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                                  United States
                       Securities and Exchange Commission
                              Washington, DC 20549

                                   FORM 10-KSB

[X]      ANNUAL  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE  SECURITIES
         EXCHANGE ACT OF 1934

         For fiscal year ended December 31, 2002

[ ]      TRANSITION  REPORT  PURSUANT  TO SECTION 13 OR 15(d) OF THE  SECURITIES
         EXCHANGE ACT OF 1934

                         Commission File Number: 0-31483

                               TERRA SYSTEMS CORP
                               ------------------
             (Exact name of registrant as specified in its charter)

                                      UTAH
                                      ----
         (State or other jurisdiction of incorporation or organization)

                                   87-0476073
                                   ----------
                      (I.R.S. Employer Identification No.)

                7001 South 900 East, Ste 260, Midvale, Utah 84047
                -------------------------------------------------
                    (Address of principal executive offices)

                    5912 West 11600 South, Payson, Utah 84651
                                 (Prior Address)

                                 (801) 208-1289
              (Registrant's telephone number, including area code)

Securities registered pursuant to Section 12 (b) of the Act:   None.

Securities registered pursuant to section 12(g) of the Exchange Act:
Common, $0.001 par value

Check whether the registrant  (1) has filed all reports  required to be filed by
section 13 or 15(d) of the Securities  Exchange Act of 1934 during the preceding
12 months (or for such shorter  period that the  registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. (1) Yes       No  X    (2)  Yes  X    No
                 ---      ---            ---      ---

Indicate the number of shares  outstanding  of each of the  issuer's  classes of
common stock, as of the latest practicable date.
Class  Common  Stock,  $0.001 par value  Outstanding  as of December  28,  2005:
43,302,288

Check whether  there is no  disclosure of delinquent  filers in response to Item
405 of  Regulation  S-B  contained  in  this  form,  and no  disclosure  will be
contained,  to the best of the  registrant's  knowledge,  in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).     Yes   X   No
                                 ---      ---

State issuer's revenue for the fiscal year ended December 31, 2002: $149,934



<PAGE>


As of December 31, 2002, the  registrant  had 22,791,880  shares of common stock
outstanding. The aggregate market value of the 17,945,122 shares of voting stock
held by non-affiliates as of that date was approximately $ 2,153,414.

As of December 28,  2005,  when this report was  prepared,  the  registrant  had
43,302,288 shares of common stock outstanding. The aggregate market value of the
31,455,345  shares of voting  stock held by  non-affiliates  as of that date was
approximately $ 20,131,420.

Documents incorporated by reference: None.

Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
































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                                TABLE OF CONTENTS

                                     PART I

Item 1.    Description of Business                                             4
Item 2.    Description of Property                                            11
Item 3.    Legal Proceedings                                                  11
Item 4.    Submission of Matters to a Vote of Security Holders                12

                                     PART II

Item 5.    Market for Common Equity, Related Stockholder Matters and
           Issuer Purchase of Securities                                      12
Item 6.    Management's Discussion and Analysis                               13
Item 7.    Financial Statements                                               16
Item 8.    Changes in and Disagreements with Accountants on Accounting
            and Financial Disclosure                                          16
Item 8A.   Controls and Procedures                                            16
Item 8B.   Other Information                                                  17

                                    PART III

Item 9.    Directors, Executive Officers, Promoters and Control Persons,
            Compliance with Section 16(a) of the Exchange Act                 17

Item 10.   Code of Ethics                                                     18

Item 11.   Executive Compensation                                             18

Item 12.   Security Ownership of Certain Beneficial Owners and Management
            and Related Stockholder Matters                                   19

Item 13.   Certain Relationships and Related Transactions                     20

Item 14.   Exhibits and Reports on Form 8-K                                   20

Item 15.   Principal Accountant Fees and Services                             21

Signatures                                                                    22









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                                     PART I

Item 1.  Description of Business

Note:  This Annual Report for the year ended  December 31, 2002, was prepared in
December  2005 and January  2006 in  connection  with the  Company's  efforts in
becoming current in its periodic reporting.

         BUSINESS

         Business Overview

         We were formed as a Utah  corporation  on  February  16, 1996 under the
name Terra  Systems,  Inc.,  and are a  development  stage company whose primary
business  purpose  is  the  development  and  commercialization  of a  pneumatic
conveyance system to handle materials in a bulk state.

         On May 1, 1996, we merged with Xullux, Inc., a Utah corporation. In the
merger,  our shareholders  received  48,000,000 shares of Xullux common stock in
exchange  for  their  shares  of  Terra  Systems  common  stock.  Following  the
reorganization,  Xullux changed its name to Terra Systems,  Inc. In this report,
reference to the terms  "Terra  Systems,"  "we," "us," "our," and "the  company"
refer  collectively  to Terra  Systems,  Inc. and its  predecessors,  unless the
context clearly indicates otherwise.

         Our common  stock began  trading in July 1996 and was quoted  under the
ticker symbol "TSYI" on the OTC Bulletin  Board in 2001. As of November 15, 2001
the stock ceased to trade on the OTC Bulletin  Board,  and began  trading on the
Pink Sheets under the ticker symbol TSYI.PK.

         Products

         Our principal product is a low-pressure  pneumatic  conveyance  system.
Low-pressure  systems  such as our  system  are  used  in  connection  with  the
pulverization,  moisture control,  classification,  transport, and processing of
bulk materials in a number of basic industries.

         Our system  relies on a slow moving  laminar  flow gas bearing to allow
for the  transportation  of material through a carrying duct. A laminar flow gas
bearing is formed  when the air in the center of a pipeline is  surrounded  by a
slow moving  turbulent  flow  boundary  air layer next to the inside wall of the
pipe. It is referred to as a boundary  because it acts to insulate the pipe from
severe abrasive  contact with the transported  material.  The amount of wear and
tear or erosion on the inside of a pipe  caused by the flow of a given  material
is referred to in the industry as the abrasion  signature.  Our process  reduces
this abrasion  signature because the material being transported is caught up and
carried by the faster moving gas in the center of the pipe. Unlike high-pressure
conveyance systems, low-pressure systems do not allow for the build-up or caking
of material inside the containment pipe. In pneumatic conveyance,  caking occurs
when dust combines with moisture and starts to gradually  build up on the inside
wall of the pipe.

         High-pressure  pneumatic  conveyance systems rely on the compression of
air for operation. When the air is compressed, the moisture contained in the air
collects inside the pipe. These pressurized  systems have to be enclosed and can
only purge  moisture at the end of their  conveyance  cycle.  The material  they
carry becomes exposed to this moisture,  which may lead to caking.  On the other
hand, a  low-pressure  system like ours  operates in an open  environment.  This
allows the  material  being  transported  to breathe any moisture out during the
transportation process.

         Many components are pre-fabricated in our warehouse with final assembly
occurring at the client's  site. In most cases,  we bill the client an hourly or
daily  rate  for  constructing  a system  that  will  vary in cost  based on the
customization  involved  for each  client  and their  unique  requirements.  For
example,  some  applications  may require just product drying before going to an
existing  milling  operation.  Thus our equipment could provide just the product
drying service onsite.

         The prospective markets for our industrial particle accelerator include
power generation, mining, agriculture,  environmental,  ceramics,  construction,
and  materials  transportation.  We  believe  that  because  of the  nature  and


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flexibility of our process,  many bulk materials used in basic industries can be
economically separated, classified, and otherwise processed.

         Distribution, Marketing, and Customer Relations

         Our marketing strategy is to promote,  advertise and increase our brand
visibility and attract new customers through multiple channels, including:

         o        Developing strategic alliances;
         o        Establishing our brand name; and
         o        Direct marketing to existing and potential customers.

         We believe that the use of multiple  marketing channels will reduce our
reliance  on any one source  for  obtaining  customers.  This in turn will lower
costs and maximize brand awareness.

         Strategic alliances

         We do not  currently  have any  strategic  alliances.  We do,  however,
believe that future joint venture relationships will allow us to gain additional
insight,  expertise and  penetration  into markets where joint venture  partners
already  operate and may serve to increase  our  revenue and income  growth.  We
expect to review  potential  strategic  alliance  candidates,  and to enter into
agreements  in the future  should we feel these  alliances  would be in the best
interest of the company.

         Establish our name brand

         We cannot  guarantee  that we will be able to  successfully  market and
distribute our services in either the United States or other countries,  and the
failure to do so could have an adverse effect on our operations. We believe that
building  awareness of the Terra Systems brand is important in establishing  and
expanding our customer  base. We currently  have a web site  (www.tsyi.com)  and
will use traditional media as our revenues permit, to attract new customers.  We
are providing an inactive textual  reference only to our website because it does
not constitute a part of this report.

         Direct marketing

         To  date  our  marketing   activity  has  been  largely   word-of-mouth
referrals,  on-site  demonstrations,  as well as contacts generated from our web
site. We plan to move forward with industrial and agricultural  clients entering
into  exclusive  licensing  agreements,  which we  expect to  generate  fees and
royalty revenues.

         We  believe  that our  ability  to  establish  and  maintain  long-term
relationships with our customers and encourage repeat business depends, in part,
on the strength of our customer  support and service  operations  and staff.  We
value frequent  communication  with and feedback from our clients to continually
improve  our  services.  We focus  on  designing  high  quality  applications  -
engineered  products  that are  designed  to address  specific  customer  needs.
Although our existing customer  relationships are strong,  our operating results
may  fluctuate  due to  factors  such as the  addition  or  loss of  significant
customers.

         Industry Background and Competitive Conditions

         Nearly  all  bulk  materials  used in basic  industries  can or must be
separated,  pulverized,  classified, or otherwise enhanced.  Opportunities exist
for many  applications  in both organic and  inorganic  materials in an array of
large   industries,    including   power   generation,    mining,   agriculture,
environmental,  ceramics,  construction, and materials transportation.  Our main
competition  consists of companies  providing or engaging in traditional methods
of pulverization and transport of bulk materials; these include manufacturers of
roller  mills and ball  mills.  We  believe  that we compete on the basis of the
unique nature of our technology.  Specific  competitors in our industry would be
Bechtel,  Babcock & Wilcox,  and Ecology & Environment.  These companies provide
coal pulverization,  mineral  processing,  and remediation of industrial wastes.
They are  larger,  better  funded  and  possess  greater  name  recognition  and


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reputation in the market than Terra Systems.  There is no assurance that we will
be able to compete successfully against these larger players in the industry.

         Raw Materials and Suppliers

         We do not purchase or supply raw materials.  Numerous raw materials are
used to conduct on-site  demonstrations  on the effectiveness of our process and
equipment;  however,  our  prospective  clients provide these  materials.  These
materials  used  in  on-site   demonstrations  include  rice,  coal,  coal  ash,
limestone,  gypsum,  agricultural  waste and other materials  containing various
heavy minerals, such as gold, silver, and platinum.

         Customers

         One customer,  Alpine Reserve  accounted for 100% of our revenues as of
December 31, 2002.

         The  following  is  a  partial  list  of  major  industries  where  our
technology could be adopted or utilized.

         *        Coal
                  *        Reduce moisture
                  *        Reduce ash
                  *        Raise heat (Btu) value
                  *        Micropulverize (80% of coal throughput ground down to
                           325 mesh)
                  *        Transport
                  *        Reclaim from gob piles

         *        Electric Power Generation With Coal
                  *        Reduce air pollution emissions, especially Nox
                  *        See "Coal" above
                  *        Contain fugitive dust

         *        Agriculture
                  *        Rice, coarse grains, sugar
                           *        Drying
                  *        Soil conditioning
                           *        Restore depleted trace minerals

         *        Environmental
                  *        Extract/dry/remove waste from
                           *        Food processing
                           *        Animals
                           *        Industry
                           *        Radioactive materials

         *        Mining
                  *        Precious metals
                           *        Classify and concentrate desired ores

         *        Construction
                  *        Cement and concrete

         *        Ceramics
                  *        Micropulverize

         *        Transportation
                  *        Waterways
                  *        Dredging
                  *        Loading/unloading/transloading


                                       6
<PAGE>


         Patents

         We own one patent,  U.S. Patent No.  6,170,768,  covering our pneumatic
accelerator  and granted  January 9, 2001.  We expect that we will  upgrade this
patent  or file  additional  applications  as  developments  are  made  with our
technology. We rely upon a combination of patents,  copyright protection,  trade
secrets,   know-how,   continuing   technological   innovation   and   licensing
opportunities  to develop and  maintain  our  competitive  position.  Our future
prospects depend in part on our ability to obtain and maintain patent protection
for our  technology.  We also  need to  continue  to  preserve  our  copyrights,
trademarks  and  trade  secrets  and we  must  operate  without  infringing  the
proprietary rights of third parties.

         We cannot  guarantee  that any of our future patent  applications  will
result  in  issued  patents,  nor  can we  assure  that  we  will  develop  more
proprietary  technologies that are patentable.  Patents issued may not provide a
basis for  commercially  viable  products  or may not  provide  any  competitive
advantages.  Third  parties could  challenge our patents.  The patents of others
could limit our ability to use some of our  processes  or  technologies.  Any of
these  situations  could have a  material  adverse  effect on our  ability to do
business.  We cannot prevent  others from  independently  developing  similar or
alternative  technologies,  duplicating any of our technologies,  or, if patents
are issued to us,  designing  around our patented  technologies.  We could incur
substantial costs in litigation if we are required to defend ourselves in patent
suits  brought by third parties or if we initiate  these suits against  possible
infringers of our patent rights.

