**U.S.
      SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





FORM
      10-QSB/A





**QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR**


**15(D)
      OF THE SECURITIES EXCHANGE ACT OF 1934**





For
      the
      quarterly period ended December 31, 2006







Commission
      file number 0-4846-3




**CONVERGENCE
      ETHANOL, INC.** ****


**(Name
      of small business issuer in its charter)**








Nevada
              ____________________________________
              **(State
                or other jurisdiction of**
              **incorporation
                or organization)**
              
              
              5701
                Lindero Canyon Road, Suite 2-100
              Westlake
                Village, California
              ____________________________________
              **(Address
                of principal executive offices)**
            82-0288840
              ____________________________________
              **(I.R.S.
                employer**
              **identification
                no.)**
              
              
              
              91362
              ____________________________________
              **(Zip
                code)**





**Issuer’s
      telephone number, including area code**  (818)
      735-4750




Check
      whether the issuer (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.




Yes x No o




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act)




Yes o No x




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




Common
      Stock Outstanding as of February
      10, 2007 was 17,487,254.




Transitional
      Small Business Disclosure Format: Yes o No x





**Explanatory
      Note:**





This
      10-QSB/A is filed to replace the 10-QSB filed on February 20, 2007, which
      inadvertently excluded the final version of the Notes to the Consolidated
      Financial Statements. ****







**PART
      I**


**FINANCIAL
      INFORMATION**


**Page**Item
                1.
            Financial
                StatementsConsolidated
                Balance Sheet as of December 31, 2006 (Unaudited)
            F-4Consolidated
                Statement of Operations for the Three Months Ended December 31, 2006
                and
                2005 (unaudited)
            F-5Consolidated
                Statement of Cash Flows for the Three Months Ended December 31, 2006
                and
                2005 (Unaudited)
            F-6Notes
                to Consolidated Financial Statements (Unaudited)
            F-7Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of Operations
            26Item
                3.
            Controls
                and Procedures
            32




**PART
                II**
              **OTHER
                INFORMATION**







Item
                1.
            Legal
                Proceedings
            32Item
                1A.
            Risk
                Factors
            33Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            39Item
                3.
            Defaults
                Upon Senior Securities
            34Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            39Item
                5.
            Other
                Information
            39Item
                6.
            Exhibits
            40Signatures
            41






3


ITEM
      1 --
      FINANCIAL STATEMENTS




**CONVERGENCE
        ETHANOL, INC. (fka Mems USA, Inc.)**
 **Consolidated
        Balance Sheet**
 **(Unaudited)**
 
 December
                  31, 2006A
                  S S E T SCurrent
                  assets:Cash
                  and cash equivalent
              
              $
              169,306Accounts
                  receivable, net allowance for uncollectible of$144,060
              
              
              1,534,644Inventories,
                  net
              
              
              1,177,066Other
                  current assets
              
              
              730,719Total
                  current assets
              
              
              3,611,735Plant,
                  property and equipment, net
              
              
              2,548,235Other
                  assets
              
              
              721,703Total
                  assets
              
              $
              6,881,673LIABILITIES
                  AND STOCKHOLDERS' DEFICITCurrent
                  liabilities:Accounts
                  payable and accrued expenses
              
              $
              1,667,038Current
                  portion of long-term debt
              
              
              8,044Other
                  liabilities
              
              
              142,812Loans
                  from shareholders
              
              
              103,108Liability
                  to be satisfied through the issuance of shares
              
              
              1,200,375Derivative
                  liability
              
              
              3,953,337Total
                  current liabilities
              
              
              7,074,714Long-term
                  liabilities
              
              
              13,446Liability
                  related to convertible debenture payable
              
              
              876,228Total
                  liabilities
              
              
              7,964,388Minority
                  interests
              
              
              101,125Stockholders'
                  Deficit :Common
                  stock, $0.001 par value; 100,000,000 shares authorized;20,256,938shares
                  issued and outstanding
              
              
              20,257Additional
                  paid in capital
              
              
              19,559,734Accumulated
                  deficit
              
              
              (16,964,274
              )Treasury
                  stock (2,710,436 shares)
              
              
              (3,799,558
              )Total
                  stockholders' deficit
              
              
              (1,183,840
              )Total
                  liabilities and stockholders' deficit
              
              $
              6,881,673




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


F-4


**CONVERGENCE
        ETHANOL, INC. (fka Mems USA, Inc.)**
 **Consolidated
        Statement of Operations**
 **Three
        month periods ended December 31, 2006 and 2005**
 **(Unaudited)**
 
 
 2006
              
              2005Net
                  Revenue
              
              $
              3,947,772
              
              $
              2,626,519Cost
                  of revenue
              
              
              3,281,511
              
              
              2,071,744Gross
                  profit
              
              
              666,261
              
              
              554,775Selling,
                  general and administrative expenses
              
              
              1,387,825
              
              
              1,321,547Loss
                  from operations
              
              
              (721,564
              )
              
              (766,772
              )Other
                  income (expenses)Gain
                  from change in derivative liability
              
              
              543,469
              
              
              -Income
                  due to legal settlement
              
              
              -
              
              
              3,703,634Interest
                  expense
              
              
              (249,869
              )
              
              (35,498
              )Other
                  income (expense)
              
              
              (65,093
              )
              
              12,217Total
                  other income
              
              
              228,507
              
              
              3,680,353Income
                  (loss) before minority interest
              
              
              (493,057
              )
              
              2,913,581Loss
                  attributable to minority interest
              
              
              2,806
              
              
              -Net
                  income (loss)
              
              $
              (490,251
              )
              $
              2,913,581Net
                  income (loss) per share, basic and diluted:Weighted
                  average number of shares outstanding, basic & diluted
              
              
              17,610,368
              
              
              18,439,506Net
                  income (loss) per share, basic & diluted
              
              $
              (0.03
              )
              $
              0.16
   The
        accompanying notes are an integral part of these unaudited consolidated
        financial statements.


F-5




**CONVERGENCE
                    ETHANOL, INC. (fka Mems USA, Inc.)****CONSOLIDATED
                    STATEMENT OF CASH FLOWS****Three
                    Month Periods ended December 31, 2006 &
                    2005****(Unaudited)**
 2006
                
                
                2005Cash
                    flows used for operating activities:Net
                    income (loss)
                
                $
                (490,251
                )
                $
                2,913,581Adjustments
                    to reconcile net income (loss) to net cash used in operating
                    activities:Income
                    due to legal settlement
                
                
                -
                
                
                (3,703,634
                )Depreciation
                    and amortization
                
                
                64,989
                
                
                61,693Stock
                    base compensation, director and employee
                
                
                85,894
                
                
                -Amortization
                    of prepaid loan fees
                
                
                47,864
                
                
                -Amortization
                    of discount on convertible debenture
                
                
                178,593Gain
                    from derivative liability
                
                
                (543,469
                )
                
                -Common
                    stock issued for services
                
                
                6,000
                
                
                10,000Loss
                    attributable to minority interest
                
                
                (2,805
                )Change
                    in assets and liabilities:Accounts
                    receivable
                
                
                (252,646
                )
                
                (186,172
                )Inventories
                
                
                862,622
                
                
                112,176Other
                    current assets
                
                
                287,750
                
                
                72,133Accounts
                    payable and accrued expenses
                
                
                (1,714,428
                )
                
                5,445Other
                    current liabilities
                
                
                63,533
                
                
                -Total
                    adjustments
                
                
                (916,103
                )
                
                (3,628,359
                )Net
                    cash used for operating activities
                
                
                **(1,406,354**
                **)**
                
                **(714,778**
                **)**Cash
                    flows from investing activities:Purchase
                    of property and equipment
                
                
                -
                
                
                (20,769
                )Other
                    assets
                
                
                -
                
                
                24,000Net
                    cash used for investing activities
                
                
                **-**
                
                
                **3,231**Cash
                    flows from financing activities:Proceeds
                    from convertible loan
                
                
                3,177,000
                
                
                -Debts
                    issuance cost
                
                
                (476,370
                )
                
                -Lines
                    of credit
                
                
                (325,114
                )
                
                -Promissory
                    notes payable
                
                
                (365,245
                )
                
                -Current
                    portion of long-term debt
                
                
                (43,860
                )
                
                (30,398
                )Convertible
                    loan
                
                
                (150,000
                )
                
                -Payment
                    due to legal settlement
                
                
                (307,000
                )
                
                -Repayment
                    of loan from shareholders
                
                
                (64,300
                )
                
                20,000Net
                    cash provided by (used in) financing activities
                
                
                **1,445,111**
                
                
                **(10,398**
                **)**Net
                    increase (decrease) in cash and cash equivalents
                
                
                38,756
                
                
                (721,945
                )Cash
                    and cash equivalents, beginning of period
                
                
                130,550
                
                
                828,153Cash
                    and cash equivalents, end of period
                
                **$**
                **169,306**
                
                **$**
                **106,208**Supplemental
                    disclosure of cash flow information:Interest
                    paid
                
                $
                71,276
                
                $
                35,498Income
                    taxes paid
                
                $
                -
                
                $
                -Supplemental
                    disclosure of non-cash financing activities:Common
                    stock issued for finder's fees for HEO property
                
                $
                38,500
                
                $
                -
   The
        accompanying notes are an integral part of these unaudited consolidated
        financial statements.


F-6




**CONVERGENCE
      ETHANOL, INC** . (fka
      MEMS
      USA, Inc.)


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**








**1)           
      Organization and Summary of Significant Accounting
      Policies:**




**Organization**




Convergence
      Ethanol, Inc. formerly known as MEMS USA, Inc. (the “Company” or “we”) has been
      incorporated in November, 2002; The Company changed its name to Convergence
      Ethanol, Inc. in November 2006.  The Company’s mission is to support the
      energy industry in producing cleaner burning fuels. Each of our subsidiaries
      has
      a specific eco-energy focus: (1) development of a woodwaste to bio-renewable
      fuel-grade alcohol/ethanol project (HEO); (2) selling engineered products
      (Bott); and (3) engineering, fabrication and sale of eco-focused energy systems
      (Gulfgate).




**Subsidiaries:**




The
      Company is comprised of three wholly owned subsidiaries, California MEMS USA,
      Inc., a California Corporation (“CA MEMS”), Bott Equipment Company, Inc.
      (“Bott”), a Texas Corporation, and Gulfgate Equipment, Inc. (“Gulfgate”) a Texas
      Corporation, and a majority interest (87%) of Hearst Ethanol One, Inc, a Federal
      Canadian Corporation (“HEO”).




**CA
      Mems**




CA
      MEMS
      engineers, designs and oversees the construction of “Intelligent Filtration
      Systems” (“IFS”) for the gas and oil industry. The Company’s IFS systems are
      fully integrated and are composed of a “Smart Backflush Filtration System” with
      an integral electronic decanting system, a carbon bed filter and an ion-exchange
      resin bed system.




**Bott**




Bott
      is a
      stocking distributor for premier lines of industrial pumps, valves and
      instrumentation. Bott specializes in the construction of aviation refueling
      systems for helicopter refueling on oil rigs throughout the world.  Bott
      and Gulfgate have a combined direct sales force as well as commissioned sales
      representatives that sell their products.




**Gulfgate**




Gulfgate
      engineers, designs, fabricates and commissions eco-focused energy systems
      including particulate filtration equipment for the oil and power
      industries.   Gulfgate also makes and sells vacuum dehydration and
      coalescing systems that remove water from hydrocarbon oils.  Gulfgate
      maintains and operates a rental fleet of filtration and dehydration
      systems.




**HEO
      - Hearst Ethanol One**




In
      December 2005, the Company incorporated Hearst Ethanol One, Inc., a Federal
      Canadian Corporation (“HEO”). Since that time, HEO has acquired 720 acres in
      Hearst, Ontario, Canada together with approximately 1.3 million cubic meters
      of
      woodwaste. The property was purchased to provide the site and the biomass
      material to produce bio-renewable fuel-grade alcohol/ethanol from
      woodwaste.  HEO has obtained construction and zoning permits. The Company
      currently owns 87% of HEO.


F-7


**Fair
      Value of Financial Instruments:**




The
      Company measures its financial assets and liabilities in
      accordance with accounting principles generally accepted in the United
      States of America.  For certain of the Company's financial instruments,
      including accounts receivable (trade and related party), notes receivable
      and accounts payable (trade and related party), and
      accrued expenses, the carrying amounts approximate fair
      value due to their short maturities.




**Use
      of Estimates:**




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




**Concentration
      of Credit Risk:**




The
      Company's financial instruments that are exposed to concentrations of credit
      risk consist primarily of cash and accounts receivable. The Company maintains
      cash with various major financial institutions and performs evaluations of
      the
      relative credit standing of these financial institutions in order to limit
      the
      amount of credit exposure with any institution. The Company extends credit
      to
      customers based upon an evaluation of the customer's financial condition and
      credit history and generally requires no collateral. The Company's customers
      are
      principally located throughout North America, and their ability to pay amounts
      due to the Company may be dependent on the prevailing economic conditions of
      their geographic region. Management performs regular evaluations concerning
      the
      ability of its customers to satisfy their obligations and records a provision
      for doubtful accounts based on these evaluations. The Company's credit losses
      for the periods presented are insignificant and have not significantly exceeded
      management's estimates.




**Cash
      and Cash Equivalents:**




All
      highly liquid investments maturing in three months or less when purchased are
      considered as cash equivalents.




**Accounts
      Receivable:**




In
      the
      normal course of business, the Company provides credit to customers. We monitor
      our customers’ payment history, and perform credit evaluation of their financial
      condition. We maintain adequate reserves for potential credit losses based
      on
      the age of the receivable and specific customer circumstance.




