**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-QSB**





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





For
      the
      quarterly period ended June 30, 2006





**oTRANSITION
      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 jurisdictionof
                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 a shell company (as defined in Rule
      12-b-2 of the Exchange Act).


Yes
o 
No
x




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




There
      is
      a limited trading market for the registrant's Common Stock, there were
      102,907,510shares of Common Stock, and 2,342,081shares of preferred stock issued
      and outstanding as of June 30, 2006.




Documents
      Incorporated by Reference: None




1




**INTERNAL
      HYDRO INTERNATIONAL, INC.**


**UNAUDITED
      CONDENSED FINANCIAL STATEMENTS**


**for
      the three months and six months ended June 30, 2006 and
      2005**








**Table
                of
                Contents**
            PagePART
              I
            FINANCIAL
              INFORMATION
            4Item
                1
            Financial
                Statements
            4BALANCE
              SHEET for the three months and six months ended June 30, 2006 and 2005
              (Unaudited)
            4STATEMENT
              OF OPERATIONS For the quarters ended June 30, 2006 and 2005
              (Unaudited)
            5STATEMENT
              OF CASH FLOWS For the quarters ended June 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
            24PART
                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-QSB 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 which 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****BALANCE
                  SHEET**(A
                  Development Stage Company)**As
                  of June 30, 2006****ASSETS****CURRENT
                  ASSETS**Cash
                  and equivalents
              
              **$**
              **621**Security
                  Deposit
              
              
              **2,500****3,121****PROPERTY
                  & EQUIPMENT**Computers
                  & Equipment(net
                  of accumulated depreciation)
              
              
              **9,156****OTHER
                  ASSETS**Investment
                  - Langley Park
              
              
              **14,124**Investment
                  - Kinetic Energy
              
              
              **68,750**Prepaid
                  Rent
              
              
              **8,025**Licensing
                  Fee
              
              
              **100,000****190,899****$**
              **203,176****LIABILITIES
                  & STOCKHOLDERS' EQUITY****CURRENT
                  LIABILITIES**Accounts
                  payable
              
              **$**
              **70,935**Contingent
                  Payroll Tax
              
              
              **248,659**Accrued
                  Liabilities
              
              
              **145,212**Due
                  to shareholder
              
              
              **22,000****486,806****OTHER
                  LIABILITIES**Debt
                  under professional management (Note 4)
              
              
              **906,879**Total
                  Liabilities
              
              
              **1,393,685****STOCKHOLDERS'
                  EQUITY**Preferred
                  stock, $.001 par value, 70,000,000 shares authorized2,342,081
                  shares issued and outstanding
              
              
              **2,342**Common
                  stock, $.001 par value,200,000,000 shares authorized102,907,510
                  shares issued and outstanding
              
              
              **102,907**Additional
                  paid-in capital
              
              
              **11,219,051**Unrealized
                  loss on Investment
              
              
              **(83,786**
              **)**Deficit
                  accumulated during Development Stage
              
              
              **(12,431,023**
              **)**Total
                  Stockholders' Equity
              
              
              **(1,190,509**
              **)****$**
              **203,176**




See
        accompanying notes to unaudited financial statements which are an integral
        part
        of these financial statements


4
  **INTERNAL
                    HYDRO INTERNATIONAL INC.****STATEMENT
                    OF OPERATIONS**(A
                    Development Stage Company)For
                    the quarters ended June 30, 2006 and 2005**Date
                    of Inception****3
                    MonthsEnded**
                
                
                **3
                    Months Ended**
                
                
                **6
                    Months Ended**
                
                
                **6
                    Months Ended**
                
                
                **through****June
                    30, 2006**
                
                
                **June
                    30, 2005**
                
                
                **June
                    30, 2006**
                
                
                **June
                    30, 2005**
                
                
                **June
                    30, 2006**NET
                    SALES
                
                $
                -
                
                $
                -
                
                
                
                
                
                
                
                $
                -COST
                    OF SALES
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                -GROSS
                    PROFIT
                