         Others  may have  filed and in the  future  are  likely to file  patent
applications that are similar or identical to ours. To determine the priority of
inventions,  we may have to participate in interference  proceedings declared by
the United States Patent and Trademark Office. Those proceedings could result in
substantial  cost to us.  We  cannot  ensure  that any such  third-party  patent
application  will not have  priority over ours.  Additionally,  the laws of some
foreign  countries  may not protect our patent and other  intellectual  property
rights to the same extent as the laws of the United States.

         Our future  prospects  also  depend in part on our  neither  infringing
patents or  proprietary  rights of third parties nor breaching any licenses that
may relate to our  technologies  and products.  We cannot guarantee that we will
not infringe the patents, licenses or other proprietary rights of third parties.
We could in the future receive notices claiming  infringement from third parties
as well as  invitations to take licenses under  third-party  patents.  Any legal
action  against  our  strategic  partners  or us that claim  damages and seek to
enjoin  commercial  activities  relating to the affected  products and processes
could subject us to potential  liability for damages.  Those legal actions could
also  require  our  strategic  partners  or us to obtain a  license  in order to
continue to manufacture or market the affected products and processes. We cannot
ensure that our strategic  partners or we would prevail in any action. We cannot
ensure that any license,  including licenses proposed by third parties, required
under any patent would be available on terms that are  commercially  acceptable,
if at all.  We have not  conducted  an  exhaustive  patent  search and we cannot
ensure  that  patents  do not  exist or could  not be filed  that  would  have a
material adverse effect on our ability to develop and market our products. If we
become involved in such  litigation,  it could consume a substantial  portion of
our  managerial  and financial  resources,  which would have a material  adverse
effect  on  our  business,  financial  condition,  results  of  operations,  and
relationships with corporate partners.

         We  attempt  to  control  the  disclosure  and  use of our  proprietary
technology,  know-how  and  trade  secrets  under  agreements  with the  parties
involved.  However,  we cannot ensure that others will honor all confidentiality
agreements.  We cannot prevent others from  independently  developing similar or
superior technology, nor can we prevent disputes that could arise concerning the
ownership of intellectual property.

         Government Regulation

         We are not  currently  subject to direct  regulation by any domestic or
foreign  governmental  agency,  other than  regulations  applicable  to business
generally,  export control laws, and laws or regulations  directly applicable to
the industry.  We will be required to ensure the enforcement of the Occupational
and Health Administration (OSHA) regulations.



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<PAGE>


         We believe that we will be able to comply in all material respects with
the laws and  regulations  governing the  industry,  and that such laws will not
have a material  effect on our  operations.  However,  various federal and state
agencies may propose new  legislation  that may  adversely  affect our business,
financial condition and results of operations.  We are not aware of any probable
government regulations that may adversely affect our business.

         Research and Development Activities

         Our  success and ability to compete  will be  dependent  in part on the
protection  of our  existing and  potential  patents,  trademarks,  trade names,
service marks, and other  proprietary  rights.  Thus, a majority of our research
and development efforts has been focused on product  development,  testing,  and
patent application

         We seek to continue developing our products internally through research
and development or if appropriate,  through strategic  partnerships.  We expect,
however, that if we can purchase or license products,  services, or technologies
from third  parties at a  reasonable  cost,  we will do so in order to avoid the
time  and  expense   involved  in  developing   such  products,   services,   or
technologies.

         Employees

         As of December 31, 2002,  we had four  full-time  employees,  and three
consultants  and  advisors.  There were no organized  labor  agreements or union
agreements  between  Terra  Systems  and our  employees.  We  believe  that  our
relations with our employees have been and will continue to be good.

RISK FACTORS

         We have a history of losses and an accumulated deficit of approximately
$9,646,798 as of December 31, 2002, and approximately  $9,087,545 as of December
31,  2001.  If we do not become  profitable  or  maintain  profitability  in the
future, we may not be able to continue to operate.

         We incurred net losses of approximately  $9,646,798 for the period from
February  1996  through  December  31,  2002.  We  expect to  continue  to incur
substantial net losses in the foreseeable future. If we do not become profitable
within the time frame  expected  by  investors,  the market  price of our common
stock  likely will  decline.  If we continue to incur net losses,  we may not be
able to  maintain or  increase  our number of  employees  or our  investment  in
capital equipment,  sales, marketing,  and research and development programs. We
do  not  know  when  or  if  we  will  become  profitable.   If  we  do  achieve
profitability,  we may not sustain or increase profitability in the future. As a
result, we may not be able to continue to operate.

         Our limited  operating  history  makes it difficult  to predict  future
results.

         Our  business  model is still  emerging,  and the  revenue  and  income
potential of our business and market are unproven.  We have a limited  operating
history  on which to base  estimates  for  future  performance.  Our  technology
represents a new approach to the challenges  presented in our selected  markets,
which to date have been dominated by established companies with longer operating
histories.  Although we expect that ongoing  negotiations with potential clients
may result in the  finalization  of feasibility  study and licensing  agreements
that would result in revenues and cash flows, there is no assurance that we will
be successful in those negotiations. Key markets within our industry may fail to
adopt  our  proprietary  technologies  and  products,  or we may  not be able to
establish  distribution  channels.  Any  evaluation  of  our  business  and  our
prospects must be considered in light of our limited  operating  history and the
risks and uncertainties  often encountered by companies in their early stages of
development.

         Technological  and other  developments  in our  markets  may render our
technologies  and products  obsolete or limit our ability to  penetrate  our key
markets.

         Technological change,  continuing process development,  and new product
introductions may affect the markets for our products.  Our success will depend,
in part, upon our continued  ability to manufacture  products that meet changing


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customer needs,  successfully  anticipate or respond to technological changes in
manufacturing  processes  on a  cost-effective  and timely basis and enhance and
expand  our  existing  product  offerings.  Current  competitors  or new  market
entrants may develop new products with features that could adversely  affect the
competitive  position of our  products.  We have invested and continue to invest
substantial  resources in research and  development in an effort to improve upon
our existing  processes.  However,  there can be no  assurance  that our process
development   efforts  will  be   successful   or  that  the  emergence  of  new
technologies,  industry standards,  or customer requirements will not render our
technology,  equipment,  or processes obsolete or uncompetitive.  Any failure or
delay in  accomplishing  these goals could have a material adverse effect on our
business,  results of operations,  and financial condition.  In addition, to the
extent that we determine  that new  manufacturing  equipment  or  processes  are
required  to remain  competitive,  the  acquisition  and  implementation  of the
technologies,   equipment,   and  processes   required  are  likely  to  require
significant capital investment.

         Our reliance  upon  intellectual  property  licenses from third parties
limits the  control we have over  aspects of our  business  development  and may
increase the expense of doing  business,  which would reduce  profitability.  In
addition, the possibility of infringing upon the intellectual property rights of
third  parties  may  result  in  litigation  and  divert  the  attention  of our
management, adversely affecting our business.

         We may rely on intellectual  property licenses from third parties,  and
may be required to license  additional  products or services in the future,  for
use in the general  operations of our business plan. We cannot assure that these
third party licenses will be available or will continue to be available to us on
acceptable  terms,  if at all.  The  inability to enter into and maintain any of
these licenses could have a material  adverse effect on our business,  financial
condition,  or operating results. In addition,  policing unauthorized use of our
proprietary  and other  intellectual  property  rights could be expensive if not
difficult or impossible.

         Additionally,  we cannot  guarantee  that third  parties will not bring
claims of copyright or trademark  infringement against us, or claim that aspects
of our processes or other features  violate a patent they may hold. There can be
no  assurance  that third  parties  will not claim that we have  misappropriated
their  creative ideas or formats or otherwise  infringed upon their  proprietary
rights.  Any  claims  of  infringement,  with or  without  merit,  could be time
consuming to defend,  result in costly litigation,  divert management attention,
or require us to enter into  costly  royalty or  licensing  arrangements.  These
potentialities  could have a material adverse effect on our business,  financial
condition, or operating results.

         Our audited  financial  statements have been prepared on the assumption
that we will  continue as a going  concern.  If we fail to continue in business,
you would lose your investment.

         Our  independent  public  accountants  have issued  their  report dated
October 30, 2005 that includes an explanatory paragraph stating that our deficit
in working capital,  negative cash flows from operations,  shareholders  deficit
and recurring net losses raise  substantial  doubt about our ability to continue
as a going  concern.  If we are not successful in generating  additional  sales,
reducing expenses,  or obtaining  additional  financing through this offering or
otherwise, we may be required to scale back or discontinue operations,  in which
case our investors could lose all or substantially all of their investment.

         If we  are to be  competitive,  we  need  to  attract  and  retain  key
personnel. Without the proceeds from this offering, our financial resources will
be limited,  and it may be difficult to attract and retain  personnel who are or
would be instrumental to our success.

         Our future success depends  significantly  on the continued  service of
our senior  management.  The familiarity of these  individuals with the industry
makes them especially  critical to our success.  The loss of the services of one
or more  of our key  employees  could  have a  material  adverse  effect  on our
business.  We do not currently  have key man insurance on any of our  employees,
but we do anticipate  obtaining  that  insurance in the near future.  Our future
success  also  depends on our  ability to attract  and retain  highly  qualified
design, technical, sales, marketing, customer service, and management personnel.
Competition for these personnel is intense, and we cannot guarantee that we will
be able to attract or retain a sufficient  number of highly qualified  employees
in the  future.  The lack of  qualified  management  personnel  could  limit our


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<PAGE>


ability to grow our business and may limit our ability to effectively compete in
our markets.

         Our  inability to  effectively  manage  growth may increase the cost of
doing business or result in inefficiencies  that would reduce cash available for
growth and prevent us from becoming profitable.

         To execute our business plan, we must grow  significantly.  This growth
will  place a  significant  strain on our  personnel,  management  systems,  and
resources.   We   expect   that  the   number   of  our   employees,   including
management-level employees, will continue to increase in the foreseeable future,
and  that  we may  need  additional  office  space  and  expanded  technological
infrastructure.  Failure to manage growth effectively will materially  adversely
affect our business, results of operations, and financial condition.

         We may not obtain  sufficient patent  protection,  which could harm our
competitive position and increase our expenses.

         Our success and ability to compete depends to a significant degree upon
the  protection  of our  proprietary  technology.  Currently,  one of our patent
applications  has been  allowed.  These legal  protections  afford only  limited
protection  for our  technology,  and the rights  that may be granted  under any
future patents that may be issued may not provide competitive  advantages to us.
Patent  protection in foreign  countries may be limited or unavailable  where we
need this protection. It is possible that:

         *        our pending patent applications may not be issued;

         *        competitors may independently  develop similar technologies or
                  design around our patents;

         *        patents  issued to us may not be broad  enough to protect  our
                  proprietary rights; and

         *        any issued patent could be successfully challenged.

         Our stock is  considered  a penny  stock.  Penny  stocks are subject to
special  regulations,  which may make them more  difficult  to trade on the open
market.

         Our common  stock  trades on the Pink  Sheets  under the ticker  symbol
"TSYI.pk."  Securities in the Pink Sheets market are generally more difficult to
trade than those on the Nasdaq  National  Market,  the Nasdaq SmallCap Market or
the major stock  exchanges.  In addition,  accurate  price  quotations  are more
difficult  to  obtain.  Additionally,  our  common  stock is  subject to special
regulations governing the sale of penny stock.

         A "penny  stock," is  defined  by  regulations  of the  Securities  and
Exchange Commission as an equity security with a market price of less than $5.00
per share.  However, an equity security with a market price under $5.00 will not
be considered a penny stock if it fits within any of the  following  exceptions,
which are not applicable to our securities:

         *        the  equity  security  is  listed  on  Nasdaq  or  a  national
                  securities exchange;

         *        the  issuer  of the  equity  security  has been in  continuous
                  operation  for less than three  years,  and either has (a) net
                  tangible assets of at least $5,000,000,  or (b) average annual
                  revenue of at least $6,000,000; or

         *        the  issuer  of the  equity  security  has been in  continuous
                  operation  for more than  three  years,  and has net  tangible
                  assets of at least $2,000,000.

         If you buy or sell a penny stock,  these  regulations  require that you
receive,  prior to the  transaction,  a  disclosure  explaining  the penny stock
market and associated risks.  Furthermore,  trading in our common stock would be
subject to Rule 15g-9 of the  Exchange  Act,  which  relates to  non-Nasdaq  and
non-exchange  listed securities.  Under this rule,  broker-dealers who recommend
our  securities  to persons  other than  established  customers  and  accredited


                                       10
<PAGE>


investors  must  make  a  special  written  suitability  determination  for  the
purchaser and receive the purchaser's  written  agreement to a transaction prior
to sale.

