UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                   FORM 10-QSB

[X]  QUARTERLY  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT
     OF 1934

                  For the quarterly period ended June 30, 2006


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

          For the transition period from _____________ to ___________.

                        Commission File Number: 000-50542


                          HYDROGEN ENGINE CENTER, INC.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)


           NEVADA                                               82-0497807
----------------------------                                 -------------------
(State or other jurisdiction                                   (IRS Employer
      of incorporation)                                      Identification No.)

                   2502 East Poplar Street, Algona, Iowa 50511
                    (Address of principal executive offices)

       Registrant's telephone number, including area code: (515) 295-3178

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

Indicate by check mark whether the Registrant is a large  accelerated  filer, an
accelerated  filer or a  non-accelerated  filer.  See definition of "accelerated
filer and large  accelerated  filer" in Rule 12b-2 of the Exchange  Act.  (Check
one):

Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]


State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest  practicable  date:  25,456,097 shares of Common Stock,
par value $.001 outstanding at August 11, 2006.


<PAGE>

<TABLE>
<CAPTION>

                                               FORM 10-QSB

                                            TABLE OF CONTENTS

                                                                                                          Page
PART I.    FINANCIAL INFORMATION

<S>                                                                                                           <C>
Item 1.  Consolidated Financial Statements (Unaudited)......................................................  3

         Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005..............................  3

         Consolidated  Statements  of  Operations  for the Three  Months and Six
         Months Ended June 30, 2006 and 2005 and the period from inception (May
         19, 2003) through June 30, 2006....................................................................  5

         Consolidated Statements of Stockholders' Equity (Deficit) for the period from
         inception (May 19, 2003) through June 30, 2006.....................................................  6

         Consolidated  Statements  of Cash  Flows for the Three  Months  and Six
         Months Ended June 30, 2006 and 2005 and the period from  inception (May
         19, 2003) through June 30, 2006....................................................................  8

         Notes to Consolidated Financial Statements......................................................... 10

Item 2.  Management's Discussion and Analysis of Financial Condition and
           Results of Operations............................................................................ 29

Item 3.  Quantitative and Qualitative Disclosure About Market Risk.......................................... 37

Item 4.  Controls and Procedures............................................................................ 39

PART II.   OTHER INFORMATION

Item 1A.  Risk Factors...................................................................................... 40

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds........................................ 49

Item 6.  Exhibits and Reports on Form 8-K................................................................... 50

Notes About Forward-looking Statements...................................................................... 50

Signatures.................................................................................................. 51

</TABLE>

                                      -2-
<PAGE>


ITEM 1.  FINANCIAL INFORMATION
<TABLE>
<CAPTION>

                  HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                    (a corporation in the development stage)

                           Consolidated Balance Sheets


------------------------------------------------------------------------------------------
                                                              June 30,        December 31,
ASSETS                                                          2006              2005
------------------------------------------------------------------------------------------
                                                             (Unaudited)
<S>                                                          <C>              <C>
Current Assets
   Cash and cash equivalents                                 $2,551,230       $2,346,248
   Accounts receivable                                           55,698            3,200
   Related party receivable                                        --             26,257
   Other receivables                                               --            103,695
   Inventories                                                  849,913          206,091
   Prepaid expenses                                             175,475           77,723
                                                             ----------       ----------
     Total current assets                                     3,632,316        2,763,214

Property, Plant and Equipment
   Building                                                   1,459,972          282,901
   Construction in progress                                     696,993        1,322,798
   Equipment                                                    617,751          280,780
   Land and improvements                                        367,379          196,124
   Leasehold improvements                                        17,156           16,023
                                                             ----------       ----------
                                                              3,159,251        2,098,626
   Less accumulated depreciation                                 83,819           39,818
                                                             ----------       ----------
     Net property and equipment                               3,075,432        2,058,808
                                                             ----------       ----------

     Total Assets                                            $6,707,748       $4,822,022
                                                             ==========       ==========
</TABLE>











                             See accompanying notes.



                                      -3-
<PAGE>

<TABLE>
<CAPTION>

                  HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                    (a corporation in the development stage)

                           Consolidated Balance Sheets


------------------------------------------------------------------------------------------
                                                                June 30,      December 31,
LIABILITIES AND EQUITY                                            2006            2005
------------------------------------------------------------------------------------------
                                                               (Unaudited)
<S>                                                            <C>            <C>
Current Liabilities
    Notes payable, bank                                        $ 1,095,337    $   262,647
    Current portion long-term debt                                  43,140         24,984
    Accounts payable                                               623,278        236,341
    Accrued expenses                                               131,703         69,768
    Accrued purchase commitment losses                             336,257           --
    Construction payable                                             9,945        232,208
    Unearned revenue                                               126,772           --
                                                               -----------    -----------
     Total current liabilities                                   2,366,432        825,948

Long-term debt, net of current maturities                          798,865        791,541

Commitments and Contingencies

Stockholders' Equity
   Preferred stock,  $0.001 par value;
   10,000,000 shares  authorized, none issued                         --             --
   Common  stock, $0.001 par value; 100,000,000 shares
     authorized, 25,456,097 and 25,157,905 shares
     issued and outstanding, respectively                           25,456         25,158
   Additional paid-in capital                                    7,840,085      4,837,602
   Unearned stock-based compensation                                  --         (275,332)
   Accumulated other comprehensive income - foreign currency           722         (2,207)
   Deficit accumulated during the development stage             (4,323,812)    (1,380,688)
                                                               -----------    -----------

     Total stockholders' equity                                  3,542,451      3,204,533
                                                               -----------    -----------


     Total Liabilities and Stockholders' Equity                $ 6,707,748    $ 4,822,022
                                                               ===========    ===========
</TABLE>


                             See accompanying notes.

                                      -4-
<PAGE>

<TABLE>
<CAPTION>

                                       HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                                         (a corporation in the development stage)

                                           Consolidated Statements of Operations
                                                        (Unaudited)

--------------------------------------------------------------------------------------------------------------------------



                                           Three months ended June 30,      Six months ended June 30,     From Inception
                                          ----------------------------    ----------------------------    (May 19, 2003)
                                              2006            2005            2006           2005        to June 30, 2006
                                          ------------    ------------    ------------    ------------   -----------------

<S>                                       <C>             <C>             <C>             <C>             <C>
Sales                                     $     47,119    $      1,600    $     75,709    $     13,600    $    119,269

Cost of Sales                                   39,580           1,434          55,256           6,195          78,800
                                          ------------    ------------    ------------    ------------    ------------

Gross Profit                                     7,539             166          20,453           7,405          40,469
                                          ------------    ------------    ------------    ------------    ------------

Operating Expenses
   Sales and marketing                         172,200            --           412,488            --           534,062
   General and administrative                  965,762          66,603       1,573,731         106,153       2,377,234
   Research and development                    421,100           8,068         504,752          17,781         958,464
   Decline in market value of inventory        111,480            --           111,480            --           111,480
   Loss on purchase commitments                336,257            --           336,257            --           336,257
                                          ------------    ------------    ------------    ------------    ------------

                                             2,006,799          74,671       2,938,708         123,934       4,317,497
                                          ------------    ------------    ------------    ------------    ------------

Operating Loss                              (1,999,260)        (74,505)     (2,918,255)       (116,529)     (4,277,028)
                                          ------------    ------------    ------------    ------------    ------------

Other Income (Expense)
   Interest income                              12,415           1,095          25,913           1,097          57,936
   Interest expense                            (37,822)         (7,784)        (50,782)        (12,352)       (104,720)
                                          ------------    ------------    ------------    ------------    ------------

                                               (25,407)         (6,689)        (24,869)        (11,255)        (46,784)
                                          ------------    ------------    ------------    ------------    ------------

Net Loss                                  $ (2,024,667)   $    (81,194)   $ (2,943,124)   $   (127,784)   $  4,323,812
                                          ============    ============    ============    ============    ============


Weighted-average shares outstanding         24,860,561      16,297,200      24,857,733      16,297,200
                                          ============    ============    ============    ============


Basic and diluted net loss per share      $      (0.08)   $      (0.00)   $      (0.12)   $      (0.01)
                                          ============    ============    ============    ============
</TABLE>




                             See accompanying notes.

                                      -5-
<PAGE>

<TABLE>
<CAPTION>

                                          HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                                            (a corporation in the development stage)
                                    Consolidated Statements of Stockholders' Equity (Deficit)
                                                                                                             Deficit
                                                                                              Accumulated     Accum.
                                            Common       Common      Additional   Unearned    Other Com-   During the
                                            Stock        Stock        Paid-in    Stock-Based  prehensive   Development
                                            Shares       Amount       Capital    Compensation    Loss         Stage        Total
                                          -----------  -----------  -----------  -----------  -----------  -----------  -----------

<S>                                         <C>        <C>          <C>          <C>          <C>          <C>          <C>
Issuance of common stock to founder in
exch. for equip. & expenses incurred        2,000,000  $     2,000  $    98,165  $      --    $      --    $      --    $   100,165

Net loss                                         --           --           --           --           --        (65,642)     (65,642)
                                          -----------  -----------  -----------  -----------  -----------  -----------  -----------


Balance at December 31, 2003                2,000,000        2,000       98,165         --           --        (65,642)      34,523

Company-related expenses paid by
founder                                          --           --         39,187         --           --           --         39,187

Net loss                                         --           --           --           --           --       (192,476)    (192,476)
                                          -----------  -----------  -----------  -----------  -----------  -----------  -----------

Balance at December 31, 2004                2,000,000        2,000      137,352         --           --       (258,118)    (118,766)

Company-related expenses paid by
founder                                          --           --         12,135         --           --           --         12,135

Exchange of previous shares by sole
shareholder of HEC Iowa                    (2,000,000)        --           --           --           --           --           --

Shares in Green Mt.  Labs  acquired  in
reverse merger                              1,006,000        1,006       (1,006)        --           --           --           --

Stock split of 3.8 to 1 prior to the
merger                                      2,816,804        2,817       (2,817)        --           --           --           --

Issuance of common stock to sole
shareholder of HEC Iowa                    16,297,200       14,297      (14,297)        --           --           --           --

Issuance of restricted common stock to
employees & directors                         426,000          426      425,574     (275,332)        --           --        150,668

Issuance of common stock in  connection
with  the  private  placement,  net  of
expenses                                    3,948,500        3,949    3,590,940         --           --           --      3,594,889

Issuance of common stock in  connection
with conversion of debt                       663,401          663      556,388         --           --           --        557,051

Consultants compensation associated
with stock options                               --           --        133,333         --           --           --        133,333
                                                                                                                        -----------
                                                                                                                          4,329,310
                                                                                                                        -----------
Comprehensive Loss

  Foreign currency translation                   --           --           --           --         (2,207)        --         (2,207)
  Net loss                                       --           --           --           --           --     (1,122,570)  (1,122,570)
                                                                                                                         ----------

Total comprehensive loss                         --           --           --           --           --           --     (1,124,777)
                                           -----------  -----------  -----------  -----------  -----------  -----------  -----------


Balance at December 31, 2005               25,157,905   $   25,158   $ 4,837,602  $  (275,332) $    (2,207) $(1,380,688) $3,204,533
</TABLE>


                                  - Continued -


                             See accompanying notes.

                                      -6-
<PAGE>


<TABLE>
<CAPTION>

                                        HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                                          (a corporation in the development stage)
                                  Consolidated Statements of Stockholders' Equity (Deficit)
                                                         -Continued-
                                                                                                           Deficit
                                                                                           Accumulated      Accum.
                                           Common       Common    Additional    Unearned     Other       During the
                                            Stock       Stock      Paid-in    Stock-Based Comprehensive  Development
                                           Shares       Amount     Capital    Compensation    Loss          Stage         Total
                                        -----------  ----------- -----------  -----------  -----------   -----------   -----------


<S>                                      <C>         <C>         <C>          <C>          <C>           <C>           <C>
Balance at December 31, 2005             25,157,905  $    25,158 $ 4,837,602  $  (275,332) $    (2,207)  $(1,380,688)  $ 3,204,533

Reclassification due to implementation
of FASB 123R                                   --           --      (275,332)     275,332         --            --            --

Compensation associated with vesting of
restricted stock to employees and
directors                                      --           --        43,000         --           --            --          43,000

Compensation associated with issuance or
vesting of stock options to employees and
directors                                      --           --       393,146         --           --            --         393,146

Consultant compensation associated
with stock options                             --           --        36,666         --           --            --          36,666

Issuance of common stock in connection
with private placement, net of expenses     290,192          290   2,797,011         --           --            --       2,797,301

Issuance of stock related to option
exercises                                     8,000            8       7,992         --           --            --           8,000
                                                                                                                        ----------

                                                                                                                         6,482,646
Comprehensive Loss

  Foreign currency translation                 --           --          --           --          2,929          --           2,929
  Net loss                                     --           --          --           --           --      (2,943,124)   (2,943,124)
                                                                                                                        ----------
Total comprehensive loss                       --           --          --           --           --            --      (2,940,195)
                                        -----------  ----------- -----------  -----------  -----------   -----------    -----------

Balance at June 30, 2006 (Unaudited)     25,456,097  $    25,456 $ 7,840,085  $      --    $       722   $(4,323,812)   $3,542,451
                                        ===========  =========== ===========  ===========  ===========   ===========   ============
</TABLE>





                             See accompanying notes.

