ITEM 1.     BUSINESS




Overview



Clean Energy ("we," "our company" or "Clean Energy") is a recently-organized
development stage enterprise formed and organized on March 1, 1999 to market
"burner units" based upon two patented and innovative burner designs we acquired
under license-our "pulse combustion technology" and our "diesel fuel combustion
technology." These designs were originally invented by one of our founders, Mr.
John D. Chato, and are now in a position to be introduced to the market having
completed their primary development stage. Each design has a large number of
potential industrial, commercial and residential applications. We have one
wholly-owned subsidiary, Clean Energy Technologies (Canada) Inc., which focuses
on pulse combustion research and development activities. 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.


A burner unit is a furnace or other combustion chamber which uses the combustion
process to convert the chemical energy contained in various fuel sources, such
as natural gas, propane, gasoline, diesel fuel, oil, or coal, 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 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 carbon-based fuels in the
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.


The first of our designs, which we refer to as our "pulse combustion
technology," is an elongated or "linear" configured pulse burner technology
which can operate on a variety of fuels, including natural gas, propane,
powdered coal, and hydrogen. This design can be used to manufacture
highly-compact burner units that are more energy-efficient, and emit
significantly lower levels of pollutants, than conventional steady-state and
"tubular" configured pulse combustion designs. For a description and
illustration of our "linear" design as compared to conventional "tubular"
configured pulse combustion designs, see that section of this annual report
captioned "Business-How Conventional Pulse Combustion Technology Works" and
"Business-How Our Pulse Combustion Technology Works." Due to the compactness,
simplicity of design and lack of moving parts inherent in our technology, our
design also allows burner units to be more inexpensively, easily and quickly
manufactured, installed and serviced than conventional steady-state and tubular
pulse combustion designs.



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We are currently working on production proto-types under pending proposals for
the following applications of this technology:


º A 13 million BTU/hour powdered-coal burning pulse combustion unit that will
be used for the retrofit of 1,000 boilers used to produce steam for the
heating of public buildings.


º A number of natural gas-fueled burner units, ranging from 30,000 BTU//hour
to 69 million BTU/hour, to be used to create a low oxygen content exhaust
flue reducing gas required for the effective operation of catalytic
absorption pollution control systems. An exhaust flue is the pipe or duct
which carries the products of combustion out of the combustor. A catalytic
absorption pollution control system is a system that cleans combustion
exhaust by reacting harmful exhaust components with a catalyst to render
them harmless. This project will most likely be extended to diesel fuel
applications.


º An 8,000 BTU/hour natural gas-fueled burner unit used to create a low
oxygen content hydrocarbon reducing gas required for the operation of fuel
cells. A fuel cell is an electrochemical device which combines hydrogen
fuel with oxygen to produce electric power, heat and water.


º A natural gas-fueled burner unit used to burn residual flare gases emitted
from producing oil wells, and to convert the heat energy created into
electricity through a turbo-generator. Flare gases are generally residual
or "waste" gases containing contaminants like sulfur that render them
difficult to utilize. Because these gases are surplus they are flared off
instead of being collected and processed-i.e., they are combined with air
and burned in the atmosphere at the end of a tall stack. A turbo-generator
is a small, self contained gas turbine generator designed to provide a
source of electricity for remote sites like oil wells or to provide
commercial or industrial users a additional or supplementary source of
electricity to the power they receive from the utility grid.


º A 50,000 to 200,000 BTU/hour diesel-based burner to be used for space
heaters in heavy-duty special-purpose vehicles.


º A natural gas-fueled burner unit to be used for industrial paper and pulp
dryers.


º A natural gas fueled 400,000 to 500,000 BTU/hour instantaneous water
heater.


Most of the testing of our pulse combustion technology to date, as well as under
our pending proposals, are fueled by either natural gas or powdered coal,
although our pulse combustion technology has the capability to use any
carbon-based fuel as its energy source. Natural gas is a logical fuel choice,
particularly in North America, due to its abundant supply and clean-burning
characteristics. 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. Coal is also a logical fuel choice
world-wide due to its abundant supply, although there are still outstanding
environmental issues relating to the burning of coal and the cost of scrubbing
and other emission-control technologies required to reduce resultant pollutants,
particularly sulfur dioxide (SO2) or "acid rain."


We believe the demand for cleaning burning fuels will continue as clean air
legislation and public environmental pressures increase. Even though our current
focus is on natural gas and coal burning applications, our pulse combustion
technology can also use other carbon-based fuels as its energy source. We have,
for example, successfully burned gasoline, propane, and a powdered coal and
hydrogen mix, and also believe our technology will be equally successful in
burning diesel and oil.


The second of our designs, which we refer to as our "diesel fuel combustion
technology," is a burner technology which enables some conventional steady-state
burner units to burn diesel fuel instead of natural gas or propane. This design
not only allows a user to use diesel as his fuel of choice where warranted by
price or supply considerations, but also results in lower levels of pollutants
than that emitted through the burning of natural gas or propane in these types
of burner units. We are currently working on production proto-types under
pending proposals for the adaptation of two natural gas fueled burner units to
burn diesel fuel.



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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
best 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 and
commercial emissions in the four counties comprising the Los Angeles
metropolitan area.


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 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.


Our objective is to enter into licensing, royalty, joint venture or
manufacturing agreements with established national and international heat
transfer industry manufacturers which will result in the introduction of a
variety of different burner units based upon our technology into various
selected market segments.


We have no revenues to date, nor have we entered into any revenue producing
contracts to date, although we are currently working on a number of proto-types
under several proposal requests which could lead to revenue producing contracts
over the next four to six months.



Our Corporate History



Our company was formed and organized on March 1, 1999 under the name Clean
Energy Technologies, Inc., by two groups of founders, whom we refer to as the
"BO Group" and the "Alberta Group." We changed our corporate name to Clean
Energy Combustion Systems, Inc. on May 20, 1999.


The "BO Group" is comprised of BO Tech Burner Systems Ltd. and several of their
principals, including Messrs. John D. Chato, John P. Thuot, Barry A. Sheahan,
and James V. DeFina. BO Tech Burner Systems Ltd., in turn, is part of a group of
three affiliated British Columbia corporations, whom we refer to as the "BO
Companies," who expended over Cdn. $4 million in primary development for our
pulse combustion technology over the ten year period ended December 31, 1998.
The other two members of the BO Companies are BO Gas Limited, a majority-owned
subsidiary of BO Tech Burner Systems Ltd., and BO Development Enterprises Ltd.,
the majority-owned parent of BO Tech Burner Systems Ltd.


Mr. John D. Chato is the inventor of both our pulse combustion and diesel fuel
combustion technologies, as well as the owner and licensor of our diesel fuel
combustion technology. Messrs. Chato, Thuot, and Sheahan are also officers and
directors of each of the BO Companies, as well as direct or indirect
stockholders of each of these companies through BO Development Enterprises Ltd.
Mr. DeFina is a key employee of the BO Companies, as well as a direct or
indirect stockholder of each of these companies.



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Messrs. Chato, Thuot and Sheahan were appointed as executive officers and
directors, and Mr. DeFina as one of our executive officers, as part of our
formation. In connection with our formation, we issued 6,525,713 shares of our
common stock to BO Tech Burner Systems Ltd., and a total of 1,074,287 shares of
our common stock to Messrs. Chato, Thuot, Sheahan, DeFina and Robert Alexander,
who served at that time as an unpaid advisor. BO Tech Burner Systems Ltd.
subsequently distributed 2,599,084 of our common shares held by it to BO
Development Enterprises Ltd., while at the same time transferring an additional
753,724 shares to BO Gas.