**Inventories:**




Inventories
      are valued at the lower of cost (first-in, first-out) or market value and have
      been reduced by an allowance for excess, slow-moving and obsolete inventories.
      The estimated allowance is based on Management's review of inventories on hand
      compared to historical usage and estimated future usage and sales. Inventories
      under long-term contracts reflect accumulated production costs, factory
      overhead, initial tooling and other related costs less the portion of such
      costs
      charged to cost of sales and any un-liquidated progress payments. In accordance
      with industry practice, costs incurred on contracts in progress include amounts
      relating to programs having production cycles longer than one year, and a
      portion thereof may not be realized within one year.


F-8


**Property
      and Equipment:**




Property
      and equipment are stated at cost. Depreciation of equipment is provided for
      by
      the straight-line method over their estimated useful lives ranging from three
      to
      ten years for equipment and 28 to 30 years for plants.




**Impairment
      of Long-Lived Assets**




The
      Company adopted Statement of Financial Accounting Standards No. 144, "Accounting
      for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which
      addresses financial accounting and reporting for the impairment or disposal
      of
      long-lived assets and supersedes SFAS No. 121,"Accounting for the Impairment
      of
      Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the
      accounting and reporting provisions of APB Opinion No. 30, "Reporting the
      Results of Operations for a Disposal of a Segment of a Business." The Company
      periodically evaluates the carrying value of long-lived assets to be held and
      used in accordance with SFAS 144. SFAS 144 requires impairment losses to be
      recorded on long-lived assets used in operations when indicators of impairment
      are present and the undiscounted cash flows estimated to be generated by those
      assets are less than the assets' carrying amounts. In that event, a loss is
      recognized based on the amount by which the carrying amount exceeds the fair
      market value of the long-lived assets. Loss on long-lived assets to be disposed
      of is determined in a similar manner, except that fair market values are reduced
      for the cost of disposal .




**Accounts
      Payable and accrued expenses:**




Accounts
      payable and accrued expenses includes trade accounts payable of $1,132,980
      for
      the three month periods ended December 31, 2006 and accrued expenses of $534,059
      respectively.




**Revenue
      Recognition:**




The
      Company’s revenue recognition policies are in compliance with Staff accounting
      bulletin (SAB) 104. Sales revenue is recognized at the date of shipment to
      customers when a formal arrangement exists, the price is fixed or determinable,
      the delivery is completed, no other significant obligations of the Company
      exist
      and collectibility is reasonably assured. Payments received before all of the
      relevant criteria for revenue recognition are satisfied are recorded as unearned
      revenue.




**Advertising
      Costs:**




The
      Company expenses the cost of advertising as incurred. The advertising expense
      charged against operations for the three month periods ended December 31, 2006
      and 2005 were $3,798 and $5,561 respectively.




**Income
      Taxes:**




The
      Company accounts for income taxes under the provisions of Statement of Financial
      Accounting Standards No. 109 ("SFAS 109"). Under SFAS 109,
      deferred income tax assets or liabilities are computed based on the temporary
      difference between the financial statement and income tax bases of assets and
      liabilities using the currently enacted marginal income tax rate. Deferred
      income tax expenses or credits are based on the changes in the deferred income
      tax assets or liabilities from period to period. Deferred tax assets may be
      recognized for temporary differences that will result in deductible amounts
      in
      future periods and for loss carry forwards. A valuation allowance is established
      if, based on the weight of available evidence, it is more likely than not that
      some portion or all of the deferred tax asset will not be
      realized.


F-9


**Earnings
      Per Share:**




Basic
      earnings (loss) per share are computed by dividing net income (loss)
      attributable to common stockholders by the weighted average number of common
      shares outstanding. Diluted earnings (loss) per share is computed similar to
      basic earnings (loss) per share except that the denominator is increased to
      include the number of additional shares of common stock that would have been
      outstanding if the potential shares of common stock equivalents had been
      exercised and issued and if the additional common shares were dilutive. Diluted
      earnings per share reflects the potential dilution that could occur if
      securities or other contracts to issue common stock were exercised or converted
      into common stock or resulted in the issuance of common stock that then shared
      in the earnings of the Company. There were 87,919 shares of common stock
      equivalents for the three month period ended December 31, 2006 which were
      excluded because they are not dilutive. Common stock equivalents includes,
      but
      is not limited to warrants, stock options, convertible debentures,
      etc.





**Stock-based
      compensation**





The
      Company adopted SFAS No. 123 (Revised 2004), Share Based Payment (“SFAS
      No. 123R”), under the modified-prospective transition method on
      October 1, 2006. SFAS No. 123R requires companies to measure and
      recognize the cost of employee services received in exchange for an award of
      equity instruments based on the grant-date fair value. Share-based compensation
      recognized under the modified-prospective transition method of SFAS
      No. 123R includes share-based compensation based on the grant-date fair
      value determined in accordance with the original provisions of SFAS
      No. 123, Accounting for Stock-Based Compensation, for all share-based
      payments granted prior to and not yet vested as of October 1, 2006 and
      share-based compensation based on the grant-date fair-value determined in
      accordance with SFAS No. 123R for all share-based payments granted after
      October 1, 2006. SFAS No. 123R eliminates the ability to account for
      the award of these instruments under the intrinsic value method prescribed
      by
      Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock
      Issued to Employees, and allowed under the original provisions of SFAS
      No. 123. Prior to the adoption of SFAS No. 123R, the Company accounted
      for our stock option plans using the intrinsic value method in accordance with
      the provisions of APB Opinion No. 25 and related
      interpretations.





As
      of
      December 31, 2006, the Company has adopted one share-based compensation plan
      which is described below:





**MEMS
      USA, Inc. 2004 Stock Incentive Plan**





The
      MEMS
      USA, Inc. 2004 Stock Incentive Plan, which was approved by the board of
      directors and stockholders, permits the grant of share options to officers,
      directors, employees, and consultants of the Company for up to 1,850,000 shares
      of common stock. The board of directors has the right to amend, suspend or
      terminate the MEMS USA, Inc. 2004 Stock Incentive Plan at any time. Unless
      sooner terminated by the board of directors, the MEMS USA, Inc. 2004 Stock
      Incentive Plan will terminate on December 31, 2007. As of December 31, 2006,
      under the 2004 plan the Company has granted options to purchase 1,297,500 shares
      of common stock under the MEMS USA, Inc. 2004 Incentive Plan, 345,000 of which
      have been forfeited leaving 952,500 outstanding, of which, 587,250 have vested.





F-10


The
      fair
      value of each option and warrant award is estimated on the date of grant using
      the Black-Scholes option-pricing model that uses the assumptions noted in the
      following table. The Black-Scholes option valuation model was developed for
      use
      in estimating the fair value of traded options. In addition, option valuation
      models require the input of highly subjective assumptions including the expected
      stock price volatility. Because the Company’s stock options and warrants have
      characteristics significantly different from those of traded options, and
      because changes in the subjective assumptions can materially affect the fair
      value estimate, in management’s opinion, the existing models do not necessarily
      provide a reliable single measure of the fair value of its stock options and
      warrants. The expected dividend yield assumption is based on the Company’s
      expectation of dividend payouts. Expected volatilities are based on historical
      volatility of the Company’s stock. The average risk-free interest rate is based
      on the U.S. treasury yield curve in effect as of the grant date. The expected
      life is primarily determined using guidance from SAB 107. As such, the expected
      life of the options and warrants is the average of the vesting term and the
      full
      contractual term of the options and warrants. In addition to the assumptions
      in
      the table, the Company applies a forfeiture-rate assumption in its estimate
      of
      fair value that is primarily based on historical annual forfeiture rates of
      the
      Company.





Three
                Months Ended
              December
                31, 2006Expected
                dividend yield
            
            
            0.00%Expected
                volatility
            
            
            92.5%
                to 93.6%Average
                risk-free interest rate
            
            
            4.52%
                to 4.81%Expected
                life (in years)
            
            
            2.5
                to 6





The
      Company did not issue stock options or warrants during the three months ended
      December 31, 2005.





During
      the three months ended December 31, 2006, $163,677 of employee and director
      compensation cost has been recognized from the grant and vesting of options,
      $85,893 of which has been charged against income, and $77,784 of which
      represents the unamortized portion of deferred director compensation cost.
      Deferred director compensation cost is being amortized on a straight-line basis
      over two years.





**Stock
      Options and Warrants Issued to Third Parties for Services**





The
      Company accounts for stock options and warrants issued to third parties for
      services in accordance with the provisions of the Emerging Issues Task Force
      (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to
      Other Than Employees for Acquiring, or in Conjunction with Selling Goods or
      Services”. Under the provisions of EITF 96-18, because none of the Company’s
      agreements have a disincentive for nonperformance, the Company records a charge
      for the fair value of the portion of the stock options and warrants earned
      from
      the point in time when vesting of the stock options and warrants becomes
      probable. Final determination of fair value of the stock options and warrants
      occurs upon actual vesting.





The
      Company did not issue stock options or warrants to third parties for services
      during the three months ended December 31, 2006 and 2005.


F-11


**Stock
      Options Issued to Employees and Directors for Compensation**





Following
      is the Company’s stock option activity during the three months ended December
      31, 2006:





On
      October 1, 2006, the date the Company adopted SFAS 123R, the Company had
      outstanding options to purchase 1,884,358 shares of common stock with officers,
      directors and employees. Of these options, 1,000,000 vested immediately and
      the
      remainder vest over 3 years. The options have exercise prices ranging from
      $0.90
      to $2.70 per share, and expire in 10 years. Of these options, 539,324 were
      unvested on October 1, 2006 with an unrecognized unvested grant date fair value
      of $527,858. During the three months ended December 31, 2006, $328,887 of the
      unrecognized unvested fair value of these options was forfeited, the Company
      recorded officer, director and employee compensation of $71,609 relating to
      these options, and $127,363 remained unrecognized as of December 31, 2006.





On
      October 18, 2006, the Company issued options to purchase 300,000 shares of
      common stock to a director. The options vested upon issuance, have an exercise
      price of $0.51 per share, and expire in 5 years. The fair value of these options
      on the date of grant amounted to $86,829, was recorded as deferred director
      compensation, and is being amortized over two years on the straight-line method.
      Amortization of this deferred director compensation amounted to $9,045 during
      the three months ended December 31, 2006. The unamortized deferred director
      compensation amounted to $77,784 at December 31, 2006.





On
      November 1, 2006, the Company issued options to purchase 300,000 shares of
      common stock to an officer. The options vest over 3 years, have an exercise
      price of $0.45 per share, expire in 10 years, and also vest the day before
      any
      merger or acquisition of more than 50% of the Company’s capital stock, or the
      purchase of substantially all of the Company’s assets, by a third-party. The
      fair value of these options on the date of grant amounted to $104,792 and is
      being recognized on a straight-line basis over the requisite service period.
      The
      Company recorded officer compensation of $5,240 relating to these options during
      the three months ended December 31, 2006.





The
      Company did not issue stock options to employees and directors for compensation
      during the three months ended December 31, 2005.





Prior
      to
      October 1, 2006, the Company accounted for its stock options in accordance
      with
      the intrinsic value provisions of Accounting Principles Board Opinion No. 25,
      “Accounting for Stock Issued to Employees” (“APB 25”). Under APB 25, the
      difference between the quoted market price as of the date of grant and the
      contractual purchase price of shares was recognized as compensation expense
      over
      the vesting period on a straight-line basis. The Company did not recognize
      compensation expense in its consolidated financial statements for stock options
      as the exercise price was not less than 100% of the fair value of the underlying
      common stock on the date of grant.





The
      following table illustrates the effect on net income and net income per share
      had the Company recognized compensation expense consistent with the fair value
      provisions of SFAS No. 123 “Accounting for Stock-Based Compensation”, as amended
      by SFAS 148 “Accounting for Stock-Based Compensation Transaction and Disclosure
      - An Amendment to SFAS 123, prior to the adoption of SFAS 123R:


F-12





Three
                Months Ended
              December
                31,
              2005Net
                income, as reported
            
            
            
            
            $
            2,913,581Deduct:
                Total stock-based employee compensation expenses determined under
                the fair
                value Black-Scholes method with a 128% volatility at December 31,
                2005 and
                a 6% risk free rate of return assumption
            
            
            
            
            
            (175,664
            )Pro
                forma net income
            $
            2,737,917Income
                per share:Weighted
                average shares, basic
            
            
            
            
            
            18,439,506Basic,
                pro forma, per share
            
            
            
            
            $
            0.15Weighted
                average shares, diluted
            
            
            
            
            
            19,131,642Diluted,
                pro forma, per share
            
            
            
            
            $
            0.14





A
      summary
      of option activity relating to employee and director compensation as of December
      31, 2006, and changes during the three months then ended is presented
      below:




Options
            
            
            Shares
            
            
            Weighted-
              Average
              Exercise
                Price
            
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
            
            
            Aggregate
              Intrinsic
              ValueOutstanding
                at October 1, 2006
            
            
            1,884,358
            
            $
            1.85
            
            
            
            
            $
            20,000Granted
            
            
            600,000
            
            
            .48
            
            
            
            
            
            -Exercised
            
            
            -
            
            
            -
            
            
            
            
            
            -Forfeited
            
            
            (345,000
            )
            
            1.50
            
            
            
            
            
            -Converted
            
            
            -
            
            
            -
            
            
            
            
            
            -Expired
            
            
            -
            
            
            -
            
            
            
            
            
            -Canceled
            
            
            -
            
            
            -
            
            
            
            
            
            -Outstanding
                at December 31, 2006
            
            
            2,139,358
            
            $
            1.52
            
            
            7.60
            
            $
            132,000Exercisable
                at December 31, 2006
            
            
            1,758,696
            
            $
            1.65
            
            
            7.25
            
            $
            64,500




A
      summary
      of the status of the Company’s non-vested option shares relating to employee and
      director compensation as of December 31, 2006, and changes during the three
      months then ended is presented below:




Non-vested
                Options
            
            
            Shares
            
            
            Weighted-Average
              Grant-Date
              Fair
                ValueNon-vested
                at October 1, 2006
            
            
            539,324
            
            $
            1.25Granted
            
            
            300,000
            
            $
            0.35Vested
            
            
            (143,662
            )
            $
            1.16Forfeited
            
            
            (315,000
            )
            $
            1.09Non-vested
                at December 31, 2006
            
            
            380,662
            
            $
            0.70





As
      of
      December 31, 2006, there was approximately $227,000 of total unrecognized
      compensation cost related to non-vested option share-based compensation
      arrangements. Of the amount, $133,000 is expected to be recognized throughout
      the remainder of fiscal year ending September 30, 2007, and $49,000 and $45,000
      is expected to be recognized throughout fiscal years ending September 30, 2008
      and 2009, respectively.