                                      -7-
<PAGE>
<TABLE>
<CAPTION>

                                          HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                                            (a corporation in the development stage)

                                              Consolidated Statements of Cash Flows
                                                           (Unaudited)

-------------------------------------------------------------------------------------------------------------------------------
                                                                                                                       From
                                                                                                                     Inception
                                                                                                                     (May 19,
                                                        Three months ended June 30,    Six months ended June 30,       2003)
                                                        --------------------------    --------------------------    to June 30,
                                                            2006           2005           2006           2005          2006
                                                        -----------    -----------    -----------    -----------    -----------
<S>                                                     <C>            <C>            <C>            <C>            <C>
Cash Flows from Operating Activities
  Net loss                                              $(2,024,667)   $   (81,194)   $(2,943,124)   $  (127,784)   $(4,323,812)

  Adjustments to reconcile net loss
  to net cash used in operations:
   Depreciation                                              25,424          4,210         44,001          8,392         83,819
   Compensation  to directors and employees from             21,500           --           43,000           --          193,668
   restricted stock
   Compensation to directors and employees from stock       261,031           --          393,146           --          393,146
   options
   Compensation to consultants from stock options            14,999           --           36,666           --          169,999
   Impairment loss on equipment                             103,300           --          103,300           --          103,300
   Change in assets and liabilities:
     Accounts receivable                                     26,404         (7,460)       (52,498)        (7,460)       (55,698)
     Related party receivables                                 --             --           26,257           --             --
     Other receivables                                         --           (1,058)         3,695         (1,058)          --
     Inventories                                           (577,040)       (20,796)      (755,302)       (28,910)      (961,393)
     Prepaid expenses                                        (9,367)          --          (97,752)          --         (175,475)
     Accounts payable                                       385,744          6,669        498,417         13,139        838,394
     Accrued expenses                                        38,799          8,167         61,935         12,651        131,703
     Accrued purchase commitment losses                     336,257           --          336,257           --          336,257
     Unearned revenue                                        75,364         (2,400)       126,772         (2,400)       126,772
                                                        -----------    -----------    -----------    -----------    -----------
      Net cash used in operating activities              (1,322,252)       (93,862)    (2,175,230)      (133,430)    (3,139,320)

Cash Flows from Investing Activities
  Purchases of property, plant and equipment               (202,721)          (585)      (303,415)          (585)      (651,642)
  Payments for construction in progress                    (516,938)          --       (1,031,672)          --       (2,022,841)
                                                        -----------    -----------    -----------    -----------    -----------
      Net cash used in investing activities                (719,659)          (585)    (1,335,087)          (585)    (2,674,483)

Cash Flows from Financing Activities
  Proceeds from note payable, bank                          832,690        650,000        832,690        650,000      1,482,690
  Payments on note payable, bank                               --             --             --             --         (650,000)
  Proceeds from long-term debt                                 --          130,000        100,000        160,000      1,172,052
  Payments on long-term debt                                (12,296)          --          (25,621)          --          (40,621)
  Proceeds from exercise of stock options                     3,000           --            8,000           --            8,000
  Issuance of common stock in private placement           2,923,134           --        2,923,134           --        6,871,634
  Payments of expense in connection with private
  placement                                                (125,833)          --         (125,833)          --         (479,444)
                                                        -----------    -----------    -----------    -----------    -----------
      Net cash provided by financing activities           3,620,695        780,000      3,712,370        810,000      8,364,311
                                                        -----------    -----------    -----------    -----------    -----------

Net Increase in Cash and Cash Equivalents                 1,578,784        685,553        202,053        675,985      2,550,508

Effect of Exchange Rates on Cash and Cash Equivalents         2,940           --            2,929           --              722

Cash and Cash Equivalents - Beginning of Period             969,506         10,241      2,346,248         19,809           --
                                                        -----------    -----------    -----------    -----------    -----------

Cash and Cash Equivalents - End of Period               $ 2,551,230    $   695,794    $ 2,551,230    $   695,794    $ 2,551,230
                                                        ===========    ===========    ===========    ===========    ===========
</TABLE>



                                  - Continued -


                             See accompanying notes.

                                      -8-
<PAGE>

<TABLE>
<CAPTION>

                                          HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                                            (a corporation in the development stage)

                                              Consolidated Statements of Cash Flows
                                                           (Unaudited)
                                                           -Continued-


------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                       From
                                                                                                                    Inception
                                                                                                                     (May 19,
                                                        Three months ended June 30,    Six months ended June 30,       2003)
                                                        --------------------------    --------------------------    to June 30,
                                                            2006           2005           2006           2005          2006
                                                        -----------    -----------    -----------    -----------    -----------
<S>                                                     <C>            <C>            <C>            <C>            <C>

Supplemental Cash Flow Information

   Interest paid                                        $      5,920   $     --      $     12,775    $       84     $   50,702
                                                        ============   ==========    ============    ==========     ==========




Supplemental Disclosure of Non-cash
 Investing and Financing Activities

   Additional paid-in capital
     contribution for expenses
     paid by founder                                    $       --     $    6,871    $       --      $   39,187     $  103,636
                                                        ============   ==========    ============    ==========     ==========

   Issuance of common stock for equipment               $       --     $     --      $       --      $     --       $   47,851
                                                        ============   ==========    ============    ==========     ==========

   Issuance of common stock for
     conversion of debt                                 $       --     $     --      $       --      $     --       $  557,051
                                                        ============   ==========    ============    ==========     ==========

   Acquisition  of  property, plant and
     equipment through financing                        $       --     $     --      $     51,101    $     --       $  530,272
                                                        ============   ==========    ============    ==========     ==========

   Payables for construction in progress                $      9,945   $     --      $     32,594    $     --       $  264,802
                                                        ============   ==========    ============    ==========     ==========

   Receivable for state loan                            $       --     $     --      $       --      $     --       $  100,000
                                                        ============   ==========    ============    ==========     ==========
</TABLE>







                             See accompanying notes.

                                      -9-
<PAGE>


                  HYDROGEN ENGINE CENTER, INC. AND SUBSIDIARIES
                    (a corporation in the development stage)
                   Notes to Consolidated Financial Statements
                                   (unaudited)
                                  June 30, 2006


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Overview of Companies
---------------------

Hydrogen  Engine Center,  Inc.,  formerly  known as Green  Mountain  Labs,  Inc.
("Green  Mt.   Labs"),   is  a  Nevada   corporation.   Green  Mt.  Labs  was  a
public-reporting   shell  company  and,  in  connection  with  the  Transactions
described  below,  changed  its  name  to  Hydrogen  Engine  Center,  Inc.  (the
"Company"). Also, as a result of the Transactions described below, the Company's
operations are those of its wholly owned  subsidiaries,  Hydrogen Engine Center,
Inc., an Iowa corporation ("HEC Iowa"),  and Hydrogen Engine Center (HEC) Canada
Inc. ("HEC Canada").

HEC Iowa was incorporated on May 19, 2003 ("inception  date") for the purpose of
commercializing  internal combustion  industrial engines.  HEC Iowa's operations
are located in Algona, Iowa.

HEC Canada was  incorporated as a Canadian  corporation on August 25, 2005, with
the goal of  establishing  a research  and  development  center to assist in the
development of alternative fuel and hydrogen  engines.  HEC Canada is located in
Quebec, Canada and works with Universite Du Quebec a Trois-Rivieras.

Green Mt. Labs was  originally  organized to acquire and develop  mining claims;
however, these operations were discontinued in 1997.

Description of Business - A Corporation in the Development Stage
----------------------------------------------------------------

The Company  designs,  manufactures  and distributes  alternative  fuel internal
combustion engines and generators for use in the industrial and power generation
markets.  These engines are designed to run on alternative  fuels  including but
not limited to gasoline, propane, natural gas, ethanol and hydrogen. The engines
and engine products are sold under the brand name Oxx Power TM.

Through June 30, 2006, the Company remains in the development  stage. This stage
is  characterized  by minimal  revenues with efforts focused on fund raising and
significant  expenditures  for  the  design  and  development  of the  Company's
products and manufacturing  processes, and for the construction of the Company's
new facilities.

                                      -10-
<PAGE>

Merger and Private Placement (the "Transactions")
-------------------------------------------------

On August 30, 2005,  Green Mt. Labs  completed the  acquisition of HEC Iowa. The
acquisition was made pursuant to an agreement and plan of merger entered into on
June 3,  2005,  and  revised  on July 6, 2005,  and July 29,  2005 (the  "Merger
Agreement").  To  accomplish  the  acquisition,  Green Mt. Labs merged its newly
created,  wholly owned subsidiary,  Green Mt. Acquisitions,  Inc., with and into
HEC Iowa, with HEC Iowa being the surviving  entity. As part of the acquisition,
Green Mt. Labs  completed  a 3.8 share to 1 share  stock  split which  increased
outstanding  shares of common stock from 1,006,000 to 3,822,804.  Also under the
terms  of  the  Merger  Agreement,  the  Company  issued  16,297,200  shares  of
post-split  common  stock  (representing  81% of the  total  outstanding  shares
immediately  following the  transaction) to Theodore G.  Hollinger,  who was the
sole  stockholder  of HEC Iowa,  in exchange for 100% of HEC Iowa's  outstanding
capital  stock  (2,000,000  shares).  As stated above,  in  connection  with the
Transactions, Green Mt. Labs changed it's name to Hydrogen Engine Center, Inc.

The  transactions  have  been  accounted  for as a  recapitalization,  which  is
accounted for similar to the issuance of stock by HEC Iowa for the net assets of
Green Mt. Labs with no goodwill or other intangibles being recorded.

On October 11, 2005, the Company closed a private placement of the common stock.
The Company sold 3,948,500 shares of common stock,  $.001 par value, for a total
of $3,948,500.  Costs related to this offering amounted to $353,611. The Company
sold the shares in a private  transaction  at $1.00 per share,  and the  Company
relied on an  exemption  from  registration  pursuant  to  Regulation  D,  Rules
Governing the Limited Offer and Sale of Securities  without  Registration  under
the Securities Act of 1933.

On May 22, 2006, the Company  announced the intention to offer up to 1.5 million
shares of its  unregistered  common stock to accredited  investors and qualified
institutional  buyers in a second private placement.  The Company also announced
its intention to offer,  subject to market  conditions and other factors,  $35.5
million in aggregate  principal  amount of 8% Senior Series 2006 Corporate Notes
due in 2010 accredited investors and qualified  institutional buyers. On June 6,
2006,  the  Board of  Directors  voted to  increase  the  number of shares to be
included in this private  placement to 3 million  shares.  At June 30, 2006, the
Company had sold  290,192  shares at prices  ranging  from $9.04 to $10.65.  The
Company,  at June 30, 2006, had received $2,923,134 from this private placement,
which is currently  ongoing.  The Company has  incurred  expenses of $125,833 in
connection with this second private placement.

Principles of Consolidation
---------------------------

The consolidated  financial  statements  include the accounts of the Company and
its  wholly  owned  subsidiaries,  HEC Iowa  and HEC  Canada.  All  intercompany
balances and transactions have been eliminated in consolidation.

Going Concern
-------------

The  financial  statements  have  been  prepared  on  the  basis  of  accounting
principles  applicable  to a going  concern.  As a result,  they do not  include


                                      -11-
<PAGE>

adjustments  that would be  necessary if the Company was unable to continue as a
going  concern and was therefore  obligated to realize  assets and discharge its
liabilities other than in the normal course of operations.

Since  inception,  the Company has  incurred  substantial  operating  losses and
expects to incur additional  operating losses into the foreseeable  future.  The
Company has financed  operations  since inception  primarily  through equity and
debt financings.  At June 30, 2006, the Company has reported  accumulated losses
of $4,323,812 and has cash and cash equivalents  available to fund future losses
and  developments  of  $2,551,230.  The Company  anticipates  its expenses  will
significantly  increase  as it  commences  operations  in its new  manufacturing
facility,  including  additional  personnel,   product  development,   inventory
purchases,  and additional  construction  costs.  Based on current  projections,
existing capital will fund the Company's operations through September 2006. This
timeframe may be shorter if events occur which  negatively  effect the Company's
operations.

Continuing operations is dependent upon obtaining significant further financing.
Although  the  Company  is  engaged  in a private  placement  of its  common and
preferred stock and has authorized the use of debt  securities,  there can be no
assurance  that the Company will  successfully  complete  this  offering or that
these   proceeds,   if  completed,   will  be  sufficient  to  satisfy   capital
requirements.  Also,  there are no assurances  that  additional  funding will be
available at terms acceptable to the Company. These conditions raise substantial
doubt about the ability to continue as a going concern.