The Alberta Group is comprised of 818879 Alberta, Ltd., an Alberta corporation
which currently owns and licenses our pulse combustion technology to us, and
Ravenscraig Properties Limited, an affiliate of 818879 Alberta, Ltd. Both 818879
Alberta, Ltd. and Ravenscraig Properties Limited are owned and controlled by Mr.
R. Dirk Stinson, who became one of our directors in January 2000. Neither of
these companies or Mr. Stinson are related to any of the members of the BO Group
or their respective principals. In connection with our formation, we issued
2,043,750 shares of our common stock to Ravenscraig Properties Limited and 1,000
shares of our series "A" preferred stock to 818879 Alberta, Ltd.


On February 16, 1999, our founders caused our wholly-owned research and
development Canadian subsidiary, Clean Energy Technologies (Canada) Inc., a
British Columbia corporation which we refer to as "Clean Energy Canada, " to be
incorporated and organized, and we acquired all of the common stock of Clean
Energy Canada on March 1, 1999.



How Conventional Pulse Combustion Technology Works



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 and the exterior of
the combustion chamber cools, 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 60 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.



How Our Pulse Combustion Technology Works



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 60 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. As
illustrated below, our company's solution to these problems was to maintain the
most efficient shape of the "bottle" in terms of its "cross-section," while
extending the "depth" of the bottle in a linear or straight-line direction:



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[ILLUSTRATION OF CONVENTIONAL COMPARED TO LINEAR PULSE




COMBUSTORS]




Our design eliminates the noise and vibration levels associated with
conventional pulse combustion since the design of our unit allows it to operate
at anywhere from 350 to 650 cycles per second depending upon the configuration
and application. Moreover, the depth implicit in our design allows us to
significantly increase the unit's overall heat output, without loss of
efficiencies and increase of emissions.


We use two different pulse combustion designs depending upon the application
required-our initial "linear" configuration and a more recently developed
"cylindrical" variant. Set forth below is a diagram of a water or space heating
system containing three combustion chambers based upon our linear configuration:




[ILLUSTRATION OF LINEAR PULSE COMBUSTOR]





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Note the elongated or "linear" shape of each burner chamber as indicated in the
above diagram, both height- and width-wise as they progress from the wider
combustion chamber into the narrower tailpipe, as well as depth-wise. The basic
dimensions of each burner chamber, in terms of relative height, width and depth,
resembles the shape of a "blade." For this reason our company sometimes refers
to our pulse combustion technology as "pulse 'blade' combustion" or "PBC"
technology, principally to differentiate our original linear blade configuration
from the "tubular" pulse combustion configuration conventionally used today.


It is important to note that so long as we maintain the basic geometries of our
"blade" design, whether in the linear or cylindrical configuration, we can
obtain additional heat output where required, by making one or both of the
following simple alterations to the basic design depending upon space and use
considerations:


º extending or "scaling-up" either:


º the depth of the system (i.e., the length of the existing pulse
combustion burner chambers and intervening water or air chambers),
while maintaining the width and height of the burner chambers, or


º the width or height of the burner chambers, while maintaining basic
blade design geometries; or


º adding or "stacking" one or more additional pulse combustion burner
chambers and intervening water or air chambers on a side-by-side basis, as
illustrated above.


The principal advantage of our linear configuration over our cylindrical
configuration is that it lends itself more readily to the joining together on a
side-by-side basis of separate operating "modules," each module containing one
or more combustion units. We can then regulate or adjust heat output by turning
one or more of these adjoining modules on or off. This on-off capacity, which we
refer to as "turn-down capability," allows our linear unit to operate at a
number of differing pre-selected higher or lower output levels while maintaining
optimum heat output and heat transfer efficiencies. Conventional systems have
very low efficiencies and high emissions while operating in a lengthy startup
modes or partial capacity during low demand periods of operation.


We developed our cylindrical configuration for use in applications where
turn-down capability is not a consideration. There are several benefits to the
cylindrical shape for these applications, including lower manufacturing costs,
innate structural integrity, and elimination of gases collecting in corners.



Competing Pulse Combustion Products



Pulse combustion technology is not a new development. It has been in the public
domain since early in the 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



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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:


º Hydrotherm Corporation, which markets three natural gas-fueled pulse water
boiler systems rated at from 100,000 BTUs/hr to 300,000 BTUs/hr for
residential and commercial "hydronic" 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 .


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


º Fulton Boiler Works, Inc., which markets:


º 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 BTUs/hr input, and a line of high pressure
models rated at between 500,000 to 700,000 BTUs/hr input; and


º two lines of pulse boilers used for hydronic heating purposes, rated
at between 300,000 to 1,400,000 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 a
long "tubular" design. 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 60 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.



Competitive Advantages Of Our Pulse Combustion Technology



Summary Of Competitive Advantages Over Conventional Steady-State Combustion And
Conventional Tubular Pulse Combustion Technologies


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:


º Our pulse combustion technology enables burner units to operate with:


º significantly higher energy conversion efficiencies than conventional
steady-state combustion technology, leading to significantly higher
fuel savings than these technologies, and


º slightly higher heat output and heat transfer conversion efficiencies
than conventional tubular pulse combustion technologies, leading to
slightly higher fuel savings than these technologies.



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º Our pulse combustion technology enables burner units to emit:


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


º significantly lower emissions of oxides of nitrogen, commonly known as
"NOx," than conventional tubular pulse combustion technologies, and
comparable or slightly lower emission levels than these technologies
with respect to emissions other than Nox.


º Our pulse combustion technology allows unlimited size or output variations
with our pulse blade design, as opposed to conventional "tub" pulse burners
which have no scalability and thus are very limited in operating
efficiently outside their comparatively narrow application range;


º 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.


º 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 linear design, 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 exisiting
boiler unit thereby saving considerable capital cost. You should note that
a burner unit retrofit is a fraction of the cost of a complete boiler
replacement.


º 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 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.


º 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.



Better Energy Conversion Efficiencies



º Background:   Among the principal considerations is evaluating a burner
unit are its relative "energy conversion efficiencies," which 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 is more energy conversion efficient 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 efficiency of a
burner unit can be broken down into the following constituent elements:


º Heat Output Efficiency:   As previously discussed in this annual
report, a burner unit uses the combustion process to convert the
chemical energy contained in various fuel sources into heat energy
measured in BTUs. The term "heat output efficiency" simply refers to
the ability of the combustion process to effectively convert the
maximum amount of chemical energy contained in the selected fuel into
heat energy. For example, ten cubic feet of natural gas could
potentially produce 1,000 BTUs of heat energy assuming its entire
chemical energy was converted



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into heat energy through the combustion process-although, as a practical matter,
perfect heat output efficiency never occurs due to a number of variables. To the
extent chemical energy is not converted into heat energy, it is discharged as
part of the exhaust stream in the form of various post-burn chemical gases
including NOx, carbon monoxide and sulfur dioxide-resulting in unextracted or
"wasted" of heat energy potential.


º Heat Transfer Efficiency:   As previously discussed in this annual
report, the commercial application of a burner unit is to act as a
"heat transfer" device to heat water or air. The term "heat transfer
efficiency" simply refers to the ability of the heat transfer surfaces
of the combustion unit to effectively "transfer" the maximum amount of
heat generated by the combustion process to warm the water or air,
instead of allowing any of this heat to be discharged as part of the
exhaust stream-resulting in unapplied or "wasted" heat energy.


º Start-Up Efficiencies:   All combustion units, including both
conventional steady-state and pulse combustion units, require a period
of time to "warm-up" before they attain optimum combustion
temperatures. Generally speaking, the bigger the combustion unit in
terms of BTU output capacity, the longer the warm-up period. The
warm-up time for a conventional steady-state 10 million BTU/hour
boiler, for instance, is approximately two hours.


º 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:


º 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.