                
                -
                
                
                -
                
                
                -
                
                
                -SELLING,
                    GENERAL & ADMINISTRATIVE EXPENSES
                
                
                **3,779,386**
                
                
                **502,294**
                
                
                **5,309,069**
                
                
                **1,002,250**
                
                
                **9,482,444**RESEARCH
                    & DEVELOPMENT
                
                
                **557,074**
                
                
                **26,419**
                
                
                **643,718**
                
                
                **85,154**
                
                
                **1,309,651**LOSS
                    FROM OPERATIONS
                
                
                **4,336,460**
                
                
                **528,713**
                
                
                **5,952,787**
                
                
                **1,087,404**
                
                
                **10,792,095**LOSS
                    ON SALE OF SECURITIES
                
                
                **-**
                
                
                **-**
                
                
                **-**
                
                
                **-**
                
                
                **697,237**PERMANENT
                    IMPAIRMENT WRITEDOWN ONMARKETABLE
                    SECURITIES
                
                
                **-**
                
                
                **-**
                
                
                **7,996**
                
                
                **-**
                
                
                **911,464**OTHER
                    INCOME
                
                
                
                
                
                
                
                
                **(65,000**
                **)**
                
                
                
                
                **(65,000**
                **)**INTEREST
                    EXPENSE
                
                
                **10,100**
                
                
                
                
                
                **11,196**
                
                
                
                
                
                **95,227**NET
                    LOSS
                
                **$**
                **4,346,560**
                
                **$**
                **528,713**
                
                **$**
                **5,906,979**
                
                **$**
                **1,087,404**
                
                **$**
                **12,431,023**BASIC
                    NET LOSS PER COMMON SHARE
                
                **$**
                **(0.06**
                **)**
                **$**
                **(0.01**
                **)**
                **$**
                **(0.08**
                **)**
                **$**
                **(0.03**
                **)**DILUTED
                    NET LOSS PER COMMON SHARE
                
                **$**
                **(0.06**
                **)**
                **$**
                **(0.01**
                **)**
                **$**
                **(0.08**
                **)**
                **$**
                **(0.03**
                **)**WEIGHTED
                    AVERAGE OF COMMON SHARES OUTSTANDING
                
                
                **77,906,902**
                
                
                **44,174,424**
                
                
                **73,942,857**
                
                
                **34,016,070**
  See
          accompanying notes to unaudited financial statements which are an integral
          part
          of these financial statements
    5
  **INTERNAL
                    HYDRO INTERNATIONAL INC.****STATEMENT
                    OF CASH FLOWS**(A
                    Development Stage Company)For
                    the quarters ended June 30, 2006 and 2005**Accumulated
                    from****Date
                    of
                    Inception****For
                    the period ended**
                
                
                **For
                    the period ended**
                
                
                **through****June
                    30, 2005**
                
                
                **June
                    30, 2005**
                
                
                **June
                    30, 2006****OPERATING
                    ACTIVITIES**Net
                    Loss
                
                $
                (4,346,560
                )
                $
                (1,087,404
                )
                $
                (12,431,023
                )Adjustments
                    to reconcile net loss to cash used by operating
                    activities:Depreciation
                    expense
                
                
                980
                
                
                1,850
                
                $
                9,591Rent
                    Deposit
                
                
                (2,500
                )
                
                
                
                $
                (2,500
                )Issuance
                    of common and preferred stock for services performed
                
                
                3,304,801
                
                
                855,988
                
                $
                8,126,885Issuance
                    of common stock for Regent
                
                
                450,000
                
                
                -
                
                $
                746,000Prepaid
                    Rent
                
                
                (8,025
                )
                
                
                
                $
                (8,025
                )Amortization
                    of Debt Discount
                
                
                
                
                
                15,000
                
                $
                15,000Other
                    Income from cancellation of common stock
                
                
                -
                
                
                
                
                $
                (65,000
                )Loss
                    on sale of securities
                
                
                -
                
                
                -
                
                $
                697,237Permanent
                    Impairment of marketable securities
                
                
                
                
                
                
                
                $
                911,464Changes
                    in assets and liabilitiesStock
                    Loan receivable
                
                
                -
                
                
                -
                
                $
                7,000Contingent
                    payroll liability
                
                
                151,032
                
                
                
                
                $
                248,658(Decrease)
                    Increase in accounts payable and accrued liabilities
                
                
                143,196
                
                
                78,991
                
                $
                217,244Cash
                    used by operating activities
                
                $
                (307,076
                )
                $
                (135,575
                )
                $
                (1,527,469
                )**INVESTING
                    ACTIVITIES**Purchase
                    of equipment
                
                $
                -
                
                $
                (64
                )
                $
                (16,668
                )Cash
                    on proceeds on sale of marketable securities
                