Sales of the Company's products through June 30, 2006, have amounted to $119,269
and  consisted of customized  engines and parts.  The Company is also engaged in
two power  generation  projects  for which the  Company  has  recorded  unearned
revenue of $126,772.  The Company has  commenced  limited  production in its new
manufacturing  facility.  The Company  anticipates  beginning full production of
4.9L remanufactured  engines in September 2006. Production of the remanufactured
engines will enable the Company to gain efficiencies in manufacturing processes.
The Company anticipates  production of the new 4.9L Oxx Power engine to begin in
October 2006. The Company has experienced  delays in obtaining needed components
which has delayed the beginning of production.  The Company has also encountered
delays in receiving the needed permits to operate the dynamometer room which has
delayed the completion of construction in this facility. The Company anticipates
that the dyno room will be fully  functional  in the fourth  quarter of 2006. In
addition,  the Company has incurred a loss to reduce  inventory to lower of cost
or market.  If the Company is successful  in obtaining the necessary  financing,
the Company could use the remanufactured engines in generators which could yield
higher gross margins.  Even if the Company is able to manufacture  its products,
there are no  assurances  they will be accepted by the market place.  Also,  the
Company  estimates  it may cost  approximately  $1 million  per  engine  type to
certify its engines to meet certain laws and regulations.  Currently,  there are
three engines the Company plans to certify.

As the  Company  continues  to  ramp  up its  operations,  it has  entered  into
significant  commitments  as  described in Note 13. The Company has entered into
several research and development  arrangements  with other  organizations.  Each
research and development  agreement  requires the Company to incur upfront costs
prior to receiving reimbursements from the other organizations.


                                      -12-
<PAGE>

Foreign Currency Translation
----------------------------

Results of operations and cash flows of foreign  subsidiaries  are translated to
U.S. dollars at average period currency  exchange rates.  Assets and liabilities
are translated at end-of-period  exchange rates.  Foreign  currency  translation
adjustments  related to foreign  subsidiaries  using the local currency as their
functional currency are included in Other comprehensive income (loss).

Cash and Cash Equivalents
-------------------------

The Company  considers  highly-liquid  investments with an original  maturity of
ninety  days or less to be cash  equivalents.  The  Company  maintains  its cash
balances in three institutions. At times throughout the year, the Company's cash
and cash equivalents  balances may exceed amounts insured by the Federal Deposit
Insurance Corporation. The Company believes it is not exposed to any significant
credit risk on cash and cash equivalents.

Accounts Receivable
-------------------

Accounts  receivable are recorded at their estimated net realizable  value.  The
Company  follows a policy of  providing  an  allowance  for  doubtful  accounts.
However,  based on the  evaluation of receivables at June 30, 2006, and December
31, 2005, the Company  believes that such accounts will be collectible and thus,
an allowance is not necessary.  Accounts are  considered  past due if payment is
not made on a timely  basis in  accordance  with the  Company's  credit  policy.
Accounts considered  uncollectible are written off. Credit terms are extended to
customers in the normal course of business.  The Company performs ongoing credit
evaluations of its customers'  financial condition and,  generally,  requires no
collateral.

Inventories
-----------

Inventories  consist  mainly of parts,  finished  engines and  gensets  that are
stated at the lower of cost  (determined by the first-in,  first-out  method) or
market value.

Property, Plant and Equipment
-----------------------------

Property,  plant and equipment  are recorded at cost.  Once assets are placed in
service,  depreciation  is provided  over  estimated  useful lives by use of the
straight-line  method.  Leasehold  improvements are depreciated over the life of
the lease (Note 6).  Maintenance  and repairs are  expensed as  incurred;  major
improvements and betterments are capitalized.

The Company  reviews its  property,  plant,  and  equipment  for  indicators  of
impairment  when events or changes in  circumstances  indicate that the carrying
value may not be recoverable. Cash flows expected to be generated by the related
assets are estimated over the asset's useful life based on updated  projections.
If the  evaluation  indicates  that the carrying  amount of the asset may not be
recoverable,   the  potential  impairment  is  measured  based  on  a  projected

                                      -13-
<PAGE>

discounted cash flow model. If an impairment loss exists, the amount of the loss
will be recorded in the consolidated statements of operations. At June 30, 2006,
the Company  recognized  an  impairment  loss of $103,300  for engine  component
moulds  which they were unable to secure  title.  This  expense was  recorded in
research and development expenses.

Unearned Revenue
----------------

The Company is  currently  engaged in sales  agreements  to deliver  products to
customers in the future.  The sales agreements  require that payments be made to
the Company as certain  milestones  are reached  prior to delivery of product to
customer.  The amounts  recorded as unearned are the amounts paid to the Company
as milestone payments.

Revenue Recognition
-------------------

Revenue from the sale of the Company's  products is recognized at the time title
and risk of ownership transfer to customers. This generally occurs upon shipment
to the customer or when the customer picks up the goods.

Sales and Marketing Costs
-------------------------

Sales and marketing  expenses include payroll,  employee  benefits,  stock-based
compensation,  and other costs associated with sales and marketing personnel and
advertising,  promotions,  tradeshows,  seminars,  and  other  marketing-related
programs. The Company expenses advertising costs as they are incurred.

Research and Development Costs
------------------------------

The  Company's  research and  development  expenses  include  payroll,  employee
benefits,  stock-based  compensation,  and other costs  associated  with product
development.  The Company has determined that technological  feasibility for the
engines is reached shortly before the products are released to manufacturing.

Income Taxes
------------

The Company recognizes  deferred taxes by the asset and liability method.  Under
this method,  deferred income taxes are recognized for  differences  between the
financial statement and tax bases of assets and liabilities at enacted statutory
tax rates in  effect  for the years in which the  differences  are  expected  to
reverse.  The effect on deferred taxes of a change in tax rates is recognized in
income in the period that  includes the enactment  date. In addition,  valuation
allowances are established, when necessary, to reduce deferred tax assets to the
amounts  expected to be realized.  The primary sources of temporary  differences
are depreciation and net operating loss carryforwards.

Net Loss Per Share
------------------

Basic loss per share is  computed  by dividing  the  Company's  net loss for the
period by the  weighted-average  number of  shares of common  stock  outstanding
during the period.  Diluted net loss per share excludes  potential common shares
since the effect is anti-dilutive. Unvested shares are included in the number of
shares  outstanding,  but are not used in the  computation  of weighted  average
shares outstanding.

                                      -14-
<PAGE>

The Company  assumed the effects of the  recapitalization,  described in Note 1,
were  effective  at  the  beginning  of  the  earliest   reporting  period  when
calculating weighted-average shares outstanding.

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 periods. Actual results could differ from those estimates.

Fair Value of Financial Instruments
-----------------------------------

The  carrying   amounts  reported  in  the  balance  sheet  for  cash  and  cash
equivalents,   accounts  receivable,   accounts  payable  and  accrued  expenses
approximate their fair value due to the short-term nature of these instruments.

Stock-Based Compensation
------------------------

Effective  January 1,  2006,  the  Company  adopted  the fair value  recognition
provisions  of SFAS No.  123R.  As  prescribed  in SFAS No.  123R,  "Share-Based
Payment,"  the Company  elected to use the  "modified  prospective  method." The
modified  prospective  method  requires  expense to be recognized for all awards
granted, modified or settled in the year of adoption.  Historically, the Company
applied the intrinsic method as provided in Accounting  Principles Board ("APB")
Opinion No. 25 ("APB No. 25"),  Accounting  for Stock Issued to  Employees,  and
related   interpretations  and  accordingly,   no  compensation  cost  had  been
recognized for stock options issued to employees in the prior year.

In March  2005,  the SEC issued SAB 107  providing  supplemental  implementation
guidance for SFAS 123R. The Company has applied the provisions of SAB 107 in its
adoption of SFAS 123R.  As a result of adopting  the fair value method for stock
compensation,  all future  stock  options and  restricted  stock  awards will be
expensed  over the award  vesting  period.  These awards are expensed  under the
accelerated  amortization  approach using the same fair value measurements which
were used in calculating pro forma stock-based  compensation  expense under SFAS
123. For  stock-based  awards  granted on or after January 1, 2006,  the Company
records  stock-based  compensation  expense  on a  straight-line  basis over the
requisite service period, which is generally a four to five year vesting period.

SFAS  123R  requires  the  use of a  valuation  model,  explained  in Note 12 to
calculate  the fair value of  stock-based  awards.  The  Company  has elected to
utilize the  Black-Scholes  option  pricing  model to estimate the fair value of
options.


                                      -15-
<PAGE>

Prior to the adoption of SFAS 123R, the Company accounted for stock-based awards
to employees and directors  using the intrinsic  value method in accordance with
APB  No.  25  as  allowed  under  SFAS  No.  123,  "Accounting  for  Stock-Based
Compensation" ("SFAS 123"). As permitted by SFAS 123, the Company has elected to
follow  APB No. 25 and  related  interpretations  for its  employee  stock-based
compensation.  Under APB No. 25, no  compensation  expense is  recognized at the
time of option grant if the exercise price of the employee stock option is fixed
and equals or exceeds the fair value of the underlying  common stock on the date
of grant and the number of shares to be issued  pursuant to the exercise of such
option  are  known  and  fixed  at the date of  grant.  The  Board of  Directors
determines the fair value of common stock.

SFAS 123R requires that the deferred  stock-based  compensation on the condensed
consolidated  balance sheet on the date of adoption be netted against additional
paid-in  capital.  As of December 31,  2005,  there was a balance of $275,332 of
deferred  stock-based  compensation that was netted against  additional  paid-in
capital on January 1, 2006.

The Company accounts for options issued to non-employees  (other than directors)
under  SFAS 123 and  Emerging  Issues  Task  Force  Issue  ("EITF")  No.  96-18,
"Accounting for Equity  Instruments  that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling,  Goods, or Services." Therefore,  the
fair  value  of  options  issued  to  non-employees  as  calculated,  using  the
Black-Scholes  pricing  formula  (See Note 12),  is  recorded  as an expense and
periodically  remeasured over the vesting terms. Options issued to non-employees
and employees are issued using the same methodology and assumptions.

The  following  table  illustrates  the effect on net loss as if the Company had
applied  the  fair  value  recognition   provisions  for  stock-based   employee
compensation  of  SFAS  123,  as  amended  by  SFAS  No.  148,  "Accounting  for
Stock-Based Compensation -- Transition and Disclosure."
*****
                                                  Period from Inception
                                                    (May 19, 2003) to
                                                      June 30, 2006

Net loss, as reported                           $          (4,323,812)

Add: options and restricted stock-based
employee compensation expense included
in reported net (loss)                                        756,813

Deduct: options and restricted stock-based
employee and non-employee compensation
expense determined under fair value based
method                                                       (942,615)
                                                ----------------------

Pro forma net loss                              $          (4,509,614)
                                                ======================


The  Company  did not have any  stock-based  compensation  for the three and six
months  ended June 30,  2005.  Total  employee and  nonemployee  non-cash  stock
compensation  expense,  net of  forfeitures,  for the three and six months ended
June 30, 2006, was $276,030 and $429,810 recognized under SFAS 123R.

As a result of adopting SFAS 123R,  our loss for the three months ended June 30,
2006,  was  $(2,024,667)  and would have been  $261,031  less if the Company had
continued to account for employee stock-based compensation under APB 25; and our
loss for the six months ended June 30,  2006,  was  $(2,943,124)  and would have


                                      -16-
<PAGE>

been  $393,146  less if the  Company  had  continued  to  account  for  employee
stock-based compensation under APB 25.

For purposes of pro forma  disclosures,  the estimated fair value of the options
granted is amortized to expense over the option vesting  periods as services are
performed. See Note 12 for further discussion of stock-based compensation.

Warrants
--------

As described in Note 11, the Company has granted  warrants to certain finders in
the private placement,  entitling the finders to purchase 69,640 shares at $1.00
per share. Based on EITF 00-19, "Accounting for Derivative Financial Instruments
Indexed to, and  Potentially  Settle in, a Company's Own Stock," the sale of the
warrants was reported in permanent equity and accordingly, there is no impact on
the Company's financial position and results of operation. Subsequent changes in
fair  value  will  not be  recognized  as long as the  warrants  continue  to be
classified as an equity instrument.

The  Company  has agreed to issue  warrants  to certain  finders in the  private
placement  now  underway as  described  in Note 13. At June 30,  2006,  warrants
associated  with the  current  private  placement  had not been  granted  as the
private placement had not been closed.

Recent Accounting Pronouncements
--------------------------------

In November  2004,  the FASB issued SFAS 151,  "Inventory  Costs." The Statement
requires  that  abnormal  amounts of idle facility  expense,  freight,  handling
costs,  wasted materials and overhead expense be recognized as period costs. The
primary basis of accounting for inventory is cost.  This Statement  standardizes
the amount of idle  facility  expense that could be  classified as inventory and
requires  these  expenses  be  recognized  as  period  costs.  The  Company  has
implemented SFAS 151 as of January 1, 2006. There was no effect on the financial
statements since the company is still in the development stage.

2. INVENTORY

Inventories are stated at the lower of cost or market value.  Cost is determined
by the first-in, first-out method:

                                          June 30,             December 31,
                                            2006                   2005
                                     ---------------         ----------------

        Component parts              $       574,975         $        109,351
        Work in process                      190,521                   12,302
        Finished goods                        84,417                   84,438
                                     ---------------         ----------------

                 Total               $       849,913         $        206,091
                                     ===============         ================

As a result of recent changes in the Company's  effort to market  remanufactured
engines, carrying amounts of those inventories have been reduced by $111,480 due
to the competitive nature of remanufactured  products.  Management believes that
this reduced inventory to its lower of cost or market at June 30, 2006.

                                      -17-
<PAGE>

The Company accrues for losses on non-cancelable  purchase orders. The estimated
losses result from anticipated future sales of remanufactured  engines for sales
prices  less  that  the  estimated  cost  to  manufacture.   Inventory  purchase
commitment losses at June 30, 2006, were $336,257.  There were no allowances for
purchase commitments prior to June 30, 2006.