F-13


A
      summary
      of warrant activity relating to compensation to consultants as of December
      31,
      2006, and changes during the three months then ended is presented
      below:




Warrants
            
            
            Shares
            
            
            Weighted-
              Average
              Exercise
                Price
            
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
            
            
            Aggregate
              Intrinsic
              ValueOutstanding
                at October 1, 2006
            
            
            822,000
            
            $
            2.61
            
            
            
            
            $
            -Granted
            
            
            -
            
            $
            -
            
            
            
            
            
            -Exercised
            
            
            -
            
            $
            -
            
            
            
            
            
            -Forfeited
            
            
            -
            
            $
            -
            
            
            
            
            
            -Converted
            
            
            -
            
            $
            -
            
            
            
            
            
            -Expired
            
            
            -
            
            $
            -
            
            
            
            
            
            -Canceled
            
            
            -
            
            $
            -
            
            
            
            
            
            -Outstanding
                at December 31, 2006
            
            
            822,000
            
            $
            2.61
            
            
            2.13
            
            $
            -Exercisable
                at December 31, 2006
            
            
            822,000
            
            $
            2.61
            
            
            2.13
            
            $
            -





All
      of
      the Company’s warrants were fully vested as of October 1, 2006.





**Interim
      Financial Statements:**





The
      accompanying unaudited consolidated financial statements for the three months
      ended December 31, 2006 and 2005 include all adjustments (consisting of only
      normal recurring accruals), which, in the opinion of management, are necessary
      for a fair presentation of the results of operations for the periods presented.
      Interim results are not necessarily indicative of the results to be expected
      for
      a full year. These unaudited consolidated financial statements should be read
      in
      conjunction with the audited consolidated financial statements for the year
      ended September 30, 2006 included in the Company’s 2006 Annual
      Report.





**Going
      Concern:**




The
      accompanying financial statements have been prepared in conformity with
      accounting principles generally accepted in the United States of America, which
      contemplates the Company as a going concern. However, the Company has sustained
      net losses of $16,964,274 and has used substantial amounts of working capital
      in
      its operations. Realization of a major portion of the assets reflected on
      the accompanying balance sheet is dependent upon continued operations of the
      Company which, in turn, is dependent upon the Company's ability to meet its
      financing requirements and succeed in its future operations. Management believes
      that actions presently being taken to revise the Company's operating and
      financial requirements provide them with the opportunity for the Company to
      continue as a going concern. We will continue to raise additional cash through
      debt or equity financings in 2007 in order to meet our working capital
      requirements.




**Derivative
      Instruments**





In
      June
      1998, the Financial Accounting Standards Board issued SFAS No. 133, “Accounting
      for Derivative Instruments and Hedging Activities.” SFAS No. 133, as amended by
      SFAS No. 137, is effective for fiscal years beginning after June 15, 2000.
      SFAS
      No. 133 requires the Company to recognize all derivatives as either assets
      or
      liabilities and measure those instruments at fair value. It further provides
      criteria for derivative instruments to be designated as fair value, cash flow
      and foreign currency hedges and establishes respective accounting standards
      for
      reporting changes in the fair value of the derivative instruments. After
      adoption, the Company is required to adjust hedging instruments to fair value
      in
      the balance sheet and recognize the offsetting gains or losses as adjustments
      to
      be reported in net income or other comprehensive income, as appropriate.


F-14


**Reclassifications**




Certain
      reclassifications have been made to prior year amounts to conform to the current
      year presentation. These changes had no effect on reported financial positions
      or results of operations.




**Recent
      Accounting Pronouncements:**




In
      September 2006, FASB issued SFAS 158 Employers Accounting for Defined Benefit
      Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87,
      88, 106, and 132(R). This Statement improves financial reporting by requiring
      an
      employer to recognize the over-funded or under-funded status of a defined
      benefit postretirement plan (other than a multiemployer plan) as an asset or
      liability in its statement of financial position and to recognize changes in
      that funded status in the year in which the changes occur through comprehensive
      income of a business entity or changes in unrestricted net assets of a
      not-for-profit organization. This Statement also improves financial reporting
      by
      requiring an employer to measure the funded status of a plan as of the date
      of
      its year-end statement of financial position, with limited exceptions An
      employer with publicly traded equity securities is required to initially
      recognize the funded status of a defined benefit postretirement plan and to
      provide the required disclosures as of the end of the fiscal year ending after
      December 15, 2006. An employer without publicly traded equity securities is
      required to recognize the funded status of a defined benefit postretirement
      plan
      and to provide the required disclosures as of the end of the fiscal year ending
      after June 15, 2007. However, an employer without publicly traded equity
      securities is required to disclose the following information in the notes to
      financial statements for a fiscal year ending after December 15, 2006, but
      before June 16, 2007, unless it has applied the recognition provisions of this
      Statement in preparing those financial statements. The disclosures include
      a
      brief description of the provisions of this Statement; the date that adoption
      is
      required; and the date the employer plans to adopt the recognition provisions
      of
      this Statement, if earlier.




This
      statement is effective for fiscal year ending after December 15, 2008 Management
      has not determined the effect if any, the adoption of this statement will have
      on the financial statements.




**(2)         
       Investments in Hearst Ethanol One, Inc.:**




**Hearst
      Ethanol One Inc. Agreement:**




In
      December 2005, the Company incorporated Hearst Ethanol One, Inc., a Federal
      Canadian Corporation (“HEO”). On April 21, 2006 the Company completed the
      acquisition of 720 acres of real property, together with all biomass material
      located thereon. The site is located in the Township of Kendall, District of
      Cochrane, Canada, The property was purchased from C. Villeneuve Construction
      Co.
      LTD., a Canadian Corporation to provide the site and the biomass material for
      the construction and operation of bio-renewable woodwaste-to-fuel-grade
      alcohol/ethanol refinery to be owned by HEO.




Pursuant
      to the provisions of the Agreement, HEO issued ten point five percent (10.5%)
      of
      HEO’s common shares to Villeneuve as consideration for the transfer of the
      Property. At the close of the transaction, the Company owned 87% of the common
      stock of HEO.




Pursuant
      to a Memorandum of Understanding entered into on April 20, 2006 between HEO
      and
      Villeneuve to clarify the Agreement, Villeneuve shall be entitled to appoint
      one
      member of HEO’s board of directors for so long as Villeneuve is at least a ten
      percent (10%) shareholder of HEO.


F-15


**Hearst
      Ethanol One Inc. Valuation:**




The
      valuation based on the residual property valuation of the land is $253,070,
      building $88,574, raw material (mature timber) of $647,953 and Forest Waste
      Disposal license Bond $67,780. Also included in the valuation was the residual
      value of the biomass on the HEO site of US$11,461,362.




The
      other
      tangible and intangible assets owned by HEO include: a small rock quarry (and
      associated mineral rights) on the property, as well as a landfill license and
      permits as issued by the Government of Ontario Ministry of the Environment
      (“MOE”).




**Writing
      off Inventory:**





During
      the fourth quarter of last year the company wrote off the value of HEO’s
      inventory to a nominal amount. After conducting an asset evaluation review
      it
      was determined that no known market for the materials other than utilization
      in
      the Company’s planned manufacturing facility currently exists.




At
      September 30, 2006, HEO’s inventory with a gross value of US $11,461,362 was
      fully written off.





**(3** **)          
      Business Acquisition:**




On
      October 26, 2004 (“Closing Date”), effective October 1, 2004, the Company
      purchased 100% of the outstanding shares of two Texas corporations, Bott
      Equipment Company, Inc. (“Bott”) and Gulfgate Equipment, Inc. (“Gulfgate”) from
      their president and sole shareholder, Mr. Mark Trumble.




Under
      the
      terms of the stock purchase agreement, the Company acquired 100% of the shares
      of Bott and Gulfgate from Mr. Trumble for $50,000 in cash and 1,309,677 shares
      of the Company’s newly issued common stock.




The
      Company also agreed, to raise $2,000,000 in gross equity funding within 120
      days
      of the Closing Date. The Company failed to achieve this milestone and issued
      Trumble an additional 123,659 shares of its restricted stock




During
      the first quarter of fiscal year 2005, the Company, in order to avoid the
      issuance of 61,829 penalty shares, paid $75,000 directly to Mr. Trumble. As
      of
      the date of this report the Company has received approximately $39,000 of the
      $75,000 from Mr. Weisdorn Sr. The Company has recorded this payment as a
      reduction to additional paid-in capital.




On
      December 15, 2005, the Company assumed Weisdorn Sr.’s obligation to purchase
      165,054 shares from Mr. Trumble at $1.86 per share.




**First
      amended stock purchase agreement with Mark Trumble**




Effective
      May 8, 2006, the Company and its officers entered into a First Amended Stock
      Purchase Agreement and Release (“Agreement”) with Mark Trumble, amending that
      certain Stock Purchase Agreement dated September 1, 2004 (the “SPA”), pursuant
      to which the parties agreed to, among other things, Trumble agreed to release
      the Company from its obligations under the put, including any obligation to
      make
      the interest payment or to pay interest on any sum whatsoever, and release
      any
      security interest he claims in the real estate owned by Gulfgate and/or Bott,
      and the Company, within 60 days, shall secure a funding commitment in which
      Trumble shall be paid the sum of $307,000 at the time of the closing of the
      funding. This sum shall be used to purchase 165,053 shares of the common stock
      of the Company from Trumble at the price of $1.86 per share. The Company shall
      also pay from the funding all amounts of bank or other indebtedness owed by
      the
      Company, Bott or Gulfgate, which is personally guaranteed by Trumble. The
      Company shall issue Trumble, upon closing of the funding, 60,000 shares of
      the
      Company’s common stock. This additional issuance of shares of the common stock
      of the Company shall be in full and final satisfaction of all claims that
      Trumble has or may have to additional shares of the Company’s common stock as a
      result of any breach of, or failure to meet a milestone under, the
      SPA.


F-16


**(4)          
      Accounts Receivable:**




Accounts
      receivable has been reduced by an allowance for amounts that may become
      uncollectible. This estimated allowance is based primarily on Management's
      evaluation of the financial condition of the customer and historical bad debt
      experience. The Company has provided reserves for doubtful accounts as of
      December 31, 2006 in the amount of $144,060  that the Company believes
      are adequate.




**(5)          
      Inventories:**




Inventories
      consist of finished goods of $568,070, raw material of mature timber of
      $647,953, and work in process in the amount of $362,497 at December 31, 2006.
      The inventory reserves in the books is $401,454.




**(6)          
      Plant, Property and Equipment** :




A
      summary
      at December 31, 2006 are as follows:




Land
            
            $
            817,108Buildings
                and improvements
            
            
            1,244,453Furniture,
                Machinery and equipment
            
            
            1,025,414Automobiles
                and trucks
            
            
            47,5083,134,483Less
                accumulated depreciation
            
            
            (586,248
            )$
            2,548,235




Depreciation
      expense charged to operations totaled $64,989 and $61,693 respectively, for
      the
      three months ended December 31, 2006 and 2005.




We
      evaluate impairment of long-lived assets in accordance with SFAS No. 144, *Accounting
      for the Impairment or Disposal of Long-Lived Assets.* We
      assess
      the impairment of long-lived assets, including property and equipment and
      purchased intangibles subject to amortization, when our review of events, or
      changes in circumstances suggest the fair value of assets could be less then
      their net book value. In such event, we would assess long-lived assets for
      impairment by determining their fair value based on the forecasted, undiscounted
      cash flows the assets are expected to generate plus the net proceeds expected
      from the sale of the asset. An impairment loss would be recognized when the
      fair
      value is less than the related asset’s net book value, and an impairment expense
      would be recorded in the amount of the difference. Forecasts of future cash
      flows are judgments based on our experience and knowledge of our operations
      and
      the industries in which we operate. These forecasts could be significantly
      affected by future changes in market conditions, the economic environment,
      and
      capital spending decisions of our customers and inflation. We have not
      recognized any impairment losses on long-lived assets for the period ended
      December 31, 2006.




**(7)          
      Business Lines of Credits - Bott:**




Bott
      previously maintained three lines of credits with a bank in Houston, Texas.
      The
      credit lines were evidenced by three promissory notes, a Business Loan Agreement
      and certain commercial guarantees issued in favor of the bank.


F-17


In
      May
      2004, Bott entered into a promissory note with a bank whereby Bott could borrow
      up to $250,000 over a three year term. The note required monthly payments of
      one
      thirty-sixth (1/36) of the outstanding principal balance plus accrued interest
      at the Bank's prime rate plus 1.0 percent.




In
      June
      2004, Bott executed a promissory note ("Note") with a bank whereby Bott could
      borrow up to $600,000, at an interest rate equal to the bank's prime rate.
      The
      Note provided for monthly payments of all accrued unpaid interest due as of
      the
      date of each payment. The Note further provided for a balloon payment of all
      principal and interest outstanding on the Note's one year anniversary The
      Company informed the bank that it would not renew the line of credit and
      negotiated a long-term promissory note.




This
      replacement promissory note was finalized in December 2005, for $372,012 at
      a
      variable interest rate equal to the bank's prime rate. The note provides for
      five monthly principal payments of $3,092 and a final payment of the remaining
      principal and interest in June 2006.




