**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549





**FORM
      10-QSB**





**x
      QUARTERLY REPORT UNDER
      SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934**





For
      the
      quarterly period ended September 30, 2006





**o
      TRANSITION REPORT UNDER
      SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934**


For
      the
      transition period from _______________ to _________________





000-29743


(Commission
      file number)







**INTERNAL
      HYDRO INTERNATIONAL INC**


(Exact
      name of small business issuer as specified in its charter)






**Florida**
            **88-0409143**(State
                or other jurisdiction of
                incorporation or organization)
            (IRS
                Employer Identification
                No.)







**334
      S. HYDE PARK AVE., TAMPA, FLORIDA 33606**


**** (Address
      of principal executive offices) (Zip Code)





813-944-3185


(Issuer's
      telephone number)







Check
      whether 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 past 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 an accelerated filer (as defined
          in
          exchange A Rule 12b-2) Yes   ̈Nox
 
 Indicate
          by check mark whether the registrant is a shell company (as defined in
          Rule
          12b-2 of the Exchange Act). Yes   ̈Nox


The
      number of shares outstanding of common stock as of September 30, 2006 is shown
      below:




There
      is
      a limited trading market for the registrant's Common Stock, there were 108,066,568 shares
      of
      Common Stock, and 1,255,180 shares
      of
      preferred stock issued and outstanding as of September 30, 2006.




Documents
      Incorporated by Reference: None




1
 
 **INTERNAL
        HYDRO INTERNATIONAL INC.**
 **INDEX
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED SEPTEMBER 30, 2006**





Table
                  of Contents
              PagePART
                  I
              FINANCIAL
                  INFORMATION
              4Item
                  1
              Financial
                  Statements
              4Balance
                    Sheet line should read "BALANCE SHEET as of  September 30, 2006 and
                    2005 (Unaudited)
              4STATEMENT
                  OF OPERATIONS For the quarters ended  September 30, 2006 and 2005
                  (Unaudited)
              5STATEMENT
                  OF CASH FLOWS For the quarters ended  September  30, 2006 and
                  2005 (Unaudited)
              6Notes
                  to Financial Statements
              7Item
                  2
              Management's
                  Discussion and Analysis or Plan of Operations
              16Item
                  3
              Controls
                  and Procedures
              25PART
                  II
              OTHER
                  INFORMATION
              25Item
                  1
              Legal
                  Proceedings
              25Item
                  2
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              25Item
                  6
              Exhibits
              26SIGNATURES
              26





2





Forward
      looking statements





We
      are
      including the following cautionary statement in this Form 10-KSB to make
      applicable and take advantage of the safe harbor provision of the Private
      Securities Litigation Reform Act of 1995 for any forward-looking statements
      made
      by, or on behalf of, the Company. Forward-looking statements include statements
      concerning plans, objectives, goals, strategies, expectations, future events
      or
      performance and underlying assumptions and other statements that are other
      than
      statements of historical facts. The statements contained herein and other
      information contained in this report may be based, in part, on management's
      estimates, projections, plans and judgments. These forward-looking statements
      are subject to certain risks and uncertainties that could cause actual results
      to differ materially from historical results or those anticipated. In this
      report, the words "anticipates", "believes", "expects", "intends", "future",
      "plans", "targets" and similar expressions identify forward-looking statements.
      Readers are cautioned not to place undue reliance on the forward-looking
      statements contained herein. We undertake no obligation to publicly revise
      these
      forward-looking statements to reflect events or circumstances that may arise
      after the date hereof. Our expectations, beliefs and projections are expressed
      in good faith and are believed to have a reasonable basis, including without
      limitations, management's examination of historical operating trends, data
      contained in our records and other data available from third parties, but there
      can be no assurance that management's expectations, beliefs or projections
      will
      result or be achieved or accomplished. In addition to other factors and matters
      discussed elsewhere herein, the following are important factors that could
      cause
      actual results to differ materially from those discussed in the forward-looking
      statements: our dependence on limited cash resources, dependence on certain
      key
      personnel within the Company, and the ability to raise additional capital;
      our
      ability to obtain acceptable forms and amounts of financing; the demand for,
      and
      price level of, our products and services; competitive factors; the ability
      to
      mitigate concentration of business in a small number of customers; the evolving
      industry and technology standards; the ability to protect proprietary
      technology; the dependence on key personnel; and our ability to efficiently
      manage our operations. Accordingly, actual results may differ, possibly
      materially, from the predictions contained herein.

















3


**PART
      I. FINANCIAL INFORMATION**


**Item
      1. Financial Statements**


**INTERNAL
                  HYDRO INTERNATIONAL INC****(A
                  Development Stage Company)****BALANCE
                  SHEET****As
                  of September 30, 2006, 2005****ASSETS****2006**
              
              
              **2005****CURRENT
                  ASSETS****Cash
                  and Equivalents**
              
              **$**
              **2,340**
              
              **$**
              **116****2,340**
              
              
              **116****PROPERTY
                  & EQUIPMENT****Computers
                  & Equipment****(net
                  of accumulated depreciation)**
              
              
              **9,430**
              
              
              **11,441****OTHER
                  ASSETS****Investment
                  - Langley Park**
              
              
              **14,124**
              
              
              **11,533****Investment
                  - Kinetic Energy**
              
              
              **68,750**
              
              
              **187,500****Security
                  Deposit**
              
              
              **2,500**
              
              
              **-****Prepaid
                  Rent**
              
              
              **4,800**
              
              
              **-****Accounts
                  / Loan Receivable**
              
              
              **-**
              
              
              **7,000****Licensing
                  Fee**
              
              
              **100,000**
              
              
              **-****190,174**
              
              
              **206,033****$**
              **201,944**
              
              **$**
              **217,590****LIABILITIES
                  & STOCKHOLDERS' EQUITY****CURRENT
                  LIABILITIES****Accounts
                  Payable**
              
              **$**
              **59,190**
              
              **$**
              **218,851****Contingent
                  Payroll Tax**
              
              
              **265,753**
              
              
              **-****Accrued
                  Liabilities**
              
              
              **156,290**
              
              
              **4,130****Notes
                  Payable**
              
              
              **-**
              
              
              **52,445****Due
                  to Shareholder**
              
              
              **22,000**
              
              
              **99,750****503,233**
              
              
              **375,176****OTHER
                  LIABILITIES****Debt
                  Under Professional Management**
              
              
              **906,879**
              
              
              **906,879****Total
                  Liabilities**
              
              
              **1,410,112**
              
              
              **1,282,055****STOCKHOLDERS'
                  EQUITY****Preferred
                  Stock, $.001 par value, 70,000,000 shares
                  authorized****1,255,180
                  shares issued and outstanding**
              
              
              **1,255**
              
              
              **8,886****Common
                  Stock, $.001 par value,200,000,000 shares
                  authorized****108,066,568
                  shares issued and outstanding**
              
              
              **108,066**
              
              
              **51,643****Additional
                  Paid-In Capital**
              
              
              **11,777,708**
              
              
              **4,976,833****UnrealizedLloss
                  on Investment**
              
              
              **(83,786**
              **)**
              
              **(103,780**
              **)****Deficit
                  Accumulated During Development Stage**
              
              
              **(13,011,411**
              **)**
              
              **(5,998,047**
              **)****Total
                  Stockholders' Equity**
              
              
              **(1,208,168**
              **)**
              
              **(1,064,465**
              **)****$**
              **201,944**
              
              **$**
              **217,590****See
                  accompanying notes to unaudited financial
                  statements**





4





**INTERNAL
                HYDRO INTERNATIONAL INC****(A
                Development Stage Company)****STATEMENT
                OF OPERATIONS****For
                the quarters ended September 30, 2006 and 2005****Date
                of****For
                the 3**
            
            
            **For
                the 3**
            
            
            **For
                the 9**
            
            
            **For
                the 9**
            
            
            **Inception****Months
              Ended**
            
            
            **Months
              Ended**
            
            
            **Months
              Ended**
            
            
            **Months
              Ended**
            
            
            **through****September
              30,**
            
            
            **September
              30,**
            
            
            **September
                30,**
            
            
            **September
              30,**
            
            
            **September
              30,****2006**
            
            
            **2005**
            
            
            **2006**
            
            
            **2005**
            
            
            **2006****NET
                SALES**
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -**COST
                OF SALES**
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -**GROSS
                PROFIT**
            
            
            -
            
            
            -
            
            
            -
            
            
            -**Selling,
                General, and Administrative Expenses**
            
            
            **563,954**
            
            
            **407,789**
            
            
            **5,873,023**
            
            
            **1,389,095**
            
            
            **10,046,398****Research
                & Development**
            
            
            **38,934**
            
            
            
            
            
            **682,652**
            
            
            **85,154**
            
            
            **1,348,585****LOSS
                FROM OPERATIONS**
            
            
            **602,888**
            
            
            **407,789**
            
            
            **6,555,675**
            
            
            **1,474,249**
            
            
            **11,394,983****Loss
                on Sale of Securities**
            
            
            **-**
            
            
            **-**
            
            
            **-**
            
            
            **-**
            
            
            **697,237****Permanent
                Impairment on Writedown of****Marketable
                Securities**
            
            
            **-**
            
            
            **775,312**
            
            
            **7,996**
            
            
            **775,312**
            
            
            **911,464****Other
                Income**
            
            
            **(22,500**
            **)**
            
            
            
            
            **(65,000**
            **)**
            
            
            
            
            **(87,500**
            **)****Interest
                Expense**
            
            
            
            
            
            **16,701**
            
            
            **11,196**
            
            
            **37,645**
            
            
            **95,227****NET
                LOSS**
            
            **$**
            **580,388**
            
            **$**
            **1,199,802**
            
            **$**
            **6,509,867**
            
            **$**
            **2,287,206**
            
            **$**
            **13,011,411****BASIC
                NET LOSS PER COMMON SHARE**
            
            **$**
            **(0.01**
            **)**
            **$**
            **(0.02**
            **)**
            **$**
            **(0.07**
            **)**
            **$**
            **(0.06**
            **)****DILUTED
                NET LOSS PER COMMON SHARE**
            
            **$**
            **(0.01**
            **)**
            **$**
            **(0.02**
            **)**
            **$**
            **(0.07**
            **)**
            **$**
            **(0.04**
            **)****WEIGHTED
                AVERAGE OF COMMON SHARES OUTSTANDING**
            
            
            **103,395,256**
            
            
            **49,267,421**
            
            
            **94,754,900**
            
            
            **39,174,615****See
                accompanying notes to unaudited financial
                statements**






5





**INTERNAL
                  HYDRO INTERNATIONAL INC****(A
                  Development Stage Company)****STATEMENT
                  OF CASH FLOWS****For
                  the quarters ended September 30, 2006 and 2005****Accumulated
                  from****For
                  the
                  3**
              