The Company engaged in the production of  remanufactured  engines as part of the
training,  testing  and  other  steps  necessary  for  the  commencement  of its
operations.

3. CONSTRUCTION IN PROGRESS

The Company has incurred  construction costs related to construction of a 30,000
square  foot  engine  manufacturing  facility of  $1,532,767  at June 30,  2006,
$1,522,822  of which had been paid,  with an additional  $9,945 in  construction
payable.  The  Company  anticipates  there  will  be  approximately  $90,000  in
additional  costs for a fire alarm system and an exhaust system in the dyno room
of the manufacturing  facility. The manufacturing building was placed in service
at April 24,  2006.  The  dynamometer  building is  anticipated  to be placed in
service in the fourth quarter of 2006.

The Company  purchased a 30,000  square foot  building  located  adjacent to the
engine   manufacturing   building   for   generator   manufacturing   and  parts
distribution. The Company recorded a cost of $282,901 for the shell building and
has  incurred  construction  costs of  $341,297  at June 30,  2006 for  building
improvements. The Company estimates additional costs of approximately $75,000 to
complete the distribution/power generator facility.

4. NOTES PAYABLE, BANK

On December 19, 2005, the Company obtained a short-term note for $500,000 from a
bank, of which $262,647 was used for the purchase of a building located adjacent
to the  manufacturing  building  site.  As of June 30, the Company had  received
additional  proceeds  from this note in the amount of  $232,690.  The balance on
this note on June 30, 2006,  is $495,337.  Borrowings  on this  short-term  note
mature  December 16, 2006,  and accrue  interest at 5.89% with monthly  interest
payments until  maturity.  On July 18, 2006,  the Company  secured an additional
note for $75,000.  This  additional note matures on December 16, 2006, and bears
interest at 6.49%. The building serves as collateral for both notes.

On April 4, 2006, the Company  secured a $600,000  short-term  note from a bank.
The note matures April 4, 2007, and bears interest at 6%. The loan is secured by
real estate.

                                      -18-
<PAGE>

5. LONG-TERM DEBT

Long-term debt consists of the following:

                                            June 30,     December 31,
                                              2006          2005
                                           ----------   ----------

Note payable to City of Algona.  See (a)   $  185,000   $  200,000


Note payable to Algona Area Economic
Development Corporation. See (b)              146,124      146,124

Note payable to Algona Area Economic
Development Corporation.  See (c)              66,248       70,401

Notes payable to Iowa Department
of Economic Development. See (d)              400,000      400,000

Note payable to finance company. See (e)       44,633         --
                                           ----------   ----------

                                              842,005      816,525

Less amounts due within one year               43,140       24,984
                                           ----------   ----------

         Totals                            $  798,865   $  791,541
                                           ==========   ==========

Future maturities of long-term debt at June 30, 2006 are as follows:

          2007                                           $  42,846
          2008                                              24,171
          2009                                              24,595
          2010                                             165,639
          2011                                             200,594
          Thereafter                                       341,020
                                                         ---------
                  Total long-term debt                   $ 798,865
                                                         =========

         (a) In September 2005, the Company  obtained  $200,000 from the City of
         Algona. The note requires quarterly payments of $5,000 starting January
         1, 2006,  with the final  payment  due  October  1,  2015.  There is no
         interest on this loan provided the Company creates and retains at least
         42 new full-time positions for five years. If such requirements are not
         met, interest on the loan will be payable at 10% per annum. The Company
         is accruing interest on this note until the terms of the note have been
         met. The loan is collateralized by land and building.

         (b) On June 27, 2005,  the Company  executed a note payable of $146,124
         from the Algona Area Economic  Development  Corporation in exchange for
         land received to be used for the construction of the new facility.  The
         loan is a  ten-year  partially  forgivable  loan with  interest  at 8%,
         conditioned upon the Company achieving performance targets as follows:

         o    $67,650 of principal  and interest will be forgiven if the Company
              has certified that it has created 50 new full-time equivalent jobs
              by June 1, 2010, and  continuously  retained those jobs in Algona,
              Iowa until June 1, 2015.

                                      -19-
<PAGE>

         o    $67,650 of principal  and interest will be forgiven if the Company
              has  certified  that it has created and  continuously  retained 50
              additional new full-time equivalent jobs by June 1, 2015.

         o    Balance of $10,824 due on June 1, 2015,  without  interest if paid
              by that date.

         o    Payment  of a wage  for the  retained  jobs  that is  equal  to or
              greater  than the  average  hourly  wage for  workers  in  Kossuth
              County, Iowa as determined annually by Iowa Workforce Development.

         The  Company is  accruing  interest on this note until the terms of the
         note have been met. The loan is secured by the real estate.

         (c) On  December  16,  2005,  the Company  assumed a no  interest  note
         provided by the Algona Area  Economic  Development  Corporation  in the
         amount  of  $117,500  in  conjunction  with  the  purchase  of land and
         building  as  described  in note 4. This note was  recorded at the fair
         value of future  payments  using an interest rate of 10% which amounted
         to  $70,401,  resulting  in a total  purchase  price  of the  land  and
         building of  $332,901.  This note is  secondary  and  subordinate  to a
         short-term  note held by a bank (Note 4). The note  requires  quarterly
         payments of $2,500 starting January 1, 2006, with the final payment due
         July 1,  2017.  The  Company  plans  to use  this  building  for  parts
         distribution and for distributed power generation manufacturing.

         (d) On June 28,  2005,  the Iowa  Department  of  Economic  Development
         ("IDED")  awarded  the  Company a  Physical  Infrastructure  Assistance
         Program  ("PIAP") grant in the amount of $150,000.  This is a five-year
         forgivable  loan and proceeds are to be used for the  construction  and
         equipping of the 30,000 square foot manufacturing facility. The Company
         received  payment of this award in  December  2005.  Other terms of the
         loan  include  a  minimum   contribution  of  $1,543,316  for  building
         construction,   machinery  and  equipment,   and  working  capital.  In
         addition,  the Company must create 49 full-time  equivalent  positions,
         with 38 positions at a starting wage exceeding  $11.76 per hour, and an
         average wage for all  positions of $24.94 per hour. In order to qualify
         for the job count,  employees  must be Iowa  residents.  The Company is
         required  to  maintain  the  minimum   employment   level  through  the
         thirteenth week after the project  completion date. If requirements are
         not met, the balance of the forgivable  loan  determined by IDED as due
         and  payable  will be  amortized  over three  years from the  agreement
         expiration  date of July 31, 2010,  at 6% interest per annum with equal
         quarterly  payments.  IDED  requires  mid-year and  end-of-year  status
         reports to ensure compliance.  The Company is accruing interest on this
         note until the terms of the note have been met.  The note is secured by
         a security agreement on the Company's assets.

         Also on June 28, 2005,  IDED  awarded the Company a Community  Economic
         Betterment Account ("CEBA")  forgivable loan in the amount of $250,000.
         This is a  three-year  forgivable  loan and proceeds are to be used for
         the construction of the plant.  The Company  received  $150,000 of this
         award in  December  2005.  The  balance  of the  award,  $100,000,  was
         received in January  2006.  The terms of this award are the same as the
         PIAP  award  explained  in  the  previous  paragraph.  At  the  project
         completion  date,  if the Company has fulfilled at least 50% of its job
         creation/retention  and wage  obligation,  $6,579 will be forgiven  for


                                      -20-
<PAGE>


         each new full-time  equivalent  job created and retained and maintained
         for at least ninety days past the project  completion date. The project
         completion date of this award is July 30, 2010. Any balance (shortfall)
         will be  amortized  over a two-year  period,  beginning  at the project
         completion  date  at 6% per  annum  from  the  date of the  first  CEBA
         disbursement on the shortfall amount with that amount accrued as of the
         project  completion  date,  being due and payable  immediately.  If the
         Company has a current loan balance,  the shortfall balance and existing
         balance  will be  combined  to reflect a single  monthly  payment.  The
         Company is  accruing  interest on this note until the terms of the note
         have been met.  The note is  secured  by a  security  agreement  on the
         Company's assets.

         (e) On March 20, 2006,  the Company  acquired  manufacturing  equipment
         through an equipment  financing  agreement  with Wells Fargo  Financial
         Leasing,  Inc.  The note  requires  payments of $2,129 per month for 24
         months. The equipment serves as collateral for the note.

6. OPERATING LEASES

The Company leases a building which is used for  production,  storage and office
space. The Company is responsible for insurance and repairs. This lease requires
monthly  rental  payments of $600 and expired on May 30,  2006.  The Company has
extended this lease for an additional  year. The lease requires monthly payments
of $650 per month from June 1, 2006,  through May 31, 2007.  The Company has the
option and plans to extend the lease an  additional  year to May 31,  2008,  for
$700 per  month.  Rent  expense  under  this lease was $1,850 and $1,800 for the
three months ending June 30, 2006 and 2005, $3,650 and $3,600 for the six months
ending June 30, 2006 and 2005,  and $22,850 for the period from  inception  (May
19, 2003) to June 30, 2006, respectively.

The following is a schedule of future lease obligations for the building at June
30:

           2006                     $     3,900
           2007                           8,150
           2008                           3,500
                                    -----------
                                    $    15,550


7. RELATED PARTY TRANSACTIONS

One of the  members of the  Company's  Board of  Directors  is the manager of an
engine  parts  distributor  from  which  the  Company  purchases  engine  parts.
Purchases from this company totaled $32,591 and $4,871 for the six months ending
June 30, 2006 and 2005,  respectively  and $78,961 for the period from inception
(May 19,  2003) to June 30,  2006.  The Company  also has a payable of $5,241 to
this company at June 30, 2006.

Another  member  of the  Board  of  Directors  was a senior  partner  in a parts
distribution  company prior to his employment with the Company.  The Company has
made  purchases  from this  company of  $230,710  and $24,634 for the six months


                                      -21-
<PAGE>

ended June 30,  2006 and 2005,  respectively  and  $304,501  for the period from
inception  (May 19,  2003) to June 30, 2006.  As of June 30, 2006,  $148,566 was
payable to this parts company.

8. INCOME TAXES

The tax effects of significant  items  comprising the Company's net deferred tax
asset and the related valuation  allowance as of June 30, 2006, and December 31,
2005, are as follows:

                                                     June 30,    December 31,
                                                      2006          2005
                                                  -----------    -----------
Deferred tax assets:
   Net operating loss carryforward                $ 1,225,000    $   480,000
   Deferred compensation                              174,000           --
   Accrual and reserve not currently deductible       176,000           --
                                                  -----------    -----------
                                                    1,575,000        480,000
Valuation allowance                                (1,575,000)      (480,000)
                                                  -----------    -----------

Net deferred tax asset recognized                 $      --      $      --
                                                  ===========    ===========

Due to the  Company's  operating  loss  and  lack  of  operating  experience,  a
valuation  allowance  was provided for the  Company's net deferred tax assets at
June 30, 2006, and December 31, 2005.

As of June 30, 2006, the Company has net operating loss carryforward for federal
and state income tax purposes of approximately  $3,060,000,  which will begin to
expire  in  2018.  The  amount  and  availability  of  the  net  operating  loss
carryforwards  may be subject to annual  limitations  set forth by the  Internal
Revenue Code.

The effective  tax rate differs from the statutory  rate of 34% primarily due to
state income tax rates and  merger-related  costs not being  deductible  for tax
purposes.

9. PREFERRED STOCK

The Company is authorized  to issue  10,000,000  shares of preferred  stock with
such designations, voting and other rights and preferences, as may be determined
from time to time by the Board of Directors.

10. COMMON STOCK

On September 1, 2005, the Company  issued 426,000 shares of restricted  stock to
directors and employees.  122,000 shares vested immediately,  86,000 shares vest
September 1, 2006,  86,000  shares vest  September 1, 2007,  66,000  shares vest
September 1, 2008, and 66,000 shares vest September 1, 2009. All unvested shares
of restricted  stock are subject to a risk of forfeiture upon termination of the
participant's service as a full-time consultant or employee prior to vesting.

During  September 2005, the Company issued 3,948,500 shares in connection with a
private offering.

                                      -22-
<PAGE>

Unsecured  convertible long-term debt payable to a stockholder and various other
parties  totaling  $557,051 was  converted to 663,401  shares of common stock on
November 15, 2005, thus satisfying the debt requirements.

On May 22, 2006, the Company  announced the intention to offer up to 1.5 million
shares of its  unregistered  common stock to accredited  investors and qualified
institutional  buyers in a private  placement.  The Company also  announced  its
intention  to offer,  subject  to market  conditions  and other  factors,  $35.5
million in aggregate  principal  amount of 8% Senior Series 2006 Corporate Notes
due 2010 to accredited investors and qualified  institutional buyers. On June 6,
2006,  the  Board of  Directors  voted to  increase  the  number of shares to be
included in the private  placement to 3 million  shares.  At June 30, 2006,  the
Company had sold  290,192  shares at prices  ranging  from $9.04 to $10.65.  The
Company,  at June 30, 2006, had received  $2,923,134 from the private placement,
which is currently ongoing. The Company has accrued placement fees in the amount
of $125,832 and will incur  additional  fees,  and will likely issue warrants in
connection with the raising of additional  funding through the private placement
of its securities.