The
      Agreements and Notes are secured by the inventory, chattel paper, accounts
      receivable and general intangibles. The Agreements and Notes are also secured
      by
      the personal performance guarantees of certain executives of the
      Company (Commercial Guarantees). All amounts related to Bott’s outstanding
      promissory notes totaled $496,877 on September 30, 2006 and were paid in
      full on October 31, 2006.




**(8)          
      Business Line of Credit - Gulfgate:**




In
      June
      2002, Gulfgate executed a promissory note (“Note”) with a bank that allowed
      Gulfgate to borrow up to $200,000 at an interest rate equal to the bank’s prime
      rate, or a minimum interest rate of 5.00% per annum, whichever was greater.
      The
      Note provided for monthly payments of all accrued unpaid interest due as of
      the
      date of each payment. The Note remains in force and effect until the bank
      provides notice to Gulfgate that no additional withdrawals are permitted (Final
      Availability Date). Thereafter, payments equal to either $250 or the outstanding
      interest plus one percent of the outstanding principal as of the Final
      Availability Date are due monthly until the Note is repaid in full. The Note
      allows for prepayment of all or part of the outstanding principal or interest
      without penalty. The Note is secured by Gulfgate’s accounts with the bank, and
      by Gulfgate’s inventory, chattel paper, accounts receivable, and general
      intangibles. The Agreement is also secured by the performance guarantees of
      Mr.
      Mark Trumble, Mr. Lawrence Weisdorn and the Company. Amounts outstanding at
      September 30, 2006 totaled $171,539 and were paid in full on October 31,
      2006.




**(9)          
      Liability to be satisfied through the issuance of
      shares**




As
      of
      December 31, 2006, the Company incurred a liability for stock subscribed in
      the
      amount of $1,200,376.  The Company sold 670,000 shares of its common stock
      for $1,005,000 via a private placement offering through SW Bach & Company, a
      New York securities dealer.  The Company anticipates satisfying its private
      placement obligations through issuance of common stock to shareholders as soon
      as the Company completes its SB-2 registration with the Securities &
Exchange Commission.




The
      Company sold 277,978 shares of its common stock for $180,000 via another private
      placement offering from June through August 2006. The balance of the liability
      ($15,376 / 12,298 shares) was for services rendered during 2006. The Company
      intends to satisfy these obligations through issuance of common stock to
      shareholders in February 2007.


F-18


**(10)        
      Long-Term Debts:**




**Promissory
      Notes:**




In
      May
      2003, Bott executed a promissory note with a bank in the amount of $26,398
      at an
      interest rate equals to four point fifty five percent (4.55%) for a vehicle
      purchase. The term of the note is for fifty-nine (59) months at $494 per month.
      Balance outstanding at September 30, 2006 was $10,143 and was paid in full
      on
      October 31, 2006.




**Mortgage:**




On
      May
      31, 2002, Gulfgate entered into a $140,000 promissory note (“Note”) with a bank
      in connection with the refinancing of Gulfgate’s real estate.   The
      Note bears a fixed interest rate of seven percent (7.00%) per annum.  
The Loan provided for fifty-nine monthly payments of $1,267 due beginning July
      2002 and ending June 2007.  The Note may be prepaid without fee or penalty
      and is secured by a deed of trust on Gulfgate’s realty.   Balance
      outstanding at September 30, 2006 was $19,724 and was fully paid for on October
      31, 2006.




**Loans
      from shareholders:**




At
      December 31, 2006 the Company owes James A. Latty, President, CEO and Chairman,
      the sum of $91,534 in loan and accrued interest. The Company also owes Mr.
      Latty
      reimbursement for business travel expenses of $11,574. .





In
      September 2005, Daniel K. Moscaritolo, then COO and Director, and James A.
      Latty, CEO and Chairman, (“Lenders”) each loaned the Company, $95,800
      (collectively, $191,600). The transactions are evidenced by two notes dated
      November 1, 2005 (hereinafter, “Notes”). The terms of the Notes require
      repayment of the principal and interest, which accrues at a rate of ten percent
      (10%) per annum on May 1, 2006. The Notes are accompanied by Security Agreements
      that grant the Lenders a security interest in all personal property belonging
      to
      the Company, as well as granting an undivided 1⁄2 security interest in all of the
      Company’s right title and interest to any trademarks, trade names, contract
      rights, and leasehold interests. Balance outstanding at September 30, 2006
      was
      $147,163. The interest recorded was $17,563 for the year ended September 30,
      2006.





On
      October 31, 2006 the Company paid Mr. Daniel Moscaritolo a sum of $54,358 of
      which $8,558 was for accrued interest. As of October 31, 2006 Mr. Moscaritiolo’s
      loan was paid in full.





**Convertible
      Loan Payable:**




**A.**
            **Securities
                Purchase Agreement with an Individual
                Investor:**





In
      September 2004, the Company entered into a convertible loan with an investor.
      The principal amount of the convertible loan payable is $150,000 at an interest
      rate of 8% per annum paid quarterly. The loan is convertible into common stock
      at any time within two (2) years (24 months) starting September 3, 2004 at
      the
      conversion price of $2.20 or 68,182 shares. Each share converted entitles the
      holder to purchase one additional share of stock at an exercise price of $3.30
      within the ensuing 12 months.




The
      loan
      plus accrued interest was paid in full on October 31, 2006.


F-19


**B.  
      Securities Purchase Agreement with GCA Strategic Investment Fund
      Limited:**




On
      October 31, 2006, the Company closed its Securities Purchase Agreement (the
      “Agreement”) with GCA Strategic Investment Fund Limited (“Purchaser”). The
      Company issued a $3,530,000 Convertible Note due October 31, 2009 (the “Note”),
      and the purchase price of the Note was $3,177,000 (ninety per cent of the
      principal amount of the Note). The Note does not bear interest except upon
      an
      event of default, at which time interest shall accrue at the rate of 18% per
      annum.





Security-The
      Note is secured by a first security position in all assets of the Company and
      its subsidiaries, Bott Equipment Company, Inc., a Texas corporation, and
      Gulfgate Equipment, Inc., in their inventory, equipment, furniture and fixtures,
      rental fleet equipment and any other of their assets wherever located except
      accounts receivable and assets solely attributable to their alternative fuel
      projects.




Registration
      Rights-The Company agreed to use its best efforts to file a registration
      statement to register the resale of the common shares issuable upon the
      conversion of the Note and exercise of the warrants (the “Conversion Shares”) by
      December 31, 2006. The Company will also use its best efforts to cause the
      registration statement to become effective within by January 31, 2007 If the
      registration statement is not timely filed, the Company owes Purchaser
      liquidated damages in the amount of 1% of the principal amount of the then
      outstanding balance due under the Note for each 60-day period, prorated, until
      the registration statement is filed. If the registration statement is not
      declared effective within such 90 day period, the Company will owe Purchaser
      liquidated damages in the amount of 2% of the principal amount of the then
      outstanding balance of the Note for each 30-day period, prorated, until the
      registration statement is declared effective.




Conversion
      Price: The Note may be converted into Company's common shares. The conversion
      price will be 85% of the trading volume weighted average price, as reported
      by
      Bloomberg LP (the “VWAP”), for the five trading days immediately prior to the
      date of notice of conversion. During the first 30 days after the registration
      statement is effective registration the conversion price will not be less than
      $0.47 (the “Floor Conversion Price”), nor greater than $061 (the “Ceiling
      Conversion Price”). For the ninety (90) day period following the Initial Pricing
      Period and each successive ninety (90) day period thereafter (each a “Reset
      Period”), the Floor Conversion Price shall be reduced by an amount equal to 40%
      of the lesser of (i) the Floor Conversion Price or (ii) the Closing Bid Price
      as
      reported by Bloomberg on the trading day immediately following the Initial
      Pricing Period or Reset Period, as the case may be, and the Ceiling Conversion
      Price shall be increased by an amount equal to 40% of the lesser of (y) the
      current Ceiling Conversion Price or (z) the closing bid price as reported by
      Bloomberg on the trading day immediately following the Initial Pricing Period
      or
      Reset Period as the case may be.




Prepayment-For
      so long as Company is not in default and Company is not in receipt of
      a notice of conversion from the holder of the Note, Company may, at its
      option, prepay, in whole or in part, this Convertible Note for a pre-payment
      price (the “Prepayment Price”) equal to the greater of (i) 110% of the
      outstanding principal amount of the Note plus all accrued and unpaid interest
      if
      any, and any outstanding liquidated damages, if any, or (ii) (x) the number
      of Company's common shares into which the Notes is then convertible, times
      (y) the average VWAP of Company's common shares for the five (5) trading
      days immediately prior to the date that the Note is called for redemption,
      plus
      accrued and unpaid interest.




Redemption-The
      Company may be required under certain circumstances to redeem any
      outstanding balance of the Note and the warrants. The redemption price under
      these circumstances of the outstanding balance due under the Note is equal
      to
      the greater of: (i) the Prepayment Price or (ii) (x) the number of Company's
      common shares into which the unpaid balance due under the Note is then
      convertible, times (y) the five (5) day VWAP price of Company's common shares
      for the five trading days immediately prior to the date that the unpaid balance
      due under the Note is called for redemption, plus accrued and unpaid interest,
      if any.


F-20


Warrant-The
      Company issued warrants to purchase 1,000,000 shares of its common stock. These
      warrants are callable if the common stock trades at a price equal to 200% of
      the
      strike price of the warrants based on any consecutive five day trading average
      VWAP value. The warrants have a term of five years and an exercise price of
      $0.66 (120% of the average five day VWAP price for Company's common stock
      for the five trading days immediately prior to October 31, 2006).




Company paid
      an application fee to Global Capital Advisors, LLC (“Adviser”), Purchaser's
      adviser, from the proceeds of the funding in an amount equal to one percent
      of
      the funding, excluding warrants. Additionally, Company issued to Adviser on
      warrant to purchase 500,000 shares of Company's common stock. These
      warrants have a term of five years and have an initial fixed exercise price
      of $0.66 (120% of the five day VWAP for the five trading days immediately prior
      to October 31, 2006).




The
      proceeds received from this agreement were used to pay off all notes payable
      to
      third party listed under Footnotes 9, 10 and 12. Major disbursements included
      three notes payable to a bank (Notes 9 and 10) totaling $668,030; auto and
      property loans totaling $40,561; convertible loan $150,000; and $307,000 related
      to the First
      amended stock purchase agreement with Mark Trumble (Note
      3) ,
      and
      Daniel Moscaritolo.





Per
      EITF
      00-19, paragraph 4, these convertible debentures do not meet the definition
      of a
“conventional convertible debt instrument” since the debt is not convertible
      into a fixed number of shares. The debt can be converted into common stock
      at a
      conversions price that is a percentage of the market price; therefore the number
      of shares that could be required to be delivered upon “net-share settlement” is
      essentially indeterminate. Therefore, the convertible debenture is considered
      “non-conventional,” which means that the conversion feature must be bifurcated
      from the debt and shown as a separate derivative liability. This beneficial
      conversion liability has been calculated to be $2,254,258 at December 31, 2006.
      In addition, since the convertible debenture is convertible into an
      indeterminate number of shares of common stock, it is assumed that the Company
      could never have enough authorized and unissued shares to settle the conversion
      of the warrants into common stock. Therefore, the warrants issued in connection
      with this transaction have been reported as a liability at December 31, 2006
      in
      the accompanying balance sheet with a fair value of $1,076,138. The value of
      the
      warrant was calculated using the Black-Scholes model using the following
      assumptions: Discount rate of 4.64%, volatility of 93.54% and expected term
      of
      five year. The redemption liability was $622,941 as at December 31, 2006. The
      fair value of the beneficial conversion feature, redemption liability and the
      warrant liability will be adjusted to fair value each balance sheet date with
      the change being shown as a component of net income.





The
      fair
      value of the beneficial conversion feature and the warrants at the inception
      of
      these convertible debentures were $2,414,852 and $406,229, respectively.
      $2,821,081 has been recorded as a discount to the convertible debentures which
      will be amortized over the term of the debentures.





Principal
      payments on these convertible debentures are as follows:





Year
                ending September 30,2007
            
            $
            -0-2008
            
            
            -0-2009
            
            
            -0-2010
            
            
            3,530,000$
            3,530,000


F-21


**(11)**  **Warrants:**




Warrants
                outstanding as of December 31, 2006 are as
                follows:




Wt
                AvgWarrants
            
            Exercise
                PriceOutstanding
                as of October 1, 2006
            
            $
            1,569,262
            
            $
            2.39Granted
            
            
            1,561,729
            
            $
            0.66Exercised
            
            
            -Forfeited
            
            
            -Outstanding
                as of December 31, 2006
            
            $
            3,130,991
            
            $
            1.53







Outstanding
            ExercisableWeighted
            Weighted
            
            WeightedPrice
                range:
            Warrants
            Price
            Life
            Warrants
            Price
            Weighted
                Life$0.61-$3.75
            3,130,991
            1.53
            3.74
            3,130,991
            1.53
            3.74Total
            3,130,991
            1.53
            3.74
            3,130,991
            1.53
            3.74





All
      of
      the Company’s warrants were fully vested as of October 1, 2006.





**(12)        
      Stockholders’ Equity**




On
      November 10, 2005, the Company entered into a stock purchase agreement with
      Mercatus & Partners, Limited, a private limited company of the United
      Kingdom (“Mercatus Limited”), for the sale of 1,530,000 shares of the Company’s
      common stock for a minimum purchase price of $0.73 per share (the “SICAV One
      Agreement), and another stock purchase agreement with Mercatus Limited also
      for
      the sale of 1,530,000 shares of the Company’s common stock for a minimum
      purchase price of $0.73 per share (the “SICAV Two Agreement” and together with
      the SICAV One Agreement, the “SICAV Agreements”). The shares offered and sold
      under the SICAV Agreements were offered and sold pursuant to a private placement
      that is exempt from the registration provisions of the Securities Act under
      Section 4(2) of the Securities Act pursuant to Mercatus Limited’s exemption from
      registration afforded by Regulation S. Pursuant to the terms of the SICAV
      Agreements, the Company issued and delivered an aggregate number of 3,060,000
      shares of the Company’s common stock within five days of the execution of the
      respective SICAV Agreements to a custodial lock box on behalf of Mercatus
      Limited for placement into two European SICAV funds. The SICAV Agreements
      provided Mercatus Limited with up to 30 days after the delivery of the shares
      of
      the Company’s common stock to issue payment to the Company. If payment for the
      shares was not received by the Company within 30 days of the delivery of the
      shares, the Company had the right to demand the issued shares be returned.