                
                -
                
                
                -
                
                $
                193,388Employee
                    advances
                
                
                -
                
                
                -
                
                $
                (7,000
                )Cash
                    provided used in investing activities
                
                $
                -
                
                $
                (64
                )
                $
                169,720**FINANCING
                    ACTIVITIES**Decrease
                    in Notes Payables
                
                
                (4,900
                )
                
                
                
                $
                (60,000
                )Decrease
                    in Shareholder loans
                
                
                (55,000
                )
                
                
                
                $
                (55,000
                )Proceeds
                    from shareholder advances
                
                $
                273,800
                
                $
                335,000
                
                $
                1,413,370Proceeds
                    from notes payables
                
                $
                -
                
                $
                60,000
                
                $
                60,000Cash
                    provided by financing activities
                
                $
                213,900
                
                $
                395,000
                
                $
                1,358,370**INCREASE
                    IN CASH AND CASH EQUIVALENTS**
                
                $
                (93,176
                )
                $
                11,652
                
                $
                621**CASH
                    AND CASH EQUIVALENTS, beginning of period**
                
                
                93,797
                
                
                -
                
                
                -**CASH
                    AND CASH EQUIVALENTS, end of period**
                
                $
                621
                
                $
                11,652
                
                $
                621**SUPPLEMENTAL
                    SCHEDULE OF NON-CASH INVESTING AND FINANCING
                    ACTIVITIES**Stock
                    issued for debt conversion
                
                
                
                
                $
                311,500
  See
          accompanying notes to unaudited financial statements which are an integral
          part
          of these financial statements


6
 
 **INTERNAL
        HYDRO INTERNATIONAL INC.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**







**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.





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





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.

















7
 
 **INTERNAL
        HYDRO INTERNATIONAL INC.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**




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


**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.





**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
      December 31, 2005.





**Revenue**





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





**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.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**




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**





In
      1996,
      SFAS No. 123 "Accounting for Stock-Based Compensation," became effective for
      the
      Company. SFAS No. 123, which prescribes the recognition of compensation expense
      based on the fair value of options on the grant date, 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 June 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 three month period ended June 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. 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 methodused 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.


9
 
 **INTERNAL
        HYDRO INTERNATIONAL INC.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**




NOTE
      1 - DESCRIPTION OF BUSINESS AND SIGNIGICANT
      ACCOUNTING POLICIES - continued   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 will 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 Company
      anticipates that the adoption of SFAS No. 150 will 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
      the effect of implementation will have a significant impact on the Company’s
      financial statements.





**NOTE
      2 - RELATED PARTY TRANSACTIONS**





As
      of
      June 30, 2006, the Company has received loans totaling $273,800 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, we 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, our 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 our 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**





During
      the year ended December 31, 2003, HSI declared a 1 for 28.9 reverse stock split.
      The number of shares presented in these financial statements has been
      retroactively restated for all periods to reflect this reverse stock
      split.





During
      the year ended December 31, 2004, the Company declared a 5 for 1 stock split.
      The number of shares presented in these financial statements has been
      retroactively restated for all periods to reflect this reverse stock
      split.





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.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**




NOTE 3 - STOCKHOLDERS' DEFICIENCY - continue


During
      the year ended December 31, 2002, the Company 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 Company 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 was approached with the investment by the 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.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**




**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 June 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, June 30, 2006,
      a
      total of 12,638,454 shares were issued to 26 individuals as payment for services
      totaling $3,348,800.





For
      the
      quarter ended June 30, 2006, 970,645 shares of common stock were issued as
      payment for loans totaling $311,500. 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.





For
      the
      quarter ended June 30, 2006, 2,500,000 shares of common stock were issued for
      the comprehensive Agreement for Licensing, Joint Venture Agreement, and
      Manufacturing Agreement with Regent Machine Products, LLC.





For
      the
      quarter ended June 30, 2006, 6,207,416 shares of preferred stock were converted
      to 6,207,416 shares of common stock.





**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 shares 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.











12
 
 **INTERNAL
        HYDRO INTERNATIONAL INC.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**


**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 $3700 and $3931, respectively. Depreciation expense for the quarter
      ended June 30, 2006 was $980.43.