         Penny stock  regulations  will tend to reduce  market  liquidity of our
common stock,  because they limit the  broker-dealers'  ability to trade,  and a
purchaser's  ability to sell the stock in the secondary market. The low price of
our common  stock will have a negative  effect on the amount and  percentage  of
transaction costs paid by individual  shareholders.  The low price of our common
stock  may also  limit  our  ability  to raise  additional  capital  by  issuing
additional  shares.  There are several  reasons for these  effects.  First,  the
internal  policies of many  institutional  investors  prohibit  the  purchase of
low-priced stocks. Second, many brokerage houses do not permit low-priced stocks
to be used as  collateral  for margin  accounts  or to be  purchased  on margin.
Third, some brokerage house policies and practices tend to discourage individual
brokers from dealing in low-priced  stocks.  Finally,  broker's  commissions  on
low-priced  stocks usually represent a higher percentage of the stock price than
commissions  on higher priced stocks.  As a result,  our  shareholders  will pay
transaction  costs that are a higher  percentage of their total share value than
if our share price were substantially higher.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

         Some of the statements under "Risk Factors,"  "Management's  Discussion
and Analysis or Plan of  Operation,"  "Business,"  and  elsewhere in this report
constitute forward-looking  statements.  These statements involve risks known to
us,  significant  uncertainties,  and other  factors  which may cause our actual
results,  levels of activity,  performance,  or  achievements  to be  materially
different  from  any  future  results,  levels  of  activity,   performance,  or
achievements expressed or implied by those forward-looking statements.

         You can  identify  forward-looking  statements  by the use of the words
"may," "will," "should," "could," "expects," "plans," "anticipates," "believes,"
"estimates,"  "predicts," "intends,"  "potential,"  "proposed," or "continue" or
the  negative  of  those  terms.  These  statements  are  only  predictions.  In
evaluating these statements,  you should specifically  consider various factors,
including the risks outlined  above.  These factors may cause our actual results
to differ materially from any forward-looking statement.

         Although   we  believe   that  the   expectations   reflected   in  the
forward-looking  statements are reasonable,  we cannot guarantee future results,
levels of activity, performance or achievements.

Item 2.  Description of Property

         Our corporate  headquarters  moved to leased space located at: 51 South
Geneva Road, Lindon,  Utah 84052. The company was compelled to move headquarters
to Lindon, Utah in October,  2001 due to zoning issues at the previous location.
The company owned $13,000 in office  equipment and $94,000 in shop equipment net
of depreciation. The office/warehouse space was approximately 5,000 square feet.
The lease was month to month with a payment  of  $1,500.  The space was used for
general offices, warehousing and research and development.

Item 3.  Legal Proceedings

         Threatened Litigation -- The Company and certain officers and directors
of the company  received  notice from a litigant's  legal  counsel of threatened
litigation.  The  litigant  contended  that  certain  then-current  officers and
directors  held and sold a number of Xullux  shares that were free trading prior
to the merger of Xullux and Terra  Systems,  and that the alleged  sale may have
impacted the value of the litigant's  Terra Systems  restricted  publicly issued
shares in the company.  The litigant claimed that the defendants'  ownership and
alleged sale of Xullux  stock was not  disclosed to him at or during the time he
contributed  certain assets and other equipment to Terra Systems in exchange for
the Terra Systems restricted stock. The litigant sought to return 125,000 shares
to Terra Systems for value and sought other monetary and punitive  damages in an
amount of not less than  $1,500,000  including  additional  costs and attorney's
fees.

         In June 2003,  the Company  entered  into a  Settlement  Agreement  and
Mutual Release of All Claims pertaining to these claims.  Terms of the agreement


                                       11
<PAGE>


were to issue  200,000  shares of restricted  stock to the  plaintiff  valued at
$26,000  or $0.13  per  share and would be  deducted  from  amounts  owed by the
Company to a former officer. In addition to the stock, another officer deeded to
the plaintiff  one-half  interest in an industrial  building that was personally
owned by the officer.  The value of the one-half  interest was  determined to be
$150,000.  The Company agreed to reimburse the officer $150,000 for the interest
given up. The Company also  executed a note to the  plaintiff  for the amount of
$22,000,  which was due on October 1, 2003.  If the note was not paid by October
1, 2003 it would go into default and the Company would owe $35,000.  The Company
defaulted on the original note and $35,000 was paid in March 2005.

Item 4.  Submission of Matters to a Vote of Security Holders

         None.

                                     PART II

Item 5.  Market  for  Common  Equity,  Related  Stockholder  Matters  and Issuer
         Purchase of Securities

         MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

         Market For Common  Stock  continued on the Pink Sheets under the symbol
TSYI.PK

                                  High                       Low
2002
1st Quarter                       $0.27                      $0.15
2d Quarter                        $0.23                      $0.14
3d Quarter                        $0.25                      $0.14
4th Quarter                       $0.27                      $0.10

2001
1st Quarter                       $0.85                      $0.32
2d Quarter                        $0.50                      $0.30
3d Quarter                        $0.38                      $0.28
4th Quarter                       $0.22                      $0.19

2000
1st Quarter                       $0.81                      $0.38
2d Quarter                        $0.60                      $0.25
3d Quarter                        $0.38                      $0.17
4th Quarter                       $0.72                      $0.22

         The source of these high and low prices was the OTC Bulletin  Board and
the Pink Sheets. These quotations reflect  inter-dealer  prices,  without retail
mark-up, mark-down or commission and may not represent actual transactions.  The
high and low prices  listed have been rounded up to the next highest two decimal
places.

         The  market  price  of the  common  stock  is  subject  to  significant
fluctuations in response to variations in the our quarterly  operating  results,
general trends in the market for our technologies,  and other factors, over many
of which we have little or no control. In addition,  broad market  fluctuations,
as well as general economic,  business and political  conditions,  may adversely
affect the market for our common  stock,  regardless  of our actual or projected
performance.  On December 31, 2002, the closing bid price of the common stock as
reported by the OTC Bulletin Board was $0.12 per share.

         Holders

         As of December 31, 2002, there were  approximately  260 shareholders of
record of our common stock.


                                       12
<PAGE>


         Dividend Policy

         We have not paid cash  dividends  on our common stock and do not intend
to pay any cash dividends in the foreseeable future.

Sales of Unregistered Securities

         The following sets forth certain information for all securities we sold
during the past three years without registration under the Securities Act.

2000

         During the twelve  months ended  December 31, 2000,  we issued  343,340
shares of common  stock at a price of $0.25 per share for  proceeds  of $85,836;
700,000  shares of common  stock at a price of $0.25 per share for  proceeds  of
$160,000;  25,000  shares of common  stock at $0.20  per share for  proceeds  of
$5,000;  300,000  shares  of  common  stock at a price of $0.20  per  share  for
proceeds  of  $60,000;  225,000  shares of common  stock at a price of $0.20 per
share in consideration  for services  rendered;  and 33,333 shares at a price of
$0.30 per share for proceeds of $10,000.00.  In each instance, the purchasers of
these  securities were accredited or sophisticated  investors,  and each of them
were  afforded  complete  access to all of our books and records  prior to their
investment. During the same period we issued 500,000 shares of common stock upon
conversion  of notes  payable to a related  party in the amount of  $100,000  or
$0.20 per share. In addition,  during the twelve months ended December 31, 2000,
we issued 197,400 shares at a price of $0.25; 99,338 shares at a price of $0.39,
62,920 shares at a price of $0.48; 60,000 shares at a price of $0.50; and 15,000
shares at a price of $1.00 for consulting services.

2001

         During  2001,  we issued  290,000  shares of common stock at a price of
$0.20 per share for  proceeds of  $58,000;  20,000  shares of common  stock at a
price of $0.25 per share for proceeds of $5,000;  32,000  shares of common stock
at a price of $0.19 per share for proceeds of $6,046;  500,000  shares of common
stock at a price of $0.10 per share for  proceeds of $50,000;  50,000  shares of
common  stock at a price of $0.20 per share for  proceeds  of  $10,000;  130,434
shares of common  stock at a price of $0.23 per share for  proceeds  of $30,000;
750,000  shares of common  stock for  proceeds of $152,500 or $0.20 to $0.25 per
share  relating to the exercise of stock  rights;  75,000 shares of common stock
valued at $0.20 per share  relating to the exercise of stock rights with $15,000
charged to consulting expense; 500,000 shares of common stock valued at $100,000
or $0.20 per share as a stock subscription  receivable;  72,500 shares of common
stock at a price of $0.50 per share in consideration for services rendered;  and
97,500 shares of common stock at a price of $0.40 per share in consideration for
services  rendered;  1,030,000  shares of  common  stock at a price of $0.20 per
share in consideration for services rendered;  180,000 shares of common stock at
a price  of  $0.15  per  share  in  consideration  for  services  rendered.  The
purchasers of these securities were accredited or sophisticated  investors,  and
were  afforded  complete  access  to all of  our  books  and  records  prior  to
investment.

2002

         During the twelve  months ending  December 31, 2002 the Company  issued
75,000  shares of common  stock at a price of $0.15  per share for  proceeds  of
$11,250;  49,020  shares  of  common  stock at a price of $0.51  per  share  for
settlement  of debt;  1,006,295  shares of  common  stock at a price of $0.16 to
$0.19 per share for services rendered.

Item 6.  Management's Discussion and Analysis

MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

         Please  Note:  This  report,   including  the  following   Management's
Discussion  and Analysis  Section,  for the year ended  December  31, 2002,  was


                                       13
<PAGE>


prepared in December 2005 and January  2006,  in  connection  with the Company's
efforts to become current in its periodic reporting.

         You should read the following  description  of our financial  condition
and results of operations in conjunction with the audited  financial  statements
and the  notes  thereto  included  elsewhere  in this  report.  This  discussion
contains forward-looking statements based upon current expectations that involve
risks and uncertainties. Any statements contained herein that are not statements
of historical fact may be deemed to be  forward-looking  statements.  Our actual
results  and the timing of  business  events may differ  significantly  from the
results discussed in the forward-looking statements.  Factors that might cause a
discrepancy  include, but are not limited to, those discussed in "Risk Factors,"
"Business," and elsewhere in this report.

General

         Terra  Systems was  incorporated  in Utah on February 16, 1996 and is a
development-stage   company.   Our  primary  business  is  the  development  and
commercialization  of our patented pneumatic  accelerator.  This device is a gas
linear  particle  accelerator  that conveys and processes bulk materials at high
velocity in a particle isolate state,  using air as the medium of movement.  The
traditional and more costly medium for processing  bulk materials is water.  Our
technology operates efficiently at ambient temperatures and at low pressures and
does not use water. We believe that most if not all,  organic and inorganic bulk
materials used in basic industries  (such as coal,  gypsum,  black sands,  corn,
rice,  and wheat)  can be more  economically  separated  and  classified  by our
dry-process  technology.  This  capability  facilitates  a number of  associated
procedures, including: drying, micropulverizing, mixing, forming, conveying, and
loading.  In addition,  bulk  materials can be  beneficiated  in important  ways
including   moisture   reduction,   ash   reduction,   Btu   enhancement,    and
electro-customization.  Our  system  can  perform  multiple  tasks,  needs  less
maintenance,  requires no chemical  additives,  and can improve the  surrounding
environmental quality.

         Our  success and ability to compete  will be  dependent  in part on the
protection  of our  existing and  potential  patents,  trademarks,  trade names,
service marks, and other  proprietary  rights.  Thus, a majority of our research
and development efforts have been focused on product  development,  testing, and
patent application.

         We seek to continue developing our products internally through research
and development, or if appropriate,  through strategic partnerships.  We expect,
however, that if we can purchase or license products,  services, or technologies
from third  parties at a  reasonable  cost,  we will do so in order to avoid the
time  and  expense   involved  in  developing  these  products,   services,   or
technologies.

Results of Operations

12 months ended December 31, 2002 compared to 12 months ended December 31, 2001
-------------------------------------------------------------------------------

         From  inception  through  December 31, 2002,  we have  incurred  losses
totaling  $9,646,798 and generated revenues of $496,376 from operations.  During
the year ended  December  31,  2002,  we had sales  revenues of  $149,934.  This
factor,  among  others,  raises  substantial  doubt  concerning  our  ability to
continue as a going  concern.  We intend to use capital  and debt  financing  as
needed to supplement the cash flows that we expect will be provided by licensing
agreements. Our primary source of capital historically has been through the sale
of our  securities,  including  sales made upon the  exercise  of stock  options
granted to XCEL  Associates,  Inc., and under an agreement dated March 29, 2000.
XCEL  has also  been  engaged  to  provide  business  management  and  marketing
consultation services, including the review of our business plan, preparation of
a company  profile,  recommendation  of the company to various  retail  brokers,
analysts, and institutional investors and bankers.

         Realization  of  sales  of  our  products  and  services  is  vital  to
operations.  We may not be able to continue as a going concern without realizing
additional sales or raising additional capital. We cannot guarantee that we will
be able to compete  successfully or that the  competitive  pressures we may face
will not have a material  adverse effect on our business,  results of operations
and financial  condition.  Additionally,  a superior  competitive  product could
force us out of business.


                                       14
<PAGE>


         While we have been able to generate  testing  and  product  development
revenues since inception, we have been limited in the scope of potential clients
that could be contacted until our patent  application  was approved.  In January
2001,  we  received  notification  that we had  been  awarded  a  patent  on our
Pneumatic  Accelerator.  We expect that this will  enhance our ability to pursue
and enter into project development contracts.