F-22


On
      November 12, 2005, the Company also entered into another private stock purchase
      agreement with Mercatus & Partners, Limited, a private limited company of
      the United Kingdom (“Mercatus Limited”) for the sale of 170,000 shares of the
      Company’s common stock for a minimum purchase price of $0.82 per share (the
“Private SICAV One Agreement”) and another private stock purchase agreement with
      Mercatus LP also for the sale 170,000 shares of the Company’s common stock for a
      minimum purchase price of $0.82 per share (the “Private SICAV Two Agreement” and
      with the Private SICAV One Agreement, the “Private SICAV Agreements”). The
      shares offered and sold under the SICAV Agreements were offered and sold
      pursuant to a private placement that is exempt from the registration provisions
      of the Securities Act under Section 4(2) of the Securities Act pursuant to
      Mercatus Limited’s exemption from registration afforded by Regulation S.
      Pursuant to the terms of the Private SICAV Agreements, the Company issued and
      delivered an aggregate amount of 340,000 shares of the Company’s common stock
      within five days of the execution of the respective Private SICAV Agreements
      to
      a custodial lock box on behalf of Mercatus Limited for placement into a European
      bank SICAV fund. Subject to a valuation of the shares, Mercatus LP had up to
      30
      days after the delivery of the shares of the Company’s common stock to issue
      payment to the Company. If payment was not received by the Company within 45
      days of the issuance of the shares to Mercatus Limited, the Company had the
      right to demand the issued shares be returned.




In
      a
      letter to Mercatus dated April 13, 2006 the Company declared Mercatus to be
      in
      material breach of the above Private Purchase Agreements due to non-payment,
      terminated the Agreements in their entirety and exercised its right to demand
      the return of all the shares. All 3,400,000 shares were returned to the
      Company’s treasury in August 2006.




On
      December 13, 2005 the Company issued and delivered 125,000 shares of the
      Company’s common stock for $100,000.





During
      the month of December 2005, the Company issued and delivered an aggregate amount
      of 8,254 shares of the Company’s common stock to three consultants for services
      valued at approximately $16,000.





During
      the month of October 2006, the Company issued and delivered 70,000 shares of
      the
      Company’s common stock to one consultant for services valued at approximately
      $38,500.




**(13)        
      Legal settlement:**




On
      December 15, 2005, the Company and its officers entered into a Settlement
      Agreement and Release with the Weisdorn Parties and other Weisdorn related
      parties, effective as of July 1, 2005 (the “Settlement Agreement”), pursuant to
      which the Weisdorn Parties and other Weisdorn related Parties agreed to deliver
      to the Company all shares or rights to shares of the Company’s common stock
      owned by such parties. The net common stock returned to the Company by the
      Weisdorn parties and other Weisdorn related parties was 2,699,684 shares.




The
      fair
      value of 2,669,684 shares of the Company’s common stock at December 15, 2005 was
      $3,779,558. The per share closing price of the Company’s stock at December 15,
      2005 was $1.40.




**(14)        
      Assignment of the Trumble Claims:**




The
      Company and the Weisdorn Parties further agreed the Weisdorn Parties, and each
      of them; assigned to the Company any and all rights or interest they, or any
      of
      them, have in or to the Trumble Claims. On December 15, 2005, the Company
      assumed Weisdorn Sr.’s obligation to purchase 165,054 shares from Mr. Trumble at
      $1.86 per share for a total liability of $307,000. The fair value of this
      obligation at December 15, 2005 is $231,076 (165,054 shares at $1.40 per share)
      with the difference charged to other income ($75,924). This liability was paid
      in full as of December 31, 2006.


F-23


**(15)**
            **Commitments
                :**





The
      fees
      payable to the Director of the company is as follows:




For
                the year ended September 30,2007
            
            $
            44,0002008
            
            $
            48,0002009
            
            $
            48,000





**(16)       
      Amendments to Articles of Incorporation and Bylaws**




On
      December 5, 2006, the Company filed Articles of Merger with the Secretary of
      State of Nevada in order to effectuate a merger whereby the Company (as MEMS
      USA, Inc.) would merge with a newly formed wholly-owned subsidiary, Convergence
      Ethanol, Inc., as a parent/ subsidiary merger with the Company as the surviving
      corporation. This merger, which became effective as of December 5, 2006, was
      completed pursuant to Section 92A.180 of the Nevada Revised Statutes.
      Shareholder approval to this merger was not required under Section 92A.180.
      The
      purpose of this merger was to change the Company's name to "Convergence Ethanol,
      Inc."




**(17)       
      Contingencies and Subsequent Events:**





On
      February 12, 2007 the United States District Court, Central District of
      California, Western Division entered a preliminary injunction in favor of the
      Company.





F-24




**ITEM
      2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATIONS**





The
      following discussion and analysis should be read in conjunction with our
      consolidated financial statements and notes to consolidated financial statements
      included elsewhere in this report. This report and our consolidated financial
      statements and notes to consolidated financial statements contain
      forward-looking statements, which generally include the plans and objectives
      of
      management for future operations, including plans and objectives relating to
      our
      future economic performance and our current beliefs regarding revenues we might
      generate and profits we might earn if we are successful in implementing our
      business strategies. The forward-looking statements and associated risks may
      include, relate to or be qualified by other important factors, including,
      without limitation:





·
            quarterly
                variations in our revenues and operating
                expenses;





·
            announcements
                of new products or services by us;





·
            fluctuations
                in interest rates;





·
            significant
                sales of our common stock, including “short”
                sales;





·
            the
                operating and stock price performance of other companies that investors
                may deem comparable to us; and





·
            news
                reports relating to trends in our markets or general economic
                conditions;·
            anticipated
                trends in our financial condition and results of operations;
                and·
            our
                ability to successfully develop, finance, construct and operate our
                planned ethanol production
                facilities;




We
      do not
      undertake to update, revise or correct any forward-looking
      statements.




Any
      of
      the factors described above or in the “Risk Factors” section of this report
      could cause our financial results, including our net income or loss or growth
      in
      net income or loss to differ materially from prior results, which in turn could,
      among other things, cause the price of our common stock to fluctuate
      substantially.





Overview




We
      are
      engaged in the business of developing bio-renewable energy projects and
      providing professional engineered systems to the energy industry. The Company’s
      mission is to support the energy industry in producing cleaner burning fuels.
      Each of three company-operating divisions has a specific eco-energy focus:
      (1)
      development of a woodwaste to bio-renewable fuel-grade alcohol/ethanol project,
      (2) selling engineered products; and (3) engineering, fabrication and sale
      of
      eco-focused energy systems. ISO 9001:2000-certified, operating divisions have
      served customers throughout the energy sector since 1952.





We
      were
      incorporated in the State of Nevada on April 12, 2002. On November 29, 2006,
      we
      incorporated a wholly-owned Nevada subsidiary for the sole purpose of effecting
      a name change of our company through a merger with our subsidiary. On December
      5, 2006, we merged our subsidiary with and into our company, with our company
      carrying on as the surviving corporation under the name Convergence Ethanol,
      Inc. Our name change was effected with NASDAQ on December 13, 2006 and our
      ticker symbol on the OTC Bulletin Board was changed to “CETH”.





26




California-based
      Convergence Ethanol, Inc. is comprised of three wholly owned subsidiaries,
      California MEMS USA, Inc., (“CA MEMS”) a California Corporation, Bott Equipment
      Company, Inc. (“Bott”), Gulfgate Equipment, Inc. (“Gulfgate”) and a fourth
      majority-owned subsidiary, Hearst Ethanol One, Inc., a Federal Canadian
      Corporation (“HEO”).





CURRENT
      BUSINESS SUMMARY





We
      are a
      renewable energy company with a mission to support the energy industry’s
      production of cleaner burning fuels, through the development of profitable,
      bio-renewable energy projects and through the engineering, fabrication and
      sale
      of environmentally focused systems and equipment.





Our
      subsidiary, Hearst Ethanol One Inc. (HEO), is working on plans for a
      woodwaste-to-ethanol refinery to be built in Hearst Ontario Canada. The company
      owns 87% of HEO. We intend that the refinery will use modern catalytic
      processing, as used in oil refineries, to synthetically convert cellulosic
      woodwaste into ethanol. Given the high and rising price of corn, we believe
      that
      the conversion of low-cost woodwaste will be important in future ethanol
      production. Our plan of operation is to focus in geographic areas which offer
      abundant supplies of cellulosic woodwaste, superior transportation
      infrastructure, expedited permitting processes, high local demand for Ethanol
      and favorable, provincial and federal tax incentives. The Company's ability
      to
      complete this project is wholly dependent, however, on the successful
      fulfillment of several conditions, including receipt of all necessary
      environmental and other permits and the acquisition of capital for the
      development and construction of the plant.





OUR
      OPERATING SUBSIDIARIES:





**HEO**




The
      Company is currently developing a project that is expected to produce 120
      million gallons a year of bio-renewable fuel-grade alcohol/ethanol. In December
      2005, the Company incorporated Hearst Ethanol One, Inc., a Federal Canadian
      Corporation (“HEO”). HEO, which owns 720 acres in Hearst, Ontario, Canada and
      nearly 1.3 million cubic meters of woodwaste.




HEO
      plans
      to build an ecologically sound woodwaste refinery to produce bio-renewable,
      fuel-grade alcohol or ethanol. Organic woodwaste (organic chips or fiber),
      the
      raw material for fuel-grade alcohol/ethanol, is an overabundant waste stream
      of
      the Canadian forest products industries. The proposed refinery will use modern
      catalytic processing, as used in oil refineries, to synthetically convert
      organic woodwaste into fuel-grade alcohol or ethanol. We believe the convergence
      of technologies will enable the continuous production of bio renewable
      fuel-grade alcohol in high volume, at low cost. Currently, HEO is 87% owned
      by
      parent.





Fuel-grade
      alcohol/ethanol is the world's most used alternative liquid fuel. Worldwide
      demand is more than double production capacity and grows at over 25% per year.
      Next year’s market for fuel-grade alcohol/ethanol in Canada is eight times
      greater than last year’s production capability.





The
      Province of Ontario where our HEO facility will be located has mandated that
      all
      motor gasoline sold in Ontario must contain at least 5% ethanol by 2007, with
      the goal of 10% by 2010. We believe this will provide an assured market for
      fuel-grade alcohol/ethanol. HEO, owns 720 acres in Hearst, Ontario, has obtained
      forest resources, acquired construction permits, acquired a quarry for
      construction aggregate and owns a woodwaste repository containing nearly 1.5
      million tons of woodwaste. We believe that the existing woodwaste on site will
      be sufficient to run the future plant for more than one year for production
      of
      120 million gallons of fuel-grade alcohol/ethanol.


27




Formation
      of HEO




In
      December 2005, the Company incorporated Hearst Ethanol One, Inc., an Ontario
      corporation (“HEO”) for the purpose of building, owning and operating an ethanol
      production facility in Canada. On December 21, 2005, HEO entered into a land
      purchase agreement with C. Villeneuve Construction Company, Ltd. The transaction
      closed on April 7, 2006 and the Company owns 87% of HEO.





**CA
      MEMS**




Our
      CA
      MEMS subsidiary engineers, designs and oversees the construction of “Intelligent
      Filtration Systems” (“IFS”) for the gas and oil industry. These systems filter
      solids from oil or water. Our IFSTM systems are fully integrated and are composed
      of a “Smart Backflush Filtration System” with an integral electronic decanting
      system, a carbon bed filter and an ion-exchange resin bed system. This equipment
      will purify the amine fluid by removing particulate, chemical contaminants,
      and
      heat stable salts to allow the amine to more effectively remove carbon dioxide
      and sulfur compounds during refining. Unlike a typical canister filter system,
      such as the oil filter in an automobile, which needs to be periodically replaced
      and disposed of, the filters utilized in Intelligent Filtration Systems can
      last
      for decades. Furthermore, the filter system is self cleaning. Once the system
      recognizes that its filter is becoming clogged by debris filtered from the
      fluid
      flow, it turns the fluid flow through the filter off and “back flushes” the
      debris caked on the filter into a collection decanter. The system then turns
      the
      fluid flow through the system back on through the freshly cleaned filter. The
      filter cleaning process takes only seconds to complete and repeats as necessary
      to assure optimum filtration. A facility utilizing IFS technology needn’t
      dispose of contaminated filters, but only need dispose of the contaminate
      itself. Thus, while a filtration system based upon IFS technology typically
      requires a greater capital investment on the part of the purchaser, these costs
      are offset in the long run by savings in filter replacement and disposal costs.





The
      U.S.
      EPA and California CARB requirements for cleaner burning fuels have opened
      up
      additional opportunities for our IFS. We believe our IFS product can help our
      customers achieve lower operating costs and minimize wastes while enhancing
      their ability to meet the more stringent government requirements for cleaner
      burning fuels. The system dramatically reduces hazardous waste disposal
      costs.





The
      Company anticipates that it may be able to utilize its intelligent filtration
      systems as an integral part of any ethanol production facility that it may
      design. The Company is presently aware of three competitors offering similar
      technologies to CA MEMS IFS technology.





