Securities And Exchange Commission
 Washington, D.C. 20549

_________________

FORM 10-Q

_________________

(Mark One)
 [ x ]

Quarterly Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934 For The Six-month Period Ended June 30, 2003; Or
 [    ]

Transition Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934 For The Transition Period From ________ To _______

Commission File No. 333-88207

CLEAN ENERGY COMBUSTION SYSTEMS, INC.
 (Exact name of registrant as specified in its charter)

 

Delaware
(State or other jurisdiction of
incorporation or organization)

  

98-0211550
(I.R.S. Employer
Identification No.)

7087 MacPherson Avenue, British Columbia, Canada V5J 4N4
 (Address of principal executive offices) (Zip Code)

(604) 435-9339
(Registrant's telephone number, including area code)

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

11,407,269 shares of common stock, par value $0.0001 per share, as of July 16, 2003

INTRODUCTORY NOTE

The information in this quarterly report is current as of the date of this quarterly report (July 24, 2003), unless an earlier date is specified. 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 quarterly 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 interim consolidated financial statements included in this quarterly report captioned "Foreign Currency Translation".

We prepare our interim consolidated financial statements in accordance with United States generally accepted accounting principles. Our consolidated financial condition and results of operations for the six-month interim period ended June 30, 2003 are not necessarily indicative of our prospective consolidated financial condition and results of operations for the full fiscal year ended December 31, 2003. The interim consolidated financial statements presented in this quarterly report as well as other information relating to our company contained in this quarterly report should be read in conjunction with the annual consolidated financial statements and more detailed background information relating to our company and our business contained in our annual report on form 10-K for our fiscal year ended December 31, 2002.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

In this quarterly 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 like ly result", and similar expressions. Forward-looking statements contained in this quarterly report would, for example, include statements relating to the timing and completion of pending or prospective projects and contracts and receipt of revenues.

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 quarterly 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 a nd 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 quarterly 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 quarterly report to reflect new events or circumstances unless and to the extent required by applicable law. All forward-looking statements contained in this quarterly 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 quarterly 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.

-i-

TABLE OF CONTENTS

Page   

Consolidated Balance Sheets

1

Consolidated Statements Of Operations

2

Consolidated Statements Of Capital Deficiency

3

Consolidated Statements Of Cash Flow

4

Notes To Consolidated Financial Statements

5

Management's Discussion And Analysis Of Financial Condition And Results Of Operations

15

Quantitative And Qualitative Disclosure About Market Risk

19

Disclosure Controls And Procedures

19

Uncertainties And Other Risk Factors That May Affect Our Future Results And Financial Condition

19

Legal Proceedings

28

Changes In Securities And Use Of Proceeds

28

Defaults Upon Senior Securities

28

Submission Of Matters To A Vote Of Security Holders

28

Other Information

28

Exhibits And Reports On Form 8-K

28

Signatures

29

Certification Of Principal Executive Officer

30

Certification Of Principal Accounting And Financial Officer

31

-ii-

CLEAN ENERGY COMBUSTION SYSTEMS, INC.
(a development stage enterprise)
(expressed in U.S. dollars)
CONSOLIDATED BALANCE SHEETS

 
 

June 30,
2003

December 31,
2002

ASSETS

(unaudited)

  

CURRENT

    
 

Cash and cash equivalents

$                  512

$                        - -
 

Prepaid expenses

2,825

2,873

Total current assets

3,337

2,873

ADVANCES TO AN AFFILIATED COMPANY (note 4)

296,636

427,543

PATENTS

30,128

39,327

TOTAL ASSETS

$           330,101

$            469,743

LIABILITIES

    

CURRENT

    
 

Accounts payable

$          341,972

$            316,948
 

Accrued expenses (including accrued interest of $4,543 as of June 30, 2003 and $3,123 as of December 31, 2002-note 5)

71,270

48,123
 

Advances from related parties (note 5)

160,139

52,697
   

Total current liabilities

573,381

417,768

PROVISIONS AND LIABILITIES RELATED TO TRANSFER OF OWNERSHIP OF SUBSIDIARY (note 4)