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





Office
                and computer equipment
            
            $
            34,053Less
                accumulated depreciation
            
            
            24,897Furniture
                and equipment, net
            
            $
            9,156





**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 the quarter ended June 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 quarter ended June 30, 2006. Prior to the merger
      transaction with HIS 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 June 30, 2006 of approximately
      $6,395,888 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.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**




**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 and 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 June 30, 2006:






Cost
            
            
            Gross
                Gains
            
            
            Unrealized
                Losses
            
            
            Impairment
                Write-down
            
            
            Fair
                ValueLangley
              
              Kinetic
            
            $
              
              $
            890,625
              
              187,500
            
            
            ---
              ---
            
            $
              
              $
            83,787
              
              --
            
            $
              
              $
            (792,714
              
              (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.**
  **FOOTNOTES
        TO THE FORM 10-QSB**
 **FOR
        THE THREE MONTHS ENDED JUNE 30, 2006**




NOTE 11 - INVESTMENTS - continued


Proceeds
      from sales of equity securities were $193,388 and gross realized (losses) gains
      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 June 30, 2006 is determined based on the trading price of Langley and
      translated to U.S. dollars at the exchange rate on June 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
      $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 no quoted market price for its securities. The company
      recorded an impairment on the investment in the year ended December 31, 2005.
      The impaired value is $68,750. The impairment was based on management’s estimate
      of value considering the financial position and cash flows of kinetic. The
      company recorded the $118,750 impairment as a charge in the accompanying
      statement of operations for the year ended December 31, 2005. 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. ("Internal Hydro" 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 to the transaction.





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**





We
      are a
      development stage enterprise. We intend to manufacture and distribute
      alternative energy products that use water pressure flow to generate
      electricity. We are currently finalizing production units of the Energy
      Commander Version Five ("EC V") super efficient low impact hydro units. We
      have
      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


We
      have
      now entered into the production and fielding phase of its business plan, both
      domestically, and with an overseas strategic partner. We are 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, we have 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.





We
      have
      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 we have over these
      sources are its cost, its flexibility and its constant availability. In the
      United States alone, we estimate our technologies will surpass wind-generated
      power within three years and exceed solar in four years. We are 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. We
      hope 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. Our 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. We 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 our technology is that our energy conversion technology, the
      EC
      System, has no known direct competitor. No other known technology uses low
      flow
      fluid or gas pressure for the creation of vast amounts of mechanical force
      to
      create electricity. No other known 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. Our technology harnesses the flow and makes
      it
      work to create electricity wherever needed.





We
      are
      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. We 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.





Our
      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 we will retain the tax credits, renewable energy credits, and
      portions of the energy value. In the EU where we have 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 the Company 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.





We
      believe that our EC could mean 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 could have military uses. For
      instance, our technology might be 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 might also 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 should 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. 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, we 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.
      Management of Cm2 believes they will build and place a minimum of between 300
      and 600 thirty Kw units in Europe within the first year of full production.
      Under the agreement we pay no significant capital expenditure, but we receive
      revenues in various forms.





Cm2
      is a
      producer and supplier of electrical systems for European utilities and
      industrial users. Cm2 is positioned to supply our units for all of the European
      Union for the foreseeable future. Cm2 will be producing the units under a
      revenue sharing and payment license with us. 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. We will receive an up front sum of $2,000 to $3,000 per unit produced
      in
      Europe plus some 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 our units placed in the U.S. Under the
      agreement, Cm2 will be a strategic partner for delivery of the EC units to
      our
      domestic uses for less than we 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 us 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. We 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. We issued 1,250,000 shares of
      treasury shares of common stock for this interest and we agreed to help develop
      the technology and market it with our 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  We
      intend
      to help market and develop the Kinetic line of production. We will also help
      introduce Kinetic’s products to European entities for development and
      marketing.





TRITON
      TECHNOLOGIES :





In
      April
      2005, we entered into a future Marketing and Distribution Agreement with Triton
      Technologies of Reston, Virginia. Under this agreement, Triton has the rights
      to
      market our Energy Commander technology. Triton took on certain responsibilities
      for the capital support of the Energy Commander build out and engineering.
      Triton has directly taken on the contractual obligations for payment to the
      engineering firm APTEC for unit plans and production of the EC IV. We were
      relieved of such payments during the period that Triton fulfills its obligations
      to APTEC. To date, Triton has paid APTEC approximately $40,000 as reported
      to
      us. The primary purpose of the agreement is for Triton to develop and implement
      a strategic marketing plan for industry awareness and for sales of the Energy
      Commander under our 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, we would also receive an equity position in Triton based upon the
      future position of Triton’s public company. We were 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 we did not object to. Currently, 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, Internal Hydro and New Impact, LLC, a private Arizona-based
      Company, entered into a contract for the purchase of energy units from us,
      with
      rights for distribution and use of our 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 our marketing and sales arm when we have production.