              
              **For
                  the 9**
              
              
              **For
                  the 3**
              
              
              **For
                  the 9**
              
              
              **Date
                  of Inception****months
                  ended**
              
              
              **months
                  ended**
              
              
              **months
                  ended**
              
              
              **months
                  ended**
              
              
              **through****September
                  30,**
              
              
              **September
                  30,**
              
              
              **September
                  30,**
              
              
              **September
                  30,**
              
              
              **September
                  30,****2006**
              
              
              **2006**
              
              
              **2005**
              
              
              **2005**
              
              
              **2006****OPERATING
                  ACTIVITIES****Net
                  Loss**
              
              **$**
              **(580,388**
              **)**
              **$**
              **(4,926,948**
              **)**
              **$**
              **(2,287,206**
              **)**
              **$**
              **(3,933,301**
              **)**
              **$**
              **(13,011,411**
              **)****Adjustments
                  to reconcile net loss to cash used by operating
                  activities:****Depreciation
                  expense**
              
              
              **980**
              
              
              **2,940**
              
              
              **2,775**
              
              
              **4,625**
              
              
              **10,571****Rent
                  Deposit**
              
              
              
              
              
              **(2,500**
              **)**
              
              
              
              
              **(2,500**
              **)**
              
              **(2,500**
              **)****Issuance
                  of common and preferred stock for services
                  performed**
              
              
              **477,559**
              
              
              **3,782,360**
              
              
              **1,077,903**
              
              
              **2,368,996**
              
              
              **8,604,444****Issuance
                  of common stock for Regent**
              
              
              **-**
              
              
              **450,000**
              
              
              **-**
              
              
              
              
              
              **746,000****Prepaid
                  Rent**
              
              
              **3,225**
              
              
              **(4,800**
              **)**
              
              
              
              
              
              
              
              **(4,800**
              **)****Amortization
                  of Debt Discount**
              
              
              
              
              
              
              
              
              **20,000**
              
              
              **35,000**
              
              
              **60,000****Other
                  Income from cancellation of common stock**
              
              
              **(22,500**
              **)**
              
              **(87,500**
              **)**
              
              
              
              
              **-**
              
              
              **(87,500**
              **)****Loss
                  on sale of securities**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **697,237****Permanent
                  Impairment of marketable securities**
              
              
              
              
              
              
              
              
              **775,312**
              
              
              **775,312**
              
              
              **911,464****Changes
                  in assets and liabilities****Stock
                  subscription receivable**
              
              
              **-**
              
              
              **-**
              
              
              **2,500**
              
              
              **2,500**
              
              
              **2,500****Stock
                  Loan receivable**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **7,000****Contingent
                  payroll liability**
              
              
              **17,095**
              
              
              **168,127**
              
              
              
              
              
              
              
              
              **265,753****(Decrease)
                  Increase in accounts payable and accrued
                  liabilities**
              
              
              **(2,098**
              **)**
              
              **141,098**
              
              
              **194,485**
              
              
              **286,203**
              
              
              **215,146****Cash
                  used by operating activities**
              
              
              **(106,127**
              **)**
              
              **(477,223**
              **)**
              
              **(214,231**
              **)**
              
              **(463,165**
              **)**
              
              **(1,586,096**
              **)****INVESTING
                  ACTIVITIES****Purchase
                  of equipment**
              
              
              **(1,254**
              **)**
              
              **(1,919**
              **)**
              
              **(64**
              **)**
              
              **(64**
              **)**
              
              **(17,922**
              **)****Cash
                  on proceeds on sale of marketable securities**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **193,388****Employee
                  advances**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **(7,000**
              **)****Cash
                  provided used in investing activities**
              
              
              **(1,254**
              **)**
              
              **(1,919**
              **)**
              
              **(64**
              **)**
              
              **(64**
              **)**
              
              **168,466****FINANCING
                  ACTIVITIES****Decrease
                  in Notes Payables**
              
              
              
              
              
              **(4,900**
              **)**
              
              
              
              
              
              
              
              **(60,000**
              **)****Decrease
                  in Shareholder loans**
              
              
              
              
              
              **(55,000**
              **)**
              
              
              
              
              
              
              
              **(221,771**
              **)****Proceeds
                  from shareholder advances**
              
              
              **109,100**
              
              
              **672,650**
              
              
              **57,700**
              
              
              **439,900**
              
              
              **1,522,470****Proceeds
                  from sale of common stock**
              
              
              
              
              
              
              
              
              **118,650**
              
              
              **118,650**
              
              
              **118,650****Proceeds
                  from notes payables**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **-**
              
              
              **60,000****Cash
                  provided by financing activities**
              
              
              **109,100**
              
              
              **612,750**
              
              
              **176,350**
              
              
              **558,550**
              
              
              **1,419,349****INCREASE
                  IN CASH AND CASH EQUIVALENTS**
              
              
              **1,719**
              
              
              **133,608**
              
              
              **(37,935**
              **)**
              
              **95,321**
              
              
              **1,719****CASH
                  AND CASH EQUIVALENTS, beginning of period**
              
              
              **621**
              
              
              **(131,268**
              **)**
              
              **38,051**
              
              
              **(95,205**
              **)**
              
              **621****CASH
                  AND CASH EQUIVALENTS, end of period**
              
              **$**
              **2,340**
              
              **$**
              **2,340**
              
              **$**
              **116**
              
              **$**
              **116**
              
              **$**
              **2,340****SUPPLEMENTAL
                  SCHEDULE OF NON-CASH INVESTING AND FINANCING
                  ACTIVITIES****Stock
                  issued for debt conversion**
              
              
              
              
              
              
              
              **$**
              **109,100****See
                  accompanying notes to unaudited financial
                  statements**






6
 **INTERNAL
            HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
            CONDENSED FINANCIAL STATEMENTS**
 **for
            the three months and nine months ended September 30, 2006 and
            2005**
 FOOTNOTES







**NOTE
      1 - DESCRIPTION OF BUSINESS AND SIGNIGICANT ACCOUNTING
      POLICIES**





Background
      and Nature of Business





INTERNAL
      HYDRO INTERNATIONAL, INC., a Development Stage Company, (formerly Internal
      Command International (“ICI”)) was incorporated under the laws of the State of
      Florida on January 21, 2003 (the “Company”).





On
      January 2, 2004 the Company entered into a merger agreement with Home Services
      International, Inc. (“HSI”). HSI issued 27,500,000 shares of its Series A
      Preferred stock. The Company is a development stage enterprise. The Company
      intends to manufacture and distribute its alternative energy products that
      use
      water pressure flow to generate electricity. In connection with this
      acquisition, the company was re-named “Internal Hydro International,
      Inc.”





As
      a
      result of the merger transaction with HSI, the former Company stockholders
      obtained control of HSI’s voting stock. For financial accounting purposes, the
      acquisition was a reverse acquisition of HSI by the Company, under the purchase
      method of accounting, and was treated as a recapitalization with the Company
      as
      the acquirer. Accordingly, the historical financial statements have been
      restated after giving effect to the January 2, 2004, acquisition of the Company.
      The financial statements have been prepared to give retroactive effect to
      January 21, 2003 (date of inception), of the reverse acquisition completed
      on
      January 2, 2004, and represent the operations of the Company. Consistent with
      reverse acquisition accounting: (i) all of the Company’s assets, liabilities,
      and accumulated deficit, are reflected at their combined historical cost (as
      the
      accounting acquirer) and (ii) the preexisting outstanding shares of the HSI
      (the
      accounting acquiree) are reflected at their net asset value as if issued on
      January 21, 2003.





Basis
      of
      Presentation





The
      Company follows the accrual basis of accounting in accordance with accounting
      principles generally accepted in the United States of America and has adopted
      a
      year-end of December 31.





Management
      further acknowledges that it is solely responsible for adopting sound accounting
      practices, establishing and maintaining a system of internal accounting control
      and preventing and detecting fraud. The Company’s system of internal accounting
      control is designed to assure, among other items, that 1) recorded transactions
      are valid; 2) valid transactions are recorded; and 3) transactions are recorded
      in the proper period in a timely manner to produce financial statements which
      present fairly the financial condition, results of operations and cash flows
      of
      the Company for the respective periods being presented.





Development
      Stage Enterprise





The
      Company is considered a Development Stage Enterprise in that principal
      operations have not commenced and principal operations have not generated any
      revenue. During the development stage, the Company devotes most of its
      activities toward establishing business and raising capital.





Going
      Concern Uncertainty





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. As reflected in
      the
      accompanying consolidated financial statements, the Company has had recurring
      losses and negative cash flows from operations, and negative working capital.
      The Company has abandoned it’s only operating business segment and is attempting
      to raise capital, seek acquisition targets and commence operations in a new
      business segment. There are no assurances that the Company will be successful
      in
      any of these endeavors. These factors raise substantial doubt about the
      Company's ability to continue as a going concern. Without realization of
      additional capital, it would be unlikely for the Company to continue 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 its existence.





7
 
 **INTERNAL
          HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
          CONDENSED FINANCIAL STATEMENTS**
 **for
          the three months and nine months ended September 30, 2006 and
          2005**
 FOOTNOTES




NOTE
      1 - DESCRIPTION OF BUSINESS AND SIGNIGICANT
      ACCOUNTING POLICIES - continued





Principles
      of Consolidation





The
      accompanying consolidated financial statements include the accounts of HSI
      and
      its wholly owned subsidiary, ICI. All intercompany accounts and transactions
      have been eliminated.





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 revenue and expenses during
      the reporting period. Actual results could differ from those
      estimates.





Fair
      Value of Financial Instruments





The
      carrying amount of cash, accounts payable, notes payable and accrued
      liabilities, as applicable, approximates fair value due to the short term nature
      of these items.








Cash
      and
      Cash Equivalents





The
      Company considers all highly liquid investments purchased with original
      maturities of three months or less to be cash equivalents.





Concentration
      of Credit Risk





The
      Company places its cash in what it believes to be credit-worthy financial
      institutions. However, cash balances may exceed FDIC insured levels at various
      times during the year. There were no bank balances exceeding insured limits
      at
      September 30, 2006.





Revenue





There
      was
      no revenue generated in the years ended December 31, 2005 and 2004.





Two
      contracts were signed in the third quarter of 2006 for sales of three Energy
      Commander V machines. The sale price of each machine is $30,000. The first
      contract calls for a 30% deposit within 30 days of the signing of the contract.
      This deposit has not yet been paid and therefore the total contract is not
      reflected in the financial statements.


The
      second contract is for the sale of two Energy Commander V. The contract calls
      for a 30% down payment that will occur immediately after placement locations
      for
      the machines are found. The condition precedent for the down payment has not
      yet
      occurred and therefore the total contract is not reflected in the financial
      statements.