º Heat Transfer Efficiencies:   In conventional steady-state combustion,
a zone of air called a "buffer 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
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 buffer layer affect
does not occur 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. 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%.


º 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. The warm-up time for a 10 million BTU/hour
pulse combustion boiler, for instance, would be approximately two
minutes, as compared to the two hour warm-up time noted above for a
comparable conventional steady-state boiler.



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º 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 60 to 70 cycles per second. Our pulse combustion
technology, on the other hand, operates at anywhere from 350 to 650 cycles
per second depending upon the configuration and application, or 6 to 9
times the rate of conventional tubular pulse combustion, leading to better
heat output, heat transfer and start-up efficiencies.


Test evaluations conducted in 1993 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 carbon monoxide and for oxides of nitrogen, meaning
that over 99% of the heat energy of the fuel was consumed in the combustion
process. For these reasons we believe the heat output efficiency of our
pulse combustion technology exceeds 99%.



Lower Emissions



º Background:   There has been increased worldwide awareness and concern over
the past 25 years over the effect of atmospheric pollutants on the
environment and people's health, leading to ever-increasing levels of
regulatory emissions constraints, particularly in the developed countries
of the world. In order to address these concerns and satisfy current and
anticipated regulatory requirements, prospective purchasers are now
demanding burner units which emit significantly lower levels of post-burn
chemical gases, including NOx, carbon monoxide, sulfur dioxide and other
residual gases, while maintaining the energy conversion efficiencies
necessary to minimize fuel costs.


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:


º There is an inverse relationship between heat output efficiency and
emission levels. As previously discussed in this annual report, heat
output efficiencies are a function of the completeness of the burning
process. The more compete 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.


º 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
energy conversion efficiencies. By way of example, natural gas-fueled
water heaters typically operate with excess air rates of 30% to 40% of
the exhaust stream, which constitutes approximately 30% to 40% of the
amount of additional oxygen required to burn the natural gas and
convert it into heat energy.



-10-





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.


º Emission Control Advantages of Pulse Combustion Over Conventional
Steady-State Combustion:   As previously discussed in this annual report,
pulse combustion results in a more complete combustion process than
conventional steady-state combustion due to the more turbulent combustion
environment and internal combustion pressures resulting from the repetitive
pulse combustion cycles inherent in pulse combustion process, resulting in
the emission of less post-burn chemical gases as part of the exhaust
stream. Pulse combustion can, however, 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.


º 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, offers significantly reduced NOx emissions than conventional
tubular pulse combustion designs, and comparable or slightly lower levels
of other emissions, such as sulfur dioxide and carbon monoxide, as a result
of greater number of burning cycles inherent in our design. Simply put, the
greater number of burning cycles, the more complete the burning process,
and the lower the level of emissions. As previously noted, pulse burner
units using the conventional tubular pulse combustion configuration
typically operate at 60 to 70 cycles per second. Our pulse combustion
technology, on the other hand, operates at anywhere from 350 to 650 cycles
per second depending upon the configuration and application, which
translates into significantly lower emissions.


The ability of our pulse combustion technology to reduce emissions is
illustrated by the following independent test results:


º In February, 1994, the Center for Emissions Research, and
Certification, Inc., an independent testing agency under the auspices
of the Southern California Air Quality Management District located
conducted a series of tests at their facilities in the City of
Industry, California, of a 30,000 to 94,000 BTU/hour natural
gas-fueled residential water heater demonstration unit using our
cylindrical pulse combustion design. These tests followed a test
protocol developed by the Southern California Air Quality Management
District. The average NOx emissions of these tests, based upon three
test runs conducted and monitored by the Center using their testing
equipment, was 9.5 Ng/Joule.


º In May, 1994, the American Gas Association Laboratories, an
independent testing laboratory, conducted a series of tests at their
facilities in Cleveland, Ohio, on an 8,000 BTU/hour natural gas-fueled
water heater demonstration unit using our linear pulse combustion
design. These tests followed the same test protocol developed by the
Southern California Air Quality Management District and used by the
Center for Emissions Research, and Certification, Inc. in conducting
its tests. The average NOx emissions of these tests, based upon a
series of test runs conducted and monitored by the American Gas
Association Laboratories using their testing equipment, was 5.5
Ng/Joule.



-11-







º In February, 1997, the Canada Centre for Mineral and Energy
Technology, or "CANMET," conducted a series of tests at our research
and development facilities of (1) a 15,200 BTU/hour natural gas-fueled
industrial drying furnace unit using linear pulse combustion
configuration, and (2) a 10,700 BTU/hour combination natural gas and
coal powder-fueled industrial drying furnace unit. All tests were
conducted and monitored by CANMET using its own test protocols and
testing equipment. CANMET reported zero parts per million NOx and
sulfur dioxide emissions for all of these tests, with the exception of
one anomalous NO reading on one test arising from the addition of air
through a coal feeding orifice.


No further independent testing has been carried out or required since the
tests described above.


We believe that our pulse combustion technology is so effective in reducing
the emissions of post-burn chemical gases that it can be utilized as a
relatively inexpensive pollution control device. In these cases our burner
units would re-burn the exhaust from a commercial or industrial process,
while at the same time generating heat energy which can be used for various
heat transfer applications, such as electricity co-generation,
consequentially reducing operating costs. The cost to manufacture, install
and operate our burner units for these applications should be significantly
cheaper than current scrubber applications. Co-generation is the process of
supplying both electric and steam energy from the same power source-that
is, combustion heat generated from a single process is used to create both
electric or mechanical and steam energy. A scrubber is a chemical or
electrostatic process used to remove pollutants from an exhaust stream
after combustion.



Compact Size



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:


º 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; and


º 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 size advantage is extremely important where limited floor or room space
considerations apply. For instance, a 100,000 BTU/hr low pressure boiler system
utilizing our linear 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 tubular combustion unit contains
a combustion chamber which is approximately two feet in diameter and three feet
in height, and weighs in excess of 200 pounds. The size of conventional
steady-state combustion units, in turn, equal or exceed that of conventional
tubular combustion units of comparable output.



-12-






Integrated Modular Design



As previously discussed in this annual report, 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:


º Turn-down Capability:   All conventional and pulse burners operate at an
optimum energy conversion efficiency and emission levels based upon their
design, measured in terms of BTU output. A 100,000 BTUs/hour conventional
steady-state furnace, for example, is designed to operate most efficiently
at a level of fuel-mixture, referred to as the "turn-down ratio," 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 decline and emission levels increase.


As previously discussed in this annual report, one of the principal
advantages of our pulse combustion design 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 output and heat transfer efficiencies
and lower emissions levels, which we refer to as "turn-down capability," by
simply turning one or more modules contained in a combustion unit on or
off. Moreover, should an operator desire to increase the combustion units'
overall output ability, he need only attach 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 design allows 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.


º No 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 while maintaining full energy output from the remaining
modules. This feature is particularly important in commercial and
industrial applications requiring continuous operation.



No Moving Parts



Many conventional tubular pulse systems employ flapper valves on their intake
channels. Our pulse combustion technology, on the other hand, is a simple design
which requires no valves or other moving parts to operate, leading to increased
operating reliability and reduced maintenance and repair costs.



Ability to Operate on a Wide Range of Fuels



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,
propane, and a powdered coal and hydrogen mix, and believe our burner technology
will also successfully burn diesel and oil.



-13-






Reduced Operating Noise



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. As previously discussed in this
annual report, conventional tubular pulse combustion units operate at
approximately 60 to 70 cycles per second due to their configuration. The
oscillating pressure waves from these cycles create a corresponding low
frequency standing sound wave of approximately 60 to 70 Hz, 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 600 cycles per second depending upon the
configuration, and is "tuned" to create a standing sound wave of approximately
440 Hz. Although this continuous soundwave 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.