At  June  30,  2006,  of  the  25,456,097  outstanding  shares,  23,713,397  are
restricted.  During  September  2006 shares issued in connection  with the first
private  offering  will  become  tradable  under  Rule 144, subject  to  certain
restrictions for shares held by affiliates of the company.

11. WARRANTS

In August 2005, the Company issued  warrants to purchase up to a total of 69,640
shares,  for services rendered in connection with the private offering of stock.
These are  warrants to purchase  Company  stock,  for $1 per share for the first
three years, and $1.50 for years four and five. The warrants expire on the fifth
anniversary date from issuance.

The  Company  has agreed to issue  warrants  to certain  finders in the  private
placement  now  underway as  described  in Note 10. At June 30,  2006,  warrants
associated  with the  current  private  placement  had not been  granted  as the
private placement had not been closed.

12. STOCK-BASED COMPENSATION

On September 1, 2005, the Company adopted an Incentive Compensation Plan for the
purpose of encouraging key officers, directors, employees and consultants of the
Company to remain with the Company and devote their best efforts to the business
of the Company.  Under the Company's  Incentive  Compensation Plan incentive and
nonqualified stock options may be granted to eligible participants. The purchase
price of shares  under each stock  option  award is  recorded at the fair market
value on the date the award is made.  Incentive and  nonqualified  stock options
are  generally  granted  for a term of ten  years.  Incentive  and  nonqualified
options  granted under the Plan generally  vest under one of two schedules.  The
options can vest as to 20% immediately and 20% each year thereafter, or they may
be issued to vest as to 25% after the first  year of  service  and 25% each year
thereafter.  Stock-option vesting is contingent upon employment with the Company
at the  vesting  date.  The  Company  also  issues  restricted  stock  under the


                                      -23-
<PAGE>

Incentive  Compensation  Plan.  Restricted  stock awards made under this program
generally vest as to 20% - 50% immediately  and 20% - 50% each year  thereafter.
Restricted  stock is also  contingent  upon  employment  with the Company at the
vesting  date.  The aggregate  number of shares  authorized  for employee  stock
options, nonemployee stock options and restricted stock awards are 2,000,000. At
June 30, 2006 there were 700,334 shares available for grant and 1,299,666 shares
issued. Of the shares issued 426,000 were granted as restricted  stock,  201,666
were granted as  nonemployee  stock options and 672,000 were granted as employee
stock  options.  The Company issues new shares to employees upon the exercise of
an option from the shares authorized for employee stock-options.

The Company has determined,  based on the Black-Scholes  option pricing formula,
the  weighted-average  fair value of stock options granted for the quarter ended
June 30, 2006, was $6.17 per share,  using a risk-free  interest rate of 4.37% -
5.08%, expected life of 5.5 years, 1.5% forfeiture rate, zero expected dividends
and estimated volatility of 115%.

The volatility  calculation of 115% is based on the average reported  volatility
and vesting period of a representative  sample of eight comparable  companies in
the alternative fuel technology and services niches with market  capitalizations
between $45 million and $1.5 billion  ("Representative  Sample"), in addition to
the Company's actual history over an ten-month  period.  Because the Company has
only a short  trading  history,  the Company has been  required to estimate  the
potential  volatility of its common stock price. The Company has referred to the
average  reported  volatility of the  Representative  Sample because  management
believes  that the  volatility  of these  companies,  along  with the  Company's
history, is a reasonable  benchmark to use in estimating the expected volatility
for the Company's common stock over the expected life of the option.

The following table presents the  weighted-average  assumptions used to estimate
the fair values of the stock options granted to employees and  non-employees  in
the periods presented:

<TABLE>
<CAPTION>

                                                                                       Period from
                                                                                        Inception
                                            Three Months Ended   Six Months Ended   (May 19, 2003) to
                                               June 30, 2006      June 30, 2006       June 30, 2006
                                               -------------      -------------       -------------

<S>                                            <C>                <C>                 <C>
Risk-free interest rate                        4.37% - 4.55%      4.37% - 4.55%       3.81% - 4.55%
Expected volatility                               115%             112% -  115%        112% -  190%
Expected life (in years)                            5.5                5.5              5.5 - 10.0
Dividend yield                                       -                   -                  -
Weighted-average estimated fair value of
options granted during the period                 $ 7.73              $ 6.16              $ 2.52
Range of fair value of options granted
during the period                            $6.51 - $ 8.67      $4.39 - $ 8.67     $1.00 - $ 8.67
</TABLE>

The  Company  did not have any  stock-based  compensation  for the three and six
months ended June 30, 2005.

The  following  table  summarizes  the  activity  for  outstanding  employee and
nonemployee stock options for the six months ended June 30, 2006:

                                      -24-
<PAGE>

<TABLE>
<CAPTION>

                                                                      Options Outstanding
                                           ---------------------------------------------------------------------------


                                                                                 Weighted-Average
                                                                                    Remaining
                                                                                   Contractual          Aggregate
                                             Number of        Weighted Average        Term           Intrinsic Value
                                               Shares         Exercise Price        (in years)               (1)
                                           ---------------    ----------------    --------------    -----------------

<S>                                               <C>              <C>            <C>               <C>
Balance at December 31, 2005                   854,000             $ 1.34
      Granted                                  198,000             $ 7.35
      Exercised                                 (8,000)            $ 1.00
      Canceled/forfeited/expired (2)          (178,334)            $ 1.00
                                           ---------------    ----------------
Balance at June 30, 2006                       865,666             $ 2.79                9.3        $10,007,099
                                           ===============    ================
   Vested and exercisable as
      of June 30, 2006                         277,666             $ 2.12                9.3        $ 3,395,855
   Vested and expected to vest as
      of June 30, 2006                         830,818             $ 2.79                9.3        $ 9,604,256
</TABLE>

(1)      The aggregate  intrinsic value is calculated as the difference  between
         the exercise price of the underlying awards and the closing stock price
         of $14.35 of the Company's common stock on June 30, 2006.
(2)      During  the  three  months  and six  months  ending  June 30,  2006 the
         Company   discontinued   services   with   non   employees/consultants,
         resulting in forfeitures of stock awards totalling 178,334.

The Company received $5,000 and $8,000 from exercised employee stock options for
the three months and six months ended June 30, 2006, respectively. The aggregate
intrinsic value of all options  exercised  during the three and six months ended
June 30, 2006,  respectively was $30,000 and $66,000.  The total grant date fair
value of stock  options  vested  during the three and six months  ended June 30,
2006, respectively was $380,366 and $384,666.

As of June 30, 2006,  there was  $2,072,590 of  unrecognized  compensation  cost
related to outstanding stock options, net of forecasted forfeitures. This amount
is expected to be recognized over a weighted average period of 3.4 years. To the
extent the forfeiture  rate is different than we have  anticipated,  stock-based
compensation related to these awards will be different from our expectations.

The following table  summarizes the activity for our unvested  restricted  stock
units for the six months ended June 30, 2006:

                                                Unvested Restricted Stock
                                                               Weighted-Average
                                          Number of               Grant-Date
                                            Shares                Fair Value
                                         -----------           ----------------

Unvested at December 31, 2005              275,332                  $1.00
          Vested                           (43,000)                 $1.00
                                         -----------             ----------
Unvested at June 30, 2006                  232,332                  $1.00
                                         ===========             ==========

                                      -25-
<PAGE>

         As of June 30, 2006,  there was $232,332 of  unrecognized  compensation
cost related to unvested  stock units.  This amount is expected to be recognized
over a weighted  average  period of 3.0 years.  To the extent actual  forfeiture
rate is different  than we have  anticipated,  the numbers of  restricted  stock
units expected to vest would be different from our expectations.

The  following  table  summarizes  additional  information  about stock  options
outstanding and exercisable as of June 30, 2006:

<TABLE>
<CAPTION>
                             Options Outstanding                                  Options Exercisable
          ----------------------------------------------------------         -----------------------------
                                      Weighted-Average     Weighted-
                                         Remaining         Average                                Weighted-
                        Options          Contractual        Exercise            Shares            Average
  Exercise Price      Outstanding           Life              Price          Exercisable       Exercise Price
  --------------     ------------     ----------------     ---------         -----------       --------------
<S>                       <C>                 <C>             <C>             <C>                 <C>
      $1.00               607,666             9.2             $1.00           235,666             $1.00
      $5.38                71,000             9.5             $5.38              --               $5.38
      $5.88                60,000             9.5             $5.88            12,000             $5.88
      $7.25                10,000             9.8             $7.25              --               $7.25
      $7.65                50,000             9.6             $7.65            10,000             $7.65
      $7.70                27,000             9.9             $7.70              --               $7.70
     $10.25                40,000             9.9            $10.25            20,000            $10.25
                         --------                                             -------

                          865,666             9.3             $2.79           277,666             $2.12
                         ========                                             =======
</TABLE>

13. COMMITMENTS AND CONTINGENCIES

Engine Certification
--------------------

The  Company  plans to begin the  certification  of the 4.9 liter  engine in the
first  quarter of 2007.  To certify an engine to meet  regulations  for  exhaust
emissions,  an engine must successfully pass stringent  third-party testing. The
Company  anticipates the cost of the testing to be approximately  $1,000,000 per
engine. The Company expects to begin the certification process for the 7.5 liter
engine and the 2.45 liter engine in 2007.

Although  engine  certification  is necessary for the Company to sell engines to
original  equipment  manufacturers,  certification is not necessary for existing
equipment applications.

                                      -26-
<PAGE>

Product Performance - Warranty
------------------------------

Estimated  warranty costs and additional  service actions will be accrued at the
time an  engine is sold to a  distributor  or  end-user  customer.  Included  in
warranty  cost  accruals  will be costs for basic  warranty  coverage on engines
sold. The Company has not accrued  warranty costs at June 30, 2006, and December
31,  2005,  because of its limited  history  and the limited  number of sales to
date.

Component Parts Procurement
---------------------------

At June 30, 2006, the Company had issued  approximately $2.5 million in purchase
orders to several  vendors  for  inventory  to support the engine  build.  These
purchase orders have been issued with product  delivery dates through the end of
2006.

The  Company  has set up an  allowance  for  losses on  non-cancelable  purchase
orders.   The  estimated  losses  result  from   anticipated   future  sales  of
remanufactured  engines  for  sales  prices  less  that  the  estimated  cost to
manufacture.  Inventory  purchase  commitment  losses  at June  30,  2006,  were
$336,257.  The Company  engaged in the production of  remanufactured  engines as
part of the training,  testing and other steps necessary for the commencement of
operations.

Recruiting Contract
-------------------

On April 4, 2006,  the Company  engaged a staffing  specialist  to assist in the
Company's  recruitment  efforts.  The  Company  will  pay a fee  of  20%  of the
candidate's first year's annual salary upon successful placement.

14. SUBSEQUENT EVENTS

Website Redesign Agreement
--------------------------

On July 7, 2006,  the  Company  engaged a website  design  firm to assist in the
redesign of the Company's  website.  Phase I of the redesign is  anticipated  to
cost approximately $24,000 and is anticipated to be completed in October 2006.

Recruiting Contract
-------------------

On July 21, 2006, the Company  engaged another  staffing  specialist to fill two
senior executive positions. The Company will pay a fee of 25% of the candidate's
starting base salary upon successful placement.

Private Placement
-----------------

The  Company  continues  to pursue  additional  financing  through  the  private
placement of its  securities to accredited  investors.  As part of this process,
the  board of  directors  met on August  1,  2006,  to  consider  a  variety  of
mechanisms,  including the placement of convertible preferred shares.  Currently
the Board has authorized the offering of both common and  convertible  preferred


                                      -27-
<PAGE>

shares at a recommended  offering price of $7.00, is having  discussions  with a
number of potential institutional  investors,  and is continually evaluating the
offering price of its securities in this private  placement.  The Board has made
the  decision  that prior  investors  in this  private  placement  will have the
benefit of any final  reduction  in price and has  authorized  the  issuance  of
additional shares to the extent required to provide that benefit.









                                      -28-
<PAGE>

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

Going Concern

            Our  accompanying   consolidated   financial  statements  have  been
prepared on a going  concern  basis,  which  contemplates  our  continuation  of
operations, realization of assets and liquidation of liabilities in the ordinary
course of business.  Since  inception,  we have incurred  substantial  operating
losses and expect to incur  additional  operating  losses over the next  several
months. As of June 30, 2006, we had an accumulated deficit of approximately $4.3
million.  Our accompanying  financial  statements do not include any adjustments
that might result from the outcome of this uncertainty.

            We have financed our operations  since inception  primarily  through
equity  and  debt  financings  and  loans  from  our  officers,   directors  and
stockholders.  Continuing our  operations is dependent  upon  obtaining  further
financing in the third quarter of 2006.  Although we intend to raise  additional
funds in the current private  placement,  there can be no assurance that we will
successfully  complete this offering or that the proceeds of the offering  would
be  sufficient  to satisfy  our capital  requirements.  These  conditions  raise
substantial doubt about our ability to continue as a going concern.