Income
      Taxes





Income
      taxes are provided for based on the liability method of accounting pursuant
      to
      Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for
      Income Taxes.” Deferred income taxes, if any, are recorded, using enacted tax
      rates expected to apply, to reflect the tax consequences on future years of
      differences between the tax bases of assets and liabilities and their financial
      reporting amounts at each year-end.







8
 
 **INTERNAL
          HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
          CONDENSED FINANCIAL STATEMENTS**
 **for
          the three months and nine months ended September 30, 2006 and
          2005**
 FOOTNOTES





NOTE
      1 - DESCRIPTION OF BUSINESS AND
      SIGNIGICANT ACCOUNTING POLICIES - continued




Loss
      Per
      Share




The
      Company calculates earnings per share in accordance with SFAS No. 128, "Earnings
      Per Share," which requires presentation of basic earnings per share ("Basic
      EPS") and diluted earnings per share ("Diluted EPS"). The computation of Basic
      EPS is computed by dividing loss available to common stockholders by the
      weighted average number of outstanding common shares during the period. Diluted
      EPS gives effect to all dilutive potential common shares outstanding during
      the
      period. The computation of Diluted EPS does not assume conversion, exercise
      or
      contingent exercise of securities that would have an anti-dilutive effect on
      earnings. As of December 31, 2005, there were no stock options and 107,497
      warrants outstanding.





Stock
      Based Compensation





The
      Company is subject to the provisions of SFAS No. 123 "Accounting for Stock-Based
      Compensation," which prescribes the recognition of compensation expense based
      on
      the fair value of options on the grant date. SFAS No. 123 allows companies
      to
      continue applying APB 25 if certain pro forma disclosures are made assuming
      hypothetical fair value method, for which the Company uses the Black-Scholes
      option-pricing model.





The
      Company accounts for employee stock options in accordance with Accounting
      Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to
      Employees.” Under APB 25, the Company recognizes no compensation expense related
      to employee stock options, as no options are granted at a price below market
      price on the date of grant.





For
      non-employee stock based compensation, the Company recognizes an expense in
      accordance with SFAS No. 123 and values the equity securities based on the
      fair
      value of the security on the date of grant. For stock-based awards the value
      is
      based on the market value for the stock on the date of grant and if the stock
      has restrictions as to transferability a discount is provided for lack of
      tradability. Stock option awards are valued using the Black-Scholes
      option-pricing model.





Advertising





The
      Company expenses advertising costs as incurred. The Company had no advertising
      expense in the quarter ended September 30, 2006.





Interim
      Financial Statement





The
      accompanying unaudited consolidated financial statements have been prepared
      in
      accordance with generally accepted accounting principles for interim financial
      information and with the instructions to Form 10-QSB and Article 10 of
      Regulation S-B. Accordingly, they do not include all of the information and
      footnotes required by generally accepted accounting principles for complete
      financial statements. In the opinion of management, all adjustments (consisting
      of normal recurring accruals) considered necessary for a fair presentation
      have
      been included. Operating results for the nine month period ended September
      30,
      2006 and 2005 are not necessarily indicative of the results that may be expected
      for the respective full years.





A
      summary
      of the Company’s significant accounting policies and other information necessary
      to understand these consolidated interim financial statements is presented
      in
      the Company’s audited financial statements included in Form 10-KSB for the years
      ended December 31, 2005 and 2004. Accordingly, the Company’s audited financial
      statements should be read in connection with these financial
      statements.





Recently
      Issued Accounting Pronouncements





In
      December 2002, the FASB issued SFAS No. 148, *Accounting
      for Stock-Based Compensation - Transition and Disclosure - an amendment of
      FASB
      Statement No. 123* .
      SFAS
      No. 148 amends SFAS No.





9
 
 **INTERNAL
          HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
          CONDENSED FINANCIAL STATEMENTS**
 **for
          the three months and nine months ended September 30, 2006 and
          2005**
 FOOTNOTES





**NOTE
      1 - DESCRIPTION OF BUSINESS AND SIGNIGICANT ACCOUNTING POLICIES -
      continued**




123, *Accounting
      for Stock-Based Compensation* ,
      to
      provide alternative methods of transition for a voluntary change to the fair
      value-based method of accounting for stock-based employee compensation. In
      addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
      require prominent disclosures in both interim and annual financial statements
      about the method of accounting for stock-based employee compensation and the
      effect of the method used on reported results. SFAS No. 148 is effective for
      financial statements issued for fiscal years ending after December 15, 2002.
      The
      adoption of SFAS No. 148 did not have a material effect on its financial
      position or results of operations.





In
      January 2003, the FASB issued FIN No. 46, *Consolidation
      of Variable Interest Entities* ,
      and
      amended the Interpretation in December 2003. FIN No. 46 states that companies
      that have exposure to the economic risks and potential rewards from another
      entity's assets and activities have a controlling financial interest in a
      variable interest entity and should consolidate the entity, despite the absence
      of clear control through a voting equity interest. Disclosure of significant
      variable interest entities is required in all financial statements issued after
      January 31, 2003, regardless of when the variable interest was created. The
      adoption of FIN No. 46 did not have a material effect on its financial position
      or results of operations.





In
      May
      2003, the FASB issued SFAS No. 150, *Certain
      Financial Instruments with Characteristics of Both Liabilities and
      Equity* .
      SFAS
      No. 150 established standards for how a company clarifies and measures certain
      financial instruments with characteristics of both liabilities and equity.
      It
      requires a company to classify such instruments as liabilities, whereas they
      previously may have been classified as equity. SFAS No. 150 is effective for
      all
      financial instruments entered into or modified after May 31, 2003. The adoption
      of SFAS No. 150 did not have a material effect on its financial position or
      results of operations.





In
      December 2004, the FASB issued a revised Statement 123 (SFAS 123R),
“ *Accounting
      for Stock-Based Compensation* ”
      requiring public entities to measure the cost of employee services received
      in
      exchange for an award of equity instruments based on grant date fair value.
      The
      cost will be recognized over the period during which an employee is required
      to
      provide service in exchange for the award — usually the vesting period. The
      Company is evaluating the impact of this new pronouncement and does not expect
      that the effect of implementation will have a significant impact on the
      Company’s financial statements.





**NOTE
      2 - RELATED PARTY TRANSACTIONS**





As
      of
      September 30, 2006, the Company has received loans totaling $165,700 from
      officers and shareholders to cover operating expenses and certain accounts
      payable. Currently, there are no repayment terms specified for the shareholders
      loans; therefore, the Company has classified the loans as a current liability.
      These are non-interest bearing loans.





In
      addition, the Company entered into a comprehensive Agreement for Licensing,
      Joint Venture Agreement, and Manufacturing Agreement on October 12, 2005 with
      Regent Machine Products, LLC for the exclusive rights to the HydroCam/EC V
      technology which was developed by Regent Machine Products, LLC. Anthony
      Pecoraro, the Company’s Chairman of the Board and VP of New Technology, is the
      current Vice President and Co-Founder of Regent Machine Products, LLC. In
      addition, Mr. Pecoraro is married to Mary Pecoraro, the President and Co-Founder
      of Regent Machine Products, LLC who also serves as the Company’s Secretary. Mr.
      Pecoraro was appointed as Chairman of the Board of Directors on January 18,
      2006. Mr. Pecoraro was not affiliated with the Company at the time the
      comprehensive Agreement for Licensing, Joint Venture Agreement, and
      Manufacturing Agreement was signed, however Mary Pecoraro was Secretary of
      the
      Company at that time.





**NOTE
      3 - STOCKHOLDERS' DEFICIENCY**





On
      October 12, 2005, 7,400,000 shares were issued for the comprehensive Agreement
      for Licensing, Joint Venture Agreement, and Manufacturing Agreement with Regent
      Machine Products, LLC. Additionally, in the quarter ended June 30, 2006,
      2,500,000 shares were issued under this agreement. A total of 9,900,000 shares
      have been issued under this agreement.





10
 
 **INTERNAL
          HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
          CONDENSED FINANCIAL STATEMENTS**
 **for
          the three months and nine months ended September 30, 2006 and
          2005**
 FOOTNOTES





**NOTE
      3 - STOCKHOLDERS' DEFICIENCY - continued**




During
      the year ended December 31, 2002, HSI placed 2,813,180 shares of its common
      stock in an escrow account. These shares are contingently issuable as they
      are
      to be issued to creditors as part of a plan to negotiate Company obligations
      through an intermediary. The Company is attempting to settle obligations by
      negotiating with creditors to take the Company’s common stock as payment for the
      obligations. During the year ended December 31, 2002, the Company had not issued
      any of these shares to creditors. During the year ended December 31, 2003,
      the
      Company negotiated a settlement in which 249,905 shares of common stock were
      issued out of escrow to settle a creditor obligation that had an original
      balance of $65,000. The settlement was recorded at the trading value of the
      shares on the date of settlement. That value was $299,866. The result was an
      additional expense of $234,866 charged to operations for the year ended December
      31, 2003. During the year ended December 31, 2004 and December 31, 2005, the
      Company did not issued any of these shares to creditors.





On
      July
      29, 2004, the Company entered into a Stock Purchase Agreement ("Purchase
      Agreement"), effective October 7, 2004, with Langley Park Investments Plc
      ("Langley"), a corporation organized under the laws of England and Wales which
      is admitted to trade on the London Stock Exchange ("LSE") as an investment
      trust. Pursuant to the Purchase Agreement, the Company sold 2,375,000 shares
      (post-split) of its common stock ("Company Stock") to Langley for a total
      purchase price of approximately $1,780,000.





Langley
      paid the purchase price by delivering 882,778 Ordinary Shares of Langley
      ("Langley Shares") to the Company with a value of one (1.00) British Pound
      Sterling (approximately U.S. $1.80) per share. The Company issued the Company
      Stock to Langley. Both the Company Stock and the Langley Shares were initially
      placed into escrow, including fifty percent (50%) of the Langley Shares to
      be
      deposited into escrow as Downside Price Protection (the "Langley Escrow
      Shares").





On
      November 3, 2004, the Company sold 441,389 shares of Langley Park Investment,
      (London Exchange: LPI) for $193,388 (approximately .44 cents per share). This
      was the first liquidation pursuant to the Agreement. These gross proceeds
      represented a loss of $697,237 based upon the difference between the selling
      price on November 3, 2004 and the Company’s trading price on July 29,
      2004.





The
      balance of the 441,389 shares owned by the Company are valued at the market
      price of the Langley Park Investments Plc as listed on the London Stock Exchange
      ("LSE") with the difference being carried as an unrealized loss in the equity
      section of the Company’s financial statements.