         Our net loss for the year ended  December  31,  2002 was  approximately
$559,253,  compared  to a net loss for the year  ended  December  31,  2001,  of
approximately  $2,356,618.  The net loss was attributable to lower than expected
revenues  from sales of our  products  and  services.  Our expenses for the year
ended December 31, 2002, were approximately $653,912, of which approximately 54%
were general and  administrative.  Our expenses for the year ended  December 31,
2001 were approximately  $2,362,134, of which approximately 70% were general and
administrative. For the year ended December 31, 2001, we recognized compensation
expense of approximately  $787,500 in connection with the grant of stock options
to employees.  During that same period, we recognized  approximately $243,250 of
consulting  expense in  connection  with the repricing of stock rights issued to
non-employees.  The  recognition  of  these  two  items  increased  expenses  by
approximately $1,030,750,  and represented approximately 44% of the expenses for
year ended December 31, 2001. For the year ended December 31, 2002, depreciation
and amortization expense was $65,824,  compared to depreciation and amortization
expense of $124,143 for the year ended December 31, 2001.

Future Business

         We see  opportunities  for our  technology  and business in an array of
large   industries,    including   power   generation,    agriculture,   mining,
environmental,   construction,   ceramics,  and  materials  transportation.   We
anticipate  that we will generate  revenues  through the sale of our proprietary
equipment, fees, royalties, and profit sharing from licensing of our technology.

         We are continuing  discussions  with  PacifiCorp  and General  Electric
regarding  pulverized  coal  processing for the utility  industry.  We have been
working  closely  with  management  and  engineering  personnel  from  these two
companies in the  preliminary  product design and  development  stages.  A major
objective of the proposed  strategic  business alliance with these entities will
be to design a system that has the ability to produce low ash, low moisture, and
ultra fine coal, which enhance the combustion process and reduce unburned carbon
and NOx emissions.  Our research and development  team has been actively engaged
in the design of a demonstration  unit since the beginning of 2001. We currently
anticipate that the design, testing, and modification of this demonstration unit
will continue into the third quarter 2001.

         On March 28,  2001,  we entered  into an  agreement  with  Ecology  and
Environment,  Inc.  (E&E),  to  jointly  develop  commercial  opportunities  for
applications of our patented low-pressure  pneumatic accelerator  technology for
environmental  problems.  E&E is an  environmental  consulting  services company
headquartered  in Lancaster,  New York. In addition to 25 offices located in the
U.S.,  E&E  maintains  a global  presence  with  offices in 35  countries.  This
agreement establishes an alliance with an industry leader who has demonstrated a
willingness  to assist us in  introducing  our  technology  to a wider  range of
industries,  as well as providing us with guidance in our  marketing  efforts to
potential clients.

         In October  2000,  we  presented  our  technology  to P.S.G.  LLC,  who
contracts with  Morrison-Knudsen  Corp.,  to propose the clean up of a low-level
radioactive  waste site. In November 2000, a follow-up  presentation was made in
Denver, Colorado to Morrison-Knudsen.  In this presentation, we proposed a total
bulk handling system that would extract, transport,  pulverize, treat, bind, and
load-out into containment the low-level radioactive material.  Originally it was
anticipated that engineering and feasibility funds would be made available to us
upon project approval in November of 2000.  However,  ongoing litigation between
Morrison-Knudsen   and  a  general   government   contractor   has  delayed  its
decision-making  capability for our  transaction.  We anticipate a resolution to
this lawsuit by the end of the second quarter, 2001.

Liquidity and Capital Resources

         Given our current  negative cash flows,  it will be difficult for Terra
Systems to continue as a going  concern.  While the recent  issuance of a patent


                                       15
<PAGE>


should  allow  us to  more  aggressively  pursue  revenue  and  cash  generating
contracts and  opportunities,  it may be necessary to raise  additional funds or
reduce cash  expenditures.  Funds  could be  generated  through the  issuance of
additional  stock or through  the sale of existing  plant and office  equipment.
Cash  expenditures  could  be eased  through  a  reduction  in  overhead  costs,
including but not limited to labor and associated employee benefits.

         As mentioned in our audited financial statements included with our Form
10-KSB, our audited consolidated  financial statements have been prepared on the
assumption that we will continue as a going concern. Our product line is limited
and it has been  necessary  to rely upon  financing  from the sale of our equity
securities to sustain  operations.  Additional  financing will be required if we
are to continue as a going concern. If additional  financing cannot be obtained,
we may be required to scale back or discontinue  operations.  Even if additional
financing  is  available  there  can be no  assurance  that it will be on  terms
favorable  to us.  In any  event,  this  additional  financing  will  result  in
immediate and possibly substantial dilution to existing shareholders.

Periodic Reporting

         The Company was  delinquent  in filing its  periodic  reports  from the
quarter ended September 30, 2001,  through the end of December 2005. The Company
has prepared this report in connection with its efforts to become current in its
periodic public reporting.

Item 7.  Financial Statements

         Audited  financial  statements  for  the  twelve  month  period  ending
December 31, 2002 are attached.

         Report of Independent Registered Public Accounting Firm           F-1

         Consolidated Balance Sheets- December 31, 2002 and 2001           F-2

         Consolidated Statements of Operations for the Years Ended
          December 31, 2002 and 2001 and for the Cumulative period
          February 17, 1996 (Date of Inception) through
          December 31, 2002                                                F-3

         Consolidated Statement of Changes in Stockholders' Deficit
          for the Period February 17, 1996 through December 31, 2002       F-4

         Consolidated  Statements of Cash Flows for the Years Ended
          December 31, 2002 and 2001 and for the Cumulative period
          February 17, 1996 (Date of Inception) through
          December 31, 2002                                                F-6

         Notes to Consolidated Financial Statements                        F-7

Item 8.  Changes  in  and  Disagreements  with  Accountants  on  Accounting  and
         Financial Disclosure

         None

Item 8A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.
------------------------------------------------

      In December  2005, in connection  with the  preparation of this report for
the year ended December 31, 2002, our Chief  Executive  Officer and a consultant
performing  certain  services  for the  Company  commonly  performed  by a chief
financial   officer,   after  evaluating  the  effectiveness  of  the  Company's
"disclosure  controls and procedures" (as defined in the Securities Exchange Act
of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period
covered by this annual report,  have concluded that our disclosure  controls and
procedures  were  effective  based on their  evaluation  of these  controls  and
procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.


                                       16
<PAGE>


Changes in Internal Control Over Financial Reporting.
----------------------------------------------------

         There were no changes in our internal control over financial  reporting
identified  in  connection  with the  evaluation  required by  paragraph  (d) of
Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter
of the  year  ended  December  31,  2002,  that  materially  affected,  or  were
reasonably  likely to materially  affect,  our internal  control over  financial
reporting.

Section 404 Assessment.
----------------------

         Section 404 of the  Sarbanes-Oxley  Act of 2002  requires  management's
annual review and evaluation of our internal controls, and an attestation of the
effectiveness of these controls by our independent registered public accountants
beginning  with our Form 10-KSB for the fiscal year ending on December 31, 2007.
We plan to dedicate significant resources, including management time and effort,
and to incur  substantial  costs in connection  with our Section 404 assessment.
The evaluation of our internal controls will be conducted under the direction of
our senior  management.  We will  continue to work to improve our  controls  and
procedures,  and to educate and train our employees on our existing controls and
procedures  in  connection  with our efforts to maintain an  effective  controls
infrastructure at our Company.

Limitations on Effectiveness of Controls.
----------------------------------------

         A system of controls,  however well designed and operated,  can provide
only  reasonable,  and not  absolute,  assurance  that the system  will meet its
objectives.  The design of a control system is based, in part, upon the benefits
of the control system relative to its costs. Control systems can be circumvented
by the individual acts of some persons,  by collusion of two or more people,  or
by  management  override of the control.  In addition,  over time,  controls may
become inadequate because of changes in conditions,  or the degree of compliance
with the policies or procedures may deteriorate.  In addition, the design of any
control system is based in part upon assumptions  about the likelihood of future
events.

Item 8B. Other Information

         None.

                                    PART III

Item 9.  Directors,   Executive   Officers,   Promoters  and  Control   Persons,
         Compliance with Section 16(a) of the Exchange Act

MANAGEMENT

         The following table sets forth information about our board of directors
and management team as of December 31, 2002.

Name                     Age              Position
----                     ---              --------

Clayton Timothy          54               Chief Executive Officer and Chairman
L. Kent Harmon           47               President and Director
Lloyd McEwan             73               Secretary, Treasurer, and Director
Leonard Howe             43               Technical Development
Robert Underwood         58               Director

         Clayton Timothy,  Director and Chief Executive  Officer- Mr. Timothy is
the Chairman of the Board of Directors and our Chief Executive  Officer.  He has
held those  positions  since October 1996.  Prior to joining Terra Systems,  Mr.
Timothy was Vice  President of Industrial  Management  and  Engineering in Lehi,
Utah.  He was  responsible  for  corporate  marketing  and  coordination  of all
projects.  From 1990 to 1994,  he was Executive  Vice  President and Director of


                                       17
<PAGE>


COVOL  Technologies,  Inc., and its  predecessor  entities,  of Lehi,  Utah. Mr.
Timothy has an Associate  Degree in Mine Maintenance from the College of Eastern
Utah.

         L. Kent Harmon,  Director and  President- Mr. Harmon is a member of the
Board of Directors and our President.  He has held these positions since October
of 1996.  Prior  to his  employment  with  Terra  Systems  he was  President  of
Metredyne  Imaging  Services in Buena Park,  California.  Metredyne  created and
marketed  diagnostic  systems that quantified the extent of physical  impairment
caused by work related injuries.  Mr. Harmon filed for personal protection under
Chapter 13 of the Bankruptcy Code in January 2001. A plan for reorganization was
submitted in March 2001, and a hearing on the plan is set for August 2001.

         Lloyd  McEwan,  Director,  Secretary,  and  Treasurer-  Mr. McEwan is a
member of the Board of Directors and our Secretary and  Treasurer.  Prior to his
employment  with Terra  Systems in 1996,  he was the  principal  owner of State,
Inc., which is a construction company specializing in metals, mining, electrical
utility and petroleum  refinery  industries.  He has over 40 years of management
experience in this field. He has several  professional  licenses,  including his
General Contractor's  License, his Engineering License, his Master Electrician's
License,  and his Pipe and Mechanical License. Mr. McEwan is affiliated with the
Association of Iron and Steel Engineers,  the American  Institute of Mining, and
the Metallurgical and Petroleum Engineers.

         Leonard  Howe,  Technical  Development  - Mr.  Howe  has  provided  our
technical  development  since inception.  Before joining the Company,  he worked
from 1992 to 1995 at an open-pit  gold mine  operation  for  Barrick  Goldstrike
Mines as a haul truck operator,  and later for Christensen & Griffith as a heavy
equipment  operator at the same mine location.  He has been actively involved in
the research and development of our technology,  patent filing,  and feasibility
testing.  Mr.  Howe  received a  Bachelor  of Arts  degree  from  Brigham  Young
University in Asian studies, with an emphasis in China and Mandarin Chinese.

         Robert  Underwood,  Director- Mr.  Underwood has served on the Board of
Directors  since  January  1999.  He also serves as a Consultant to the company.
Prior  to  joining  Terra  Systems,  Mr.  Underwood  worked  for 27 years in the
commercial  banking  industry as Vice  President and Manager for First  Security
Bank of Utah, NA. He received his BA from Brigham Young  University in Economics
and Language and his MBA in Finance from the  University of Utah. In addition he
was an instructor of Economics at BYU and for the American  Institute of Banking
for eleven years.

Compliance with Section 16(a) of the Exchange Act

         None of the Company's executive officers or directors filed Forms 5 for
the year ended  December  31,  2002.  During the year ended  December  31, 2002,
Messrs.  Timothy,  Underwood,  Harmon,  and McEwan engaged in transactions  that
should have been reported on Forms 4.

Item 10. Code of Ethics

The  Company is in the  process of  adopting a code of ethics for our  principal
executive and financial  officers.  In the meantime,  our management  intends to
promote honest and ethical  conduct,  full and fair disclosure in our reports to
the SEC, and compliance with applicable governmental laws and regulations.

Item 11. Executive Compensation

                             EXECUTIVE COMPENSATION

         This table provides summary information concerning  compensation earned
by or  paid  to  our  chief  executive  officer  for  services  rendered  in all
capacities  to us during  fiscal year 2002.  No executive  officer was paid more
than $100,000 in any of the three fiscal years ended December 31, 2002.


                                       18
<PAGE>


         Summary Compensation Table


                                                        Bonus      All Other
Name and Principal Position   Years     Salary ($)(1)    ($)    Compensation ($)

Clayton Timothy, Chief         2002     $     60,000    $   0       $    0
Executive Officer              2001           60,000        0            0
                               2000           60,000        0            0

(1)      Mr.  Timothy's  salary has been  accrued as a liability of the company.
         Due to our limited revenues,  no salary payment was made to Mr. Timothy
         during the periods indicated.

         Stock Options Granted In 2002

         There were no stock options granted in 2002.

         Compensation of Directors

         Directors  who also serve as  executive  officers  do not  receive  any
additional compensation for their services as directors.  Non-employee directors
are not paid an annual fee for services as board members.