**GULFGATE**




Our
      Gulfgate subsidiary engineers, designs, fabricates and commissions eco-focused
      energy systems including particulate filtration equipment for the oil and power
      industries.  Gulfgate also makes and sells vacuum dehydration and
      coalescing systems that remove water from turbine engine oils.  These same
      systems are used by electric power generation facilities to remove water from
      transformer oils.  To help meet its customers’ diverse needs, Gulfgate
      maintains and operates a rental fleet of filtration and dehydration
      systems.  All Convergence Ethanol is ISO 9001:2000 certified and is a
      qualified international vendor to the oil and gas industries. Gulfgate has
      served customers throughout the energy sector since 1957; we acquired Gulfgate
      in 2004.





**BOTT**




Our
      Bott
      subsidiary is a stocking distributor for premier lines of industrial pumps,
      compressors, flow meters, valves and instrumentation. Bott specializes in the
      construction of aviation refueling systems for helicopter refueling on oil
      rigs
      throughout the world.  Bott and Gulfgate have a combined direct sales force
      as well as commissioned sales representatives that sell their products. Gulfgate
      also constructs refueling systems that Bott sells for commercial marine
      vessels.  Bott’s customers include chemical manufacturers, refineries,
      power plants and other industrial customers.





Bott
      has
      served customers throughout the energy sector since 1952; we acquired Bott
      in
      2004.




28




MARKETING





CA
      MEMS,
      Bott and Gulfgate have a combined direct sales force as well as commissioned
      sales representatives that sell their products.





Former
      Subsidiary




We
      created Can Am to manufacture, own and operate one ethanol production facility
      in British Columbia Canada.  In June 2005, the Company and its Canadian
      counterpart each made a CN$25,000 at risk deposit to open escrow toward purchase
      of 2,150 acres of land intended to serve as a plant site in British Columbia,
      Canada.




Subsequently,
      the Company paid an additional at-risk deposit of CN$50,000 for an extension
      of
      the closing date of the purchase agreement. This project was discontinued upon
      the death of one of the principals.





**Company
      History:**




We
      were
      incorporated in the State of Nevada on April 12, 2002. Prior to the reverse
      acquisition described below, our corporate name was Lumalite Holdings, Inc.
      and
      we had not generated significant revenues and were considered a development
      stage company as defined in Statement of Financial Accounting Standards No.
      7.





Pursuant
      to a Merger Agreement and Plan of Reorganization dated January 28, 2004 between
      us and MEMS USA, Inc., a California corporation (“CA MEMS”), we acquired all of
      the outstanding capital shares of CA MEMS in exchange for 10 million shares
      of
      our common stock. Since the stockholders of CA MEMS acquired approximately
      75%
      of our issued and outstanding shares and the CA MEMS management team and board
      of directors became our management team and board of directors, according to
      FASB Statement No. 141 - "Business Combinations," this acquisition has been
      treated as a recapitalization for accounting purposes, in a manner similar
      to
      reverse acquisition accounting. In accounting for this transaction:





·
            CA
                MEMS is deemed to be the purchaser and surviving company for accounting
                purposes. Accordingly, its net assets are included in our consolidated
                balance sheet at their historical book values and the results of
                operations of CA MEMS have been presented for all prior periods;
                and





·
            Control
                of the net assets and business of our company were acquired effective
                February 18, 2004. This transaction has been accounted for as a purchase
                of our assets and liabilities by CA MEMS. The historical cost of
                the net
                liabilities assumed was $-0-.





Pursuant
      to the transaction described above, we changed our name from Lumalite Holdings,
      Inc to MEMS USA, Inc. As described above, in 2006, we merged into a wholly
      owned
      subsidiary to change our name to Convergence Ethanol, Inc.





On
      October 26, 2004 (“Closing Date”), effective October 1, 2004, the Company
      purchased 100% of the outstanding shares of two Texas corporations, Bott
      Equipment Company, Inc. (“Bott”) and Gulfgate Equipment, Inc. (“Gulfgate”) from
      their president and sole shareholder, Mr. Mark Trumble.





On
      December 15, 2005, the Company assumed Weisdorn Sr.’s obligation to purchase
      165,054 shares from Mr. Trumble at $1.86 per share.


29




**Delivery
      of Intelligent Filtration SystemTM (IFS) - a $1.6 million
      contract**





On
      December 1, 2006 the Company delivered of its first Intelligent Filtration
      System (IFS) to a major Los Angeles-area oil refinery. This advanced filtration
      system enables the production of cleaner-burning, reduced-sulfur motor fuel,
      supporting refinery environmental improvement goals.




The
      IFS
      integrates previously separate units into a dynamic filtration system Engineered
      for ease of operation and maintenance, it gives the refinery exceptional and
      coordinated control. Direct ecological benefits of the energy-efficient design
      include reduced greenhouse emissions and a dramatic reduction in the volume
      of
      hazardous waste.




Comparison
      of Operations





Net
      sales
      for the three-month periods ended December 31, 2006 and 2005 were $3,947,772
      and
      $2,626,519, respectively. The sales increase for the three months (503%) ended
      December 31, 2006 as compared to the prior year were due primarily to the
      delivery of the Company’s first Intelligent Filtration System. The Company
      recognized 95% of the IFS contract value or sales of $1.5 million during the
      month of December, 2006. The remaining sales (5%) are expected to be recognized
      during the second fiscal quarter ended March 31, 2007. This represents system
      commissioning and documentation. We have received several requests for quotes
      for our IFS system products which we’re currently responding to We also continue
      to experience strong customer demand for our industrial pumps, equipment rentals
      and repairs services.





The
      Company computes gross profit as net sales less cost of sales. Gross profit
      for
      the three-month periods ended December 31, 2006 and 2005 were $666,261 and
      $554,775 respectively. The gross profit increase for the three months ended
      December 31, 2006 as compared to the prior year was due primarily to the
      delivery of an IFS system. The gross profit margin is the gross profit divided
      by net sales, expressed as a percentage. Gross profit margin for the three-month
      periods ended December 31, 2006 and 2005 were 16.9% and 21.1% respectively.
      This
      decrease of 4.2% was primarily due to a combination of lower margins on
      commercial aviation refueling systems shipments and the IFS System. Also
      impacting the margins were higher physical inventory adjustments and material
      costs as compared to the prior year. Margins for this segment of the business
      continue to reflect the significant competitive pressures encountered on bidding
      and winning this business.




Selling,
      general and administrative (SG&A) expenses were $1,387,825 and $1,321,547
      for the three months ended December 31, 2006 and 2005, respectively. The
      increase in SG&A spending for the three months ended December 31, 2006 as
      compared to the prior year were due primarily to legal costs (See Part I, Item
      3, Legal Proceedings), consulting fees and commissions.




We
      expect
      that over the near term, our selling, general and administration expenses will
      increase as a result of, among other things, increased accounting fees
      associated with increased corporate governance activities in response to the
      Sarbanes-Oxley Act of 2002, recently adopted rules and regulations of the
      Securities and Exchange Commission, the filing of a registration statement
      with
      the Securities and Exchange Commission to register for resale the shares of
      common stock and shares of common stock underlying warrants issued in various
      private offerings, increased employee costs associated with planned staffing
      increases (replacements), increased sales and marketing expenses, increased
      activities related to the design, engineering and construction of the Hearst
      Ethanol One, Inc. ethanol production facility and increased activity in
      searching for and analyzing potential acquisitions.




For
      the
      quarter ended December 31, 2006, shareholder’s deficit was $1,183,840 as
      compared to equity of $577,844 for the prior year period ended September 30,
      2006. The decrease in shareholder equity is primarily attributable to the change
      in derivative liability.


30
  Other
      expense (income), net for the three-month periods ended December 31, 2006 and
      2005 were $(228,508) and $(3,680,353), respectively. The decrease in other
      income is attributable to proceeds from a legal settlement (see note 18) in
      the
      prior year partially offset by a gain from a change in the derivative liability
      associated with the Global note and warrants outstanding at December 31, 2006.
      (See note 12).





Net
      loss
      for the three-month period ended December 31, 2006 and 2005 was $490,251 versus
      net income of $2,913,581, respectively.





The
      Company launched a profit improvement - cost savings initiative in the second
      half of 2006. The initiative is significantly improving operations efficiency,
      increasing competitiveness and improving business profitability. The cost
      savings initiative includes: administrative workforce reduction, phase out
      of
      low margin products, tighter control of travel costs and a decrease in external
      costs across the company. The initiative is expected to deliver over $1,200,000
      in annualized savings, for only a one-time $200,000 related pre-tax charge.
      On
      an annualized basis, the company expects to increase profitability by more
      than
      $2,000,000 as a combined result of cost savings and business
      growth.





This
      initiative reflects our ongoing commitment to improve our rate of return on
      invested capital and deliver stronger bottom-line performance. Senior management
      is focused on ensuring that our cost structure is competitive and that it is
      aligned with the company’s strategic market opportunities, such as our
      development of a woodwaste-to-ethanol refinery in Ontario, Canada.”





Workforce
      reductions were made in non-revenue generating areas, with the greatest
      reductions in corporate headquarters administrative jobs and outside consulting.
      The company has not reduced sales, marketing, engineering, manufacturing,
      finance or audit capabilities.





**Liquidity
      and Capital Resources** ****





Our
      plan
      of operations over the next 12 months includes the continued pursuit of our
      goal
      to design, engineer, build and operate one or more ethanol plants. In that
      regard we are dependent upon Hearst Ethanol One, Inc.’s efforts to raise the
      necessary capital. We believe that our working capital as of the date of this
      report will not be sufficient to satisfy our estimated working capital
      requirements at our current level of operations for the next twelve months.
      Our
      cash and cash equivalents were $169,306 as of December 31, 2006, compared to
      cash and cash equivalents of $130,550 as of September 30, 2006.


At
      our
      current cash “burn rate”, we will need to raise additional cash through debt or
      equity financings during 2007 in order to fund our continued development and
      marketing of our IFS product line and to finance possible future losses from
      operations as we expand our business lines and reach a profitable level of
      operations. Before considering Hearst Ethanol One, Inc., we believe that we
      require a minimum of $1,800,000 in order to fund our planned operations over
      the
      next 12 months, in addition to the capital required for the establishment of
      any
      ethanol production facilities. We plan to obtain the additional working capital
      through private placement sales of our equity securities. As of the date of
      this
      report the Company has no firm commitment for additional funds. In the absence
      of this commitment there is no assurance that such funds will be available
      on
      commercially reasonable terms, if at all. Should we be unable to raise the
      required funds, our ability to finance our continued operations will be
      materially adversely affected.





Subsequent
      Event - None


31
  **ITEM
      3. CONTROLS AND PROCEDURES**





Our
      disclosure controls and procedures are designed to ensure that information
      required to be disclosed in reports that we file or submit under the Securities
      Exchange Act of 1934 is recorded, processed, summarized and reported within
      the
      time periods specified in the rules and forms of the Securities and Exchange
      Commission and that such information is accumulated and communicated to our
      management, as appropriate, to allow timely decisions regarding required
      disclosure. Our President and Chief Financial Officer have reviewed the
      effectiveness of our disclosure controls and procedures and have concluded
      that
      the disclosure controls and procedures, overall, are effective as of the end
      of
      the period covered by this report. There has been no change in the Company’s
      internal control over financial reporting (as defined in Rule 13a-15(f) under
      the Exchange Act) during the period covered by this report that have materially
      affected, or are reasonably likely to materially affected, the Company’s
      internal control over financial reporting.




**PART
      II - OTHER INFORMATION**




**ITEM
      1. LEGAL PROCEEDINGS**





As
      a
      normal incident of the businesses in which the Company is engaged, various
      claims, charges and litigation are asserted or commenced from time to time
      against the Company. The Company believes that final judgments, if any, which
      might be rendered against the Company in current litigation are adequately
      reserved, covered by insurance, or would not have a material adverse effect
      on
      its financial statements. In addition, we are subject to the following
      proceedings:




On
      December 12, 2006, the Company filed a Form 8-K with the Securities and Exchange
      Commission disclosing the resignation and termination of Daniel Moscaritolo
      as a
      director and officer of the Company.




On
      December 13, 2006, Mr. Moscaritolo presented management with a purported action
      by written consent of the shareholders of the Company indicating that the
      shareholders had elected to remove the current board of directors and elect
      Daniel Moscaritolo and Thomas Hemingway as directors in their place. Mr.
      Moscaritolo also presented management with two separate purported actions by
      written consent of the new purported board of directors indicating that the
      Company's current officers, James A. Latty and Richard W. York, were terminated
      and that Mr. Moscaritolo was elected to serve as Secretary of the Company and
      Mr. Hemingway was elected to serve as President and Chief Executive Officer
      of
      the Company. The Company rejected the purported shareholder action on the
      grounds that, on its face, the purported action showed an insufficient number
      of
      votes had been obtained to approve the requested action, and on the further
      grounds that the consent of shareholders was solicited and obtained in violation
      of the proxy rules set forth in Section 14 of the Securities Exchange Act of
      1934, as amended (the “Act”). As a consequence of the invalidity of the
      purported shareholder action, the Company also rejected the actions of the
      new
      purported board of directors terminating and replacing the officers of the
      Company.




On
      December 14, 2006, the Company filed a lawsuit in the United States District
      Court, Central District of California, Western Division (Case No.: CV06-07971)
      against Daniel Moscaritolo for violations of the Act, declaratory relief, breach
      of fiduciary duty, intentional interference with contract, and conversion (the
      “Company Action”). Specifically, the Company alleged that Mr. Moscaritolo's
      actions to wrest control of the board of directors were invalid and unlawful.
      On
      February 8, 2007, a default was entered against Mr. Moscaritolo after he failed
      to timely file a responsive pleading to the Complaint. On February 12, 2007,
      the
      Court entered an Order granting the Company’s Motion for a Preliminary
      Injunction. Pursuant to the Order, the Court ruled that: (1) the attempted
      shareholder action initiated by Mr. Moscaritolo and his purported proxies was
      void as the proxies were solicited and obtained in violation of federal
      securities laws; (2) Mr. Moscaritolo and those acting in his control or
      direction were enjoined from (a) attempting to vote any of the illegally
      obtained proxies; (b) purporting to act as directors of officers of the Company
      or its subsidiaries; (c) further soliciting shareholder proxies in violation
      of
      federal securities laws; and (d) disclosing any confidential or proprietary
      information of the Company.