Pursuant
      to the terms and conditions of the Purchase Agreement, on the two year
      anniversary of the Purchase Agreement (Two Year Anniversary), the market value
      of the Company's common stock will be compared to the purchase price of the
      Company Stock under the Purchase Agreement "Market Value” is defined as the
      average of the ten (10) closing bid prices per share of the Company's common
      stock during the ten (10) trading days immediately preceding the Two Year
      Anniversary of the Agreement. If the Market Value of the Company's common stock
      on the Two Year Anniversary is the same or higher than purchase price per share,
      then at that time, the Company will receive all of the Langley Escrow Shares.
      If
      the Market Value on the Two Year Anniversary is less than purchase price per
      share, then for each percentage point decline in value, the Company must sell
      a
      corresponding percentage of the Langley Escrow Shares back to Langley for
      nominal consideration, up to the maximum number of Langley Escrow Shares, and
      the balance of the Langley Escrow Shares will be released from escrow to the
      Company.





Internal
      Hydro International Inc. was approached with the investment by Langley, at
      a
      time when the two year lock up of the shares to be issued was voted on by the
      Board of Directors as being acceptable for purposes of investment given the
      stock price and discount proposed by Langley. The escrowed shares were analyzed
      on December 31, 2004 and accounted for as if they would eventually be sold
      at
      the two year mark as investment holding period. At the time of the investment
      and at the time of the accounting determination, management believed that the
      Company would meet the criteria as set forth in the Langley agreement which
      would allow the sale of the remaining shares in the fund. The Company recorded
      an additional unrealized loss of $100,409 on this investment at December 31,
      2005 due to this provision. The additional write down was calculated on the
      basis of the quoted value of the Langley shares less the pro-rata value of
      shares that would be returned to Langley based on the trading value of the
      Company's common stock at December 31, 2005.





11
 
 **INTERNAL
          HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
          CONDENSED FINANCIAL STATEMENTS**
 **for
          the three months and nine months ended September 30, 2006 and
          2005**
 FOOTNOTES








**NOTE
      4 - COMMON AND PREFERRED STOCK**





The
      Company’s Articles of Incorporation authorize the issuance of up to 200,000,000
      shares of common stock, with a par value of $.001 and the issuance of up to
      70,000,000 shares of preferred stock, with a par value of $.001.





**COMMON
      STOCK**


During
      the three months ended September 30, 2006, the Company engaged in various
      transactions affecting stockholders’ equity, as follows:





The
      Company issues its common stock from time to time to compensate employees and
      consultants as consideration for services rendered. These shares are valued
      at
      the trading value on the date of grant. For the quarter ended, September 30,
      2006, a total of 2,940,157 shares were issued to 21 individuals as payment
      for
      services totaling $372,560.





For
      the
      quarter ended September 30, 2006, 1,165,334 shares of common stock were issued
      as payment for loans totaling $109,100. Loans are non-interest bearing and
      are
      paid by stock valued as of the date of issuance of the common stock. Pursuant
      to
      the terms of the loan, if the loan can not be repaid within a specified time
      period, then shares are issued to the lender equal to the amount of the loan.
      Currently, $22,000 is owed as a short-term loan to a shareholder. This loan
      is
      non-interest bearing and has no repayment term specified.





**PREFERRED
      STOCK**


The
      Company's has designated the issuance of up to 70,000,000 shares of Series
      A
      Convertible Preferred Stock, with a par value of $.001. Series A Convertible
      Preferred Stock can be exchanged at the option of the stockholder into shares
      of
      common stock at the rate of one share of Series A Convertible Preferred Stock
      for one share of Common Stock at any time after the first anniversary of the
      original date of issuance. The Series A Convertible Preferred Stock shall rank,
      as to dividends and upon liquidation senior and prior to the Company’s Common
      Stock and to all other classes or class of stock issued by the Company, except
      as otherwise approved by the affirmative vote or consent of the holders of
      a
      majority of the shares of Series A Convertible Preferred Stock. In addition,
      so
      long as any share of Series A Convertible Preferred Stock shall be outstanding,
      the holders of such convertible preferred stock shall be entitled to receive
      out
      of any funds legally available, when, as and if declared by the Board of
      Directors of the Company, preferential dividends at the rate of ten percent
      (10%) per annum, payable upon the first anniversary date of the original issue
      date, then quarterly with payment to be made in either cash or in the issuance
      of additional shares of Series A Convertible Preferred Stock. Such dividends
      shall be cumulative and begin to accrue from the original issue date, whether
      or
      not declared and whether or not there shall be net profits or net assets of
      the
      Company legally available for the payment of those dividends. To date, no
      dividend has been declared by the Board of Directors. The Series A Convertible
      Preferred stockholders shall be entitled to vote on all matters requiring a
      shareholder vote of the Company. Each Series A Convertible Preferred shareholder
      of record shall have one vote for each share of Series A Convertible Preferred
      stock outstanding.





**NOTE
      5 - FURNITURE AND EQUIPMENT**





Furniture
      and equipment is stated at cost less accumulated depreciation. Depreciation
      is
      recorded on a straight-line basis over the estimated useful lives of the assets
      of 3 to 5 years. Depreciation expense for the year ended December 31, 2005
      and
      2004 was $3,700 and $3,931, respectively. Depreciation expense for the quarter
      ended September 30, 2006 was $980.








12
 
 **INTERNAL
          HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
          CONDENSED FINANCIAL STATEMENTS**
 **for
          the three months and nine months ended September 30, 2006 and
          2005**
 FOOTNOTES





**NOTE
      5 - FURNITURE AND EQUIPMENT - continued**




Property
      and equipment consisted of the following at September 30, 2006:





Office
                and computer equipment
            $
            35,307Less
                accumulated depreciation
            
            25,877Furniture
                and equipment, net
            $
            9,430





**NOTE
      6 - STOCK OPTIONS**





There
      were no stock options granted nor was there any pro forma effect of the vesting
      of options granted in previous periods in the years ended December 31, 2005
      and
      2004 and for the nine months ended September 30, 2006.





**NOTE
      7 - INCOME TAXES**





The
      Company has no net income tax provision or benefit in the periods ended December
      31, 2005 and 2004 and the nine months ended September 30, 2006. Prior to the
      merger transaction with HSI the Company elected to be treated as an
      S-Corporation as prescribed under Section 1362 of the Internal Revenue Code.
      As
      an S-Corporation, items of income, loss, deductions and credits generated by
      the
      Company flow through directly to the stockholders and are included in the tax
      returns of the individual stockholders.





During
      the year ended December 31, 2005, the Company generated a tax benefit related
      to
      operating loss carryforwards of $2,685,047 which was equally offset by a
      valuation allowance.





The
      Company has cumulative net operating losses as of September 30, 2006 of
      approximately $580,388 that will expire in 2008 through 2023.





At
      December 31, 2005, the Company had federal net operating loss carry forwards
      of
      approximately $6,395,888 that expire from 2013 to 2024 and state net operating
      loss carry forwards of approximately $6,620,000 that expire from 2005 to 2008.
      Substantially all of the deferred income tax asset of $2,756,000 relates to
      income tax benefits from net operating loss carry forwards. Because of the
      change of control issues under Section 382 of the Internal Revenue Code and
      the
      current uncertainty of realizing the benefits of the tax carryforward, an equal
      valuation allowance has been established. The full realization of the tax
      benefit associated with the carry forward depends predominantly upon the
      Company's ability to generate taxable income during the carry forward
      period.





**NOTE
      8 - COMMITMENTS AND CONTINGENCIES**





The
      Company is not delinquent and is not attempting to pay current creditors and
      vendors with common stock.





However,
      prior to the merger of Internal Command with Home Services, the Company (HSVI)
      had incurred additional deficits in cash flow from operating activities. The
      Company had accrued approximately $343,000 in obligations to vendors,
      consultants and former employees. We are attempting to settle these obligations,
      primarily through the issuance of common stock. Management believes we will
      ultimately settle these obligations for no more than amounts accrued at December
      31, 2004. As a part of the Merger Agreement with Internal Command International,
      Inc. (ICI), our former Chief Executive Officer of HSVI, Jay Budd, had and did
      affirm that the outstanding debts of HSVI have been properly structured for
      management of the debt post-merger; namely, that the debt was in the hands
      of
      suitable professional debt management team, including Fletcher & Associates,
      and Harry J. Miller, PLLC; that there has been set aside as part of the issued
      common stock for obligation and satisfaction of the debt; and that the incoming
      principals of ICI would be held harmless for this debt. In the summer of 2005,
      we released Harry Miller, PLLC and Fletcher & Associates from their duties
      as debt managers, taking control of such matters internally. To date, the shares
      issued to secure these debts are unissued, and held by both Harry Miller PLLC
      in
      trust, and with the Company, should the need arise for settlement of any such
      debts, if communication and demand for the same is made. To date no such
      verified debt demands have been made. Any settlements will be valued at the
      fair
      value of the stock at the time the settlement is reached, or some other amount
      as negotiated.





13
 **INTERNAL
            HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
            CONDENSED FINANCIAL STATEMENTS**
 **for
            the three months and nine months ended September 30, 2006 and
            2005**
 FOOTNOTES





**NOTE
      8 - COMMITMENTS AND CONTINGENCIES - continued**




The
      Company accrues a contingent payroll tax liability every quarter which accounts
      for any payroll and income taxes that the company would be liable for should
      the
      IRS determine that any of the people paid as independent contractors are
      employees. The Company believes that it is correctly paying all individuals
      as
      independent contractors, and therefore the liability is titled “contingent
      payroll tax”.





**NOTE
      9 - MERGER TRANSACTION**





On
      January 2, 2004, the Company entered into a merger transaction with HSI. The
      Company had net assets of $385. The net deficit of HSI was approximately
      $1,034,000 at January 2, 2004. As discussed in Note 1, the Company accounted
      for
      this transaction under the purchase method of accounting, and it was treated
      as
      a recapitalization with the Company as the acquirer. HSI had office equipment
      of
      approximately $2,000, accounts payable and accrued liabilities of $400,000
      and
      other liabilities of $636,000.





**NOTE
      10 - LOSS PER SHARE**





Outstanding
      options and warrants were not considered in the calculation for diluted earnings
      per share for the years ended December 31, 2004 and 2005 because the effect
      of
      their inclusion would be anti-dilutive.





Warrants
      and options to purchase 107,497 shares of common stock were outstanding and
      excluded from the loss per share calculation at December 31, 2005.





**NOTE
      11 - INVESTMENTS**





During
      the year ended December 31, 2004, the Company entered into a Stock Purchase
      Agreement to acquire 882,778 shares of Langley Park Investments Plc (Langley),
      a
      corporation organized under the laws of England and Wales which is admitted
      to
      trade on the London Stock Exchange (LSE) as an investment trust. Pursuant to
      the
      Purchase Agreement, the Company sold 2,375,000 shares (post-split) of its common
      stock (Company Stock) to Langley for a total purchase price of $1,781,250 based
      on the trading value of the Company’s shares delivered to Langley. The Company
      sold one half of its Langley holdings during the year ended December 31,
      2004.