337,056

468,177

TOTAL LIABILITIES AND PROVISIONS

910,437

885,945

Going concern (note 1)

    

Commitments and contingencies (note 10)

    

CAPITAL DEFICIENCY

    

Authorized (note 6):

    
 

Preferred stock; par value $0.0001 per share, 2,000,000 shares

    
 

Common stock; par value $0.0001 per share, 15,000,000 shares

    

Issued (note 6):

    
 

Series 'A' convertible preferred stock;
Liquidation preference $1 per share, or $1,000 total;
1,000 shares issued and outstanding as of June 30, 2003 and December 31, 2002



1



1
 

Series 'B' convertible preferred stock;
Liquidation preference $2 per share, or $483,336 total; 241,668 shares issued and outstanding as of June 30, 2003 and December 31, 2002


242


242
 

Common stock; 11,407,269 shares issued and outstanding as of June 30, 2003 and December 31, 2002

1,141

1,141

Additional paid-in capital

2,967,683

2,836,562

Deficiency accumulated during the development stage

(3,539,403)

(3,254,148)

TOTAL CAPITAL DEFICIENCY

(580,336)

(416,202)

TOTAL LIABILITIES AND CAPITAL DEFICIENCY

$          330,101

$            469,743

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

-1-

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

x

 


Three Months Ended
June 30,


Six Months Ended
June 30,


Jan. 1, 1999
to
June 30, 2003
(Cumulative)
 

2003

2002

2003

2002

        (------------------------------------------------------unaudited-------------------------------------------------)

ADMINISTRATION AND MARKETING EXPENSES

          
 

Accounting

$            9,017

$           2,134

$         16,145

$           8,487

$            95,296
 

Administrative wages, benefits and contract fees

25,570

34,142

56,247

67,109

656,473
 

Amortization

-

-

-

-

45,027

Communications

2,101

1,299

3,804

2,849

40,763
 

Foreign exchange (gain) loss

-

(116)

(71)

(116)

(27,570)
 

Interest

1,112

22,775

1,818

27,698

91,808
 

Legal and patent maintenance

8,368

6,534

16,913

6,818

372,353
 

Marketing

10,823

15,193

38,842

26,279

386,208
 

Occupancy

2,705

-

5,325

-

105,154
 

Office and miscellaneous

-

2,462

1,428

4,450

104,365
 

Write-down of patents

-

-

9199

-

9,199
 

Professional fees

-

-

-

-

15,972
 

Transfer agent fees

$ 190

520

2,955

520

38,266

Total administration and marketing

59,886

84,423

152,605

144,094

1,933,314

RESEARCH AND DEVELOPMENT EXPENSES (note 3)

          
 

Wages and other direct costs

42,534

98,676

116,448

203,865

1,249,656
 

Overhead

10,851

21,390

26,202

51,791

366,433
   

Total research and development

53,385

120,066

142,650

255,656

1,616,089

TOTAL EXPENSES AND NET LOSS FOR THE PERIOD

$    (113,271)

$    (204,489)

$    (295,255)

$    (399,750)

$    (3,549,403)

BASIC AND DILUTED NET LOSS PER SHARE OF COMMON STOCK (note 2)

$           (0.01)

$          (0.02)

$           (0.03)

$          (0.04)

  

WEIGHTED AVERAGE SHARES OF COMMON STOCK OUTSTANDING

11,407,269

10,382,695

11,407,269

10,382,695

  

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

-2-

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

 
 

Series 'A'
Preferred Stock

Series 'B'
Preferred Stock


Common Stock


Additional
Paid-in
Capital

Accumulated During
The Development Stage

 

Shares

Amount

Shares

Amount

Shares

Amount

Period

Cumulative

 

(Six-month Interim Period Ended June 30, 2003-unaudited)

Issued on incorporation

1,000

$         1

-

$            - -

9,643,750

$       964

$             535

$                    - -

$          1,500

Private placement

-

-

250,001

250

-

-

499,752

-

500,002

Vesting of previously issued but unexercised warrants granted to consultant (note 6)