Lower Manufacturing and Installation Costs



The cost to manufacture and install a conventional steady-state 100 million
BTU/hr boiler can exceed $10 million, and could take three years to design,
manufacture and install from the date the order is placed. A conventional
tubular pulse combustion boiler with comparable output would likely be equally
expensive.


Due to the simplicity and compact size of our design, including lack of moving
parts, 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. For example, we
estimate that the 100 million BTU/hr pulse combustion boiler system mentioned
would cost approximately one-half of that of a conventional tubular pulse
combustion boiler with comparable output, and would have approximately one-third
the weight and take up approximately one-third of the floor space of the
comparable tubular pulse combustion boiler.



Competitive Disadvantages Of Our Pulse Combustion Technology



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 "Risk
Factors-Risks Relating To Our Company And Our Business."



Markets For Burner Units



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



-14-







º Water Heater and Boiler Market:   In these applications heat generated by a
burner unit is used to either heat water in an unpressurized water heating
system, or to heat water to create steam or pressurized hot water in a
pressurized boiler system. Hot water is required in a variety of
residential, commercial and industrial uses, including homes, apartment
buildings, schools, hospitals, hotels, office buildings, restaurants,
stores, laundries, car washes, warehouses, industrial plants, boats/ships
and recreational vehicles. Steam or pressurized hot water is used for many
commercial or industrial applications, including both direct applications
such as steam cleaning and indirect applications where steam is used to run
a turbine in order to generate electricity. As discussed in greater detail
below in that section of this annual report relating to our pending
proposals, we are currently working on this type of project to retrofit
boiler systems for public buildings, and are also working on water heater
applications.


º Space Heating Market:   In this application heat generated by a burner unit
called a furnace is used to heat airspace in a variety of residential,
commercial and industrial settings, including those mentioned above in the
discussion relating to water heaters. As discussed in greater detail below
in that section of this annual report relating to our pending proposals, we
are currently working on this type of project for heavy-duty
special-purpose vehicles.


º Industrial Drying Market:   In this application heat generated by a burner
unit is used in industrial processes to dry materials or break them into
small pieces, known as "atomization." Industries which employ industrial
burners include the food processing, plastic, polymer, rubber, chemical,
mineral, pulp and paper, and pharmaceutical industries. As discussed in
greater detail below in that section of this annual report relating to our
pending proposals, we are currently working on this type of project for a
pulp and paper manufacturer.


º "One-Of-A-Kind" Industrial Project Market:   In this application a burner
unit is used for industrial applications best described as "one-of-a-kind"
which often require custom engineering or fabrication, such as retrofitting
of power generation plants, new power plants, and large co-generation
installations.


º Specialty Application Markets:   In this application a burner unit is used
for various specialty applications. A good example of a specialty
application is the need for "inert" process gases for industrial
operations, such as catalytic absorption pollution control systems, fuel
cells and horizontal down-hole drilling. Inert process gases are exhaust
gases which contain low or zero levels of oxygen. As discussed in greater
detail below in that section of this annual report relating to our pending
proposals, we are currently working on these types of projects for both
catalytic absorption pollution control systems and fuel cells.


º Pollution Control Equipment Market:   In this application a burner unit is
used as a secondary pollution control device to "reburn" industrial flue
gases generated by a primary industrial or commercial processes in order to
remove the pollutants contained in these gases. Typical industrial and
commercial settings which require the use of pollution control equipment
are manufacturing facilities, power plants, chemical plants, refineries and
paper mills.



Marketing Strategy



Both our pulse combustion technology and our diesel fuel combustion technology
have completed their respective research and development stages, and the next
step in exploiting these technologies is to introduce these technologies 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 our burner 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:


º Royalty Agreements:   We will seek royalty arrangements with equipment
manufacturers which will permit them to incorporate the use of specific
pulse combustion burner unit designs in their products, in return for the
payment of royalties based upon units sold, an initial up-front fee, or a
combination of these. These agreements will be targeted toward volume
producers that will use our pulse combustion technology as an integral
component of their functional product, such as water heaters and low
emission vehicles. This is a domain requiring large capital expenditures
which will not be recovered for several years, since the end products, such
as electric automobiles, will be several years away from mass production.



-15-







º Licensing Agreements:   We will seek licensing agreements with equipment
manufacturers that allow a broader scope in application of our burner
technologies than in royalty agreements. The end products of these
arrangements will likely be commercial systems, such as large boilers and
air conditioning equipment for apartment complexes, shopping centers, and
schools and hospitals. License agreements may be consummated by payment of
an initial fee, and an annual maintenance payment.


º Engineered Projects:   We will seek contracts for site specific,
one-of-a-kind projects of a large scale, such as thermal power-plants,
co-generation and various food processing applications. We believe these
will be particularly lucrative projects insofar as they will utilize our
technology at high-end outputs where the advantages of modular scale up are
most fully realized.


º Joint Ventures:   We will seek joint venture arrangements for various
industrial projects that lend themselves to pulse combustion technology in
which we will act as prime contractor, subcontractor or joint venture
partner. Joint venture opportunities of greatest interest to us are in the
area of spin-off company formation for development and sale of products
with specific end use applications.


º Product Manufacturing:   We would consider a product manufacturing
arrangement in situations where it may be advantageous for us to
manufacture, or have subcontractors manufacture, specific products or
components for end users.



Pending Proposals For Our Technology



Our burner designs have recently 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 production proto-types under various proposal requests which
would lead to the initial introduction of the following burner units using our
technologies. These pending proposal requests are summarized below.


º Pulse Combustion Burners for China Public Building Steam Boiler
Retrofits:   On August 30, 2000, we entered into a letter of intent with
Jie Li International Environmental Group, Inc., to provide them a license
for the marketing in China of coal-fired burner units using our pulse
combustion technology. The Chinese market represents an attractive
opportunity for our pulse combustion technology since coal accounts for
approximately 75% of China's annual energy consumption and will most likely
remain the dominant energy source in China for the foreseeable future. Of
equal importance, China suffers significant air pollution-particularly
sulfur dioxide or acid rain-as a consequence of its use of coal as its
primary source of energy. The opportunity is particularly timely for us
since the Chinese government has initiated a major program to reduce air
pollution by pursuing "clean coal" technologies, while indicating its
desire to continue to use coal as its primary energy source rather than
switching to cleaner burning, but more expensive, fuels. Moreover, our
pulse combustion technology lends itself to retrofitting, and is
significantly more efficient than China's current coal burning technology.


Our agreement to enter into the letter of intent was predicated on the
relationships and business strategy formulated by Jie Li to enter the
Chinese market. Specifically, members of Jie Li have long-standing business
relations with Tian Long Holdings Group Ltd., which operates the Shandong
province hub branch of the China National Rail Ministry. Shandong province
(also known as Qi Lu) is located at the estuary of the Yellow River in the
Bohai Bay. Shandong is China's second most populous province (90 million)
after Henan (100 million). Tian Long controls 48 subsidiary companies, and
employs 1850 administrative, managerial and support personnel. Tian Long's
interests include high-tech products, shipping, hotel and restaurants,
trading companies, social services, heavy industry, advertising and
printing, and heating and cooling.



-16-





Tian Long is enjoying rapid growth and increased profits year after year.
Among its main business activities is the supply of heating and cooling to
commercial and residential clients. Tian Long has solid plans to develop
this business, as heat supply is a lucrative and successful part of its
operations. Today, Tian Long is among the top five heat suppliers in the
capital city of Shandong province (Jinan) alone. Tian Long's heating supply
arm also has a maintenance and repair service centre, a boiler water
softener plant as well as a parts distribution centre. Tian Long is able to
offer total and complete heating service.