         THE FOLLOWING  DISCUSSION  AND ANALYSIS  SHOULD BE READ IN  CONJUNCTION
WITH THE OTHER FINANCIAL  INFORMATION AND CONSOLIDATED  FINANCIAL STATEMENTS AND
RELATED NOTES APPEARING IN THIS FORM 10-QSB.  THIS DISCUSSION  CONTAINS  FORWARD
LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS WILL
DEPEND UPON A NUMBER OF FACTORS  BEYOND OUR CONTROL AND COULD DIFFER  MATERIALLY
FROM THOSE ANTICIPATED IN THE FORWARD LOOKING STATEMENTS.  SOME OF THESE FACTORS
ARE DISCUSSED UNDER "RISK FACTORS" AND ELSEWHERE IN THIS FORM 10-QSB.

Merger

         On August 30, 2005,  Hydrogen Engine Center,  Inc, an Iowa  corporation
("HEC Iowa") merged with our newly formed subsidiary (the "Merger").  The Merger
was made  pursuant  to an  agreement  entered  into on June 3, 2005,  whereby we
agreed  to  merge  our  newly  created,   wholly-owned  subsidiary,   Green  Mt.
Acquisitions,  Inc.,  with and into HEC Iowa,  with HEC Iowa being the surviving
entity.  Following the Merger,  we changed our name from Green Mt. Labs, Inc. to
Hydrogen Engine Center, Inc.

         On July 6, 2005, we revised  certain terms of the proposed  Merger and,
accordingly,  executed a revised and amended  agreement  and plan of merger.  On
July 29,  2005,  we added an addendum to the  agreement.  The revised  agreement
provided  for  effecting  a 3.8 shares for 1 share  forward  stock  split of our
issued and  outstanding  common stock,  instead of the previously  announced 1.5
shares for 1 share split. The split was payable August 17, 2005, to stockholders
of record on August 16, 2005.  As a result of the revised  forward  stock split,
our  outstanding  shares of common  stock  increased  from  1,006,000  shares to
approximately 3,822,804 shares, representing 19% of the total outstanding shares


                                      -29-
<PAGE>

following  consummation of the Merger.  Under the terms of the merger agreement,
we issued 16,297,200 shares of post-split common stock  (representing 81% of our
total  outstanding  shares  (post-split)   following  the  transaction)  to  Ted
Hollinger, who was prior to the Merger HEC Iowa's sole stockholder,  in exchange
for 100% of HEC Iowa's then  outstanding  capital stock, and HEC Iowa has become
our wholly-owned subsidiary.  In connection with the Merger, we changed our name
to Hydrogen Engine Center, Inc.

         We are a development stage company.  Since inception,  we have incurred
substantial  operating  losses and expect to incur  additional  operating losses
over the next several months. As of June 30, 2006, we had an accumulated deficit
of approximately  $4.3 million.  We have financed our operations since inception
primarily  through  private  equity  and  debt  financings  and  loans  from our
officers,  directors and stockholders,  including two private  placements of our
Common stock. On October 11, 2005, we closed the first such private placement of
our common stock ("First  Private  Offering").  We sold 3,948,500  shares of our
common stock,  $.001 par value, at $1.00 per share, for a total of $3,948,500 to
93  investors,  which  represents  15.51%  of  the  now  25,456,097  issued  and
outstanding shares of common stock. As of August 1, 2006, we have issued 290,192
shares of common  stock in our  Second  Private  Offering  of our  common  stock
("Second  Private  Offering")  at  $9.04 to  $10.65  per  share,  for a total of
$2,794,399 to 39 investors,  which represents 1.14% of the now 25,456,097 issued
and outstanding common stock. The Second Private Offering is ongoing. The shares
in both  private  placements  were  sold in  reliance  upon  an  exemption  from
registration  pursuant to  Regulation  D, Rules  Governing the Limited Offer and
Sale of Securities without Registration under the Securities Act of 1933.

         The accompanying  consolidated  balance sheets as of June 30, 2006, and
December  31,  2005,   and  the   consolidated   statements  of  operations  and
consolidated  statements  of cash flows for the three months ended June 30, 2006
and 2005,  the six months ended June 30, 2006 and 2005,  and from inception (May
19, 2003) to June 30, 2006,  consolidate the historical  financial statements of
the company  with HEC Iowa after  giving  effect to the Merger where HEC Iowa is
the accounting acquirer and after giving effect to the Private Offerings.

Overview

         As a result of the  Merger,  we own all of the issued  and  outstanding
shares of HEC Iowa and all of the  issued  and  outstanding  shares of  Hydrogen
Engine Center (HEC) Canada, Inc. ("HEC Canada"). HEC Iowa is a development stage
company engaged in design,  manufacture and  distribution of flex-fuel  internal
combustion engines for the industrial and power generation markets.  The engines
run efficiently, with minor adjustments, on hydrogen, gasoline, propane, natural
gas or ethanol  interchangeably  ("flex-fuels").  The engines can run on regular
grade  hydrogen,  or on mixed gases such as natural gas and  hydrogen.  HEC Iowa
expects to file core technology patents covering the use of hydrogen fuel in any
internal combustion engine with zero or near zero emissions.

         The Company has funded its operations  from inception  through June 30,
2006,  through a series of financing  transactions,  including an  investment of
$151,487 by Ted  Hollinger;  $3,948,500 in gross proceeds from the First Private
Offering,  $2,923,133 from the Second Private Offering, and convertible loans in
the amount of $557,051.

                                      -30-
<PAGE>

Results of Operations

         Historical information prior to the Merger is that of HEC Iowa.

         Because  we are still  developing  our  flex-fuel  internal  combustion
engines and related  products,  and just  completed our  manufacturing  facility
during first quarter 2006,  we have not realized  significant  revenues to date.
During the three months ended June 30, 2006,  we realized  $47,119 from the sale
of  twenty-nine  (29) 4.9L  remanufactured  gasoline  engines.  During the three
months  ended  June  30,  2005,  we  realized   $1,600  from  the  sale  of  one
remanufactured 4.9L naturally  aspirated gasoline engine.  During the six months
ended June 30, 2006, we realized $75,709 from the sale of thirty-three (33) 4.9L
remanufactured  gasoline  engines and one 6.8L hydrogen  engine.  During the six
months  ended June 30, 2005,  we realized  $13,600 from the sale of one hydrogen
generator and one 4.9L naturally  aspirated gasoline engine.  Since inception we
have realized total sales of $119,269.  We also have received  progress payments
of $19,600  for a 50KW  hydrogen  generator  project  and  progress  payments of
$107,172  from a 250KW "4+1"  hydrogen  generator  project.  These  receipts are
recorded as unearned revenue in our financial statements.

We are continuing our efforts toward  commencement of full operations.  Based on
the current  scheduled  shipment of parts,  including  shipment of blocks  being
produced by a supplier abroad,  we expect to produce 200 Oxx Power 4.9 L engines
in September and 600 in October.  We expect to reach full production of our 4.9L
engines  during fourth  quarter 2006.  Our  anticipated  sales have been delayed
because of a delay in receiving  parts  necessary for  production of our new Oxx
Power engines.  Management believes that we may begin to realize increased sales
revenues  by the  fourth  quarter of 2006,  subject  to timely  receipt of parts
ordered  from  suppliers  and our  ability  to market  the  engines we expect to
produce.

         The  manufacturing  portion of our new  building was  completed  during
first quarter 2006.  The  dynamometer  room will be completed  during the fourth
quarter  2006 and has just  recently  been  approved for limited use by the Iowa
State Fire Marshall. We will receive authorization to fully occupy the dyno room
once the installation of the dynos,  test equipment and sensors are complete and
we have  passed the State Fire  Marshall's  final  inspection.  The  sensors are
necessary to use the  dynamometer to test engines  running on either natural gas
or hydrogen.  We continue the process of hiring new personnel and purchasing the
inventory of parts we need to manufacture engines in our new building.

         Sales and marketing expenses for the three months and six months ending
June 30, 2006,  were  $172,200 and  $412,488.  There were no sales and marketing
expenses for the three months and six months ended June 30, 2005. There has been
a total of $534,062 in sales and marketing  costs for the period from  inception
(May 19,  2003) to June 30,  2006.  The  increase in sales and  marketing  costs
recognized  over the past six months has been  primarily  due to an  increase in
sales staff and an increase in costs for marketing our products.  We expect this
number to increase  significantly  during the  remainder  of 2006 and 2007 as we
pursue national and international sales opportunities.

                                      -31-
<PAGE>

         We have incurred a total of  $2,377,234  in general and  administrative
expenses for the period from inception (May 19, 2003) to June 30, 2006.  General
and  administrative  expenses were $965,762 and  $1,573,731 for the three months
and six months  ended June 30,  2006,  and  $66,603 and  $106,153  for the three
months and six months ended June 30, 2005. Management expects similar or greater
increases for the year ending  December 31, 2006, in general and  administrative
expenses due to the  anticipated  hiring of  additional  personnel,  purchase of
production supplies, costs related to the new facility and other efforts related
to the commencement and expansion of our operations.

         Research and development costs were $421,100 and $504,752 for the three
months and six months ended June 30, 2006,  and $8,068 and $17,781 for the three
months  and six  months  ended June 30,  2005.  The  increase  in  research  and
development costs has been a direct result of increased new product development.
We also  expensed  to  research  and  development  mould  fees in the  amount of
$103,300 for which we could not retain title.  Management  expects  research and
development  costs to continue to increase during the remainder of 2006 and into
2007.  We have incurred  $958,464 in costs  related to research and  development
since inception.

         We reported a net loss of  $2,024,667  for the three  months ended June
30, 2006,  compared to a net loss of $81,194 for the three months ended June 30,
2005.  We reported a net loss of  $2,943,124  for the six months  ended June 30,
2006, compared to a net loss of $127,784 for the six months ended June 30, 2005.
We reported a net loss of $4,323,812  from inception (May 19, 2003) through June
30,  2006.  We expect to continue to operate at a net loss until such time as we
can complete  development of our initial  engines,  reach full production in our
facilities, and begin to realize a substantial increase in sales.

         We have also recorded a current  liability for  approximately  $335,000
for non-cancelable purchase orders. The estimated losses result from future sale
of  remanufactured  engines  for sales  prices less than the  estimated  cost to
manufacture.  The assembly of  remanufactured  engines is planned as part of the
training,  testing and other steps necessary for the commencement of operations.
As of August 8, 2006, we have received a limited  number of the component  parts
necessary to begin manufacturing of our new 4.9L Oxx Power engines. We expect to
continue the transition from production of remanufactured  engines to production
of our new 4.9L Oxx Power  engines as larger  numbers of these  component  parts
arrive.

Critical Accounting Policies

         Our  discussion  and analysis of our financial  position and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting  principles  generally accepted
in the United States of America. The preparation of these condensed consolidated
financial  statements  requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities, and the disclosure of contingent
assets  and  liabilities  at the date of the  condensed  consolidated  financial
statements and the reported revenues and expenses during the period.

                                      -32-
<PAGE>

Merger and Stock-based Compensation
-----------------------------------

         We consider certain accounting policies related to the recapitalization
of the  Company and  stock-based  compensation  to be  critical to our  business
operations and the understanding of our results of operations.

Liquidity and Capital Resources

Short-Term and Long-Term Debt Sources
-------------------------------------

         From inception  through June 30, 2006, we have used  $3,139,320 in cash
in our operating activities and $2,674,483 in capital expenditures. Cash for our
operations came from various  financing  transactions,  including  $3,948,500 in
gross  proceeds from the First Private  Offering,  $2,923,134 in gross  proceeds
from the  Second  Private  Offering,  and  convertible  loans in the  amount  of
$557,051. We also received $400,000 in forgivable loans from the Iowa Department
of Economic  Development,  $200,000 from the City of Algona  revolving loan fund
and $1,172,052 from bank financing.  We incurred expenses in connection with the
private  placements of $479,444.  Our aggregated net loss from inception through
June 30, 2006, was $4,323,812.  Our cumulative net loss has resulted principally
from  expenditures  related  to  research  and  development,   as  well  as  the
commencement of operations.

         We have available credit with Iowa State Bank, secured by a mortgage on
Lot 1 of Snap-on Industrial Park in Algona, and represented by a promissory note
in the maximum amount of $575,000.  As of June 30, 2006, $495,337 has been drawn
on the note. The note carries interest at the annual rate of 5.890%. Interest is
payable  monthly and the note will mature on December  16, 2006.  We  anticipate
that this note will be rolled over into permanent  financing upon maturity,  but
cannot provide assurance that such financing will be available. On July 18, 2006
we secured an additional note from Iowa State Bank for $75,000.  This additional
note matures on December 16, 2006, and bears interest at the rate of 6.49%. This
second note is also secured by the mortgage on Lot 1 of Snap-on  Industrial Park
in Algona.

         On April 4, 2006,  we secured a mortgage  with  Farmers  State Bank for
$600,000 at an annual  adjustable  rate of 6.0%.  The mortgage is secured by the
generator manufacturing and distribution building located adjacent from the main
production facility.

         At June 30, 2006, we had cash on hand of $2,551,230,  and $2,346,248 at
December 31, 2005.

         Inventories  increased  from $206,091 at December 31, 2005, to $849,913
at June 30, 2006, due to the purchase of engines and parts.

         Our accounts  payable  increased from $236,341 at December 31, 2005, to
$623,278 on June 30,  2006,  primarily  because of  inventory  and supply  costs
associated with the start up.

         We had  accrued  expenses of  $131,703  at June 30,  2006,  compared to
$69,768 at December 31, 2005.

