industrial tissue dryer characterization study.  This program later approved the transfer of the remaining funding balance for this program, CDN $22,000, toward the completion of our glycol and heavy oil heating applications.

We had previously applied for approximately $400,000 in matching grants from CE-CERT and ICAT with respect to the development of a residential natural gas-fueled water heater for the California market. This application was declined in 2001 after being short-listed, however, we have been requested to reapply for this program for a lesser amount and will proceed with that application when we have sufficient available time and manpower to do so.

We have also been requested to file a grant application with the Alberta Energy Research Institute to fund the testing and development of large coal burning pulse combustion burners for electrical generation plants, and also intend to proceed with that application when we have sufficient available time and manpower to do so.

Dr. Jackson is also coordinating our contacts with the U.S. Department of Energy and the South Coast Air Quality Management District, to name a few, in our efforts to further promote the development of our technologies and to have them designated as best available technologies.

We currently fabricate our burner units at our facilities located in Burnaby, British Columbia, although some components are purchased to our specifications from suppliers or subcontractors. Most of these components are standard parts or fabrication projects available from multiple sources at competitive prices. We believe that we would be able to secure alternate supply sources or suppliers or subcontractors if any of these become unavailable. Given the limitations of our internal manufacturing capability, we anticipate that we will rely upon strategic partners or third party contract manufacturers or suppliers to satisfy future production requirements as demand for our products increase.

We have one wholly-owned subsidiary, Clean Energy USA, a Nevada corporation, which we formed in December, 2001 for the dual purpose of managing pulse combustion technology research & development activities and commercializing our pulse combustion technology through licensing and royalty agreements in North America.

We acquired the rights to our pulse combustion technology for consideration of $10 under a Pulse Combustion Technology License dated March 5, 1999 with 818879 Alberta, Ltd., a corporation then owned and controlled by Mr. R. Dirk Stinson, our current President and Chief Executive Officer and a founder, director and principal shareholder of our company. In June 2001, 818879 Alberta, Ltd. transferred both its ownership of the pulse combustion technology and its interest in the license agreement to Ravenscraig Properties Limited ("Ravenscraig Properties"), a corporation also owned and controlled by Mr. Stinson.

Under the terms of the Pulse Combustion Technology License, we hold an exclusive fully-paid royalty-free license to design, engineer, manufacture, market, distribute, lease and sell burner products using the pulse combustion technology within any country in the world other than Finland or Sweden, and to sublicense and otherwise commercially exploit the pulse combustion technology within the permitted countries. The term of the Pulse Combustion Technology License expires 

upon the earlier of March 5, 2019 or the lapse of the newest underlying patents for the pulse combustion technology, including any patented improvements. The oldest pulse combustion technology patent expires in 2006, and the newest current pulse combustion technology patent expires in 2019. For further information concerning the underlying patents for the pulse combustion technology, see the section of this annual report captioned "Business-Patents and Proprietary Rights".

We are generally prohibited under the Pulse Combustion Technology License from sublicensing our rights to the pulse combustion technology, or otherwise assigning our rights as licensee under the Pulse Combustion Technology License, to any third party without Ravenscraig Properties' prior consent. Ravenscraig Properties, in turn, is also generally prohibited from selling its rights to the pulse combustion technology, or otherwise assigning its rights as licensor under the Pulse Combustion Technology License, to any third party without our prior consent.

We have sublicensed our rights to the pulse combustion technology to our new, wholly-owned subsidiary, Clean Energy USA Inc. effective January 1, 2002, but have limited commercialization rights to the continent of North America. This sublicense has been undertaken with the prior consent of Ravenscraig Properties.

We are obligated under the Pulse Combustion Technology License to pay or to reimburse Ravenscraig Properties for all costs its incurs to file and prosecute new or additional patents for the pulse combustion technology in any country. We are also obligated to pay or to reimburse Ravenscraig Properties for prosecuting and defending patent infringement claims relating to the pulse combustion technology, and to pay any damages arising from these claims.

We have the right under the Pulse Combustion Technology License to acquire full ownership of the pulse combustion technology from Ravenscraig Properties for the payment of CDN $1 at such time as we procure a listing of our common shares on a "national market", which is defined under the Pulse Combustion Technology License to constitute The New York Stock Exchange, The American Stock Exchange or The Nasdaq Stock Market (including both the SmallCap and National Markets). We refer to this purchase right as the "Pulse Combustion Technology Option". In order to be approved for listing on a national market, Clean Energy would need to satisfy enumerated quantitative and qualitative listing standards, including requirements relating to minimum bid prices, market capitalization, number of unaffiliated shareholders, net income and shareholders' equity. We do not currently qualify for listing on any national market, and we can give no assurance that we will qualify in the future or, if so, make any application.

Should we acquire full title to our pulse combustion technology by reason of exercise of the Pulse Combustion Technology Option, Ravenscraig Properties will nevertheless retain the right under certain circumstances to reacquire our pulse combustion technology should we later become bankrupt or insolvent, or be threatened with bankruptcy or insolvency, or make an assignment in favor of our creditors.

Our basic pulse combustion technology and a number of design improvements to this technology are protected by a number of United States patents, the oldest of which expires in 2006, and the newest of which expires in 2019. We anticipate that we will make international patent applications in selected foreign countries for our pulse combustion technology as circumstances dictate.

We intend to diligently defend any infringement of our pulse combustion technology patents. We are not aware of any potential challenges to these patents. We have not established a fund for defense of these patents, but may do so if significant sales of its products are achieved. We intend to have all employees and consultants execute trade secret and confidentiality agreements.

We cannot give any assurance that the existing patents granted to us or our licensors will not be invalidated, that patents currently or prospectively applied for by us or our licensors will be granted, or that any of these patents will provide significant commercial benefits. Moreover, it is possible that competing companies may circumvent patents we or our licensors have received or applied for by developing products which closely emulate but do not infringe our or our licensor's patents, and consequentially market products that compete with our products without obtaining a license from us. An adverse decision from a court of competent jurisdiction affecting the validity or enforceability of our patents or proprietary rights owned by or licensed to us could have, depending generally on the economic importance of the country or countries to which these patents or proprietary rights relate, an adverse effect on our company and our business prospects. Legal costs relating to prosecuting or defending patent infringement litigation may be substantial. Costs of litigation related to successful prosecution of patent litigation are capitalized and amortized over the estimated useful life of the relevant patent. We cannot give you any assurance that we will be able to successfully defend our patents and proprietary rights, or fund the cost of that litigation. For further information concerning these risks, see that section of this annual report captioned "Uncertainties And Risk Factors-Uncertainties And Risks Generally relating To Our Company And Our Business-Our Inability To Protect Our Patents And Proprietary Rights Would Force Us To Suspend Our Operations And Possibly Even Liquidate Our Assets And Wind-Up And Dissolve Our Company".

We currently have two full-time employees and one part-time employee, and also two full-