Tian Long also has the full support of its parent, the Chinese Railways
Ministry (one of China's top four Ministries), which also owns a bank and
various financial corporations. We believe that Tian Long is an excellent
partner for its economic and political relationships and its ability to
offer one of China's largest distribution networks as well.


As a consequence of Jie Lie's business relationship with Tian Long, Jie Lie
procured an order from Tian Long for 500 coal burning pulse
combustion-based boiler retrofits, each involving at least two of our
burners, to be used to produce steam for the heating of public buildings
under Tian Longs' control. These buildings are currently heated by steam
boilers that are extremely energy inefficient and polluting as their
antiquated design does not allow for complete combustion of the coal. Clean
Energy has been asked to provide clean burning coal burners to retrofit the
existing boiler systems thereby replacing only the burner while leaving the
boiler system intact. This is an enormous opportunity for our company in
that it not only represents the first of many anticipated follow-up orders
from Tian Long, but also acts as a commercial beta site for other potential
customers and licensees. There are currently 9,500 such boilers under the
control of Tian Long alone, and an estimated 136,000 nationwide under the
Railway Ministry's control.


As part of the negotiations with Tian Long, Clean Energy sent an
engineering team to Jinan in April, 2000 to review the feasibility of the
project, followed up with a marketing and financial team visit in
August, 2000 to finalize the letter of intent and purchase commitment with
Jie Li. Based on those written commitments, Jie Li has, in turn, provided
us with a commitment letter for the first 500 retrofits (or 1,000 burner
units in total) at a price of $20,000 per burner unit, subject to the pilot
installation achieving efficiency and emission reduction targets.


The design, development and production of the first retrofit unit involves
two stages, as follows:


º First, our ability to successfully design, construct and operate a
proto-type model, including controls and coal feeder, that can burn
China's relatively poor-quality coal in a powdered form. (Previously,
the only coal we had burned with our pulse combustion technology was a
natural gas-powdered coal mixture). We accomplished this step in
December 2000, when we successfully tested a 330,000 BTU proto-type
burner. As anticipated, the burner resulted in high heat output
efficiencies and relatively low NOx emission levels. As well, our
testing also indicated an extremely low sulfur dioxide emission rate,
which has led to additional investigation of this beneficial aspect of
the high-frequency pulse burn given potential acid rain-reduction
industrial applications. At this point we are continuing to modify the
design in an attempt to further reduce emission levels, and well as
improving the design of the coal feeding system.


º The second step will be to scale-up the proto-type burner into a full
13 million BTU production model, and then install it in Shandong
province. In order for Clean Energy to accomplish this next step, we
must acquire a significantly larger research & development and testing
facility, and we are currently in the process of seeking funding
necessary to accomplish this objective. We anticipate that it will
take us at least six to twelve months to design, test and manufacture
this proto-type burner once we acquire and equip a larger research &
development and testing facility. Since our burner design can be
easily scaled-up, the principal remaining issue in designing and
manufacturing a production model will be improvements to the coal
feeding system.



-17-





In the longer term we intend, pursuant to our letter of intent and
subsequent discussions with Jie Li, to form a joint venture in China with
Tian Long for the manufacture and sale of burner units once cost savings
and volume production considerations make on-site manufacturing in China a
viable alternative. In this case Clean Energy would be paid an ongoing
royalty based on units manufactured by the joint venture, which would
approximate our profit margin in manufacturing burner units. It is
contemplated that the venture will be owned 25% each by Clean Energy and
Jie Li, with the balance held by Tian Long, who will be providing equity to
the joint venture in the form of capital assets. It has also been proposed
that we invest $500,000 into Jie Lie in return for a 25% equity interest in
order to provide Jie Li sufficient marketing funds to continue to expand
the potential customer base for these boiler retrofits. This equity
interest in Jie Li would also entitle Clean Energy to a pro-rata share of
Jie Li's interest in the manufacturing joint venture. Discussions between
Clean Energy and Jie Li regarding the ultimate form of association are
ongoing, and will be subject to a number of other factors under
consideration, including the protection of our intellectual property
rights.


º Pulse Combustion Burner to Create A Low Excess Air Reducing Gas For
Industrial Catalytic Absorption Pollution Control Systems:   Goal Line
Environmental Technologies, LLC, a Tennessee-based designer and
manufacturer of industrial catalytic absorption pollution control systems,
has requested that we give quotes for eight different natural gas-fueled
pulse combustion burner unit proto-types, ranging from 30,000 BTU/hr to 69
million BTU/hr, to be used as a component for their proprietary industrial
"SCONOx" catalytic absorption pollution control systems. Goal Line, which
is a joint venture of Sunlaw Energy Corporation and Advanced Catalyst
Systems, Inc., was initially formed to combine Sunlaw's experience in power
plant development and operation with Advanced Catalyst Systems' extensive
catalytic research and development expertise.


Goal Line's first project was to develop a catalytic absorption pollution
control system which would eliminate carbon monoxide and NOx emissions for
two 28 MW natural gas turbine powered industrial co-generation plants
operated by Sunlaw in the Los Angeles metropolitan area. This system, which
was successfully developed and installed by Goal Line at Sunlaw's
co-generation plants and now forms the basis of Goal Line's technology,
involves the following two processes:


º an oxidation/absorption process where emissions are passed through an
absorption chamber that (1) captures NOx in a potassium carbonate
absorber coating, and (2) converts carbon monoxide into harmless
carbon dioxide, which is then released through a smokestack; and


º a nitrogen regeneration process where dilute hydrogen reducing gas is
passed across the surface of the catalyst and converts the previously
captured NOx into harmless nitrogen, which is then released through a
smokestack.


The Goal Line catalytic absorption pollution control system has been found
by the United States Environmental Protection Agency to result in the
"Lowest Achievable Emission Rate" for NOx emissions to date for gas turbine
power plants, and therefore, by law, to be the "Best Available Control
Technology" standard for new gas turbines. Regardless of these findings,
the primary competitive drawback of Goal Line's system has been its
inability to identify a technology which would allow it to introduce an
oxygen-free dilute hydrogen reducing gas into the catalytic chamber for the
nitrogen regeneration process. This is currently done by redirecting steam
from the power generation process, which reduces the heat output efficiency
of the overall system by approximately 10%. Goal Line looked without
success for several years for a technology which would facilitate this
requirement since this loss of heat output efficiency is a significant cost
item. We demonstrated to Goal Line in a series of tests conducted in
January and September 1999 that our pulse combustion burner unit has the
capability, due to its ability to maintain "stable" combustion at lower
excess air levels, to deliver a 100% oxygen-free hydrogen reducing gas to
the catalytic chamber, consequentially allowing Goal Line to recapture the
lost heat output efficiency.



-18-





As a result of the noted demonstrations, we have been authorized by Goal
Line to commence designing eight different proto-types for use with Goal
Line's catalytic absorption pollution control systems. We completed the
first proto-type in November 2000, a 365,000 BTU burner unit for use with
the catalytic absorption pollution control system installed at Sunlaw's Los
Angeles gas turbine co-generation plant. This unit will also serve as a
demonstration proto-type for the sale of the catalytic absorption pollution
control system to other industrial plants. The other proto-types will be
used with catalytic absorption pollution control system used for other
types of power system applications, including diesel compressor sets and
oil pipeline pumping stations.


While we have completed the first proto-type for Goal Line, Goal Line has
not yet had the opportunity to test the proto-type with its catalytic
absorption pollution control system due to its pending relocation to larger
facilities. In addition, Goal Line has also recently received a major cash
infusion from Cummins, Inc., a world leader in engine manufacturing, and is
currently reviewing the applications of our technology with respect to
additional product requirements under this new relationship. We believe
that the proposed applications for Goal Line will most likely be extended
to diesel-fueled applications given this event. In our most recent
communications, it was agreed that the engineers of each company will meet
to review capital and running costs, and that Goal Line's executives would
visit us to commence contract negotiations.