         Employment Agreements

         We  currently  do  not  have  employment  agreements  with  any  of our
executive officers.

Item 12. Security  Ownership of Certain  Beneficial  Owners and  Management  and
         Related Stockholder Matters

         SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table provides information regarding beneficial ownership
of our common stock as of December 31, 2002, by:

         *        each  person or entity  known to us to own  beneficially  more
                  than 5% of our common stock;

         *        each of the named executive officers;

         *        each of our directors; and

         *        all executive officers and directors as a group.

         The following  table  assumes the  applicable  percentage  ownership is
based on 22,791,880  shares of common stock  outstanding as of December 31, 2002
and 1,500,000 shares of common stock options.

         Beneficial  ownership is determined  based on the rules and regulations
of the  Securities  and Exchange  Commission.  In computing the number of shares
beneficially  owned by a person and the  percentage  ownership  of that  person,
shares  of  common  stock  subject  to  options  held by that  person  that  are
exercisable  or  exercisable  within 60 days of the date of this  prospectus are
counted as outstanding.  These shares,  however,  are not counted as outstanding
for the  purposes of computing  the  percentage  ownership of any other  person.
Except as  indicated in the  footnotes to this table and pursuant to  applicable
community property laws, each shareholder named in the table has sole voting and
investment   power  with  respect  to  the  shares  set  forth   opposite   that
shareholder's name. Unless otherwise noted, the address of each beneficial owner
listed below is c/o Terra Systems,  7001 South 900 East, Ste 260, Midvale,  Utah
84047.


                                       19
<PAGE>


                                       Shares Beneficially     Percentage of
       Shareholder                            Owned              Ownership

Clayton Timothy
Chief Executive Officer, Director          1,993,000(1)             8.20%

L. Kent Harmon
President, Director                        1,050,000(1)             4.32%

Lloyd McEwan
Secretary, Treasurer, Director             2,100,000                8.64%

Robert Underwood
Director                                   1,283,758(1)             5.28%

CHT Holding Trust (2)
3037 Somoa Place                           2,505,000               10.31%
Costa Mesa, California 92626

All  Executive  Officers and Directors
as a group (4 individuals)                 6,426,758(3)            26.46%

(1)      Shares  beneficially  owned  include  500,000  shares of  common  stock
         options.
(2)      Shares held by CHT Holding Trust,  of which Howard Hucks is the trustee
         and Wayne Hansen and Valgene Blackburn are beneficiaries.
(3)      Shares  beneficially  owned  include  1,500,000  shares of common stock
         options.

Securities Authorized Under Equity Compensation Plans

         As of December 31, 2002, the Company had no equity  compensation  plans
or option plans.

Item 13. Certain Relationships and Related Transactions

                 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         In October 1996,  the company  entered into a capital lease with Spring
Lake Co. The lease ran though March 2002.  As of December 31, 2002,  the Company
was delinquent on accrued lease payments.  In 2003, the company issued 1,326,216
shares of common stock to satisfy all amounts owed to Spring Lake Co.

         The  principals  of Spring Lake Company were Clayton  Timothy and Lloyd
McEwan.  Both of these individuals were also executive officers and directors of
Terra Systems.


Item 14. Exhibits

Exhibit No.                         Title of Document
-----------                         -----------------

2                          Articles of Merger of Terra Systems,  Inc.,  with and
                           into Terra Merger Subsidiary,  Inc.,  incorporated by
                           reference from the Company's  Form 10-SB,  filed with
                           the Commission on September 6, 2000.

3.1                        Amended and  Restated  Articles of  Incorporation  of
                           Terra Systems,  Inc., formerly known as Xullux, Inc.,
                           incorporated  by reference  from the  Company's  Form
                           10-SB,  filed with the  Commission  on  September  6,
                           2000.

3.2                        Articles of Incorporation of Terra Merger Subsidiary,
                           Inc.,  incorporated  by reference  from the Company's
                           Form 10-SB, filed with the Commission on September 6,
                           2000.

3.4                        Revised Bylaws of Terra Systems, Inc. (formerly known
                           as Xullux, Inc.),  incorporated by reference from the
                           Company's  Form 10-SB,  filed with the  Commission on
                           September 6, 2000.


                                       20
<PAGE>


10.1                       Agreement  Between  Terra  Systems,  Inc.,  and  XCEL
                           Associates,  Inc., dated March 29, 2000, incorporated
                           by reference  from  Amendment  No. 1 to the Company's
                           Form 10-SB,  filed with the Commission on December 1,
                           2000.

31.1                       Rule 13a-14(a)/15d-14(a) Certification
31.2                       Rule 13a-14(a)/15d-14(a) Certification
32.1                       Section 1350 Certification
32.2                       Section 1350 Certification

99.1                       Stock Issuance With A Call Option Vesting  Schedule &
                           Stock   Issued   for   Services   -  Non   Employees,
                           incorporated by reference from Amendment No. 1 to the
                           Company's  Form 10-SB,  filed with the  Commission on
                           December 1, 2000.

Item 15. Principal Accountant Fees and Services

         The Company paid no audit fees,  audit-related fees, tax fees, or other
fees to its  accountants  during the year ended December 31, 2002. The audit and
related work for the year ended December 31, 2002, was performed in 2005

(1) AUDIT FEES

         All audit fees were paid in FY 2005 and FY 2006.

(2) AUDIT-RELATED FEES

         Not applicable.

(3) TAX FEES

         Not applicable.

(4) ALL OTHER FEES

         Not applicable.

(5) AUDIT COMMITTEE POLICIES AND PROCEDURES

         Not applicable.

(6) If greater than 50 percent, disclose the percentage of hours expended on the
principal accountant's engagement to audit the registrant's financial statements
for the most  recent  fiscal  year that were  attributed  to work  performed  by
persons other than the principal accountant's full-time, permanent employees.

         Not applicable.




                                       21
<PAGE>


                                   SIGNATURES

In accordance  with Section 13 or 15(d) of the Securities  Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

Date: March 30, 2006

                TERRA SYSTEMS, INC.

                           By:  /s/ Clayton Timothy
                                -------------------------------------
                                Clayton Timothy
                                CEO
                                (Principal Executive Officer)



                           By:  /s/ Mark Faerber
                                --------------------------------------
                                Mark Faerber
                                Consultant performing services for the Company
                                commonly performed by a chief financial officer



In  accordance  with the  Exchange  Act this report has been signed below by the
following  persons on behalf of the  registrant and in the capacities and on the
dates indicated.

Date: March  30, 2006


/s/ Clayton Timothy
------------------------------------
Name: Clayton Timothy
      Director


/s/ L Kent Harmon
------------------------------------
Name: L Kent Harmon
Director


/s/ Robert Underwood
------------------------------------
Name: Robert Underwood
Director












                                       22
<PAGE>






                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)




             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
                                       AND
                        CONSOLIDATED FINANCIAL STATEMENTS




                           December 31, 2002 and 2001




                                       23
<PAGE>




                       TERRA SYSTEMS, INC AND SUBSIDIARIES
                          (A Development Stage Company)


                                TABLE OF CONTENTS



Report of Independent Registered Public Accounting Firm                    F-1

Consolidated Balance Sheets December 31, 2002 and 2001                     F-2

Consolidated Statements of Operations for the Years Ended
   December 31, 2002 and 2001 and for the Cumulative period
   February 17, 1996 (Date of Inception) through December 31, 2002         F-3

Consolidated Statement of Changes in Stockholders' Deficit
   for the Period February 17, 1996 through December 31, 2002              F-4

Consolidated  Statements of Cash Flows for the Years Ended
   December 31, 2002 and 2001 and for the Cumulative period
   February 17, 1996 (Date of Inception) through December 31, 2002         F-6

Notes to Consolidated Financial Statements                                 F-7






                                       24
<PAGE>


 HANSEN, BARNETT & MAXWELL
 A Professional Corporation
CERTIFIED PUBLIC ACCOUNTANTS                Registered with the Public Company
  5 Triad Center, Suite 750                     Accounting Oversight Board
Salt Lake City, UT 84180-1128
    Phone: (801) 532-2200
     Fax: (801) 532-7944
       www.hbmcpas.com



             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Shareholders
Terra Systems, Inc. and Subsidiary


We have audited the accompanying  consolidated  balance sheets of Terra Systems,
Inc. and  Subsidiary (a  development  stage company) as of December 31, 2002 and
2001,  and the related  consolidated  statements  of  operations,  stockholders'
deficit,  and cash flows for the years ended  December 31, 2002 and 2001 and for
the  cumulative  period  from  February  17,  1996 (date of  inception)  through
December 31, 2002.  These  financial  statements are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audits.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and  perform  the  audits to  obtain  reasonable  assurance  about  whether  the
financial  statements  are free of  material  misstatement.  An  audit  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial  statements.  An audit also  includes  assessing  the  accounting
principles  used  and  significant  estimates  made  by  management,  as well as
evaluating the overall  financial  statement  presentation.  We believe that our
audits a reasonable basis for our opinion.

In our  opinion,  based on our  audits  the  consolidated  financial  statements
referred to above  present  fairly,  in all  material  respects,  the  financial
position of Terra Systems, Inc. and Subsidiary as of December 31, 2002 and 2001,
and the  results  of its  operations  and its cash  flows  for the  years  ended
December 31, 2002 and 2001 and for the cumulative  period from February 17, 1996
(date of inception)  through  December 31, 2002, in conformity  with  accounting
principles generally accepted in the United States.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company  will  continue as a going  concern.  The Company has  incurred
losses and negative cash flows from  operations  during each of the two years in
the period ended December 31, 2002 and from inception through December 31, 2002.
As of December 31, 2002,  the Company had an  accumulated  deficit of $9,646,798
and negative  working  capital of  $3,051,152.  These matters raise  substantial
doubt about the Company's  ability to continue as a going concern.  Management's
plans  concerning  these  matters are also  described  in Note 1. The  financial
statements do not include any adjustments  that might result from the outcome of
this uncertainty.





                                               HANSEN, BARNETT & MAXWELL
Salt Lake City, Utah
October 30, 2005


                                       F-1

<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                           CONSOLIDATED BALANCE SHEETS

                                                            December 31,
                                                     ---------------------------
                                                        2002            2001
                                                     -----------    -----------
Current Assets
 Cash                                                $     3,395    $        75
 Receivables                                                   -            500
                                                     -----------    -----------
        Total Current Assets                               3,395            575
                                                     -----------    -----------

Property and Equipment
 Furniture and equipment                                 451,809        451,809
 Building and leaseholds                                  12,500              -
 Software                                                 10,380         10,380
 Less:  Accumulated depreciation                        (420,976)      (355,152)
                                                     -----------    -----------
        Net Property and Equipment                        53,713        107,037
                                                     -----------    -----------

Total Assets                                         $    57,108    $   107,612
                                                     ===========    ===========

                     LIABILITIES AND STOCKHOLDERS' DEFICIT

Current Liabilities
 Accounts payable                                    $   467,849    $   427,395
 Accounts payable to related parties                     379,429        395,328
 Accrued liabilities                                     970,485        828,285
 Accrued interest payable to related parties             373,563        317,819
 Capital lease obligation to related party               237,954        237,954
 Notes payable to stockholders - current portion         625,267        422,534
                                                     -----------    -----------
        Total Current Liabilities                      3,054,547      2,629,315
                                                     -----------    -----------

Long-Term Liabilities
 Notes payable to stockholders -
  net of current portion                                       -        202,733
                                                     -----------    -----------
        Total Long-Term Liabilities                            -        202,733
                                                     -----------    -----------

Stockholders' Deficit
 Common stock - $0.001 par value; 100,000,000
  shares authorized; 22,791,880 and 21,791,565
  shares issued and outstanding, respectively             22,792         21,792
 Additional paid-in capital                            6,626,567      6,441,317
 Common stock subscribed                                       -       (100,000)
 Accumulated deficit                                  (9,646,798)    (9,087,545)
                                                     -----------    -----------
        Total Stockholders' Deficit                   (2,997,439)    (2,724,436)
                                                     -----------    -----------

Total Liabilities and Stockholders' Deficit          $    57,108    $   107,612
                                                     ===========    ===========


   The accompanying notes are an integral part of these financial statements.


                                      F-2
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                      CONSOLIDATED STATEMENTS OF OPERATIONS


                                                                  From Inception
                                                                      of the
                                                                   Development
                                                                     Stage on
                                                                   February 17,
                                        For the year ended             1996
                                           December 31,              Through
                                   ----------------------------    December 31,
                                       2002            2001            2002
                                   ------------    ------------    ------------

Revenues                           $    149,934    $      6,255    $    496,376
Cost of Revenues                         55,275             739         363,819
                                   ------------    ------------    ------------

Gross Profit                             94,659           5,516         132,557
                                   ------------    ------------    ------------

Expenses
 Research and development               178,170         279,689       1,797,511
 General and administrative             353,174       1,667,804       6,414,056
 Depreciation and amortization           65,824         124,143         730,858
                                   ------------    ------------    ------------
     Total Operating Expenses           597,168       2,071,636       8,942,425
                                   ------------    ------------    ------------

Loss from Operations                   (502,509)     (2,066,120)     (8,809,868)
                                   ------------    ------------    ------------

Nonoperating Income/(Expense)
 Interest expense                       (61,744)        (69,430)       (516,896)
 Interest income                              -               4           1,709
 Gain from debt relief                        -          64,284          64,284
 Loss on sale of securities                   -               -         (99,000)
 Gain (loss) on sale of assets            5,000        (285,356)       (287,027)
                                   ------------    ------------    ------------

     Net Nonoperating Expenses          (56,744)       (290,498)       (836,930)
                                   ------------    ------------    ------------

Net Loss                           $   (559,253)   $ (2,356,618)   $ (9,646,798)
                                   ============    ============    ============

Basic and Diluted Loss
 Per Share                         $      (0.03)   $      (0.12)
                                   ============    ============

Weighted Average Shares
 Outstanding                         22,174,658      19,784,749
                                   ============    ============


   The accompanying notes are an integral part of these financial statements.