         We recorded an accrual for purchase commitment loss of $336,257 at June
30, 2006. There was no purchase commitment loss at June 30, 2005.

                                      -33-
<PAGE>

         At June 30, 2006, we had current assets of $3,632,316 and stockholders'
equity of  $3,542,451,  compared  to current  assets of  $2,763,214  and total a
stockholders' equity of $3,204,533 at December 31, 2005.

Plan of Operation
-----------------

         We anticipate that our expenses will continue to increase significantly
as we work toward  full  operations,  including  additional  personnel,  product
development,   inventory   purchases,   and  construction  costs.   Accordingly,
management believes that current cash on hand will only be sufficient to satisfy
our cash  requirements  through  September  2006.  We will be  required to raise
significant  amounts of additional capital resources during the third quarter of
2006. We anticipate  that a significant  increase in sales of our products could
commence  during the fourth quarter of 2006,  subject to timely receipt of parts
ordered from suppliers, which may add to cash reserves.  Additional cash will be
needed to sustain  operations,  or if management  determines  to accelerate  the
expansion of our operations.  We intend to seek additional funds through private
or public sources and/or the sale of securities.  We anticipate  offering shares
of our Common  Stock,  Preferred  Stock,  and/or  debt  securities  in a private
placement during fiscal year 2006. There is no assurance that we will be able to
raise the necessary capital from such an offering,  that funds will be available
from any other source,  or, that even if they are  available,  that they will be
available on terms that will be acceptable to us.

         We are a  development  stage  enterprise  and, as such,  our  continued
existence  is  dependent  upon our  ability to resolve our  liquidity  problems,
principally by obtaining  additional  debt or equity  financing.  We have yet to
generate  a  positive  internal  cash flow,  and until  meaningful  sales of our
products begin, we are totally dependent upon debt and equity funding.

         In the event that we are unable to obtain debt or equity  financing  or
we are unable to obtain financing on terms and conditions that are acceptable to
us, we may have to cease or severely curtail our operations. These factors raise
substantial  doubt about our ability to continue as a going concern.  So far, we
have been able to raise the  capital  necessary  to reach  this stage of product
development and have been able to obtain funding for operating  requirements and
for construction of our manufacturing facilities,  but there can be no assurance
that we will be able to continue to do so.

         We  anticipate  that we can produce  10,000  base 4.9L  engines at full
capacity,  in our 30,000 square foot manufacturing  facility and expect to be at
full capacity during fourth quarter 2006 or first quarter 2007.  Initial contact
with our distributor  network has given us indications  that we may not have the
capacity to meet potential  demands.  We anticipate that if we are successful in
obtaining  funds  through  private or public  sources,  we plan to  explore  the
expansion of our present  facilities.  An expansion will be necessary to provide
needed  space for the  assembly of our 7.5L  engines and our 2.45L  (3-cylinder)


                                      -34-
<PAGE>

engines.  We anticipate the cost for an expansion of our production  facilities,
including equipment, to be approximately $2.5 million. We also expect during the
next 24 months to add administrative  facilities for an approximate cost of $1.5
million,  an expansion of our  generator  building  for an  approximate  cost of
$500,000,  and  possibly a research  facility  for an  approximate  cost of $1.6
million.  We anticipate our capital  expenditures for 2006 will be approximately
$6.2 million, subject to sufficient capital from anticipated financing.

         On  June  12,  2006,  we  completed  validation  of the  form,  fit and
durability  of our first Oxx  Power  4.9L  engine  by  running  the  engine on a
dynamometer,  using propane as a fuel, for a minimum of three hundred hours.  In
addition to the  durability  testing,  we plan to hot test each  individual  Oxx
Power engine for  approximately  sixty minutes prior to shipment.  We anticipate
the warranty on our 4.9L engines will be 3 years or 3,000 hours, whichever comes
first. We expect that durability testing for emission certification will involve
a minimum of 5,000 hours.  We expect that the  validation  process for our other
engines will be substantially the same.

         On August 8, 2006, we received fifteen (15) new Oxx Power blocks. These
blocks will be used to build the first Oxx Power 4.9L  engines.  In August,  our
sales  and  marketing   department   will  present  to  each  of  our  ten  (10)
distributors,  a new 4.9L Oxx Power engine.  The remaining  five engines will be
used by  engineering  for  additional  durability  testing.  We are  also in the
process  of  developing  service  and  warranty  manuals  for the 4.9L Oxx Power
engine.  Our ISO 9000  implementation  is ongoing  and we are in the  process of
completing drawings and documenting the specifications for quality testing.

         Our  distributors  will not be able to offer  our  engines  for sale to
original equipment  manufacturers for mobile applications until the engines have
passed  U.S.  Emissions  Regulations  which  are  defined  and  enforced  by the
Environmental Protection Agency and California Air Resources Board. Stand-by and
replacement  engines  are not  subject  to  these  requirements.  We  anticipate
beginning  the emissions  certification  process of our 4.9L engine in the first
quarter of 2007. It will cost approximately $1,000,000 to certify each engine in
our product line. We also anticipate beginning the certification process for our
7.5L and 2.45L  engines in 2007.  This testing  procedure  will be an expense of
research and development.  We anticipate that our research and development costs
could be approximately  $5.7 million (including $1.6 million in expenditures for
additional  facilities) in 2006,  subject to sufficient capital from anticipated
financing.

         We are dependent on a small number of vendors to supply the  components
for our  4.9L  engines.  As of June  30,  2006,  we had  total  purchase  orders
outstanding of approximately $2.5 million. In July we established a relationship
with a supplier abroad for production of the blocks used in our 4.9L engines and
as of August 3, 2006, have  outstanding  purchase orders totaling  approximately
$410,000 to this supplier and expect to issue approximately  $625,000 additional
purchase orders to this supplier  during the remainder of 2006.  Although we are
in the  process  of lining up second  and third  sources  for these  components,
production  flow of the 4.9L  engine is  dependent  upon  timely  receipt of the
blocks from this supplier as well as timely receipt of the other components from
a few other  suppliers.  As of August 3, 2006, we have issued  blanket  purchase
orders totaling  approximately $1 million to a second vendor for the purchase of
various component parts and expect to issue approximately


                                      -35-
<PAGE>

$160,000  additional  purchase  orders to this supplier  during the remainder of
2006.  As of August 3, 2006, we have issued  blanket  purchase  orders  totaling
approximately  $470,000  to a third  vendor for the  purchase  of other  various
component parts and expect to issue  approximately  $590,000 additional purchase
orders to this supplier during the remainder of 2006. Although we expect product
flow and  production  of the new 4.9L  engines to begin during  fourth  quarter,
further delivery delays from our suppliers would further delay sales of new 4.9L
engines to our distributor  network and our ability to generate revenue. We have
experienced  significant  delays in this  process  to date.  Although  we expect
product  flow and  production  of the new 4.9L  engines to begin  during  fourth
quarter, further delays are possible.

         We are expanding our search for vendors who can  manufacture  component
parts to our  specifications.  We anticipate having other sources for our engine
parts by the end of 2006.

         Although  we have not begun full  production  of our new 4.9L Oxx Power
engines,  we have begun  production of approximately  1,200 4.9L  remanufactured
engines.  We expect that  production of  remanufactured  engines will end in the
fourth quarter of 2006.  Our  distributor  network sells  primarily new engines.
Therefore, we expect to offer the remanufactured engines direct to the end-user.
Because the remanufacturing of engines is a very competitive  business,  we have
recorded a write-down  of inventory of  approximately  $110,000 this quarter and
have  recorded an allowance  for  purchase  commitment  losses of  approximately
$335,000 for  outstanding  purchase  orders.  We  undertook  the  production  of
remanufactured  engines as part of the process of preparing for the commencement
of our operations as a manufacturer of new Oxx Power engines.  The production of
these  engines  has been part of our  workforce  training,  the  development  of
service and warranty manuals and assembly procedures,  and the implementation of
ISO 9000 quality procedures.

Employees
---------

         We had 25  employees  as of June 30,  2006.  We  expect  to have  30-35
employees  on or about  October 1,  2006,  in  anticipation  of  achieving  full
production of our 4.9L engines in our new production  facilities in Algona, Iowa
during the fourth quarter 2006.

Net Operating Loss
------------------

         We have  accumulated  approximately  $3.1 million of net operating loss
carryforwards  as of June 30, 2006,  which may be offset against  taxable income
and  income  taxes in future  years.  The use of these  losses to reduce  future
income taxes will depend on the generation of sufficient taxable income prior to
the expiration of the net operating loss  carryforwards.  The carryforwards will
begin to  expire  in the year  2018.  The  amount  and  availability  of the net
operating loss  carryforwards may be subject to annual  limitations set forth by
the  Internal  Revenue  Code.  Factors  such as the number of shares  ultimately
issued within a three-year look-back period; whether there is a deemed more than
50 percent  change in control;  the  applicable  long-term tax exempt bond rate;
continuity  of historical  business;  and  subsequent  income of the Company all
enter  into the  annual  computation  of  allowable  annual  utilization  of the
carryforwards.

                                      -36-
<PAGE>


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         We are  exposed to the risk of loss  arising  from  adverse  changes in
foreign exchange rates and interest rates to a limited degree.

Foreign Exchange Risk

         We are  subject  to  foreign  currency  exchange  rate  risk  from  the
operations  of HEC Canada,  our Canadian  subsidiary.  Based on the size of this
subsidiary and our corresponding exposure to changes in the Canadian/U.S. dollar
exchange  rate,  we do not  consider  our market  exposure  relating to currency
exchange to be material at this time.

Interest Rate Risk

         We are exposed to interest  rate risk  primarily on long-term  debt. As
more fully  described  below and in our  discussion  of  liquidity  and  capital
resources  above in Item 2, we have the risk of  increased  interest on two bank
notes in the  aggregate  amount of $1.2  million.  Also as more fully  described
below and in our discussion of liquidity and capital  resources above in Item 2,
we have received  governmental  forgivable  loans and  no-interest  loans in the
aggregate amount of $863,624.  We are presently accruing interest expense at the
rate of 10% on the non-interest  bearing loans,  until the criteria for interest
forgiveness is fulfilled.

         o    We have a note with Iowa State Bank,  Algona,  Iowa, in the amount
              of $500,000  that carries a fixed annual rate of 5.890%.  Interest
              is payable  monthly and the note will mature on December 16, 2006.
              We  anticipate  that this note will be rolled over into  permanent
              financing  upon maturity,  but cannot provide  assurance that such
              financing will be available or on what terms.

         o    As of April 4,  2006,  we have a loan  from  Farmers  State  Bank,
              Algona, Iowa, in the amount of $600,000 that provides for interest
              at an annual  adjustable rate of 6.00%.  Principal and interest on
              the note are due April 4, 2007.

         o    The Company obtained $200,000 from the City of Algona in September
              2005.  There is no  interest  on this loan  provided  the  Company
              creates and retains at least 42 new  full-time  positions for five
              years. If such requirements are not met, interest on the loan will
              be payable at 10% per annum.  The Company is accruing  interest on
              this note until the terms of the note have been met.

         o    On June 27, 2005, the Company  executed a note payable of $146,124
              from the Algona Area Economic Development Corporation. The loan is
              a  ten-year  partially   forgivable  loan  with  interest  at  8%,
              conditioned  upon  the  Company  achieving   certain   performance
              targets.  The Company is accruing  interest on this note until the
              terms of the note have been met.

                                      -37-
<PAGE>

         o    On  December  16,  2005,  the Company  assumed a no interest  note
              provided by the Algona Area Economic  Development  Corporation  in
              the amount of  $117,500.  This note was recorded at the fair value
              of future payments using an interest rate of 10%.

         o    On June 28,  2005,  the Iowa  Department  of Economic  Development
              ("IDED") awarded the Company a grant in the amount of $150,000. If
              certain  requirements  are not met, the balance of the  forgivable
              loan  determined by IDED as due and payable will be amortized over
              three years from the agreement expiration date of July 31, 2010 at
              6% interest per annum with equal quarterly  payments.  The Company
              is accruing interest on this note until the terms of the note have
              been met.

         o    Also,  on June 28,  2005,  IDED  awarded  the  Company a Community
              Economic Betterment Account ("CEBA") forgivable loan in the amount
              of  $250,000.  If  certain  conditions  are not met,  any  balance
              (shortfall) will be amortized over a two-year period, beginning at
              the project  completion  date at 6% per annum from the date of the
              first CEBA disbursement.  The Company is accruing interest on this
              note until the terms of the note have been met.


                                      -38-
<PAGE>


ITEM 4.  CONTROLS AND PROCEDURES

         Our management,  including our Chief  Executive  Officer (the principal
executive officer),  Theodore G. Hollinger, and our Chief Financial Officer (the
principal  financial  officer),  Sandra Batt,  have  reviewed and  evaluated the
effectiveness  of our  disclosure  controls and  procedures  (as defined in Rule
13a-15(e) under the Securities  Exchange Act of 1934, as amended) as of June 30,
2006. Based upon this review and evaluation,  these officers have concluded that
our disclosure  controls and procedures are effective to ensure that information
required  to be  disclosed  in the  reports  that we file or  submit  under  the
Exchange Act is recorded,  processed,  summarized  and reported  within the time
periods  required  by the  forms  and  rules  of  the  Securities  and  Exchange
Commission;  and to ensure that the  information  required to be disclosed by an
issuer  in the  reports  that it files or  submits  under  the  Exchange  Act is
accumulated and communicated to our management including our principal executive
officers,  or persons  performing  similar  functions,  as  appropriate to allow
timely decisions regarding required disclosure.