- -

- -

- -

- -

- -

- -

2,000

- -

2,000

Net loss for the period ended December 31, 1999

-

-

-

-

-

-

-

(639,404)

(639,404)

Balance, December 31, 1999

1,000

1

250,001

250

9,643,750

964

502,287

(639,404)

(135,902)
                   

Vesting of previously issued but unexercised warrants granted to consultant (note 6)

- -

- -

- -

- -

- -

- -

18,500

- -

18,500

Issued on conversion of promissory note

-

-

-

-

487,944

49

975,838

-

975,887

Net loss for the year ended December 31, 2000

-

-

-

-

-

-

-

(907,826)

(907,826)

Balance, December 31, 2000

1,000

1

250,001

250

10,131,694

1,013

1,496,625

(1,547,230)

(49,341)
                   

Vesting of previously issued but unexercised warrants granted to consultant (note 6)

- -

- -

- -

- -

- -

- -

30,601

- -

30,601

Disposition of subsidiary (note 4)

-

-

-

-

-

-

294,522

-

294,522

Net loss for the year ended December 31, 2001

-

-

-

-

-

-

-

(812,445)

(812,445)

Balance, December 31, 2001

1,000

1

250,001

250

10,131,694

1,013

1,821,748

(2,359,675)

(536,663)
                   

Conversion of series 'B' convertible preferred stock into common stock

-

(8,333)

(8)

8,333

1

7

- -

- -

Conversion of loans and other debt to common stock

-

-

-

-

1,267,242

127

823,581

  

823,708

Reduction of provision for liability related to transfer of subsidiary (note 4)

 -

 -

 -

 

 -

 -

 191,226

 

 191,226

Net loss for the year ended December 31, 2002

-

-

-

-

-

-

-

(894,473)

(894,473)

Balance, December 31, 2002

1,000

1

241,668

242

11,407,269

1,141

2,836,562

(3,254,148)

(416,202)
                   

Reduction of provision for liability related to transfer of subsidiary 
   (note 4)

- -

- -

- -

- -

- -

- -

131,121

- -

131,121

Net loss for the six-month period ended June 30, 2003

-

-

-

-

-

-

-

(295,255)

(295,255)

Balance, June 30, 2003

1,000

$         1

241,668

$       242

11,407,269

$    1,141

$   2,967,683

$   (3,549,403)

$   (580,336)

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

-3-

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

 
 

Three-months Ended
June 30,

Six-months Ended
June 30,



Jan. 1, 1999 to
June 30, 2003
(Cumulative)
 

2003

2002

2003

2002

(--------------------------------------------------unaudited------------------------------------------------)

OPERATING ACTIVITIES

          
 

Total expenses and net loss

$      ( 113,271)

$      (204,489)

$     (295,255)

$     (297,959)

$     (3,549,403)
 

Adjustments to reconcile total expenses and net loss to net cash utilized in operating activities:

          
   

Amortization

-

-

-

-

45,027
   

Non-cash consulting expense

-

-

-

-

51,101
   

Write-down of patents

-

-

9,199

-

9,199
 

Change in operating assets and liabilities:

          
   

Accounts receivable and prepaid expenses

-

(2,825)

48

(2,825)

(21,144)
   

Accounts payable

(15,663)

19,685

25,024

169,689

1,001,331
   

Accrued liabilities

14,714

44,375

23,147

49,298

253,639

Net cash used in operating activities

(114,220)

(143,254)

(237,837)

(81,797)

(2,210,250)

INVESTING ACTIVITIES

          

Additions to patents

-

(480)

-

(1,278)

(39,327)
 

Purchase of property and equipment

-

-

-

-

(92,791)

Net cash provided by (used in) investing activities

-

(480)

-

(1,278)

(132,118)

FINANCING ACTIVITIES

          
 

Advances from (to) an affiliated company

51,487

(119,155)

130,907

(199,814)

115,202
 

Advances from (to) shareholders (note 5)