                                      F-3
<PAGE>

<TABLE>
<CAPTION>
                                                TERRA SYSTEMS, INC AND SUBSIDIARY
                                                  (A Development Stage Company)
                                   CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT
                                                                                                         Deficit
                                                                                                         Accumu-
                                                                                                          lated
                                                                                                         During
                                                                         Common                            the         Total
                                         Common Stock        Additional  Stock    Subscrip-  Deferred    Develop-      Stock-
                                    -----------------------   Paid-In   Subscrip    tion      Compen-      ment       holders'
                                      Shares       Amount     Capital    -tions  Receivable   sation       Stage      Deficit
--------------------------------------------------------------------------------------------------------------------------------
<S>                                 <C>            <C>       <C>        <C>      <C>          <C>      <C>           <C>
Balance - February 17, 1996
 (Inception)                                  -   $      -   $       -  $     -  $        -  $      -  $         -            -
Shares issued to founders
  March 1996 -  $0.00 per share      48,000,000     48,000     (47,520)       -           -         -            -          480
Shares issued to acquire Xullux
  May 1996 - $0.00 per share          2,955,100      2,955      (2,955)       -           -         -            -            -
Common stock subscriptions
  July 1996 through
   September 1996                             -          -           -  196,000           -         -            -      196,000
Shares issued for marketable
 securities
  September 1996 - $0.80 per share       19,000         19      15,181  174,800           -         -            -      190,000
Shares issued for cash
  September 1996 - $0.80  to $1.00
   per share                            706,500        707     667,793   10,000           -         -            -      678,500
  October 1996 - $0.80 per share        350,000        350     279,650        -           -         -            -      280,000
  November 1996 - $1.75 per share        12,000         12      20,988        -           -         -            -       21,000
  December 1996 - $1.75 to $2.00
   per share                             57,500         58     103,692        -           -         -            -      103,750
  January 1997 - $1.00 to $1.75
   per share                            126,000        126     145,374        -           -         -            -      145,500
  February 1997 - $1.00 per share       100,000        100      99,900        -           -         -            -      100,000
  March 1997 - $1.75 per share           25,413         25      44,448        -           -         -            -       44,473
  April 1997 - $2.00 per share            7,500          8      14,992        -           -         -            -       15,000
  May 1997 - $1.00 per share            100,000        100      99,900        -           -         -            -      100,000
  June 1997 - $1.00 per share            90,000         90      89,910        -           -         -            -       90,000
  August 1997 - $0.50 to $1.00
   per share                             70,000         70      44,930        -           -         -            -       45,000
  October 1997 - $1.00 per share         25,000         25      24,975        -           -         -            -       25,000
  November 1997 - $0.72 to $0.80
   per share                            172,399        173     128,243        -           -         -            -      128,416
  December 1997 - $0.80 per share        84,375         84      67,416        -           -         -            -       67,500
  April 1998 - $0.50 to $0.73
   per share                            239,502        240     146,671        -           -         -            -      146,911
  May 1998 - $0.75 to $0.80
   per share                             38,333         38      29,962        -           -         -            -       30,000
  June 1998 - $0.75 per share            30,146         30      22,579        -           -         -            -       22,609
  July 1998 - $0.36 to $0.73
   per share                            236,846        237     119,368        -           -         -            -      119,605
  August 1998 - $0.50 per share          20,000         20       9,980        -           -         -            -       10,000
  November 1998 - $0.30 to $0.33
   per share                             78,000         78      24,772        -           -         -            -       24,850
  December 1998 - $0.32 to $0.33
   per share                             72,900         73      23,664        -           -         -            -       23,737
  January 1999 - $0.50 per share        100,000        100      49,900        -           -         -            -       50,000
  April 1999 - $0.25 per share           20,000         20       4,980        -           -         -            -        5,000
  May 1999 - $0.50 per share             20,000         20       9,980        -           -         -            -       10,000
  June 1999 - $0.50 per share           100,000        100      49,900        -           -         -            -       50,000
  July 1999 - $0.25 per share           200,000        200      50,260        -           -         -            -       50,460
  September 1999 - $0.40 and $0.50
   per share                            145,000        145      59,855        -           -         -            -       60,000
  October 1999 - $0.50 per share         60,000         60      29,940        -           -         -            -       30,000
  December 1999 - $0.50 per share        60,000         60      29,940        -           -         -            -       30,000
  January 2000 - $0.25 per share         12,000         12       2,988        -           -         -            -        3,000
  February 2000 - $0.25 per share        40,000         40       9,960        -           -         -            -       10,000
  March 2000 - $0.25 per share          139,340        140      34,696        -           -         -            -       34,836
  April 2000 - $0.30 per share           33,333         33       9,967        -           -         -            -       10,000
  July 2000 - $0.25 per share            32,000         32       7,968        -           -         -            -        8,000
  August 2000 - $0.25 per share         120,000        120      29,880        -           -         -            -       30,000
Shares issued in satisfaction of
 subscription agreements
  October - December 1996 $0.80 to
   $1.00 per share                      246,000        245     205,755  (206,000)         -         -            -            -
  December 1996 - $0.76 per share       231,000        231     174,569  (174,800)         -         -            -            -
Shares issued for current and
 future services
  May 1997 - $1.00 per share             75,000         75      74,850        -           -   (74,925)           -            -
  March 1998 - $1.13 per share          350,000        350     393,400        -           -  (393,750)           -            -
  March 1999 - $0.50 per share          106,286        106      53,083        -           -         -            -       53,189
  June 1999 - $0.50 per share            60,000         60      29,940        -           -         -            -       30,000
  September 1999 - $0.70 to $0.97
   per share                             63,000         63      49,257        -           -   (19,320)           -       30,000
  December 1999 - $0.60 per share        50,000         50      29,950        -           -         -            -       30,000
  March 2000 - $0.50 per share           60,000         60      29,940        -           -         -            -       30,000
  May 2000 - $0.48 per share             62,920         63      29,937        -           -         -            -       30,000
  July 2000 - $1.00 per share            15,000         15      14,985        -           -         -            -       15,000
  September 2000 - $0.25 per share      122,400        122      29,878        -           -         -            -       30,000
  October 2000 - $0.25 per share         75,000         75      18,675        -           -         -            -       18,750
  December 2000 - $0.39 per share        99,338         99      38,901        -           -         -            -       39,000

                            The accompanying notes are an integral part of these financial statements.

                                                              F-4
</TABLE>
<PAGE>

<TABLE>
<CAPTION>
                                                TERRA SYSTEMS, INC AND SUBSIDIARY
                                                  (A Development Stage Company)
                                   CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIT
                                                           (Continued)
                                                                                                         Deficit
                                                                                                         Accumu-
                                                                                                          lated
                                                                                                         During
                                                                         Common                            the         Total
                                         Common Stock        Additional  Stock    Subscrip-  Deferred    Develop-      Stock-
                                    -----------------------   Paid-In   Subscrip    tion      Compen-      ment       holders'
                                      Shares       Amount     Capital    -tions  Receivable   sation       Stage      Deficit
--------------------------------------------------------------------------------------------------------------------------------
<S>                                 <C>            <C>       <C>        <C>      <C>          <C>      <C>           <C>
Shares issued for settlement of
 liabilities
  January 1999 - $0.25 per share        200,000        200      49,800        -           -         -            -       50,000
Exercise of share rights
  May 2000 - $0.25 per share
   (cash)                               400,000        400      99,600        -           -         -            -      100,000
  October 2000 - $0.25 per share
   (cash)                               300,000        300      59,700        -           -         -            -       60,000
  November 2000 - $0.20 per share
   (services)                           225,000        225      44,775        -           -         -            -       45,000
  December 2000 - $0.20 per share
   (cash)                                75,000         75      14,925        -           -         -            -       15,000
Exercise of stock options
  April 2000 - $0.20 per share
   (conversion of debt)                 500,000        500      99,500        -           -         -            -      100,000
  December 2000 - $0.20 per share
   (cash)                                25,000         25       4,975        -           -         -            -        5,000
Share redemptions
  September 1996 - no consideration  (3,000,000)    (3,000)      3,000        -           -         -            -            -
  December 1996 - $0.001 per share  (36,775,000)   (36,775)          -        -           -         -            -      (36,775)
  December 1999 - $1.13 per share      (100,000)      (100)   (112,300)       -           -   112,400            -            -
  March 2000 - $1.13 per share          (50,000)       (50)    (56,150)       -           -    56,200            -            -
Payment on subscription receivable            -          -           -        -           -         -            -            -
Compensation from grant of stock
 rights and options                           -          -     179,126        -           -         -            -      179,126
Consulting expense from grant of
 share right                                  -          -     575,250        -           -         -            -      575,250
Amortization of deferred
 compensation                                 -          -           -        -           -   310,137            -      310,137
Net loss from February 17, 1996
 through December 31, 2000                    -          -           -        -           -         -   (6,730,927)  (6,730,927)
                                     ----------   --------   ---------  -------  ----------  --------  -----------   ----------

Balance, December 31, 2000           18,114,131     18,114   4,689,448        -           -    (9,258)  (6,730,927)  (2,032,623)

Shares issued for cash
  January 2001 - $0.20 per share        100,000        100      19,900        -           -         -            -       20,000
  May 2001 - $0.20 to $0.25
   per share                            150,000        150      30,350        -           -         -            -       30,500
  June 2001 - $0.25 per share            10,000         10       2,490        -           -         -            -        2,500
  July 2001 - $0.19 per share            32,000         32       6,014        -           -         -            -        6,046
  August 2001 - $0.10 per share         500,000        500      49,500        -           -         -            -       50,000
  November 2001 - $0.20 to $0.23
   per share                            680,434        680     139,320        -    (100,000)        -            -       40,000
Exercise of stock options
  January 2001 - $0.20-$0.25
   per share                            825,000        825     166,675        -           -         -            -      167,500
Shares issued for current and
 future services
  January 2001 - $0.50 per share         12,500         13       6,238        -           -         -            -        6,251
  March 2001 - $0.50 per share           60,000         60      29,940        -           -         -            -       30,000
  June 2001 - $0.40 per share            97,500         98      38,902        -           -         -            -       39,000
  September 2001 - $0.20 per share      500,000        500      99,500        -           -         -            -      100,000
  October 2001 - $0.20 per share        530,000        530     105,470        -           -         -            -      106,000
  November 2001 - $0.15 per share       180,000        180      26,820        -           -         -            -       27,000
Compensation relating to grant of
 stock options                                -          -     787,500        -           -         -            -      787,500
Consulting expense relating to
 grant of stock right                         -          -     243,250        -           -         -            -      243,250
Amortization of deferred
 compensation                                 -          -           -        -           -     9,258            -        9,258
Net loss for the period                       -          -           -        -           -         -   (2,356,618)  (2,356,618)
                                     ----------   --------  ----------  -------  ----------  --------  -----------  -----------

Balance, December 31, 2001           21,791,565   $ 21,792  $6,441,317  $     -  $ (100,000) $      -  $(9,087,545) $(2,724,436)

Shares issued in satisfaction of
 liabilities
  February 2002 - $0.51 per share        49,020         49      24,951        -           -         -            -       25,000
Shares issued for cash
  March 2002 - $0.15 per share           75,000         75      11,175        -           -         -            -       11,250
Shares issued for services
  July 2002 - $0.18 to $0.19 per
  share                                 504,529        505      92,195        -           -         -            -       92,700
  November 2002 - $0.16 to $0.17
  per share                             501,766        501      82,799        -           -         -            -       83,300
Payment on subscription                       -          -           -        -      51,250         -            -       51,250
Return of shares in satisfaction
 of subscription receivable            (130,000)      (130)    (25,870)       -      26,000         -            -            -
Write off subscription receivable
 balance                                      -          -           -        -      22,750         -            -       22,750
Net Loss for Period                           -          -           -        -           -         -     (559,253)    (559,253)
                                     ----------   --------  ----------  -------  ----------  --------  -----------  -----------

Balance December 31, 2002            22,791,880   $ 22,792  $6,626,567  $     -  $        -  $      -  $(9,646,798) $(2,997,439)
                                     ==========   ========  ==========  =======  ==========  ========  ===========  ===========

                            The accompanying notes are an integral part of these financial statements.