The
      Company currently classifies all investment securities as available-for-sale.
      These securities are presented at their estimated fair value. Unrealized gains
      and losses on such securities, net of the related income tax effect, are
      excluded from earnings and reported as a separate component of stockholders’
equity until realized. Realized gains and losses are included in earnings and
      are derived using the specific identification method for determining the cost
      of
      securities sold.





Investment
      in Langley and Kinetic securities consisted of the following at September 30,
      2006:




Cost
            
            
            Gross
                Gains
            
            
            Unrealized
                Losses
            
            
            Impairment
                Write-down
            
            
            Fair
                ValueLangley
              Kinetic
            
            $
              
              $
            890,625
              
              187,500
            
            $
              
              $
            -
              
              -
            
            $
              
              $
            91,783
              
              118,750
            
            $
              
              $
            (784,718
              
              (118,750
            )
              
              )
            $
              
              $
            14,124
              
              68,750








During
      the quarter ended September 30, 2005, the Company determined that the decline
      in
      value of the Langley shares was other than temporary. They believed that it
      had
      the ability and intent to hold an investment indefinitely. However, there was
      no
      basis to determine a forecasted recovery of fair value up to (or beyond) the
      cost of the investment. Therefore, the Company wrote the carrying value down
      to
      the investment's quoted trading value at September 30, 2005.





14
 
 **INTERNAL
          HYDRO INTERNATIONAL, INC.**
 **UNAUDITED
          CONDENSED FINANCIAL STATEMENTS**
 **for
          the three months and nine months ended September 30, 2006 and
          2005**
 FOOTNOTES





**NOTE
      11 - INVESTMENTS - continued**




Proceeds
      from sales of equity securities were $193,388 and gross realized losses were
      $697,237 for the year ended December 31, 2004. The fair value at December 31,
      2005 is determined based on the trading price of Langley and translated to
      U.S.
      dollars at the exchange rate on December 31, 2005.





The
      value
      on September 30, 2006 is determined based on the trading price of Langley and
      translated to U.S. dollars at the exchange rate on September 30,
      2006.





During
      the year ended December 31, 2004, the Company invested in Kinetic Energy
      Systems, Inc. (“Kinetic”) by issuing 1,250,000 shares of its common stock for
      approximately 20% of Kinetic. The value of the investment was determined to
      be
      $187,500 based on the trading price of the Company’s common stock at the time of
      the agreement. The Company intends to jointly develop and market complimentary
      technologies with Kinetic. The Company classifies its investment in Kinetic
      as
      available- for-sale and has carried its investment at cost. Kinetic is a private
      company and there is quoted market price for its securities. The Company has
      written down the investment to reflect the trading price of IHDR common stock
      on
      September 30, 2006. The written down value is $68,750. The reason for this
      impairment is because Kinetic’s stock is not considered to be a marketable
      security and therefore there is no way to accurately value their shares. The
      Company owns 2,000,000 voting preferred shares of Kinetic Energy Systems, Inc.
      Kinetic has 10,000,000 preferred shares issued and outstanding and 1,000,000
      common shares outstanding. The Company’s interest in Kinetic is approximately
      18%. The Company exercises no management control and therefore, the cost method
      was used.







































15


**Item
      2. Management's Discussion and Analysis or Plan of Operation.**





**GENERAL
      INFORMATION ABOUT INTERNAL HYDRO**





Internal
      Hydro International, Inc. ("IHDR" or "Company") was organized on December 31,
      1996 as Tel-Voice Communications, Inc. as a Nevada Corporation. On January
      6,
      2003, we changed our name to Home Services International, Inc. On January 2,
      2004, the Company entered into a merger agreement with the Company and on
      January 13, 2004, the name was changed to Internal Hydro International, Inc.
      The
      Company was re-domiciled to Florida on February 4, 2004. We are a publicly
      traded company listed on the OTC Electronic Bulletin Board under the symbol
      "IHDR". Our offices are located at 334 S. Hyde Park Ave., Tampa, Florida 33606.
      Our website is www.internalhydro.com.





**HISTORY
      OF COMPANY**





Tel-Voice
      Communications, Inc. ("Tel-Voice") was incorporated under the laws of the State
      of Nevada on December 31, 1996 to engage in any lawful corporate activity,
      including, but not limited to, selected mergers and acquisitions. From 1996-2000
      Tel-Voice was a development stage company with no business activity. On June
      30,
      2000, Tel-Voice acquired Smartdotcom, Inc. ("SDC") in a transaction accounted
      for as a reverse merger. The Company retained the name Tel-Voice Communications,
      Inc. SDC had developed a technology that provides private electronic networks
      for labor unions and integrated communities, both of which include subscribers
      of the unions and communities. SDC intended to provide the hardware, software
      and technical support required to setup and maintain the networks; however,
      SDC
      was never able to grow the Company due to liquidity issues.





In
      December 2002, we addressed our liquidity problems and discontinued the
      operations of SDC and determined that we would abandon this business plan.
      On
      December 16, 2002, we closed a stock for debt exchange with our creditors
      effective on December 11, 2002 whereby all of our outstanding debt was converted
      to unregistered common stock at a conversion rate of one (1) share of common
      stock for each $0.45 of debt. In addition, on January 10, 2003, a majority
      of
      the shareholders approved a reverse split of the 28.9 shares of the old common
      stock for 1 share of new common stock effective January 13, 2003, the
      acquisition of a private entity name Home Services, Inc. and a name change
      to
      Home Services International, Inc.





Home
      Services International, Inc. (“HSVI”) intended to act as a holding company for
      service businesses related to the home building and home buying that want to
      expand into national markets. HSVI intended to acquire, joint venture and
      develop such businesses.





However,
      HSVI was presented with a business plan for a unique alternative energy
      technology by the management of Internal Command International (“ICI”) a Florida
      based private entity. HSVI felt that the Energy Commander technology for low
      impact hydro power production presented a unique opportunity. HSVI saw ICI’s
      technology as fulfilling a unique niche in the energy market. Thus, HSVI sought
      to acquire the technology, and related expertise through the reverse merger
      process.





On
      January 2, 2004, Internal Hydro entered into a merger agreement with Home Services
      International, Inc. ("HSVI"). HSVI issued 27,500,000 shares of its Series A
      Preferred stock to the shareholders of ICI. In connection with this acquisition,
      the company was re-named Internal Hydro International, Inc. (“IHDR”). On
      February 4, 2004, the company was redomiciled to Florida. ICI was not a related
      party.





As
      a
      result of the merger transaction with HSVI, the former Company stockholders
      obtained control of HSVI's voting stock. For financial accounting purposes,
      the
      acquisition was a reverse acquisition of HSVI, under the purchase method of
      accounting, and was treated as a recapitalization with the Company as the
      acquirer.





**BUSINESS
      STRATEGY**





IHDR
      is a
      development stage enterprise. We intend to manufacture and distribute
      alternative energy products that use water pressure flow to generate
      electricity. IHDR is currently finalizing production units of the Energy
      Commander Version Five ("EC V") super efficient low impact hydro units. The
      Company entered into an a comprehensive Agreement for Licensing, Joint Venture
      Agreement, and Manufacturing Agreement on October 12, 2005 with Regent Machine
      Products, LLC. for the exclusive rights to the HydroCam/EC V technology which
      was developed
      by Regent Machine Products, LLC. Anthony Pecoraro, our Chairman of the Board
      of
      Directors and Vice President of New Technology Development, is also the Vice
      President and Co-Founder of Regent Machine Products, LLC.


16


**Item
        2. Management's Discussion and Analysis or Plan of
        Operation** - continued


IHDR
      has
      now entered into the production and fielding phase of its business plan, both
      domestically, and with an overseas strategic partner. IHDR is now centering
      activities on the final production plans, of a 10 unit fielding of its new
      energy units, the EC V. These units will be deployed to strategic locations
      around North America and in Europe for direct industrial use and for use in
      industrial flows such a cement, chemical, refineries, electrical utility plants,
      steam lines, pipelines, cooling applications and with application to natural
      flows such as water pipelines, rivers, aquaducts, and dams that can not support
      normal turbine hydro systems. Additionally, IHDR is identifying undervalued
      and
      underutilized alternative energy technologies that the company can either
      license or acquire other technologies as second divisions for the corporation.
      This will be done in order to maximize shareholder value and to utilize the
      relationships in the EU and other alternative energy friendly
      areas.




Initial
      production of the EC units will be done in Europe with Internal Hydro’s joint
      venture partner, Cm2 and in the United States with a domestic partner and
      production team. Cm2's production facility is located in Terni, Italy, about
      one
      hour north of Rome. The facility encompasses a large 19,000 sq. meter area
      with
      a 7,000 sq. meter production warehouse. With on staff engineers, marketing
      and
      production, Cm2 is well positioned to handle the Energy Commander (“EC”)
      systems. Cm2 manufactures and produces large industrial electrical components
      for utilities and industries, including such items as transformers, MV and
      LV
      electrical switchboards, auxiliaries and conduits for big transformers, cooling
      ducts, conduit bars, motors and generators. Cm2 also works in the area of hydro
      technologies for implementation of systems to unutilized water flows, where
      the
      EC units will fill a large role. Cm2's clients include Siemens, Colgate
      Palmolive Europe, Alitalia and every large Italian utility, among others. Cm2
      has already arranged and dedicated through their engineering department a proper
      space in their 800,000 sq. foot warehouse for hosting the final development
      and
      the starting of the production line for the EC generator. Cm2 has also reached
      an agreement with Politecnico, one of the foremost Italian universities, for
      their endorsement of the technology under a transfer plan which we think will
      assist Cm2 in obtaining EU grants and the contribution from the Italian state
      and from the regional governments. Cm2 is ISO 9001 certified, and IQ NET
      certified for the production, maintenance and installation of all electrical
      systems, as well as maintaining certifications in the same for quality control.
      RINA (Italian Air and Shipping Registry), certifies that Cm2 works in accordance
      with ISO 9001 quality regulations in the making of the following products --
      process -- services: Planning, production, installation and assistance of civil
      and industrial technological systems for electric, electronic and mechanical
      sectors. We believe that additional manufacturing will occur in the United
      States, with other machining houses and manufacturers, yet to be selected and
      negotiated. However, IHDR has identified potential production partners in the
      United States that will be able to be contracted for machining and production
      purposes of the EC V.




The
      patent for the base technology is held under a permanent assignment from the
      inventor, Rianey Nelson. Other intellectual property patents on the new
      technology will be generated into patent pending status before and commensurate
      with fielding. Additional patents will, in the opinion of management, be
      generated from the improvements in the technology.