-

-

-

-

273,779
 

Advances from (to) related parties

63,127

262,889

107,442

282,889

478,561
 

Net proceeds from disposal of subsidiary

-

-

-

-

(2,051)
 

Proceeds from issue of common stock

-

-

-

-

976,887
 

Proceeds from issue of series 'A' convertible preferred stock

-

-

-

-

500
 

Proceeds from issue of series 'B' convertible preferred stock

-

-

-

-

500,002

Net cash provided by financing activities

114,614

143,734

238,349

83,075

2,342,880

NET DECREASE IN CASH AND CASH EQUIVALENTS

394

-

512

-

512

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

118

-

-

-

-

CASH AND CASH EQUIVALENTS, END OF PERIOD

$                 512

$                    - -

$               512

$                    - -

$                  512

 

SUPPLEMENTAL SCHEDULE OF INTEREST AND INCOME TAXES PAID

Interest paid for the periods ended June 30, 2003 and June 30, 2002 and the cumulative period ended June 30, 2003 was $1,818, $27,698 and $91,808, respectively, and income taxes paid for each of the periods ended June 30, 2003 and June 30, 2002 and the cumulative period ended June 30, 2003 was $0.

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

-4-

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 operations on March 1, 1999. These financial statements include 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 our organization as obligations of our company.

    We are engaged in the business of designing, engineering, manufacturing, marketing, distributing, licensing and otherwise commercially exploiting our suite of proprietary mid- to high-frequency oscillating valveless combustion or 'burner" technologies, including our patented pulse blade combustion or "PBC" technology. This technology, which is our principal 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.

    Since we have not generated operating revenues to date, we should be considered a development stage enterprise. As of June 30, 2003, we have incurred losses from inception totalling $3,549,403, have a working capital deficiency of $570,044, 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 project grants or financings, 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. These factors, among others, indicate that we may be unable to continue as a going concern for a reasonable period of time. In the event that we are unable to generate sufficient capital 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 consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or the amount and classifications of liabilities that might be necessary, should we be unable to continue as a going concern.

    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 quarterly report as "common shares", "series 'A' preferred shares", "series 'B' preferred shares" and "series 'C' preferred shares", respectively). See note 6.

2.       Significant Accounting Policies

    Basis Of Presentation

    We prepared these consolidated financial statements in conformity with accounting principles generally accepted in the United States.

-5-

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

    Consolidation

    We have consolidated the accounts of our wholly-owned subsidiary, Clean Energy USA Inc. ("Clean Energy USA") with those of Clean Energy. All significant intercompany balances and transactions between Clean Energy and Clean Energy USA were eliminated as a consequence of the consolidation process.

    Reclassifications

    Certain items in our prior year's consolidated financial statements have been reclassified to conform to our current year's consolidated financial statement presentation.

    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 accounting principles generally accepted in the United States of America 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. Clean Energy holds no cash or cash equivalents at the date of these financial statements.

    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. Clean Energy holds no short-term investments at the date of these financial statements.

    Research And Development

    Research and development costs are expensed as incurred.

    Marketing Costs

    Marketing costs, including advertising costs, are expensed as incurred.

-6-

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

    Patents

    Costs related to the acquisition of patents are capitalized and, upon production of revenues, 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 associated technology. As we have not commenced production of revenues to date, no amortization has been recorded to date in these consolidated financial statements. 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 have historically stated property and equipment at cost, and then recorded amortization on these assets on a straight-line basis over their respective estimated service lives. As a consequence of the divestiture of our research and development subsidiary on December 31, 2001, Clean Energy holds no property or equipment at the date of these financials statements. All property and equipment used by Clean Energy is currently leased from Clean Energy Research Inc. as part of an overhead charge. See note 3.

    Income Taxes

    Current income tax expense, if any, is the amount of income taxes expected to be payable for the current year. A deferred tax asset and/or liability is computed for both the expected future impact of differences between the financial statement and tax bases of assets and liabilities and for the expected future tax benefit to be derived from tax loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be 'more likely than not' realized in future tax returns. Tax rate changes are reflected in income in the period such changes are enacted.

    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