                                                               F-5
</TABLE>
<PAGE>

                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                                        From
                                                                     Inception
                                                                       of the
                                                                    Development
                                                                      Stage on
                                                                    February 17,
                                          For the year ended,           1996
                                              December 31,             Through
                                      --------------------------    December 31,
                                          2002           2001           2002
                                      -----------    -----------    -----------
Cash Flows from Operating
 Activities:
 Net loss                             $  (559,253)   $(2,356,618)   $(9,646,798)
 Adjustments to reconcile net
  loss to net cash used in
  operating activities:
   Depreciation and amortization           65,824        124,143        730,858
   Gain from debt relief                        -        (64,284)       (64,284)
   Loss on sale of investment
    securities                                  -              -         99,000
   Loss on disposal of assets                   -        285,356        292,027
   Stock based compensation               176,000      1,348,259      2,796,522
   Write off of stock
    subscription                           22,750              -         22,750
 Changes in current assets and
  liabilities:
   Receivables                                500          6,940              -
   Accounts payable                        40,454         72,380        686,106
   Accounts payable -
    related party                         (15,899)       108,899        371,840
   Accrued liabilities                    167,200        116,861      1,010,422
   Accrued interest payable                55,744         50,563        373,563
                                      -----------    -----------    -----------
 Net Cash Used in Operating
  Activities                              (46,680)      (307,501)    (3,327,994)
                                      -----------    -----------    -----------
Cash Flows from Investing
 Activities:
 Purchase of equipment                    (12,500)             -       (674,964)
 Organization costs paid                        -              -         (4,755)
 Proceeds from sale of assets                   -              -        117,715
                                      -----------    -----------    -----------
 Net Cash Used in Investing
  Activities                              (12,500)             -       (562,004)
                                      -----------    -----------    -----------
Cash Flows from Financing
 Activities:
 Proceeds from borrowings -
  stockholders                                  -              -        870,111
 Payments on borrowings -
  stockholders                                  -              -       (149,750)
 Proceeds from stock issuance
  and subscriptions                        62,500        316,546      3,358,672
 Payments on capital leases                     -        (13,809)      (185,640)
                                      -----------    -----------    -----------
  Net Cash Provided by
   Financing Activities                    62,500        302,737      3,893,393
                                      -----------    -----------    -----------

Net Increase (Decrease) in Cash             3,320         (4,764)         3,395

Cash at Beginning of Year                      75          4,839              -
                                      -----------    -----------    -----------

Cash at End of Year                   $     3,395    $        75    $     3,395
                                      ===========    ===========    ===========

Supplemental Cash Flow Information:
 Cash paid for interest               $     6,000    $         -
Non Cash Investing and
 Financing Activities:
 Conversion of liabilities
   to equity                          $    25,000    $         -
 Cancellation of subscription
  receivable                          $    26,000    $         -


   The accompanying notes are an integral part of these financial statements.


                                      F-6
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT

NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
                  POLICIES

         Organization--Terra Systems, Inc. was incorporated on February 17, 1996
pursuant to the laws of the State of Utah.  It is a  development  stage  company
whose primary  business  purpose is the development and  commercialization  of a
pneumatic  conveyance  system to handle  materials in a bulk state in industrial
research and processing.

         Xullux,  Inc. was  incorporated  under the laws of the state of Utah on
November 4, 1983 under the name of Bunker Research,  Inc. It changed its name to
Diamond  Resources,  Inc.  on May 15, 1984 and changed its name again to Xullux,
Inc.  on August 6, 1988.  On May 1, 1996,  Xullux,  Inc.  entered  into a merger
agreement with Terra Systems, Inc. whereby Terra Systems, Inc. was merged into a
newly formed subsidiary of Xullux, Inc. called Terra Merger Subsidiary, Inc. and
the Terra Systems,  Inc.  stockholders  were issued 48,000,000 shares of Xullux,
Inc. common stock.

         For financial accounting purposes,  the merger was accounted for by the
purchase method of accounting with Terra Systems,  Inc. considered the acquiring
corporation.  The historical  financial  statements of Terra Systems,  Inc. were
restated to reflect the shares issued to the Terra Systems, Inc. stockholders as
being outstanding for all periods presented,  similar to a stock split.  Xullux,
Inc.  had no  assets  at the  date  of the  merger  and was  considered  a shell
corporation;  accordingly,  the  2,955,100  shares  held  by  the  Xullux,  Inc.
stockholders  were  deemed  to  have  been  issued  for  no  consideration.  The
operations of Xullux,  Inc.  have been included in the  statements of operations
from the date of the merger.

         Following the  reorganization,  Xullux,  Inc. changed its name to Terra
Systems, Inc.

         Principles  of  Consolidation--The  consolidated  financial  statements
include the accounts of Terra  Systems,  Inc.  and its wholly  owned  subsidiary
Terra  Merger   Subsidiary,   Inc.  All  intercompany   transactions  have  been
eliminated. The consolidated entities are collectively referred to herein as the
"Company" or "Terra Systems."

         Use of Estimates--The preparation of financial statements in conformity
with  generally  accepted  accounting  principles  requires  management  to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities at the date of the financial  statements and the reported amounts of
revenues and expenses during the reporting  period.  Actual results could differ
from those estimates.

         Basis  of   Presentation--The   accompanying   consolidated   financial
statements have been prepared on a going concern basis,  which  contemplates the
realization of assets and the  satisfaction  of liabilities in the normal course
of business.  As shown in the  consolidated  financial  statements for the years
ended December 31, 2002 and 2001, the Company has received  nominal  revenue and
incurred net losses of $559,253 and $2,356,618, respectively. As of December 31,
2002 and 2001,  the  Company had a working  capital  deficit of  $3,051,152  and
$2,628,740,  respectively.  These factors, among others, raise substantial doubt
about the  Company's  ability to  continue as a going  concern for a  reasonable
period  of time.  The  consolidated  financial  statements  do not  include  any
adjustments relating to the recoverability and classification of recorded assets
or the amount and  classification  of liabilities that might be necessary should


                                      F-7
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT

the Company be unable to continue as a going concern. The Company's continuation
as a going  concern is dependent  upon its ability to generate  sufficient  cash
flows to meet its obligations on a timely basis, to obtain additional  financing
as may be required, and ultimately to attain successful operations.

         The  Company's  management  is in the  process of  negotiating  various
agreements to perform  research on and the  development of pneumatic  conveyance
systems  to  handle  materials  in a  bulk  state  in  industrial  research  and
processing.  Management also intends to use capital and debt financing as needed
to supplement  the cash flows that  potentially  could be generated  through the
successful negotiation of agreements.

         Property and Equipment--Property and equipment are recorded at cost and
are  depreciated  using the  straight-line  method based on the expected  useful
lives of the assets that range from five to fifteen years.  Depreciation expense
for the  years  ended  December  31,  2002 and 2001 was  $65,824  and  $124,143,
respectively.

         Long-Lived Assets --The realizability of long-lived assets is evaluated
periodically  when  events or  circumstances  indicate a possible  inability  to
recover the carrying amounts. An impairment loss is recognized for the excess of
the carrying amount over the fair value of the assets.  Fair value is determined
based  on  estimated  discounted  net  future  cash  flows  or  other  valuation
techniques  available in the circumstances.  This analysis involves  significant
management  judgment to  evaluate  the  capacity  of an asset to perform  within
projections.  Based upon these analyses, no impairment losses were recognized in
the accompanying financial statements.

         Financial   Instruments--The   estimated   fair   value  of   financial
instruments  is not  presented  because,  in  managements  opinion,  there is no
material  difference  between  carrying amounts and estimated fair values of the
financial instruments as presented in the accompanying balance sheet.

         Revenue  Recognition  -- The  Company's  revenue  source  has come from
providing  research and  development on behalf of another  corporation.  Revenue
from research and  development  contracts is recognized on a cost  reimbursement
basis.  As tests are performed and costs  incurred,  the Company  recognizes the
proceeds  as revenue at the time of  billing.  All  contracts  are for  specific
research and development projects and are short term in nature.

         Basic and  Diluted  Loss Per Share -- Basic  loss per  common  share is
computed by dividing net loss by the  weighted-average  number of common  shares
outstanding  during the period.  Diluted  loss per share is  calculated  to give
effect to  potentially  issuable  common  shares except during loss periods when
those  potentially  issuable common shares would decrease the loss per share. As
of December 31, 2002 and 2001,  respectively,  there were 2,250,000  potentially
issuable  common shares which were excluded from the calculation of diluted loss
per  common  share  as their  effect  would  have  been  anti-dilutive,  thereby
decreasing the net loss per common share.

     Stock Based  Compensation--  The  Company  accounts  for its stock  options
issued to directors,  officers and employees under  Accounting  Principles Board
Opinion  No.  25  and  related   interpretations   ("APB  25").  Under  APB  25,
compensation  expense  is  recognized  if an  option's  exercise  price  on  the
measurement  date is below the fair value of the  Company's  common  stock.  The
Company accounts for options issued to non-employees in accordance with SFAS No.


                                      F-8
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT

123,  Accounting for  Stock-Based  Compensation  (SFAS 123) which requires these
options to be accounted for at their fair value.

The  following  table  illustrates  the effect on net loss and basic and diluted
loss per share if the Company had applied the fair value recognition  provisions
of SFAS 123 to stock-based employee compensation:

                                                           December 31,
                                                      2002              2001
                                                   -----------      -----------
Net loss, as reported                              $  (559,253)     $(2,356,618)
Add: Stock-based employee compensation
 expense included in reported net loss                       -          787,500
Deduct:  Total stock-based employee
 compensation expense determined
 under fair value based method for
 all awards                                                  -       (1,124,833)
--------------------------------------------------------------------------------
Pro forma net loss                                 $  (559,253)     $(2,693,951)
--------------------------------------------------------------------------------

Basic and diluted loss per share,
 as reported                                       $        (0.03)  $     (0.12)
--------------------------------------------------------------------------------
Basic and diluted loss per share,
 pro forma                                         $        (0.03)  $     (0.14)
--------------------------------------------------------------------------------

NOTE 2 - RELATED PARTY TRANSACTIONS

         Certain  officers of the Company  have from time to time  advanced  the
Company funds used for operating expenses. As of December 31, 2002 and 2001, the
Company  received  additional  proceeds  of $20,600 and  $27,742,  respectively.
During  this  period the  Company  made cash  payments  of $5,619  and  $14,853,
respectively.  As of December 31, 2002 and 2001  amounts owed to theses  related
parties were $81,245 and  $66,264,  respectively.  All amounts are due on demand
and bear no interest.

         As  discussed  in Note 4, the Company has notes  payable to officers of
$625,267 as of December 31, 2002 and 2001,  respectively.  During the year ended
December 31, 2002 and 2001, the Company accrued interest on the notes of $61,744
and $64,522.  During the year ended  December  31,  2002,  the Company made cash
interest  payments of $6,000.  During  2001,  the  Company  wrote off $14,836 of
accrued  interest  related  to $31,250 in notes  payable to  officers  that were
forgiven.  At December  31, 2002 and 2001 the  Company had  interest  payable on
these notes payable to officers of $344,373 and $288,766, respectively.

         An entity  controlled  by certain  officers of the Company has advanced
the Company  funds for  operating  capital,  and, as discussed in Note 3, leased
equipment to the Company,  which includes  executory fees and accrued  interest.
During the year ended  December 31, 2002 and 2001,  the Company paid $30,880 and
$29,264 as it related to its executory  fees,  respectively.  As of December 31,
2002,  the Company owed this entity  $237,954 for the capital lease  obligation,
$239,484 in delinquent  executory fees,  $29,190 in accrued interest and $58,700
in other  payables.  As of  December  the 2001,  the  Company  owed this  entity
$237,954 for the capital  lease  obligation,  $270,364 in  delinquent  executory
fees,  $29,053 in accrued interest and $58,700 in other payables.  These amounts
are due on demand.

NOTE 3 - CAPITAL LEASE OBLIGATION

         The Company entered into capital lease obligations with a company under


                                      F-9
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT

common  ownership.  The related  company  entered into an equipment lease with a
financial  institution  and is  responsible  to make all payments  regarding the
lease.  The Company is currently paying to the related company the amount of the
lease payment plus various other executory fees.  Equipment under capital leases
as of December 31, 2002 was as follows:

        Property and Equipment                            $     282,378
        Less: Accumulated amortization                         (252,108)
        ----------------------------------------------------------------
        Net property and equipment under capital lease    $      30,270
        ----------------------------------------------------------------

         At December 31, 2002 and 2001,  the Company was delinquent on its lease
payments and thus the entire  obligation  of $237,954 has been  classified  as a
current  liability.  The  Company had  accrued  interest  payable of $29,190 and
$29,054 related to the capital leases in 2002 and 2001,  respectively.  In 2003,
the Company  issued  1,326,216  shares of common stock to settle amounts owed to
Spring Lake totaling  $477,438,  which included the capital lease and delinquent
executory fees.