º Natural Gas-Fueled Pulse Combustion Burner to Create A Low Excess Air
Reducing Gas For Fuel Cell Applications:   We are currently working on a
proposal for an Alberta-based company to design a burner which facilitates
the conversion of natural gas into an oxygen-free dilute hydrogen reducing
gas (in a similar manner as our proto-type for Goal Line) for use with a
recently developed line of fuel cells that will be marketed for a variety
of stationary electricity generation purposes. A fuel cell is an
electrochemical device which combines hydrogen fuel with oxygen to produce
electric power, heat and water. One of the biggest problems with fuel cell
technologies is the delivery of hydrogen, an extremely volatile and
combustible gas. The developer of these fuel cells, which have completed
development and reached the stage where they can be marketed commercially,
has addressed this problem using natural gas as its fuel source.
Specifically, the hydrogen required for the operation of the fuel cell is
acquired through the conversion of natural gas into hydrogen and carbon
monoxide using conventional combustion. However, the effluent of this
conventional combustion process contains oxygen or excess air as a
consequence of the combustion process, which the developer would like to
eliminate since the residue of oxygen in the effluent results in a lower
amount of electricity generated. Our pulse combustion technology should
therefore, as a consequence of its ability to convert the natural gas into
an oxygen-free dilute hydrogen reducing gas, allow more electricity to be
generated through the chemical reactive process, and accordingly add
additional commercial viability to the fuel cell product.


We have recently designed and manufactured an extremely small, 8,000
BTU/hour proto-type burner unit which operates at a 1,600 HZ frequency
level due to its extremely small size, which meets the developer's initial
requirements as set forth in its proposal, and delivered it to the
developer for testing. Assuming the proto-type unit is satisfactory to the
developer with respect to both performance and cost, we anticipate that we
will enter into discussions with the developer over the next several months
over the adoption of our pulse combustion technology for its natural gas
conversion requirements.


º Pulse Combustion Burner For Industrial Pulp and Paper Drying
Applications:   We are currently working on a proposal for a Montreal-based
manufacturer of pulp and paper industrial dryers which has asked Clean
Energy to submit a proposal to provide burner units for their products. We
believe this represents a beta-site opportunity (similar to the Jie Li
project) for Clean Energy to demonstrate the additional advantages of our
pulse combustion technology to the drying industry.



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º Diesel-Fueled Pulse Combustion Burner For Vehicle Heating:   We are
currently working on a proposal for a Canadian-based manufacturer of
heaters for heavy-duty special-purpose vehicles for a diesel-based burner
to be used for their heaters. In this regard we have designed and are
currently testing and perfecting an extremely small, 50,000 to 200,000
BTU/hour proto-type burner unit which should meet the manufacturer's
operating requirements. We anticipate that we should complete this
proto-type within three months, at which time we will deliver it to the
manufacturer for testing. We intend to use this project to demonstrate the
ability of our pulse combustion technology to burn diesel fuel.


º Adaptation Of Two Natural Gas Fueled Burner Units To Burn Diesel Fuel Using
Diesel Combustion Technology:   Acotech Corporation of Marietta, Georgia,
has requested that we design two production proto-types of our diesel fuel
combustion technology which would allow two of Acotech's natural gas-fueled
burner design to burn diesel fuel. Acotech is a 50/50 joint venture of The
Bekaert Group, the largest independent steel wire manufacturer in Europe,
and The Royal Dutch Shell Group. We have put the commencement of this
project on hold pending the focus of our limited manpower and resources on
our China, Goal Line and other Canadian projects discussed above. We are
also awaiting discussions with Acotech relative to costing, royalty and
other economic issues before work on this proposal proceeds.


º Flare Gas-Fueled Pulse Combustion Burner to Operate Turbo-Generator:   We
have also worked on a proposal for Allied Signal Power Systems, Inc., to
assess the application of our pulse combustion technology to be used in
conjunction with Allied Signal Power Systems' flare-gas operated
turbo-generator. Allied Signal Powers Systems is a division of
AlliedSignal, which recently merged with Honeywell, Inc. to form Honeywell.
Similar to Acotech, we have also put this project on hold pending the focus
of our limited manpower and resources on our China, Goal Line and other
Canadian projects discussed above. We are also awaiting further input from
Allied Signal Powers Systems relative to the direction of this project
pending restructuring issues relating to their recent acquisition by
Honeywell.


Flare gas is residual natural gas emitted as a byproduct of producing oil
wells. Flare gas is ordinarily burned at the source, and the resultant
emissions released into the environment, since the amount of residual
natural gas is relatively small and the cost to collect and market the gas
is not commercially justified. Allied Signal Power Systems uses the heat
energy resulting from the combustion of flare gas to power its
turbo-generator, and create electricity than can then be funneled into the
electricity grid. The attractiveness of our burner unit to Allied Signal
Power Systems is its ability to provide both higher energy efficiencies and
lower-NOx exhaust gases than the burner unit Allied Signal Powers Systems
currently uses to fuel its turbo-generator.


We have successfully competed the first stage of this project, which was to
conduct flow tests establishing our ability to meet Allied Signal Power
Systems' unusual flow capacity requirements. The cost of this first phase,
approximately $15,000, has been borne by our company as a development
expense. We will need to complete a second step, involving the design and
scale up of the prototype to meet Allied's output requirements, and a third
and final step, to fabricate and successfully test a demonstration
proto-type. The cost of the second phase, which has not yet been
determined, will be shared equally by our company and Allied. The cost of
phase 3 also has not yet been determined, and cost sharing arrangements
will be negotiated upon conclusion of the second phase.


In previous reports Clean Energy disclosed that we had worked on a proposal to
finalize development of a natural gas-fueled 400,000 to 500,000 BTU/hr
instantaneous water heater for State Industries, Inc., and a proposal to develop
a natural gas-fueled burner unit for STM Corporation to provide an oxygen-free
reducing gas as a heat source for the operation of their external combustion
engine for industrial. The water heater proposal has since expired as a



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consequence of State Industries' financial situation and the elimination of its
research and development department, and the STM Corporation proposal has
expired as a consequence of technical issues relating to their technology. Clean
Energy has since hired the head of State Industries research and development
team to further our instantaneous water heater technology, and is actively
pursuing grants with CE-CERT and ICAT to further develop and commercialize this
technology for the California market.


Please note that completion of proto-types under the foregoing proposals are
still pending, and no orders will be placed or enforceable contracts entered
into until the proto-types are completed and approved in the case of all of the
proposals, and mutually acceptable contract terms have been negotiated in the
case of all of the proposals other than China. We cannot give you any assurance
that we will enter into any licensing, royalty, joint venture or other agreement
with any of the foregoing parties after we complete the noted prototypes.



Additional Applications Of Our Technology We Intend To Target In The Near Future



Additional applications of our pulse combustion technology which we intend to
pursue in the future include the following:


º Commercial Dryer for Industrial Waste, Wood Products and Wood Waste, and
the Agri-food Drying Industry:   This is an application identified by The
Canadian Center For Mineral And Energy Technology, or CANMET, following
their testing and evaluation of our pulse combustion technology that is of
particular suitability to its design. The acoustic wave associated with
pulse combustion, when applied to drying applications, provides a 22%
mechanical advantage over conventional drying technologies because of the
acoustic signal's physical manipulation of the drying environment. This 22%
advantage, when added to the 90%+ heat output efficiency of our pulse
combustion technology, can offer the highest levels of overall system
efficiency. We believe that this will translate into substantial fuel
savings in large industrial drying applications.