32
  On
      December 15, 2006, Mr. Moscaritolo and Mr. Hemingway, individually, and
      purporting to act derivatively on behalf of the shareholders of the Company,
      filed a lawsuit in Nevada State Court, County of Washoe (Case No.: CV0603002)
      against Mr. Latty and Mr. York for injunctive relief, declaratory relief,
      receivership, and accounting relating to the failed effort to remove them from
      the Board of Directors of the Company and seeking a court order approving their
      removal (the “Moscaritolo Action”). In January 2007, Mr. Moscaritolo and Mr.
      Hemingway voluntarily dismissed the Moscaritolo Action.





On
      January 10, 2007, Mr. Moscaritolo and Charles L. Christensen filed a lawsuit
      in
      the First Judicial District Court of the State of Nevada in and for Carson
      City
      (Case No.: 07-00035A) against the Company, Dr. Latty, and Mr. Newsom for
      injunctive relief to hold an Annual Shareholders Meeting. On February 9, 2007,
      the Company filed a Motion to Dismiss or Stay the Action based upon the Company
      Action pending in the United States District Court, Central District of
      California, Western Division.





**ITEM
      1A.** **RISK
      FACTORS** ****





*An
      investment in our common stock involves a high degree of risk. In addition
      to
      the other information in this report and in our other filings with the
      Securities and Exchange Commission, you should carefully consider the following
      risk factors before deciding to invest in shares of our common stock or to
      maintain or increase your investment in shares of our common stock. If any
      of
      the following risks actually occur, it is likely that our business, financial
      condition and results of operations could be seriously harmed. As a result,
      the
      trading price of our common stock could decline, and you could lose part or
      all
      of your investment.*





**Risks
      Related to our Business**





We
      make
      written and oral statements from time to time regarding our business and
      prospects, such as projections of future performance, statements of management’s
      plans and objectives, forecasts of market trends, and other matters that are
      forward-looking statements within the meaning of Section 27A of the
      Securities Act of 1933 and Section 21E of the Securities Exchange Act of
      1934. Statements containing the words or phrases “will likely result,” “are
      expected to,” “will continue,” “is anticipated,” “estimates,” “projects,”
“believes,” “expects,” “anticipates,” “intends,” “target,” “goal,” “plans,”
“objective,” “should” or similar expressions identify forward-looking
      statements, which may appear in documents, reports, filings with the Securities
      and Exchange Commission, news releases, written or oral presentations made
      by
      officers or other representatives made by us to analysts, stockholders,
      investors, news organizations and others, and discussions with management and
      other representatives of us.




Our
      future results, including results related to forward-looking statements, involve
      a number of risks and uncertainties. No assurance can be given that the results
      reflected in any forward-looking statements will be achieved. Any
      forward-looking statement made by or on behalf of us speaks only as of the
      date
      on which such statement is made. Our forward-looking statements are based upon
      assumptions that are sometimes based upon estimates, data, communications and
      other information from suppliers, government agencies and other sources that
      may
      be subject to revision. Except as required by law, we do not undertake any
      obligation to update or keep current either (i) any forward-looking
      statement to reflect events or circumstances arising after the date of such
      statement, or (ii) the important factors that could cause our future
      results to differ materially from historical results or trends, results
      anticipated or planned by us, or which are reflected from time to time in any
      forward-looking statement which may be made by or on behalf of us.




In
      addition to other matters identified or described by us from time to time in
      filings with the SEC, there are several important factors that could cause
      our
      future results to differ materially from historical results or trends, results
      anticipated or planned by us, or results that are reflected from time to time
      in
      any forward-looking statement that may be made by or on behalf of us. Some
      of
      these important factors, but not necessarily all important factors, include
      the
      following:


33
  **We
      are an emerging growth company with limited operating history, accordingly
      there
      is limited historical information available upon which you can judge the merits
      of an investment in our company.**




**We
      have generated net losses since inception, which may continue for the
      foreseeable future as we try to grow our business, which means that you may
      be
      unable to realize a return on your investment for a long period of time, if
      ever** .
      Our
      present business operation’s commenced in February, 2004. >From inception
      through December 31, 2006, incurred a cumulative net loss of $16,964,274 which
      included non-cash net asset impairment charges of $10,900,000 and gains from
      a
      change in derivative liability of $543,469. We expect to continue incurring
      operating losses until we are able to derive meaningful revenues from our
      proposed business relating to ethanol production, energy generation and supply.





**We
      have limited available working capital and require significant additional
      capital in order to sustain our operations, and if we cannot obtain additional
      financing we might cease to continue** .
      As of
      December 31, 2006, we had total current assets of $ 3,611,735 and working
      capital of $1,690,733 before including a liability for common stock subscribed
      of $1,200,375 and the derivative liability of $3,953,337. We believe that we
      require a minimum of $1,800,000 in order to fund our planned operations over
      the
      next 12 months, in addition to the capital required for the establishment of
      any
      ethanol production facilities. We plan to obtain the additional working capital
      through private placement sales of our equity securities. We have not received
      any funds, nor can there be any assurance that such funds will be forthcoming.
      Should we be unable to raise the required funds, our ability to finance our
      continued operations will be materially adversely affected.





**Our
      independent auditors' report raises substantial doubt about our ability to
      continue as a going concern** .
      Our
      independent auditors have prepared their report on our 2006 financial statements
      assuming that we will continue as a going concern. Their report has an
      explanatory paragraph stating that our recurring losses from operations since
      inception, limited operating revenue and limited capital resources raise
      substantial doubt about our ability to continue as a going
      concern. Realization of a major portion of the assets reflected on the
      accompanying balance sheet is dependent upon continued operations of the Company
      which, in turn, is dependent upon the Company's ability to meet its financing
      requirements and succeed in its future operations. Management believes that
      actions presently being taken to revise the Company's operating and financial
      requirements provide them with the opportunity for the Company to continue
      as a
      going concern.




The
      accompanying financial statements have been prepared in conformity with
      accounting principles generally accepted in the United States of America, which
      contemplate continuation of the Company as a going concern. The financial
      statements do not include any adjustments relating to the recoverability and
      classification of recorded asset amounts, or amounts and classification of
      liabilities that might be necessary, should the Company be unable to continue
      as
      a going concern.




**Because
      we have few proprietary rights, others can provide products and services
      substantially equivalent to ours** .
      We hold
      a provisional patent application relating to our MEMS operations, however we
      hold no patents or patents applications relating to our energy generation and
      supply business or our proposed ethanol production business. We believe that
      most of the technology used in the design and building of ethanol production
      facilities and in the area of the energy generation and supply business is
      generally known and available to others. Consequently, others will be able
      to
      compete with us in these areas. We rely on a combination of confidentiality
      agreements and trade secret law to protect our confidential information. In
      addition, we restrict access to confidential information on a ‘‘need to know’’
basis. However, there can be no assurance that we will be able to maintain
      the
      confidentiality of our proprietary information. If our proprietary rights are
      violated, or if a third party claims that we violate their trademark or other
      proprietary rights, we may be required to engage in litigation. Proprietary
      rights litigation tends to be costly and time consuming. Bringing or defending
      claims related to our proprietary rights may require us to redirect our human
      and monetary resources to address those claims.


34
  **We
      may not be able to compete effectively or competitive pressures faced by us
      may
      materially adversely affect our business, financial condition, and results
      of
      operations** .
      We
      expect to face significant competition in our ethanol production, energy
      generation and supply and MEMS operations. Virtually all of our competitors
      have
      greater marketing and financial resources than us and, accordingly, there can
      be
      no assurance that we will be able to compete effectively or that competitive
      pressures faced by us will not materially adversely affect our business,
      financial condition, and results of operations.




**We
      are dependent upon our key personnel** ***.*** **** Our
      performance is substantially dependent on the continued services and on the
      performance of our senior management and other key personnel. We plan to obtain
      “key person” life insurance for our key personnel, however, at this time, no
      such policies are in effect. Our performance will also depend upon our ability
      to retain and motivate other officers and key employees. The loss of the
      services of any of our executive officers or other key employees could have
      a
      material adverse effect on our business, prospects, financial condition and
      results of operations. Our future success also depends on our ability to
      identify, attract, hire, train, retain and motivate other highly skilled
      technical and managerial personnel. Competition for such personnel is intense,
      and there can be no assurance that we will be able to successfully attract,
      assimilate or retain sufficiently qualified personnel. The failure
      to retain and attract the necessary technical, and managerial personnel
      could have a material adverse effect on our business, prospects, financial
      condition and results of operations.




**Because
      we are smaller and have fewer financial and other resources than many ethanol
      producers, we may not be able to successfully compete in the very competitive
      ethanol industry.** Ethanol
      is a commodity. There is significant competition among existing ethanol
      producers. Our business faces competition from a number of producers that can
      produce significantly greater volumes of ethanol than we can or expect to
      produce, producers that can produce a wider range of products than we can,
      and
      producers that have the financial and other resources that would enable them
      to
      expand their production rapidly if they chose to. These producers may be able
      to
      achieve substantial economies of scale and scope, thereby substantially reducing
      their fixed production costs and their marginal productions costs. If these
      producers are able to substantially reduce their marginal production costs,
      the
      market price of ethanol may decline and we may be not be able to produce ethanol
      at a cost that allows us to operate profitably. Even if we are able to operate
      profitably, these other producers may be substantially more profitable than
      us,
      which may make it more difficult for us to raise any financing necessary for
      us
      to achieve our business plan and may have a materially adverse effect on the
      market price of our common stock.





**Competition
      from large producers of petroleum-based gasoline additives and other competitive
      products may impact our profitability.** Our
      success depends substantially upon continued demand for ethanol from major
      oil
      refiners. There are other gasoline additives that have octane and oxygenate
      values similar to those of ethanol but which currently cannot be produced at
      a
      cost that makes them competitive. The major oil refiners have significantly
      greater financial, technological and personal resources than we have to reduce
      the costs of producing these alternative products or to develop other
      alternative products that may be produced at lower cost. The major oil refiners
      also have significantly greater resources than we have to influence legislation
      and public perception of ethanol. If the major oil refiners are able to produce
      ethanol substitutes at a cost that is lower than the cost of ethanol production,
      the demand for ethanol may substantially decrease. A substantial decrease in
      the
      demand for ethanol will reduce the price of ethanol, adversely affect our
      profitability and decrease the value of your stock.





**If
      ethanol and gasoline prices drop significantly, we will also be forced to reduce
      our prices, which potentially may lead to losses.** Prices
      for ethanol products can vary significantly over time and decreases in price
      levels could adversely affect our profitability and viability. The price of
      ethanol has some relation to the price of gasoline. The price of ethanol tends
      to increase as the price of gasoline increases, and the price of ethanol tends
      to decrease as the price of gasoline decreases. Any lowering of gasoline prices
      will likely also lead to lower prices for ethanol and adversely affect our
      operating results. We cannot assure you that we will be able to sell our ethanol
      profitably, or at all.


35
  **Lax
      enforcement of environmental and energy policy regulations may adversely affect
      the demand for ethanol.** Our
      success will depend, in part, on effective enforcement of existing environmental
      and energy policy regulations. Many of our potential customers are unlikely
      to
      switch from the use of conventional fuels unless compliance with applicable
      regulatory requirements leads, directly or indirectly, to the use of ethanol.
      Both additional regulation and enforcement of such regulatory provisions are
      likely to be vigorously opposed by the entities affected by such requirements.
      If existing emissions-reducing standards are weakened, or if governments are
      not
      active and effective in enforcing such standards, our business and results
      of
      operations could be adversely affected. Even if the current trend toward more
      stringent emissions standards continues, our future prospects will depend on
      the
      ability of ethanol to satisfy these emissions standards more efficiently than
      other alternative technologies. Certain standards imposed by regulatory programs
      may limit or preclude the use of our products to comply with environmental
      or
      energy requirements. Any decrease in the emission standards or the failure
      to
      enforce existing emission standards and other regulations could result in a
      reduced demand for ethanol. A significant decrease in the demand for ethanol
      will reduce the price of ethanol, adversely affect our profitability and
      decrease the value of your stock.





**Price
      increases or interruptions in needed energy supplies could cause loss of
      customers and impair our profitability.** Ethanol
      production requires a constant and consistent supply of energy. If there is
      any
      interruption in our supply of energy for whatever reason, such as availability,
      delivery or mechanical problems, we may be required to halt production. If
      we
      halt production for any extended period of time, it will have a material,
      adverse effect on our business. Natural gas and electricity prices have
      historically fluctuated significantly. We purchase significant amounts of these
      resources as part of our ethanol production. Increases in the price of natural
      gas or electricity would harm our business and financial results by increasing
      our energy costs.





**Our
      common stock may be thinly traded, so you may be unable to sell at or near
      ask
      prices or at all if you need to sell your shares to raise money or otherwise
      desire to liquidate your shares.** Our
      common stock is thinly traded and we will be required to undertake efforts
      to
      develop market recognition for us and support for our shares of common stock
      in
      the public market. The price and volume for our common stock that will develop
      cannot be assured.





The
      number of persons interested in purchasing our common stock at or near ask
      prices at any given time may be relatively small or non-existent. This situation
      may be attributable to a number of factors, including the fact that we are
      a
      small company which is relatively unknown to stock analysts, stock brokers,
      institutional investors and others in the investment community that generate
      or
      influence sales volume, and that even if we came to the attention of such
      persons, they tend to be risk-averse and would be reluctant to follow an
      unproven company such as ours or purchase or recommend the purchase of our
      shares until such time as we became more seasoned and viable. As a consequence,
      there may be periods of several days, weeks, months, or more when trading
      activity in our shares is minimal or non-existent, as compared to a seasoned
      issuer which has a large and steady volume of trading activity that will
      generally support continuous sales without an adverse effect on share price.
      We
      cannot give you any assurance that a broader or more active public trading
      market for our common stock will develop or be sustained. While we are trading
      on the OTC Bulletin Board, the trading volume we will develop may be limited
      by
      the fact that many major institutional investment funds, including mutual funds,
      as well as individual investors follow a policy of not investing in Bulletin
      Board stocks and certain major brokerage firms restrict their brokers from
      recommending Bulletin Board stocks because they are considered speculative,
      volatile and thinly traded.