NOTE 4-NOTES PAYABLE TO STOCKHOLDERS

         Notes payable to stockholders are as follows:

                                                            December 31,
                                                         2002            2001
                                                      ---------       ---------

Notes payable to stockholders,
 interest at 10% payable monthly,
 all such notes are currently
 due, unsecured                                       $ 607,742       $ 607,742

Notes payable to stockholders for
 redemption of stock 10% interest
 payable monthly, all such notes
 are currently due                                       17,525          17,525

                                                      ---------       ---------
Total notes payable to stockholders                     625,267         625,267

 Less current portion                                  (625,267)       (422,534)
                                                      ---------       ---------

Notes payable stockholders - long-term                $       -       $ 202,733
                                                      =========       =========


NOTE 5 - STOCKHOLDERS' DEFICIT

         Stock-Based  Compensation for Current and Future Services -- During the
year ended  December 31, 1999,  the Company issued 20,000 shares of common stock
at $0.001 per share to various  employees for current and future  services.  The
shares  had a  market  value  of  $19,320,  or $0.97  per  share,  on the day of
issuance.  Under the terms of the stock issuance,  the Company can reacquire all
the stock at $0.001  per share  within  one year from the date of  issuance  and
one-half of the shares within two years from the date of issuance.  These shares


                                      F-10
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT

are considered  non-vested and have been accounted for in accordance with APB 25
Accounting  for Stock Issued to  Employees,  whereby the Company is  recognizing
compensation  expense  over the vesting  period of the stock for the  difference
between the fair value of the stock on the day of issuance and the consideration
paid by the  employees.  In the  event  employment  should  be  terminated,  the
employee shall forfeit all non-vested shares of stock.

         During the year ended December 31, 2000, an officer of the Company, who
had been issued 150,000 shares of the above mentioned stock, which was issued in
1999, forfeited 50,000 shares of non-vested common stock valued at $56,200

         The Company recognizes  compensation  expense for the above shares over
the period the shares  vest.  During the year ended  December 31, 2002 and 2001,
the Company recognized compensation expense of $0 and $9,258.

         Common  Stock  Issued  for Cash -- During  2002 and 2001,  the  Company
issued 75,000 and 1,472,434  shares of common stock at prices ranging from $0.10
to $0.25 per share for proceeds of $11,250 and $249,046, respectively.

         In 2001,  the  Company  issued  500,000  shares of stock for a $100,000
subscription  receivable.  During 2002, the Company received proceeds of $51,250
under the  subscription.  The  shareholder  returned  and the Company  cancelled
130,000 shares valued at $26,000. The remaining $22,750 subscription  receivable
was written off and included as part of bad debt.

         Common Stock Issued for Services -- During the years ended December 31,
2002 and 2001, the Company issued 1,006,295 and 1,380,000 shares,  respectively,
of common stock for consulting  services.  The common stock was valued at prices
ranging from $0.14 to $0.50 per share. For the years ended December 31, 2002 and
2001,  the  Company  charged  $176,000  and  $308,251 of  consulting  expense to
operations,  respectively. The shares were valued based on the fair value of the
Company's common stock on the date of issuance.

         Common  Stock Issued for  Satisfaction  of Debt - During the year ended
December  31,  2002,  the  Company  issued  49,020  shares of  common  stock for
satisfaction  of $25,000 in  accounts  payable.  The common  stock was valued at
$0.51 per share.

NOTE 6 - STOCK RIGHTS

         On March  29,  2000,  the  Company  entered  into an  agreement  with a
corporation  for  consultation   and  advisory   services  related  to  business
management and marketing.  In consideration for the services to be provided, the
Company agreed to grant to the  corporation  the right to purchase 50,000 equity
units at a purchase  price of $5.00 per unit.  Each unit  consists  of 20 freely
tradable  common  shares and the option to purchase  five shares at $0.50,  five
shares at $0.75,  five  shares at $1.00,  and five  shares at $1.25 - all freely
tradable shares.

         The Company  measured  compensation  under this  stock-based  agreement
using the fair value at the grant date consistent with SFAS No. 123,  Accounting
for  Stock-Based  Compensation.   Under  this  method,  the  Company  recognized
consulting  expense of  $560,000.  The fair value of $11.20 for each equity unit
granted was estimated on grant date using the Black-Scholes option pricing model
with the following  assumptions:  dividend yield of 0.0%; expected volatility of
145.00% risk-free rate of 6.13% and expected life of options of 1.0 year.


                                      F-11
<PAGE>

                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT


         In November  2000,  the Company  modified the terms of the agreement by
reducing the  exercise  price of the rights from $5.00 to $4.00 per equity unit.
In December  2000,  the Company  again  modified  the terms of the  agreement by
reducing the exercise price of 25,000 options exercisable at $0.50 per option to
$0.20 per option.  In  accordance  with  Financial  Accounting  Standards  Board
Interpretation   44,  Accounting  for  Certain   Transactions   Involving  Stock
Compensation,  the rights and options  have been  accounted  for as variable and
were thus revalued at the dates of the modifications.  By modifying the exercise
prices of the equity units and the options, the Company recognized an additional
$15,250 of  consulting  expense.  The Company  recognized a total of $575,250 of
consulting expense as of December 31, 2000.

         By December 31, 2000, the corporation exercised its right and purchased
20,000  equity units for $100,000 or $0.25 per share,  purchased  18,750  equity
units  for  $75,000  or $0.20 per share and  purchased  11,250  equity  units by
providing  services valued at $45,000 or $0.20 per share. In connection with the
exercise  of these  stock  rights,  the  Company  issued  options to purchase an
additional 250,000 shares at $0.50,  250,000 shares at $0.75,  250,000 shares at
$1.00 and 250,000 shares at $1.25.

         On three separate  occasions in January 2001, the Company  modified the
terms of the  agreement  by  reducing  the  exercise  price of  225,000  options
exercisable at $0.50 per share to $0.20 per share,  200,000 options  exercisable
at $0.75 per share to $0.20 per share,  50,000 options  exercisable at $0.75 per
share to $0.25 per  share,  250,000  options  exercisable  at $1.00 per share to
$0.20 per share and 100,000 options  exercisable at $1.25 per share to $0.20 per
share. In accordance with Financial  Accounting  Standards Board  Interpretation
44,  Accounting  for Certain  Transactions  Involving  Stock  Compensation,  the
options have been  accounted for as variable and were thus revalued at the dates
of the  modifications.  By  modifying  the exercise  prices of the options,  the
Company recognized an additional $243,250 of consulting expense in January 2001.

         During  the year  ended  December  31,  2001  and 2000 the  corporation
exercised  825,000 and 25,000  options for proceeds of $167,500  and $5,000.  In
2001, 150,000 options at $1.25 per share expired unexercised.

NOTE 7 - STOCK OPTIONS

         Employee Grants -- On February 22, 2001, the Company granted  2,250,000
stock  options to  employees  and  directors  of the  Company.  The  options are
exercisable  at $0.20 per share,  exercisable  immediately  and expire two years
from the grant date. In accordance with APB 25, compensation expense of $787,500
was  recorded.  During 2001,  1,750,000  options at $0.20 per share to employees
expired unexercised. During 2002, no options were granted.

         Non Employee  Options -- As  discussed  in Note 6, the Company  entered
into an agreement  with a corporation  for  consultation  and advisory  services
related to business management and marketing.  In consideration for the services
to be  provided,  the Company  agreed to grant to the  corporation  the right to
purchase all 50,000 equity units.  During the year ended  December 31, 2000, the
corporation exercised its right and purchased all 50,000 equity units.

         Outstanding Stock Options -- A summary of stock option activity for the
years ending December 31, 2002 and 2001 is as follows:


                                      F-12
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT

                                                                    Weighted
                                                      Range of       Average
                                                      Exercise      Exercise
                                      Options          Prices        Price
-------------------------------------------------------------------------------
Balance, December 31, 2000           2,725,000      $0.20 - 1.25    $   0.44
 Granted                             2,250,000      $       0.20    $   0.20
 Exercised                            (850,000)     $       0.20    $   0.20
 Expired                            (1,900,000)     $0.20 - 1.25    $   0.27
-------------------------------------------------------------------------------
Balance, December 31, 2001           2,225,000      $       0.20    $   0.20
-------------------------------------------------------------------------------
Balance, December 31, 2002           2,225,000      $       0.20    $   0.20
-------------------------------------------------------------------------------

Options Exercisable at
 December 31, 2001                   2,225,000      $       0.20    $   0.20
Options Exercisable at
 December 31, 2002                   2,225,000      $       0.20    $   0.20

Weighted average fair value
 of options granted during
 year ended:
  December 31, 2002                  $       -
                                     =========
  December 31, 2001                  $    0.50
                                     =========


A summary of stock option outstanding and exercisable as of December 31, 2002 is
as follows:

                           Weighted Average
                         ---------------------
Range of      Number      Remaining                   Number        Weighted
Exercise   Outstanding   Contractual  Exercise     Exercisable      Average
 Prices   at 12/31/2002     Life        Price     at 12/31/2002  Exercise Price
--------  -------------  -----------  --------    -------------  --------------

$   0.20      2,250,000   .25 years   $   0.20        2,250,000  $         0.20


         The  proforma  fair  value was  estimated  on the grant  date using the
Black-Scholes   option-pricing   model  with  the   following   weighted-average
assumptions: dividend yield of 0.0%; expected volatility of 136%; risk-free rate
of 4.61% and expected life of options of 2.0 years.

NOTE 8 - RESEARCH AND DEVELOPMENT EXPENSE

         Research and development and patent development have been the principal
functions  of the Company.  Expenses in the  accompanying  financial  statements
include certain costs which are directly  associated with the Company's research
and  development.   These  costs,  which  consist  primarily  of  fees  paid  to
individuals,  materials and supplies,  amounted to $178,170 and $279,689 for the
year ended December 31, 2002 and 2001, respectively.

NOTE 9 - OPERATING LEASES

         The Company conducts its operations in a building leased from a related
party through common  ownership,  which was to expire in June 2003. Rent expense
under this lease was $679 and $56,377 for the periods  ended  December  31, 2002
and 2001, respectively.


                                      F-13
<PAGE>


                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT

         During 2002,  the Company  abandoned the building and ceased all leases
from the related  party.  See Note 2 for summary of amounts owed to this related
party.

         The Company  leased  office / warehouse  space of  approximately  5,000
square  feet.  The lease was month to month with a payment of $1,500.  The space
was used for general offices, warehousing and research and development.

NOTE 10 - INCOME TAXES

         There was no benefit or provision for income taxes during 2002 or 2001.
The  following  presents  the  components  of the net  deferred  tax asset as of
December 31, 2002 and 2001:

                                                           December 31,
                                                  -----------------------------
                                                      2002              2001
                                                  -----------       -----------
Tax loss carryforward                             $ 2,648,693       $ 2,500,848
Accrued and deferred compensation                     360,578           308,358
                                                  -----------       -----------

 Total deferred tax assets                          3,009,271         2,809,206

 Less: valuation allowance                         (3,009,271)       (2,809,206)
                                                  -----------       -----------

 Net deferred tax assets                          $         -       $         -
                                                  ===========       ===========

         The Company has a net  operating  loss  carryforward  of  approximately
$7,100,000 which expire, if unused, in the years 2012 through 2022.

         The  following is a  reconciliation  of the amount of tax that would be
result from applying the federal rate to pretax income with provision for income
taxes as of December 31, 2002:

                                                             December 31,
                                                       ------------------------
                                                          2002           2001
                                                       ---------      ---------

Benefit at US federal statutory rate (34%)             $(190,146)     $(801,250)
Non includible items                                       8,536        389,637
Deferred tax asset valuation change                      200,065        489,381
State tax benefit, net of federal effect                 (18,455)       (77,768)
                                                       ---------      ---------

   Income tax provision                                $       -      $       -
                                                       =========      =========


NOTE 11 - CONTINGENCIES

         Threatened Litigation -- The Company and certain officers and directors
of the Company  received  notice from a litigant's  legal  counsel of threatened
litigation.  The litigant  contends that certain current  officers and directors
held and sold a number of Xullux  shares  that  were free  trading  prior to the
merger of Xullux and Terra Systems. The alleged sale may have impacted the value


                                      F-14
<PAGE>

                        TERRA SYSTEMS, INC AND SUBSIDIARY
                          (A Development Stage Company)
                    NOTES TO CONSOLIDATED FINANCIAL STATEMENT


of the  litigant's  Terra  Systems  restricted  publicly  issued  shares  in the
company. The litigant claims that the defendant's  ownership and alleged sale of
Xullux  stock  was not  disclosed  to him at or during  the time he  contributed
certain  assets and other  equipment to Terra  Systems in exchange for the Terra
Systems  restricted  stock. The litigant seeks to return 125,000 shares to Terra
Systems for value and seeks other monetary and punitive  damages in an amount of
not less than $1,500,000 including additional costs and attorney's fees.

         In June 2003,  the Company  entered  into a  Settlement  Agreement  and
Mutual  Release of All  Claims.  Terms of the  agreement  were to issue  200,000
shares of restricted stock to the plaintiff valued at $26,000 or $0.13 per share
and would be deducted from amounts owed by the Company to a former  officer.  In
addition to the stock, another officer deeded to the plaintiff one-half interest
in an industrial building that was personally owned by the officer. The value of
the one-half  interest was  determined  to be  $150,000.  The Company  agreed to
reimburse  the officer  $150,000  for the  interest  given up. The Company  also
executed a note to the  plaintiff  for the amount of  $22,000,  which was due on
October  1,  2003.  If the note was not paid by October 1, 2003 it would go into
default and the Company would owe $35,000. The Company defaulted on the original
note and $35,000 was paid in March 2005.





























                                      F-15