We have received a proposal from CANMET, a quasi-governmental "think tank"
which specializes in researching and marketing innovative mineral and
energies technologies, to work in consultation to our company to design and
manufacture a working proto-type industrial dryer and to approach potential
users in the industrial dry cleaning market. Under this proposal, CANMET
would lend the assistance of its scientific and technical staff and
industry contacts to assist us at their cost of manpower. No potential
users have been contacted to date from CANMET, however, we have recently
been contacted by, and have submitted a proposal to, a Montreal-based
manufacturer for a pulp and paper industrial dryer.


º 40 to 80 Million BTU/hr Flow-Through Water Heater:   This unit is intended
for large industrial applications such as pulp mills. A design feasibility
study to apply our pulse combustion technology to the requirements of a
specific mill was requested by a large pulp and paper manufacturer.


º Electric Car Heater and Recharging System:   It is currently proposed that
the batteries of the all-electric car mandated for California be reserved
for one purpose only, the movement of the car. This means that all other
energy requirements, such as heating, cooling, headlights, radio and
perhaps most importantly, a trickle charge back into the battery, be loaded
onto a different energy system. Pulse combustion burner unit emissions are
sufficiently low to qualify for the so-called "zero emissions" standards
being applied to electric vehicles in California. We believe that this
advantage, as well as the compact size of our pulse combustion technology,
perfectly suit it to be the heat source for this application.


º Transit Bus Heater:   We plan to design a 50,000 BTU/hr natural-gas-fired
heater for natural gas transit buses. This is a rapidly expanding market
area. Natural gas has been acclaimed "the fuel of choice" for transit buses
by most leading authorities in the United States, including the American
Gas Association.



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º 10 Million BTU/hr. Burner Head for Large Scale Power Plant Retrofit such as
Burrard Thermal in Vancouver:   The Burrard Thermal Plant, which is located
in the greater Vancouver, British Columbia, area, is a major local source
of NOx emissions and the current remedy of installing
after-combustion-scrubbers is an expensive stop gap measure. We believe
that once its scale-up progress continues to ten million BTU, we would be
in a position to assess whether our technology can be engineered to
retrofit one of the large units, consisting of approximately one billion
BTU output, at the Burrard Thermal Plant. If so, we would have the unique
opportunity of providing a practical and inexpensive solution for high
output, high pollution industrial sites such as the Burrard Thermal Plant.



Manufacturing Capacity and Suppliers



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.



Research and Development



Our principal activities since our formation in March 1999 have been research
and development activities in adapting our proto-types into production models.
Our research and development team is currently comprised of six employees,
including Messrs. Chato and DeFina. Our gross research and development expenses
amounted to $400,107 and $221,037 for our 2000 and 1999 fiscal years,
respectively. Our research and development budget for fiscal 2001 is $825,000.


One of our objectives in meeting our operating expenses is to fund a significant
portion of our research and development expenditures through grants. We are in
the process, for example, of applying for approximately $400,000 in matching
grants from CE-CERT and ICAT with respect to the development of our natural
gas-fueled water heaters. Previously, the BO companies have procured Cdn.
$1,785,000 in grants for developmental purposes. Our contract and grant
procuring efforts are being headed by Dr. William Jackson, who is one of our
directors. Dr. Jackson received his Ph.D. from Glasgow in Scotland, and received
a Fulbright Scholarship as a Post-Doctoral Fellow at the Massachusetts Institute
of Technology. He subsequently joined the faculty at MIT and established himself
as an internationally recognized authority on advanced energy technologies and
systems. This led him to the U.S. Department of Energy where he held senior
management and technical positions during the energy crises of the 1970's. He is
presently a Professor of Engineering at George Washington University in
Washington DC and has also taught at several prestigious universities around the
world, including Manchester (UK), Technical University of Berlin, Germany;
University of Illinois; and the University of Tennessee Space Institute. In 1983
he established and has continuously headed the HMJ Corporation, a Washington DC
based engineering analysis and consulting organization specializing in advanced
energy systems. Dr. Jackson gained much of his industrial research exposure at
the AVCO - EVERETT Reseach Laboraties where he was the Principal Research
Scientist. 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.



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License Agreements Governing Our Technologies




Pulse Combustion Technology License



On March 5, 1999, we entered into a pulse combustion technology license with
818879 Alberta, Ltd. under which it granted us, in consideration of $10, an
exclusive 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. Under the terms of the pulse combustion technology license,
we have no obligation to pay any royalty or license fees to 818879 Alberta, Ltd.
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 July 2006, and the newest current pulse
combustion technology patent expires in July 2012. 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 818879 Alberta, Ltd.'s prior consent. 818879 Alberta,
Ltd., 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 are obligated under the pulse combustion technology license to pay or to
reimburse 818879 Alberta, Ltd. 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 818879 Alberta, Ltd. 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 818879 Alberta, Ltd. on or
after March 5, 2004, based upon the occurrence of conditions revolving around
our success or failure in procuring a listing of our common stock 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."
Specifically:


º We have the right, commencing March 5, 2004, to elect to acquire full
ownership of the pulse combustion technology from 818879 Alberta, Ltd. for
the payment of Cdn. $1, so long as our common stock has been accepted for
listing or quotation on a national market by the date we notify 818879
Alberta, Ltd. that we are exercising this option and we tender payment. We
have made no application to date to obtain any listing or quotation, and we
can give no you assurance that we will make any application.


º 818879 Alberta, Ltd., in turn, has the right to terminate the pulse
combustion technology license anytime after March 5, 2004, if our common
stock is not actively trading on a national market by the date it exercises
its termination right. In order to exercise this right, 818879 Alberta,
Ltd. must give us 90-days notice accompanied by the payment of Cdn. $1.
Should 818879 Alberta, Ltd. exercise this termination right, we will lose
all rights to market burner products using the pulse combustion technology
unless we subsequently procure the listing or quotation of our common stock
on a national market by the end of our 90-day cure period, or are able to
exercise other protective rights described below which we retain to acquire
the pulse combustion technology.



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º Should 818879 Alberta, Ltd. exercise its termination right, and should we
fail to procure the listing or quotation of our common stock on a national
market by the lapse of our 90-day cure period, we can nevertheless acquire
full title to the pulse combustion technology by paying 818879 Alberta,
Ltd. the sum of Cdn. $525,000 within ten business days of the end of our
90-day cure period, subject to downward adjustment, plus interest on the
amount which has accrued since January 1, 1999 at the rate of 13% per
annum. In order to be entitled to receive the full Cdn. $525,000, 818879
Alberta, Ltd. must remit to us concurrent with our payment all shares of
our series "A" preferred stock which are then outstanding as well as
593,750 shares of our common stock. If 818879 Alberta, Ltd. is unable to
tender all 593,750 shares of our common stock, the Cdn. $525,000 cash
consideration we must pay to 818879 Alberta, Ltd. will be reduced on a pro
rata basis based upon the number of shares of our common stock which 818879
Alberta, Ltd. actually remits to us.


º If our common stock is not actively trading on a national market by
March 5, 2004, and should 818879 Alberta, Ltd. not exercise its termination
right by that date, then we may pay 818879 Alberta, Ltd. the sum of Cdn. $1
and demand that 818879 Alberta, Ltd. exercise its termination right within
90 days of our demand, in which case we may, in turn, elect to acquire full
ownership of the pulse combustion technology on the terms described above.
If 818879 Alberta, Ltd. fails to make its election by the end of our 90 day
demand period, full title to the pulse combustion technology will
automatically revert to us.


º Should we acquire full title to our pulse combustion technology by reason
of any of the above purchase rights, 818879 Alberta, Ltd. will nevertheless
retain the right 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.


For further information concerning risks associated with the termination of the
pulse combustion technology license, see that section of this annual report
captioned "Risk Factors-Risks Relating To Clean Energy And Its Business-We Could
Lose Our Technology Licenses If We Fail To List Our Common Stock on a National
Market."