IHDR
      has
      several advantages over all other alternative energy sources available. The
      patented Energy Commander (“EC”) system represents the first time, to our
      knowledge, that a technology has been created to use the positive displacement
      of water pressure to create mechanical force to create electricity. The
      advantages of the EC are numerous. Primarily, the system will use 100% of the
      flow pressure into the system, unlike hydro units that are only 30% to 70%
      efficient at best. The EC system uses less water flow than normal hydro, and
      is
      able to be used where flows for traditional hydro will not work. Second, the
      EC
      units will take up very little space; an EC unit takes up 1/100 the space of
      a
      solar array to gain the same amount of electrical output. Third, the price
      of EC
      system will be a fraction of the competition. Per Kw, the system cost will
      be
      around $150.00 that is 1/10 the usual renewable energy goal. This means enormous
      profit margins with the three available revenue streams and more competitive
      market entry. The EC has no direct competition. Solar, wind, biomass and large
      flow hydro-power sources are much different than the IHI technology, and these
      alternative energy sources can co-exist. The advantages that IHDR has over
      these
      sources are its cost, its flexibility and its constant availability. In the
      United States alone, IHDR estimates our technologies will surpass wind-generated
      power within three years and exceed solar in four years. IHDR is not competing
      with these segments, since our source of power is different than solar, wind,
      geothermal (although the system can use geothermal outlets as power sources),
      or
      biomass. The EC V technology is related to traditional hydropower, only in
      the
      sense that it can use water flows; however, the flows of water necessary for
      hydropower are much larger. Thousands of gallons per second are required. Our
      technology is low flow, and much less demanding than hydro. EC system optimizes
      and efficiently uses 100% of the flow. Hydropower is much less efficient. IHDR
      hopes to be a contributor to the renewable energy segment of the United States
      economy.


17


**Item
        2. Management's Discussion and Analysis or Plan of
        Operation** **-
        continued**




The
      search and demand for alternative energy sources is reaching the highest
      priority possible, with many alternative energy initiatives being proposed
      domestically and internationally. IHDR’s EC technology saves expenditures,
      provides reliable electricity at a cheaper cost than current alternatives,
      and
      does so with free flows of wasted water or gas flows. The need for alternative
      energy is only as great as its reliability and value on a per kilowatt-hour
      of
      electricity basis. The common industry standard in the alternative energy field
      is to attempt to beat the cost of $1,500.00 per kilowatt of energy produced.
      IHDR will set a new benchmark for that goal in the alternative energy industry
      and we believe that the Energy Commander System beats that goal in the $150
      per
      kilowatt range **.**





The
      unique aspect of IHDR’s technology is that our energy conversion technology, the
      EC System, has no direct competitor. No other technology uses low flow fluid
      or
      gas pressure for the creation of vast amounts of mechanical force to create
      electricity. No other technology has utilized positive displacement of flow
      pressure to create electricity. Solar power depends upon a clear day; wind
      upon
      the strength of nature at a given point, and hydro upon vast amounts of water
      flow. EC uses small flows to create mechanical force up to a hundred times
      the
      incoming pressure of natural or manmade flows. These flows are wasted potential
      energy and are free. We harness it and make it work to create electricity
      wherever needed.





In
      today’s energy and renewable energy market, the positions of the players have
      stagnated. The renewable energy market has hinged around the six per cent mark
      for a number of years. IHDR is targeting industries as a whole. We are not
      tied
      to the notion that our technology somehow has to be seen in the same vein as
      solar, biomass, or wind. This technology will simply fit where the opportunity
      is present in the flows available in a given area, building, or industrial
      use.
      IHDR is targeting industries with high electric utility costs and access to
      flow
      pressures of gas or fluid, which will run the EC. Wasted flows will give rise
      to
      the target areas. IHDR will target those who have the need to cut utility costs
      in the sectors identified with special emphasis on the textile, oil and gas
      refining and drilling, home development, agricultural, poultry, and other
      industries, which have communicated the greatest interest in placement of units.
      All of the industries are ones that will either have access to natural flow,
      be
      near man-made flow, which is wasted, or have internal wasted flow after the
      flow
      is used.





IHDR’s
      Energy Commander System will be used in the industrial areas of steel and metals
      manufacturing, oil and gas drilling, oil and gas refining, chemical plants
      and
      processing, wood processing, paper and wood pulp, battery manufacturing, all
      areas of agriculture and food processing, cement and material processing, gas
      pipelines, and numerous other industrial and commercial applications. The EC
      technology will have many applications in rural and third world areas. In the
      United States alone, there are over 70,000 dams that do not produce electricity,
      but many are capable of doing so with no environmental impact. The technology
      has numerous applications in third world areas where ready access to natural
      flow exists, and yet is unused. Such flows as in these areas would not support
      conventional hydropower systems, but will support constant 24 hour a day power
      from the EC. Each unit of the EC will be kept as a corporate asset in North
      America, and will be shared with the user on a lease/revenue sharing model.
      Each
      unit will create and approximate $17,500.00 in revenue in the United States
      and
      Canada, which will be shares with the end user through savings on electrical
      costs, while IHDR will retain the tax credits, renewable energy credits, and
      portions of the energy value. In the EU where IHDR has strategic partnership
      for
      manufacturing and distribution of the units, the same model will be in place,
      where the units will be held by the Joint Venture, and the revenue distribution
      will be shared by IHDR along with the JV partner, and the user will be able
      to
      enjoy the reduced electrical costs, and revenue sharing in the EU, where
      revenues for a 30 Kw unit have been estimated by Cm2 to be approximately
      $44,000.00 per unit, per year.





EC
      will
      mean huge savings, and potentially, even payback to municipal, county, state
      and
      federal government facilities. Lowering or excluding power costs, while giving
      back potential revenue to governmental entities utilizing the EC to produce
      electricity in buildings, compounds, and governmental facilities. IHDR’s
      technology will have far reaching military aspects, able to be used by the
      U.S.
      military to help build nations the third world areas where power projection
      can
      be accomplished by the supplying of power to areas of need. EC will be used
      as a
      power source for direct power supply and for back-up power sourcing for
      hospitals, nursing homes, and other uses where back up power generation is
      required. The potential applications for the EC will only be limited by the
      flows available where they are found.


18




**Item
      2. Management's Discussion and Analysis or Plan of
      Operation** **-
      continued**




We
      have
      prepared a business model that will market the EC V system through a distributor
      network around the world. Numerous municipalities, counties, manufacturing,
      textile, petroleum, residential development, and other industries have entered
      into agreements and intents with the Company for application of these units.
      We
      also intend to further its business plan by acquisition of similar technologies
      and by execution of contracts for future units and rights to distribution of
      the
      technology.





However;
      since inception, we have suffered recurring losses from operations and have
      been
      dependent on existing stockholders and new investors to provide the cash
      resources to sustain our operations.





Our
      long-term viability as a going concern is dependent on certain key factors,
      as
      follows:





-
            Our
                ability to continue to obtain sources of outside
                financing.





-
            Our
                ability to increase profitability and sustain a cash flow level that
                will
                ensure support for continuing
                operations.





**ACQUSITIONS
      OF SIMILAR TECHNOLOGIES**





CM2
      AGREEMENT:





In
      February 2005, IHDR ** entered
      into a large scale joint venture agreement for production, distribution and
      sale
      of its Energy Commander units to the European Union. Under the performance
      based
      contract, Cm2,
      an
      Italian Energy Manufacturing and Supply Company, will manufacture units in
      Italy
      for distribution, sale, and lease into Europe. Cm2 will supply engineering,
      production, marketing, distribution, and service for the Energy Commander units.
      Cm2 believes they will build and place a minimum of between 300 and 600 thirty
      Kw units in Europe in the first year of full production. Under the agreement
      IHDR pays no significant capital expenditure, however, it receives revenues
      in
      various forms.





Cm2
      is a
      producer and supplier of electrical systems for European utilities and
      industrial users. Cm2 is positioned to supply Internal Hydro’s units for all of
      the European Union for the foreseeable future. Cm2 will be producing the units
      under a revenue sharing and payment license from IHDR. Cm2 believes they will
      be
      able to produce 100 units per week in full production.





Cm2
      will
      distribute, and service the units throughout Europe through a joint venture
      entity. IHDR shall receive an up front sum of $2,000 to $3,000 per unit produced
      for Europe plus a large portion of the revenue stream from all units placed
      in
      Europe, including electricity, renewable energy credits, and other readily
      available credits. Cm 2 estimates the unit revenue for a 30 Kw unit to be
      approximately $44,000 per unit per year. Energy credits in Italy are expected
      to
      be about 3 to 10 times the projection of revenue for IHDR units placed in the
      U.S. Under the agreement, Cm2 will be a strategic partner for delivery of the
      EC
      units to IHDR’s domestic US use for less than IHDR could produce the units in
      the United States. Due to their extensive experience in the European energy
      market, Cm2’s ability to produce, sell, and maintain the units, will give IHDR a
      strong partner for the EU.





KINETIC
      ENERGY





On
      July
      8, 2004, we announced that we had entered into an agreement with Kinetic Energy
      Systems, Inc. (“Kinetic”), a privately held Florida Corporation, for a strategic
      partnership. IHDR received 20% of the shares of the private company with access
      to license and assist in the development of the technology Kinetic held for
      underwater and over water power generation. IHDR issued 1,250,000 shares of
      treasury stock for this interest. IHDR agreed to help develop the technology
      and
      market it within its resources. Kinetic has several new hydro and wind based
      technologies, all patented or patent pending at this time. These include the
      Hydrokinetic Generator; Offshore Energy Platform; KESC Bowsprit Generator;
      and,
      KESC Tidal Generator. These technologies create generate electrical power or
      hydrogen using kinetic energy from moving water and wind, utilizing wind and
      tides. The Hydrokinetic Generator is at the prototype and engineering stage.
      The
      Offshore Energy Platform is at the prototype and engineering stage. The KESC
      Bowsprit Generator at the prototype and engineering stage. The Bowsprit is
      being
      designed for prototyping in the dual role of hydrogen production. The KESC
      Tidal
      Generator is at the engineering and prototype stage. KESC is preparing to
      display the Bowsprit technology for the first time at the NERL conference.


19


**Item
      2. Management's Discussion and Analysis or Plan of
      Operation** **-
      continued**


To
      date
      this relationship still exists, and IHDR will help market and develop the
      Kinetic line of production, in Europe and the United States. This support of
      Kinetic is tied to IHDR’s capital ability to do so. IHDR will help introduce
      Kinetic’s products to European entities for development and
      marketing.