WORLD
      ENVIRONMENTAL SOLUTIONS COMPANY, INC.





We
      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, we announced on March 16, 2006 that we had 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), we have agreed to enter into a definitive
      agreement, pursuant to which we 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. We paid WESCA a $100,000
      down payment on the initial licensing fee. The agreement will also provide
      for
      WESCO to be paid a continuing royalty of $100,000 for each European country
      in
      which we intend to establish an operational CAVD plant. In addition, we 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, we will
      maintain the right of first refusal to Tennessee, Illinois, Louisiana and
      Minnesota at a predetermined license arrangement of $250,000 per
      state.




Our
      soon-to-be-deployed Energy Commander's core technology and variations notably
      complement WESCO's CAVD technology, thus creating strong synergies since we
      will
      be able to produce our core technologies in the same facilities.






20




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


RESULTS OF OPERATIONS


We
      have
      completed production and internal testing of our Energy Commander V (EC V)
      low
      impact hydro energy unit. We are now displaying the completed EC V unit on
      its
      website, before transportation to its testing site. The unit's internal testing
      was 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. With the completed internal testing
      of
      the unit, the system will now be transported to its testing and on-site
      production engineering site, with an anticipated delivery date in the next
      few
      months, for field tests and engineering certification of this production
      unit.




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. Our website
      shows viewers photographs of some of the internal parts of the unit, 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.






The
      EC V
”slice'' concept was used in production of the 12 cylinder unit. As built, each
      rotary 360 degree slice houses twelve 4 inch cylinders, will be able to be
      stacked with other slices to provide the 30 kilowatts of standard output, with
      additional or less slices, each of 12 cylinders, needed or not needed based
      upon
      the flow that is present at any one location. We recently announced that the
      EC
      V was able to plan for as little as 30 p.s.i. of pressure for production of
      electricity in multiple units at a single site, something that traditional
      turbine technology does not support.




We
      have
      sought the identification of undervalued and undercapitalized technologies
      that
      would be part of our corporate philosophy for renewable energy products. We
      have
      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, as discussed above, we 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.





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





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





General
      and administrative expenses increased by $3,277,092 from $502,294 for the three
      months ended June 30, 2005 to $3,779,386 for the three months ended June 30,
      2006. This increase was due primarily to an increase in stock issued for
      services. Research and development costs also increased by $530,655 from $26,419
      for the three months ended June 30, 2005 to $557,074 for the three months ended
      June 30, 2006. Accordingly, the net loss increased by $3,807,747 from $528,713
      for the three months ended June 30, 2005 to $4,336,460 for the three months
      ended June 30, 2006.





**COMPARISON
      OF SIX MONTHS ENDED JUNE 30, 2006 TO SIX MONTHS ENDED JUNE 30, 2005.**





Revenue
      for the six months ended June 30, 2006 and 2005 was $-0-.





General
      and administrative expenses increased by $4,306,819from $1,002,250 for the
      six
      months ended June 30, 2005 to $5,309,069 for the six months ended June 30,
      2006.
      This increase was due primarily to an increase in stock issued for services.
      Research and development costs also increased by $558,564 from $85,154 for
      the
      six months ended June 30, 2005 to $643,718 for the six months ended June 30,
      2006. Accordingly, the net loss increased by $4,865,383 from $1,087,404 for
      the
      six months ended June 30, 2005 to $5,952,787 for the six months ended June
      30,
      2006.


21




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


*LIQUIDITY
      AND CAPITAL RESOURCES*





Our
      operating activities used cash in the amount of $307,076 for the quarter ended
      June 30, 2006 related primarily to and increase in common and preferred stock
      issuances and a decrease in accounts payable. 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.





We
      have
      incurred additional deficits in cash flow from operating activities. These
      deficits have been funded from loans from significant shareholders. We are
      in
      discussions with several capital organizations with a view to selling more
      common and preferred shares as a means of financing future capital needs. We
      anticipate that we will be successful in these discussions; however there can
      be
      no assurances that we will be successful in doing so. The cash provided by
      financing activities decreased by $181,100 from $395,000 for the quarter ended
      June 30, 2005 to $213,900 for the quarter ended June 30, 2006.