36
  **Our
      common stock is subject to the “penny stock” rules which could limit the trading
      and liquidity of the common stock, adversely affect the market price of our
      common stock and increase your transaction costs to sell those
      shares.** The
      trading price of our common stock is below $5 per share; and therefore, the
      open-market trading of our common stock will be subject to the “penny stock”
rules, unless we otherwise qualify for an exemption from the “penny stock”
definition. The “penny stock” rules impose additional sales practice
      requirements on certain broker-dealers who sell securities to persons other
      than
      established customers and accredited investors (generally those with assets
      in
      excess of $1,000,000 or annual income exceeding $200,000 or $300,000 together
      with their spouse). These regulations, if they apply, require the delivery,
      prior to any transaction involving a penny stock, of a disclosure schedule
      explaining the penny stock market and the associated risks. Under these
      regulations, certain brokers who recommend such securities to persons other
      than
      established customers or certain accredited investors must make a special
      written suitability determination regarding such a purchaser and receive such
      purchaser’s written agreement to a transaction prior to sale. These regulations
      may have the effect of limiting the trading activity of our common stock,
      reducing the liquidity of an investment in our common stock and increasing
      the
      transaction costs for sales and purchases of our common stock as compared to
      other securities.





**The
      market price for our common stock may be particularly volatile given our status
      as a relatively unknown company with a small and thinly traded public float
      and
      lack of history as a public company which could lead to wide fluctuations in
      our
      share price.** The
      market for our common stock may be characterized by significant price volatility
      when compared to seasoned issuers, and we expect that our share price could
      continue to be more volatile than a seasoned issuer for the indefinite future.
      The potential volatility in our share price is attributable to a number of
      factors. First, as noted above, our shares of common stock may be sporadically
      and thinly traded. As a consequence of this lack of liquidity, the trading
      of
      relatively small quantities of shares by our stockholders may disproportionately
      influence the price of those shares in either direction. The price for our
      shares could, for example, decline precipitously in the event that a large
      number of our shares of common stock are sold on the market without commensurate
      demand, as compared to a seasoned issuer which could better absorb those sales
      without adverse impact on its share price. Many of these factors will be beyond
      our control and may decrease the market price of our common shares, regardless
      of our operating performance. We cannot make any predictions or projections
      as
      to what the prevailing market price for our common stock will be at any
      time.




In
      addition, the market price of our common stock could be subject to wide
      fluctuations in response to:




·
            quarterly
                variations in our revenues and operating
                expenses;





·
            announcements
                of new products or services by us;





·
            fluctuations
                in interest rates;





·
            significant
                sales of our common stock, including “short”
                sales;





·
            the
                operating and stock price performance of other companies that investors
                may deem comparable to us; and





·
            news
                reports relating to trends in our markets or general economic
                conditions





The
      stock
      market, in general, and the market prices for penny stock companies in
      particular, have experienced volatility that often has been unrelated to the
      operating performance of such companies. These broad market and industry
      fluctuations may adversely affect the price of our stock, regardless of our
      operating performance.


37
  Stockholders
      should be aware that, according to SEC Release No. 34-29093, the market for
      penny stocks has suffered in recent years from patterns of fraud and abuse.
      Such
      patterns include (1) control of the market for the security by one or a few
      broker-dealers that are often related to the promoter or issuer; (2)
      manipulation of prices through prearranged matching of purchases and sales
      and
      false and misleading press releases; (3) boiler room practices involving
      high-pressure sales tactics and unrealistic price projections by inexperienced
      sales persons; (4) excessive and undisclosed bid-ask differential and markups
      by
      selling broker-dealers; and (5) the wholesale dumping of the same securities
      by
      promoters and broker-dealers after prices have been manipulated to a desired
      level, along with the resulting inevitable collapse of those prices and with
      consequent investor losses. Our management is aware of the abuses that have
      occurred historically in the penny stock market. Although we do not expect
      to be
      in a position to dictate the behavior of the market or of broker-dealers who
      participate in the market, management will strive within the confines of
      practical limitations to prevent the described patterns from being established
      with respect to our securities. The occurrence of these patterns or practices
      could increase the volatility of our share price.




**Limitations
      on director and officer liability and indemnification of our officers and
      directors by us may discourage stockholders from bringing suit against a
      director.** Our
      bylaws provide, with certain exceptions as permitted by governing state law,
      that a director or officer shall not be personally liable to us or our
      stockholders for breach of fiduciary duty as a director, except for acts or
      omissions which involve intentional misconduct, fraud or knowing violation
      of
      law, or unlawful payments of dividends. These provisions may discourage
      stockholders from bringing suit against a director for breach of fiduciary
      duty
      and may reduce the likelihood of derivative litigation brought by stockholders
      on our behalf against a director. In addition, our articles of incorporation
      and
      bylaws may provide for mandatory indemnification of directors and officers
      to
      the fullest extent permitted by governing state law.




**We
      do not expect to pay dividends for the foreseeable future, and we may never
      pay
      dividends.** We
      currently intend to retain any future earnings to support the development and
      expansion of our business and do not anticipate paying cash dividends in the
      foreseeable future. Our payment of any future dividends will be at the
      discretion of our board of directors after taking into account various factors,
      including but not limited to our financial condition, operating results, cash
      needs, growth plans and the terms of any credit agreements that we may be a
      party to at the time. In addition, our ability to pay dividends on our common
      stock may be limited by state law. Accordingly, investors must rely on sales
      of
      their common stock after price appreciation, which may never occur, as the
      only
      way to realize their investment.





**Our
      management owns 29.7% and an investment group may own a significant percentage
      of our outstanding common stock, which may limit your ability and the ability
      of
      our other shareholders, whether acting alone or together, to propose or direct
      the management or overall direction of our Company.** Such
      concentrated control of the Company may adversely affect the price of our common
      stock. Our principal stockholders may be able to control matters requiring
      approval by our shareholders, including the election of directors, mergers
      or
      other business combinations. Such concentrated control may also make it
      difficult for our shareholders to receive a premium for their shares of our
      common stock in the event we merge with a third party or enter into different
      transactions which require shareholder approval. These provisions could also
      limit the price that investors might be willing to pay in the future for shares
      of our common stock. Accordingly, if all of our officers and directors exercise
      outstanding option this shareholder together with our directors and executive
      officers could have the power to control the election of our directors and
      the
      approval of actions for which the approval of our shareholders is required.
      If
      you acquire shares, you may have no effective voice in the management of the
      Company.





**Future
      sales of our equity securities could put downward selling pressure on our
      securities, and adversely affect the stock price. There is a risk that this
      downward pressure may make it impossible for an investor to sell his securities
      at any reasonable price, if at all.** Future
      sales of substantial amounts of our equity securities in the public market,
      or
      the perception that such sales could occur, could put downward selling pressure
      on our securities, and adversely affect the market price of our common
      stock.


38
  **ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS**





During
      the month of October 2006, the Company issued and delivered 70,000 shares of
      the
      Company’s common stock to one consultant for services valued at approximately
      $38,500.





The
      company issued warrants to the underwriters to purchase 310,000 shares of its
      common stock at a price of $1.60 per share. The proceeds from the issuance
      of
      the 2,013,510 shares were recorded net of the fair value of the warrants and
      the
      underwriter’s fees. The fair value of the warrants, $419,639 was calculated
      using the Black Scholes option pricing model using the following assumptions:
      risk free rate of return of 6%, volatility of 145%, dividend yield of 0% and
      expected life of 3 years.





Exemption
      from the registration provisions of the Securities Act of 1933 for the
      transactions described above is claimed under Section 4(2) of the Securities
      Act
      of 1933, among others, on the basis that such transactions did not involve
      any
      public offering and the purchasers were sophisticated or accredited with access
      to the kind of information registration would provide.







ITEM
      3.
      DEFAULTS UPON SENIORSECURITIES





There
      were no material defaults with respect to any of our indebtedness during the
      first quarter of 2007.




**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS** -
      None







**ITEM
      5. OTHER INFORMATION**





**Departure
      of Directors or Principal Officers;** **Election
      of Directors; Appointment of Principal** **Officers:**





**A.  
      Appointment of Director**




Effective
      October 18, 2006, Mr. Steven Newsom was appointed to the Board of Directors
      of
      the Company. As of November 15, 2006, the Board of Directors is comprised of
      two
      members, Mr. Newsom and James A. Latty.




Pursuant
      to his appointment, Mr. Newsom and the Company entered into a Consulting
      Agreement. Pursuant to the Consulting Agreement, Mr. Newsom shall receive the
      following: (i) the sum of $20,000, (ii) the sum of $4,000 per month payable
      on
      the first day of each month during his tenure as a member of the Company's
      Board of Directors, (iii) an additional $2,000 per trip, if Mr. Newsom makes
      more than three trips (per quarter) to attend meetings on Company's
      business, (iv) $250 per hour for work performed for the Company over and
      above time spent on trips to attend meetings on Company's business, (v)
      travel expenses for trips to attend meetings on Company's business, and
      (vi) options for the purchase of up to 300,000 shares of common stock of
      the Company at an exercise price of $0.51 per share. The option period
      shall be 60 months from October 18, 2006.





**B** . **Resignation and termination of Daniel Moscaritolo as a director and
      officer:**




On
      December 14, 2006, the Company filed a lawsuit in the United States District
      Court, Central District of California, Western Division (Case No.: CV06-07971)
      against Daniel Moscaritolo for violations of the Securities Exchange Act of
      1934, declaratory relief, breach of fiduciary duty, intentional interference
      with contract, and conversion arising out of Mr. Moscaritolo's improper actions
      to wrest control of the Company by soliciting proxies for a shareholder vote
      to
      take over the Company.




On
      December 15, 2006, Mr. Moscaritolo and Mr. Hemingway, individually, and
      purporting to act derivatively on behalf of the shareholders of the Company,
      filed a lawsuit in Nevada State Court, County of Washoe (Case No.: CV0603002)
      against Dr. Latty and Mr. York for injunctive relief, declaratory relief,
      receivership, and accounting relating to the failed effort to remove them from
      the Board of Directors of the Company and seeking a court order approving their
      removal (the “Moscaritolo Action”). The Moscaritolo action has been dismissed,
      but on January 9, 2007 he filed a second lawsuit in Nevada State Court against
      the Company, Dr. Latty, and Mr. Newsom for injunctive relief to hold Annual
      Shareholders Meeting.




The
      Company intends to pursue the claims set forth in the Company Action and to
      oppose the claims set forth in the Second Moscaritolo Action.




39





**ITEM
      6. EXHIBITS**





(a) Exhibits




3.1
              Articles
                  of Incorporation, as amended, of Convergence Ethanol,
                  Inc.3.2
              Bylaws,
                  as amended, of Convergence Ethanol, Inc.10.1
              Securities
                  Purchase Agreement dated as of October 27, 2006 between the Company
                  and
                  Global Capital Advisors, LLC.10.2
              Form
                  of Convertible NoteAgreement dated as of October 27, 2006 between the Company and
                  Global
                  Capital Advisors, LLC.10.3
              Form
                  of Registration Rights Agreement dated as of October 27, 2006 between
                  the
                  Company and Global Capital Advisors, LLC.10.4
              Deed
                  of Trust and Security Agreement dated as of October 27, 2006 between
                  the
                  Company and Global Capital Advisors, LLC.10.5
              Form
                  of Escrow Agreement dated as of October 27, 2006 between the Company
                  and
                  Global Capital Advisors, LLC.10.6
              Form
                  of Common Stock Warranty Agreement dated as of October 27, 2006
                  between
                  the Company and Global Capital Advisors, LLC. (Exhibit
                  F)10.7
              Form
                  of Common Stock Warranty Agreement dated as of October 27, 2006
                  between
                  the Company and Global Capital Advisors, LLC. (Exhibit
                  G)10.8
              Promissory
                  Note dated as of November 1, 2005 between the Company and Daniel
                  K.
                  Moscaritolo.10.9
              Promissory
                  Note dated as of November 1, 2005 between the Company and James
                  A.
                  Latty.10.10
              Offer
                  letter of employment dated July 1, 2002 between the Company and
                  James A.
                  Latty.10.11
              Offer
                  letter of employment dated July 1, 2002 between the Company and
                  Daniel K.
                  Moscaritolo.10.12
              Executive
                  employment agreement dated November 1, 2006 between the Company
                  and
                  Richard W. York.10.13
              Agreement
                  dated October 18, 2006 between the Company and Steven
                  Newsom10.14
              Factoring
                  agreement dated November 22, 2006 between the Company (Gulfgate
                  Equipment,
                  Inc.) and BLX Funding, LLC.10.15
              Factoring
                  agreement dated November 22, 2006 between the Company (Bott Equipment
                  Company, Inc.) and BLX Funding, LLC.31.1
              Certification
                  of PresidentPursuant
                  to Rule 13a-14(a) of the Securities Exchange Act of 1934 (Filed
                  electronically herewith)31.2
              Certification
                  of Chief Financial OfficerPursuant
                  to Rule 13a-14(a) of the Securities Exchange Act of 1934 (Filed
                  electronically herewith)32.2
              Certification
                  of President and Chief Financial Officer Pursuant to18
                  U.S.C Section 1350 (Furnished electronically
                  herewith).


40


SIGNATURES





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the Registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.





CONVERGENCE
      ETHANOL, INC.


(Registrant)








Date:
                February 23, 2007
            /s/James
                A.
                LattyJames
                A. LattyChief
                Executive Officer






41