TRITON
      TECHNOLOGIES :





In
      April
      2005, IHDR entered into a future marketing and distribution agreement with
      Triton Technologies of Reston Virginia. Through this agreement, Triton has
      the
      rights to market the Energy Commander technology. Under the agreement, Triton
      took on certain responsibilities for the capital support of the Energy Commander
      build out and engineering. Through the third quarter of 2005, Triton had
      directly taken on the contractual obligations for payment to the engineering
      firm APTEC for unit plans and production of the EC IV. IHDR was relieved of
      such
      payments during the period that Triton fulfills its obligations to APTEC, and
      to
      date has paid APTEC approximately $40,000 as reported to IHDR. The primary
      purpose of the agreement will be for Triton to develop and implement a strategic
      marketing plan for industry awareness and for sales of the Energy Commander
      under IHDR’s control, once units are fielded and able to be displayed. Under the
      agreement, Triton will receive a portion of the revenue flow from units placed
      under its marketing and distribution work. As part of the agreement, IHDR would
      also receive an equity position in Triton based upon the future position of
      Triton’s public company. IHDR was informed by management of Triton in September,
      2005, that they would be repositioning the assets of Triton, and this agreement
      for marketing and licensing to a new private entity in the near future, which
      IHDR did not object to. To date this contract will be fulfilled by the use
      of
      Triton as a marketing arm for the EC technology in the United States.





NEW
      IMPACT





On
      November 2, 2004, IHDR and New Impact, LLC, a private Arizona based Company,
      entered into a contract for the purchase of energy units from IHDR, with rights
      for distribution and use of IHDR's technology. The initial phase of the contract
      calls for supplying ten units at a purchase price of $500,000 for use in New
      Impact's water treatment facilities and other areas in the Southwest. This
      contract has not been funded to date; however, in March 2005, this contract
      was
      absorbed by the later agreement with Triton Technologies of Reston Virginia,
      to
      be the marketing and sales arm of IHDR when IHDR is in a nit production ability.





WORLD
      ENVIRONMENTAL SOLUTIONS COMPANY, INC.





The
      Company entered into a second area of alternative energy and waste recycling
      to
      add to its superior small hydro technologies, soon to be commercially available.
      Specifically, IHDR announced on March 16, 2006 that the Company entered into
      a
      Letter of Intent with World Environmental Solutions Company, Inc. (WESCO),
      a
      wholly-owned subsidiary of EarthFirst Technologies, Incorporated (OTC
      BB: EFTI.OB - News ),
      to
      purchase WESCO's Catalytic Activated Vacuum Distillation (CAVD) waste tire
      and
      solid waste remediation plant currently in operation in Mobile, Alabama, for
      total consideration of $2 million.




Pursuant
      to the Letter of Intent (LOI), Internal Hydro has agreed to enter into a
      definitive agreement, pursuant to which it shall pay WESCO a one-time license
      fee of $500,000 for exclusive rights to deploy WESCO's Catalytic Activated
      Vacuum Distillation (CAVD) technology in the European Union. A $100,000 down
      payment on the initial licensing fee has been paid to WESCO by Internal Hydro.
      The agreement will also provide for WESCO to be paid a continuing royalty of
      $100,000 for each European country in which Internal Hydro intends to establish
      an operational CAVD plant. In addition, Internal Hydro will pay WESCO a one-time
      license fee of $250,000 per state for rights to deploy the technology in Alabama
      and West Virginia, as well as a royalty stream equal to 5% of gross revenue
      per
      plant (projected at $5.2 million per year in gross revenue), excluding carbon
      credits and tire tipping fees. Further, Internal Hydro will maintain the right
      of first refusal to Tennessee, Illinois, Louisiana and Minnesota at a
      predetermined license arrangement of $250,000 per state.






IHDR's
      soon-to-be-deployed Energy Commander's core technology and variations notably
      complement WESCO's CAVD technology, thus promoting strong synergy and use of
      IHDR's core technologies in the same facilities.













20




**Item
      2. Management's Discussion and Analysis or Plan of
      Operation** **- continued**




RESULTS OF OPERATIONS


The
      company has completed production and internal testing of the Energy Commander
      V
      (EC V) low impact hydro energy unit. The Company is now displaying the completed
      EC V unit on its web site, before transportation to its fielding site. The
      unit's internal testing were successful. The 12 cylinder rotary motor, which
      runs from the patented positive displacement of fluid instead of less efficient
      turbines, runs from a six inch inlet of water, in an expandable mode which
      can
      be used on waste water flows from tens of thousands of sources. The Energy
      Commander V (EC V) system was tested with the results being better than
      previously published. The EC V consistently operated on lower than calculated
      water pressures of 50 p.s.i. instead of 65 p.s.i. to produce the force necessary
      for production of 30 kilowatts from a six inch flow. The unit was demonstrated
      to partners and select visiting parties in Mobile, Alabama.




The
      EC V
      system utilizes a dual cycle cylinder to produce energy in a completely
      efficient manner, from all twelve cylinders in the rotary fashion. The unit,
      displayed on the Company's web site, shows viewers photographs of some of the
      internal parts, and the completed EC V rotary, 12 cylinder unit which will
      now
      be passed off for field testing at a location to be announced within the next
      week. The Energy Commander system is a positive displacement low impact energy
      technology patented for use of low flows, and waste flows of industrial and
      natural flows.




IHDR
      has
      also sought the identification of undervalued and undercapitalized technologies
      that would be part of the corporate philosophy for renewable energy products.
      IHDR has explored other possible technologies including tire remediation,
      ethanol and bio-diesel production from appropriate feedstocks, clean water
      technologies, rapid response home security for provision of electricity and
      waste remediation, hazardous waste technologies, and other renewable and
      critical use technologies. As part of this goal, the Company entered into a
      letter of intent with World Environmental Solutions Company to purchase WESCO’s
      Catalytic Activated Vacuum Distillation (CAVD) waste tire and solid waste
      remediation plant currently in operation in Mobile, Alabama.





Two
      contracts were signed in the third quarter for sales of three Energy Commander
      V
      machines. The sale price of each machine is $30,000. The first contract is
      with
      Greater Sooner Holdings, Inc. The contract calls for a 30% deposit within 30
      days of the signing of the contract. This deposit has not yet been paid and
      therefore the total contract is not reflected in the financial statements.





The
      second contract is with Kingswell Funding LLC. The contract is for the sale
      of
      two Energy Commander V. The contract calls for a 30% down payment that will
      occur immediately after placement locations for the machines are found. The
      condition precedent for the down payment has not yet occurred and therefore
      the
      total contract is not reflected in the financial statements.





**COMPARISON
      OF THREE MONTHS ENDED SEPTEMBER 30, 2006 TO THREE MONTHS ENDED SEPTEMBER 30,
      2005.**





Revenue
      for the three months ended September 30, 2006 and 2005 was $-0-.





Two
      contracts were signed in the third quarter for sales of three Energy Commander
      V
      machines. The sale price of each machine is $30,000. The first contract is
      with
      Greater Sooner Holdings, Inc. The contract calls for a 30% deposit within 30
      days of the signing of the contract. This deposit has not yet been paid and
      therefore the total contract is not reflected in the financial statements.





The
      second contract is with Kingswell Funding LLC. The contract is for the sale
      of
      two Energy Commander V. The contract calls for a 30% down payment that will
      occur immediately after placement locations for the machines are found. The
      condition precedent for the down payment has not yet occurred and therefore
      the
      total contract is not reflected in the financial statements.





General
      and administrative expenses increased by $156,165 from $407,789 for the three
      months ended September 30, 2005 to $563,954 for the three months ended September
      30, 2006. This increase was due primarily to an increase in stock issued for
      services. However, for the three months ended September 30, 2005, the company
      had a one time permanent impairment writedown on marketable securities of
      $775,312 related to the Park Investments Plc investment (see footnote 11 in
      the
      financials). Research and development costs also increased by $38,934 from
      $0
      for the three months ended September 30, 2005 to $38,934 for the three months
      ended September 30, 2006. Accordingly, the net loss decreased by $619,414 from
      $1,199,802 for the three months ended September 30, 2005 to $580,388 for the
      three months ended September 30, 2006.


21


**Item
      2. Management's Discussion and Analysis or Plan of
      Operation** **- continued**





**COMPARISON
      OF NINE MONTHS ENDED SEPTEMBER 30, 2006 TO NINE MONTHS ENDED SEPTEMBER 30,
      2005.**





Revenue
      for the nine months ended September 30, 2006 and 2005 was $-0-.





General
      and administrative expenses increased by $4,483,928 from $1,389,095 for the
      nine
      months ended September 30, 2005 to $5,873,023 for the nine months ended
      September 30, 2006. This increase was due primarily to an increase in stock
      issued for services. Research and development costs also increased by $597,498
      from $85,154 for the nine months ended September 30, 2005 to $682,652 for the
      nine months ended September 30, 2006. Accordingly, the net loss increased by
      $4,222,661 from $2,287,206 for the nine months ended September 30, 2005 to
      $6,509,867 for the nine months ended September 30, 2006.




**LIQUIDITY
      AND CAPITAL RESOURCES**







Our
      operating activities used cash in the amount of $106,127 for the quarter ended
      September 30, 2006 related primarily to and increase in common and preferred
      stock issuances. We intend to continue development of the Energy Commander
      systems but will need additional private placements, debt financing or equity
      investment in order to participate fully and at the levels intended. There
      can
      be no assurance that any of the plans developed will produce cash flows
      sufficient to ensure its long-term viability.





The
      Company has incurred additional deficits in cash flow from operating activities.
      These deficits have been funded from loans from significant shareholders. The
      Company is in discussions with several capital organizations with a view to
      selling more common and preferred shares as a means of financing future capital
      needs. The company anticipates it will be successful in these discussions;
      however there can be no assurances that the Company will be successful in doing
      so. The cash provided by financing activities decreased by $67,250 from $176,350
      for the quarter ended September 30, 2005 to $109,100 for the quarter ended
      September 30, 2006.





In
      addition, 1,165,334 shares of common stock were issued for debt conversion
      for
      the quarter ended September 30, 2006 in the amount of $109,100.





**OUTLOOK
      FOR 2006**





During
      the next twelve months, IHDR hopes to enter the full production phase of its
      business plan, with revenues being produced, and further, an implementation
      of
      the new management structure for roll out in the global energy market. With
      the
      contractual arrangement with Cm2, IHDR has now partnered with a ready and able
      partner for production, and implementation of the Energy Commander systems
      in
      Europe. Given the vast experience and ongoing operations of Cm2 in the energy
      market, IHDR will have significant production ability for the EC units. IHDR
      forecasts that the final stage units will be made with Cm2, and other domestic
      resources for final stage production hopefully by the second half of 2006.
      IHDR
      will implement the new radial system of low impact hydro with Cm2, for
      production in the latter part of 2006, and for production of the initial 10
      units of the system for field testing IHDR will also be implementing the portion
      of its business plan which for new personnel to take over certain management
      positions, and the creation of new positions in order to get ready for direct
      market participation in the alternative energy sector, and for the expansion
      of
      the company beyond the start up phase and into the global and domestic
      alternative energy market. Included in this plan is the implementation of new
      management with energy experience, and new board membership. IHDR met this
      goal
      with the implementation of a new board of directors in January, 2006.
      Additionally, a strategic consultant was retained as Chief Energy Marketing
      Director. This was required as IHDR prepares to market both the Energy Commander
      and CAVD systems.