In
      addition, 970,645 shares of common stock were issued for debt conversion for
      the
      quarter ended June 30, 2006 in the amount of $311,500.





**OUTLOOK
      FOR 2006**





During
      the next twelve months, our technology is targeted to be produced and field
      tested. At that point, we will be entering into the is 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. Under
      the contractual arrangement with Cm2, we have 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, we will have significant production ability for the EC units. We
      forecast 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.
      We
      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, we will also be implementing the portion
      of its business plan which for 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. We 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 we prepare to market both the Energy Commander
      and CAVD systems.





In
      the
      second half of 2006, we will enter into three important phases for the
      production mode and field testing of its energy units. 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. Our
      second projected phase 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.




**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.


22


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


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
              June
                30,
              2006
            Date
                of Inception
              Through
              December
                31, 2003Net Income (loss)
            $4,346,560
            $12,431,023




Our
      continuing negative operating results have produced a working capital deficit
      accumulated during Development Stage of $8,084,463 as of June 30, 2006. The
      above factors represent continue to raise doubt about our ability to fully
      establish itself as a going concern.





Development
      Stage Company


We
      are in
      the development stage. There is no assurance that our activities will be
      profitable. Our likelihood of the success 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.





Going
      Concern


The
      financial statements are presented on the basis that we are 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 our operations and a combination of its
      financing and capital raising plans will provide sufficient working capital
      to
      allow us to continue as a going concern.





Costs
      of Conducting Business


We
      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 our
      products, and its operating costs.





Technological
      Change


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


23


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


Contracts


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





Fluctuations
      in Operating Results


Our
      revenues and results of operations may vary significantly in the future. Our
      revenues and results of operations are difficult to forecast and could be
      adversely affected by many factors, some of which are outside our control,
      including, among others, the expected relatively long sales and implementation
      cycles for our products; the size and timing of individual license transactions
      and joint venture arrangements; seasonality of revenues; changes in our
      operating expenses; changes in the mix of products sold; timing of introduction
      or enhancement of our products by us or our 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 our products will achieve broad market acceptance or that
      we will be successful in marketing its products or enhancements thereto. In
      the
      event that our current or future competitors release new products that have
      more
      advanced features, offer better performance or are more price competitive than
      our products, demand for our products would decline. A decline in demand for,
      or
      market acceptance of our products as a result of competition, technological
      change, or other factors would have material adverse effects on our business,
      financial condition and results of operations.





Seasonality


We
      do not
      expect to experience material seasonal variations in revenues or operating
      costs.





**OFF
      BALANCE SHEET ARRANGEMENTS.**





For
      the
      period ended June 30, 2006, we did not engage in any off balance sheet
      transactions.


**Item
        3. Controls and Procedures**
  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 June 30, 2006.  There have been no changes in our internal
        control over financial reporting during the last fiscal quarter that has
        materially affected, or is reasonably likely to materially affect our internal
        control over financial reporting.


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**PART
      II - OTHER INFORMATION**




Pursuant
      to the Instructions on Part II of the Form 10-QSB, Items 3, 4 and 5 are omitted.







**Item
      1. Legal Proceedings**





On
      June
      21, 2006, we settled the lawsuit titled *Internal
      Hydro International v. Raymond Breland and Breland and
      Associates* filed in
      the Thirteenth Judicial Circuit in and for Hillsborough County Florida. This
      lawsuit involves the attempt by Mr. Breland and his company to convert shares
      of
      our common stock to his own use. The shares were originally issued to Mr.
      Breland as a consulting fee for him to secure financing for the Company.
      Although Mr. Breland failed to perform the required services, he nonetheless
      tried to convert the shares and sell them for his own profit. Under the terms
      of
      the settlement, Mr. Breland received 400,000 shares of stock.





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 June 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 that 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 12,638,454 shares were issued to employees and outside consultants for a
      recognized compensation expense of $3,302,454. A total of 970,645 shares were
      issued in payment for loans to the company for a total loan value of
      $311,500.







During
      the period January 1, 2005 to June 30, 2006 shareholders converted 1,157,868
      shares of Preferred Stock into shares of our common stock on a 1-for-1
      basis.








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**Item
      6. Exhibits**





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.





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.





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.





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.**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: *August
              14, 2006*
            By:
            /s/ *CRAIG
              A. HUFFMAN**CRAIG
              A. HUFFMAN*Title:
              *Chief Executive
              Officer*










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