Diesel Fuel Combustion Technology License



On March 5, 1999, in consideration of the sum of $10 paid to Mr. John D. Chato,
we entered into a diesel fuel combustion technology license with Mr. Chato under
which he granted us an exclusive worldwide license to design, engineer,
manufacture, market, distribute, lease and sell burner products using the diesel
fuel combustion technology, and to sublicense and otherwise commercially exploit
the diesel fuel combustion technology. We are obligated under the diesel fuel
combustion technology license to pay Mr. Chato or his assignees a 10% royalty
based upon our net profits, after reasonable allowance for bad debts and the
allocation of administrative and other overhead items, from the sale of products
incorporating the diesel fuel combustion technology. The term of the diesel fuel
combustion technology license expires upon the earlier of March 5, 2019, or the
lapse of the newest underlying patents for the diesel fuel combustion
technology, including any patented improvements. An application for a patent for
the diesel fuel combustion technology was filed in August 1998 and, if issued,
will expire 17 years after the issue date. For further information concerning
the underlying patents for the diesel fuel combustion technology, see that
section of this annual report captioned "Business-Patents and Proprietary
Rights."


We are generally prohibited under the diesel fuel combustion technology license
from sublicensing our rights to the diesel fuel combustion technology, or
otherwise assigning our rights as licensee under the diesel fuel combustion
technology license, to any third party without Mr. Chato's prior consent. Mr.
Chato, in turn, is also generally prohibited from selling his rights to the
diesel fuel combustion technology, or otherwise assigning his rights as licensor
under the diesel fuel combustion technology license, to any third party without
our prior consent.



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We are obligated under the diesel fuel combustion technology license to pay or
to reimburse Mr. Chato for all costs he incurs to file and prosecute new or
additional patents for the diesel fuel combustion technology in any country. We
are also obligated to pay or to reimburse Mr. Chato for prosecuting and
defending patent infringement claims relating to the diesel fuel combustion
technology, and to pay any damages arising from these claims.


The diesel fuel combustion technology agreement provides that we will
automatically obtain full ownership of the diesel fuel combustion technology,
without the payment of any additional consideration, as of the same date as we
acquire title to the pulse combustion technology. We refer to this acquisition
right as the "Diesel Fuel Combustion Technology Option." Should we acquire full
ownership of the diesel fuel combustion technology, we will nevertheless
continue to be obligated to pay the 10% royalty to Mr. Chato or his assigns.


Should the pulse combustion technology license be terminated without our
acquiring full ownership of the pulse combustion technology, then the diesel
fuel combustion technology license will expire concurrently, and we will lose
all rights to market burner products using the diesel fuel combustion
technology.


For further information concerning risks associated with the termination of the
diesel fuel combustion technology license, see the section of this annual report
captioned "Risk Factors-Risks Relating To Clean Energy And Its Business-We Could
Lose Our Technology Licenses If We Fail To List Our Common Stock on a National
Market."



Patents And Proprietary Rights



Our basic pulse combustion technology and a number of design improvements to
this technology are protected by a number of United States patents in the name
of Mr. Chato, as inventor, the oldest of which expires in July, 2006, and the
newest of which expires in July 2012. The diesel fuel combustion technology is
also protected by a United States patent filed in 1998 which expires in
August 2012. We anticipate that we will make international patent applications
in selected foreign countries for our pulse combustion technology and our diesel
fuel combustion technology in the upcoming months.


We acquired our rights to our pulse combustion technology under a pulse
combustion technology license we entered into with 818879 Alberta, Ltd. on
March 5, 1999. 818879 Alberta, Ltd. acquired its rights to the pulse combustion
technology in December 1998 from a creditor of the BO Group and its related
companies. Excluded from this transfer were the rights to early pulse combustion
patents relating to Finland and Sweden which the creditor had purchased
separately from the BO Group. As part of 818879 Alberta, Ltd.'s acquisition of
its rights to the pulse combustion technology, Mr. Chato agreed to release all
of his rights to the initial pulse blade combustion patents and any
improvements. Mr. Chato owns the diesel fuel combustion technology, which he
licensed to us on March 5, 1999. For more complete information concerning these
transactions, see the sections of this annual report captioned
"Business-Corporate Structure" and "Business-License Agreements."


We intend to diligently defend any infringement of our pulse combustion
technology and diesel fuel 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 you 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,



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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 costs of that litigation. For further
information concerning these risks, see "Risk Factors-Risks Relating To Clean
Energy And Its Business-Our Ability To Compete Is Dependent Upon Our Patents and
Proprietary Rights."



Employees



We currently have eight full-time employees and one part-time employee,
including two in executive management and six in research and development. We
expect to add two or three additional full-time employees over the next 12
months. None of our employees are represented by a union. We believe that our
relations with our employees are good.



Government Regulation



The heat transfer industry, which we anticipate will represent the primary
purchasers of burner products using our technologies, is subject to evolving and
often increasingly stringent federal, state, local and international laws and
regulations concerning the environment and energy conservation. The principal
environmental regulations affecting the heat transfer industry in place today
that also have a direct bearing on our burner products relate to the control of
a variety of atmospheric emissions, principally nitrogen oxides, that result
from the combustion process. These regulations accomplish their objectives in
one of three ways-by establishing permitted emission levels for designated
pollutants, by prohibiting selected business operations, and by specifying
acceptable technologies, commonly known as "Best Available Control
Technologies."


A representative example of a state regulation governing atmospheric emission
standards is the "Zero Ammonia Technology Policy" adopted by the Massachusetts
Department of Environmental Protection on January 9, 1999, which requires all
applicants for permits for industrial scrubber technologies to evaluate
ammonia-free technologies as the Best Available Control Technology.


A representative example of a local regulation governing atmospheric emission
standards is Rule 1146.2, titled "Emissions of Oxides of Nitrogen from Large
Water Heaters and Small Boilers," adopted by the South Coast Air Quality
Management District or "SCAQMD," a California regional agency governing Los
Angeles, Orange, Riverside and San Bernardino counties. This regulation, which
was adopted in January of 1998:


º limits nitrogen oxides emission levels for water heaters, boilers or
process heaters to be sold in the region after January 1, 2000 to 30ppm for
all units with an output between 400,000 to 2 million BTUs/hr, and 55ppm
for all units with an output between 75,000 and 400,000 BTUs/hr;


º prohibits the operation in the region after July 1, 2002 of any water
heaters, boilers or process heaters manufactured before 1992 that have
nitrogen oxides emissions in excess of 30ppm; and


º prohibits the operation in the region after January 1, 2006 of any water
heaters, boilers or process heaters manufactured before 2000 that have
nitrogen oxides emissions in excess of 30ppm.


Each of these regulations is designed to reduce emissions of nitrogen oxides.
The Massachusetts case deals with scrubbers which use ammonia to remove nitrogen
oxides after it is formed, while the SCAQMD case regulates the amount of
nitrogen oxides allowable in the first place. These regulations directly impact
our business since the attractiveness of our technology is its ability to
inhibit the production of nitrogen oxides at the source. Those applications
which are restricted by these regulations will be entirely open to our
technology. Since our technology is a new technology engineered to meet these
more stringent requirements, there are no additional costs or liabilities
imposed on our business to satisfy these standards.



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Although one of the principal benefits of our burner technologies are their
ability to satisfy lower pollution standards, we cannot give you any assurance
that emission standards will not be increased by any governmental agency to a
level that our technologies will either not satisfy, or which will require
significant expenditures in research and development costs in order to satisfy.


We are also subject to laws governing our relationship with our employees,
including minimum wage requirements, overtime, working conditions and
citizenship requirements.