We
      will
      enter into three important phases for the production mode and field testing
      of
      its energy units, set to occur in the next six months. First, we will seek
      new
      capital contribution for carryover of operations and production in the United
      States, and for a limited need of capital for use with the existing relationship
      in Italy with Cm2. This will be done in order to fulfill basic financial
      obligations such as audit costs, payroll, travel and engineering support for
      the
      Italian operations, and for final unit development for production with Cm2.
      Since we do not have significant production costs related to the energy unit
      production in Italy of the ten units, the need for capital has been kept to
      a
      minimum. Cm2 under its agreement pays for all related costs of engineering
      and
      production of the unit, as well as some on site costs for IHDR personnel. Second
      is the final production unit plan for the EC V, which we will be the radial
      system twelve cylinder unit. This will be accomplished through Cm2 on site
      in
      Terni, Italy at their production facility, as well as initial production
      occurring for the units in the United States utilizing contracted or strategic
      partners. Our personnel and the prototype unit of the EC V will be transported
      on site for production of the final unit in both Europe and in the United
      States. With the machining and parts assembly and plans being completed, the
      final production value, first unit will be made.


22


**Item
      2. Management's Discussion and Analysis or Plan of
      Operation** **- continued**




**CRITICAL
      ACCOUNTING POLICIES AND ESTIMATES**





Our
      discussion and analysis of the financial condition and results of operations
      are
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with generally accepted accounting principles in the United States.
      The preparation of these financial statements requires us to make estimates
      and
      judgments that affect the reported amounts of assets, liabilities, revenue
      and
      expenses, and related disclosure of contingent assets and liabilities. On an
      ongoing basis, we evaluate estimates. We base our estimates on historical
      experience and on various other assumptions that are believed to be reasonable
      under the circumstances. These estimates and assumptions provide a basis for
      making judgments about the carrying values of assets and liabilities that are
      not readily apparent from other sources. Actual results may differ from these
      estimates under different assumptions or conditions, and these differences
      may
      be material.





We
      believe the following critical accounting policies affect its more significant
      judgments and estimates used in the preparation of its consolidated financial
      statements.





**UNCERTAINTIES**




Implementation
      of Business Strategy Dependent on Additional Financing






Internal
      Hydro must obtain financing to fund the expansion of operations. Such outside
      financing must be provided from the sale of equity or third party financing.
      Further, the sale of equity securities will dilute our existing stockholders'
      interests, and borrowings from third parties could result in our assets being
      pledged as collateral. While the Company is currently able to fund all basic
      operating costs, it is possible our operations could be restricted if loan
      terms
      increase our debt service requirements. There is no assurance that we can obtain
      financing on favorable terms.







Quarter
                Ended
            
            
            Date
                of InceptionSeptember
                30,
            
            
            Through2006
            
            
            September
                30, 2006Net
              Income (loss)
            
            $
            580,388
            
            $
            13,011,411




The
      above
      factors represent continue to raise doubt about the Company's ability to fully
      establish itself as a going concern.





Development
      Stage Company


The
      Company is in the development stage. There is no assurance that the Company's
      activities will be profitable. The likelihood of the success of the Company
      must
      also be considered in light of the problems, expenses, difficulties,
      complications, delays and all of the inherent risks frequently encountered
      in
      the formation and operation of a relatively new business.











23


**Item
      2. Management's Discussion and Analysis or Plan of
      Operation** **- continued**




Going
      Concern


The
      financial statements are presented on the basis that the Company is a going
      concern, which contemplates the realization of assets and the satisfaction
      of
      liabilities in the normal course of business over a reasonable length of
      time.





Management
      believes that current plans to expand the Company's operations and a combination
      of its financing and capital raising plans will provide sufficient working
      capital to allow the Company to continue as a going concern.





Costs
      of Conducting Business


The
      Company will be required to incur substantial costs for research and development
      and equipment, establishing production and marketing operations, and related
      costs. A substantial portion of those costs must be paid whether or not any
      of
      its products prove to be commercially successful on a broad scale. The ability
      to generate a profit depends, among other factors, on the amount of equipment
      acquisition costs incurred, the amount of revenues from the sale of its products
      by the Company, and its operating costs.





Technological
      Change


The
      Company expects that many new technologies and products will be introduced
      over
      the next several years. The Company's success will depend, among other things,
      on its ability to develop and maintain a competitive position technologically.
      There can be no assurance that the Company will have access to subsequently
      developed technology by other persons. Technological advances by a competitor
      may result in the Company's present or future products becoming non-competitive
      or obsolete. The Company cannot be assured that competitors will not develop
      functionally similar or superior products, which event could have an adverse
      effect on the Company's business.





Contracts


There
      can
      be no assurance that the Company will be able to obtain sufficient and suitable
      contracts for its business plan.





Fluctuations
      in Operating Results


The
      Company's revenues and results of operations may vary significantly in the
      future. The Company's revenues and results of operations are difficult to
      forecast and could be adversely affected by many factors, some of which are
      outside the control of the Company, including, among others, the expected
      relatively long sales and implementation cycles for the Company's products;
      the
      size and timing of individual license transactions and joint venture
      arrangements; seasonality of revenues; changes in the Company's operating
      expenses; changes in the mix of products sold; timing of introduction or
      enhancement of products by the Company or its competitors; market acceptance
      of
      new products; technological changes in technology; personnel changes and
      difficulties in attracting and retaining qualified sales, marketing, technical
      and consulting personnel; changes in customers' budgeting cycles; quality
      control of products sold; and economic conditions generally and in specific
      industry segments.





There
      can
      be no assurance that the Company's products will achieve broad market acceptance
      or that the Company will be successful in marketing its products or enhancements
      thereto. In the event that the Company's current or future competitors release
      new products that have more advanced features, offer better performance or
      are
      more price competitive than the Company's products, demand for the Company's
      products would decline. A decline in demand for, or market acceptance of, the
      Company's products as a result of competition, technological change, or other
      factors would have material adverse effects on the Company's business, financial
      condition and results of operations.





Seasonality


The
      Company does not expect to experience material seasonal variations in revenues
      or operating costs.





**OFF
      BALANCE SHEET ARRANGEMENTS.**





The
      Company's liquidity has not dependent upon off balance sheet transactions.
      For
      the period ended September 30, 2006, the Company did not engage in any off
      balance sheet transactions.














24


**Item
      3. Controls and Procedures**





The
      Company maintains disclosure controls and procedures that are designed to ensure
      that information required to be disclosed in our annual and periodic reports
      filed with the SEC is recorded, processed, summarized and reported within the
      time periods specified in the SEC's rules and forms. These disclosure controls
      and procedures are further designed to ensure that such information is
      accumulated and communicated to our management, including our Chief Executive
      Officer and Principal Accounting Officer, to allow timely decisions regarding
      required disclosure.





Based
      on
      the most recent evaluation, which was completed within 90 days of the filing
      of
      this report, our Chief Executive Officer and Principal Accounting Officer
      believes that the Company's disclosure controls and procedures are effective
      and
      there have been no significant changes in the Company's internal controls or
      in
      other factors that could significantly affect the internal controls subsequent
      to the date of the most recent evaluation.





Craig
      A.
      Huffman, our Chief Executive Officer, and Lior Segal, our Chief Financial
      Officer, have concluded that our disclosure controls and procedures are
      appropriate and effective. They have evaluated these controls and procedures
      as
      of the end of the period covered by this report on Form 10-QSB. There were
      no
      significant changes in our internal controls or in other factors that could
      significantly affect these controls subsequent to the date of their evaluation,
      including any corrective actions with regard to significant deficiencies and
      material weaknesses.








**PART
      II - OTHER INFORMATION**




Pursuant
      to the Instructions on Part II of the Form 10-QSB, Items 3, and 5 are omitted.







**Item
      1. Legal Proceedings**





As
      of the
      date hereof, Internal Hydro is not a party to any further legal proceedings,
      and
      none are known to be contemplated against Internal Hydro.







**Item
      2.****Unregistered
      Sales of Equity Securities and Use of Proceeds**






During
      our quarter ended September 30, 2006, we completed the following transactions
      in
      reliance upon exemptions from registration under the Securities Act of 1933,
      as
      amended (the "Act") as provided in Section 4(2) thereof. Each certificate issued
      for unregistered securities contained a legend stating that the securities
      have
      not been registered under the Act and setting forth the restrictions on the
      transferability and the sale of the securities. None of the transactions
      involved a public offering. We believe that each person had knowledge and
      experience in financial and business matters which allowed them to evaluate
      the
      merits and risks of our securities. We believe that each person was
      knowledgeable about our operations and financial condition.




A
      total
      of 2,940,157 shares were issued to employees and outside consultants for a
      recognized compensation expense of $372,560. A total of 1,165,334 shares were
      issued in payment for loans to the company for a total loan value of
      $109,100.







During
      the period January 1, 2005 to September 30, 2006 shareholders converted
      2,244,769 Preferred shares into the Company’s Common shares on a 1 for 1
      basis.







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




None














25


**Item
      6. Exhibits**





Exhibit
      31.1 - Certification of Chief Executive Officer of Internal Hydro International,
      Inc. required by Rule 13a - 14(1) or Rule 15d - 14(a) of the Securities Exchange
      Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.





Exhibit
      31.2 - Certification of Chief Financial Officer of Internal Hydro International,
      Inc. required by Rule 13a - 14(1) or Rule 15d - 14(a) of the Securities Exchange
      Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.





Exhibit
      32.1 -- Certification of Chief Executive Officer of Internal Hydro
      International, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
      and Section 1350 of 18 U.S.C. 63.





Exhibit
      32.2 -- Certification of Chief Financial Officer of Internal Hydro
      International, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
      and Section 1350 of 18 U.S.C. 63.







**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Action
      of
      1934, as amended, the registrant has duly caused this Report to be signed on
      its
      behalf by the undersigned, thereunto duly authorized.









**INTERNAL
              HYDRO INTERNATIONAL INC.**Date: *November
              13, 2006*
            By:
            /s/ *CRAIG
              A. HUFFMAN**CRAIG
              A. HUFFMAN*Title *CHIEF
              EXECUTIVE OFFICER*







Pursuant
      to the requirements of the Securities Exchange Act of 1934, as amended, this
      Report has been signed below by the following persons on behalf of the
      registrant and in the capacities and on the dates indicated.






Date: *November
              13, 2006*
            By:
            /s/ *CRAIG
              A. HUFFMAN**CRAIG
              A. HUFFMAN*Title *CHIEF
              EXECUTIVE OFFICER*


26