         Our  President  and our Board of Directors are currently in the process
of  working  with our  Chief  Financial  Officer  to  complete  the  design  and
implementation  of internal  control and  disclosure  controls and procedures in
accordance  with  Sarbanes  Oxley  404.  Although  this  process  has  not  been
formalized,  we believe  that the controls  and  procedures  in place during the
first and second  quarter have allowed us to secure  information  required to be
disclosed,  within  the  time  periods  specified  in the  SEC's  rules  for the
preparation of this report.



                                      -39-
<PAGE>


PART II.  OTHER INFORMATION

ITEM 1A.  RISK FACTORS

                                  RISK FACTORS

YOU SHOULD  CAREFULLY  CONSIDER THE RISKS DESCRIBED BELOW TOGETHER WITH THE RISK
FACTORS  DISCLOSED IN OUR FORM 10-KSB FOR THE YEAR ENDED  DECEMBER 31, 2005. YOU
SHOULD ALSO  CONSIDER ALL OF THE OTHER  INFORMATION  INCLUDED IN OUR FORM 10-KSB
AND IN THIS FORM 10-QSB WHEN EVALUATING THE COMPANY AND ITS BUSINESS.  IF ANY OF
THE RISKS ACTUALLY  OCCURS,  OUR BUSINESS,  FINANCIAL  CONDITION,  OR RESULTS OF
OPERATIONS  COULD  SUFFER.  IN THAT CASE,  THE PRICE OF OUR COMMON  STOCK  COULD
DECLINE AND OUR STOCKHOLDERS MAY LOSE ALL OR PART OF THEIR INVESTMENT.

     We have a limited  operating  history and have not  recorded  an  operating
     profit  since our  inception.  Continuing  losses may  exhaust  our capital
     resources and force us to discontinue operations.
     ---------------------------------------------------------------------------

         HEC Iowa was incorporated on May 19, 2003, and has a limited  operating
history and has incurred net losses since  inception,  including  $2,024,667  of
losses incurred during the quarter ended June 30, 2006. Prior to the Merger, the
Company  (then known as "Green Mt.  Labs,  Inc.") had been  inactive for several
years.  The  potential  for us to  generate  profits  depends  on many  factors,
including the following:

         o    the reliability of our suppliers;

         o    the costs of building,  maintaining,  and expanding our facilities
              and our operations; and

         o    the quality and reliability of our products.

         o    our  ability to attract  and  retain a  qualified  work force in a
              small town.

         o    the  size  and  timing  of  future  customer   orders,   milestone
              achievement, product delivery and customer acceptance;

         o    success  in   maintaining   and   enhancing   existing   strategic
              relationships  and  developing  new strategic  relationships  with
              potential customers;

         o    our ability to protect our intellectual property;

         o    actions taken by competitors,  including  suppliers of traditional
              engines,  hydrogen  fuel cells and new product  introductions  and
              pricing changes;

         We cannot  assure you we will achieve any of the  foregoing  factors or
realize profitability in the immediate future or at any time.

                                      -40-
<PAGE>

     Additional  financing to proceed with our anticipated  business  activities
     will be required during third quarter 2006.  There can be no assurance that
     financing will be available on terms beneficial to us, or at all.
     ---------------------------------------------------------------------------

         In order to proceed with our anticipated business  activities,  we will
need to obtain additional  financing.  If we raise additional capital by selling
equity or equity-linked securities,  these securities would dilute the ownership
percentage of our existing stockholders.  Also, these securities could also have
rights,  preferences  or  privileges  senior  to  those  of  our  common  stock.
Similarly,  if we raise  additional  capital by issuing debt  securities,  those
securities may contain covenants that restrict us in terms of how we operate our
business,  which  could  also  affect  the value of our  common  stock.  We have
financed  our  operations  since  inception  primarily  through  equity and debt
financings and loans from our officers, directors and stockholders.  Although we
expect to offer  securities of the Company for sale during 2006, there can be no
assurance  that we will  successfully  complete  such an  offering  or that  the
proceeds of the  offering,  if  completed,  would be  sufficient  to satisfy our
capital requirements.

         We  anticipate  that if we are  successful  in obtaining  funds through
private or public  sources,  we plan to explore  the  expansion  of our  present
facilities.  An  expansion  will be  necessary  to provide  needed space for the
assembly of our 7.5L engines and our 2.45L engines.

         If we are not able to obtain  the  needed  financing,  our  ability  to
fulfill our business plans and reach full production capacity will be materially
impaired.

     Reliance on principal supplier and contract manufacturer.
--------------------------------------------------------------------------------

         We contract the manufacture of many of our components for our Oxx Power
engines to third parties. In many cases, we do not have an alternative source of
manufacturing,  and a suitable replacement would be time-consuming and expensive
to obtain. If, for any reason, one of our third party manufacturers is unable or
refuses to produce  these  components,  our  business,  financial  condition and
results of operations would be materially and adversely affected

         We are dependent on a small number of vendors to supply the  components
for our 4.9L  engines.  In July we  established a  relationship  with a supplier
abroad for production of the blocks used in our 4.9L engines and as of August 3,
2006, have outstanding purchase orders totaling  approximately  $410,000 to this
supplier and expect to issue  approximately  $625,000 additional purchase orders
to this supplier during the remainder of 2006. Although we are in the process of
lining up second and third sources for these components,  production flow of the
4.9L engine is dependent upon timely receipt of the blocks from this supplier as
well as timely receipt of the other components from a few other suppliers. As of
August 30, 2006, we have issued blanket  purchase orders totaling  approximately
$1 million to a second  vendor for  production  of various  component  parts and
expect  to issue  approximately  $160,000  additional  purchase  orders  to this
supplier  during the  remainder of 2006.  As of August 30, 2006,  we have issued
blanket  purchase orders purchase  orders totaling  approximately  $470,000 to a
third vendor for production of other various component parts and expect to issue
approximately  $590,000  additional  purchase orders to this supplier during the
remainder of 2006. We have experienced significant delays in this process to


                                      -41-
<PAGE>

date.  Although we expect product flow and production of the new 4.9L engines to
begin during fourth  quarter,  further  delivery delays from our suppliers would
further  delay sales of new 4.9L  engines to our  distributor  network and would
adversely affect our ability to generate revenue.

     We may experience significant and rapid growth if we are able to capitalize
     on the expansion of the  industrial  engine and genset  markets.  If we are
     unable to hire and train staff to produce our  products,  handle  sales and
     marketing  of our  products  and manage our  operations,  such growth could
     materially and adversely affect us.
     ---------------------------------------------------------------------------

         We intend to proceed with  initiatives  intended to  capitalize  on the
need for more efficient  industrial engines,  engines that use alternative fuels
and the interest in more  environmentally  friendly sources of power. This could
potentially  lead to significant and rapid growth in the scope and complexity of
our business.  Any inability on our part to manage such growth  effectively will
have a material adverse effect on our product development,  business,  financial
condition and results of  operations.  Our ability to manage and sustain  growth
effectively  will  depend,  in part,  on the  ability  of our  relatively  small
management team to implement appropriate  management,  operational and financial
systems and  controls  and to  successfully  hire,  train,  motivate  and manage
employees.  As of June 30, 2006,  HEC Iowa had 20 employees and HEC Canada had 5
employees. As of August 1, 2006, we had a total of 26 employees. We hope to have
a total of 30-35 employees by October 1, 2006.

     We may not be able to manage our growth effectively,  which could adversely
     affect our operations and financial performance.
     ---------------------------------------------------------------------------

         The  ability to manage  and  operate  our  business  as we execute  our
development and growth  strategy will require  effective  planning.  Significant
rapid  growth  could  strain  our  management  and other  resources,  leading to
increased  cost of  operations,  an  inability  to ship  enough  product to meet
customer  demand and other  problems that could  adversely  affect our financial
performance.  We expect that our efforts to grow will place a significant strain
on personnel, management systems, infrastructure and other resources. We believe
that our management team is currently under considerable strain with the current
level  of our  growth  and  expansion.  Our  ability  to  manage  future  growth
effectively will require us to successfully attract, train, motivate, retain and
manage new  employees  and  continue  to update  and  improve  our  operational,
financial and management controls and procedures. If we do not manage our growth
effectively,  our operations  could be adversely  affected,  resulting in slower
growth and a failure to achieve or sustain profitability.

     If we are unable to  effectively  and  efficiently  implement the necessary
     internal  controls and procedures,  there could be an adverse effect on our
     operations or financial results.
     ---------------------------------------------------------------------------
         Our  President  and our Board of Directors are currently in the process
of  working  with our  Chief  Financial  Officer  to  complete  the  design  and
implementation  of internal  controls and disclosure  controls and procedures in
accordance  with  Sarbanes  Oxley  404.  Although  this  process  has  not  been
formalized,  we believe  that the controls  and  procedures  in place during the


                                      -42-
<PAGE>

fourth quarter have allowed us to secure  information  required to be disclosed,
within the time periods specified in the SEC's rules for the preparation of this
report.

     Our future  success  depends on retaining  our existing key  employees  and
     hiring and assimilating new key employees. The loss of key employees or the
     inability to attract new key  employees  could limit our ability to execute
     our growth strategy, resulting in lost sales and a slower rate of growth.
     ---------------------------------------------------------------------------

         Our  future  success  depends  in part on our  ability  to  retain  key
employees  including our executive officers and, in particular,  our founder Ted
Hollinger.  We  currently do not carry "key man"  insurance  on our  executives;
however, we are in the process of securing such insurance. It would be difficult
for us to replace any one of these individuals.  In addition, as we grow we will
need  to  hire  additional  key  personnel.  We  may  experience  difficulty  in
recruiting  experienced  engineers,  management  personnel  and  others  who are
interested in living and working in the Algona area.

     We may experience labor shortages.
     ---------------------------------------------------------------------------

         Our production  facilities  are located in Algona,  Iowa, a town with a
population of approximately  5,500 people.  We may find it difficult to hire and
retain a  workforce  sufficient  to meet our  production  needs  and  allow  for
sustained  growth of our  operations.  Our ability to hire and retain  qualified
employees  for  our  production  facilities  will  be key to  our  success.  Our
inability to do this may have a materially adverse effect on our future results.

     We  may  experience  production  gaps  or  delays  in the  commencement  of
     production,  which  could  materially  and  adversely  impact our sales and
     financial results and the ultimate acceptance of our products.
     ---------------------------------------------------------------------------

         We are in the  process  of  transitioning  to  production  in our newly
constructed facility. Because all of the production procedures and processes, as
well  as the  facility,  are  new to us and  all  of  our  employees,  we  could
experience   unexpected   delays  in   production   during   fiscal  year  2006.
Additionally, it is possible that we could experience unforeseen quality control
issues as we ramp up to full  production.  Should any such  delay or  disruption
occur in  transitioning  to  production,  our  anticipated  sales will likely be
materially and adversely affected.

         The products  produced in our new  facility  could  contain  undetected
design faults  despite our testing.  We may not discover  these faults or errors
until  after a product has been used by our  customers.  Any faults or errors in
our products may cause delays in product  introduction  and  shipments,  require
design  modifications  or  harm  customer  relationships,  any  of  which  could
adversely affect our business and competitive position.

     We cannot  assure you that there will be an active  trading  market for our
     common stock.
     ---------------------------------------------------------------------------

         Even though our common stock is quoted on the OTC Bulletin Board,  most
shares  outstanding,   including  those  issued  pursuant  to  the  Merger,  are
"restricted  securities"  within the meaning of Rule 144  promulgated by the SEC
and are therefore  subject to certain  limitations  on the ability of holders to


                                      -43-
<PAGE>

resell such shares.  Restricted shares may not be sold or otherwise  transferred
without registration or reliance upon a valid exemption from registration. Thus,
holders of restricted shares of our common stock may be required to retain their
shares for a long period of time.

     If we cannot  achieve  commercial  application  of our hydrogen  engine and
     other products and technologies, we may not achieve profitability.
     ---------------------------------------------------------------------------

         Members of the  public may be wary of  hydrogen  because  hydrogen,  as
compared  to other  fuels,  has the  largest  flammability  limit  (4% to 77% of
hydrogen in air). This means that it takes very little hydrogen to start a fire.
On the other  hand,  hydrogen  is a light gas.  As such,  if there is a hydrogen
leak,  it will  immediately  diffuse  into  the  surrounding  air.  With  proper
precaution  hydrogen  could be as safe as any other  fuel.  The main  benefit of
hydrogen as a fuel is that it produces no pollution or greenhouse  gases when it
is used in an internal  combustion  engine.  The development of a market for our
engines is dependent in part upon the  development of a market for hydrogen as a
fuel, which may be impacted by many factors, including:

         o    consumer  perception of the safety of hydrogen and  willingness to
              use engines powered by hydrogen;

         o    the cost  competitiveness  of hydrogen as a fuel relative to other
              fuels;

         o    the future availability of hydrogen as a fuel;

         o    adverse regulatory developments, including the adoption of onerous
              regulations regarding hydrogen use or storage;

         o    barriers to entry created by existing energy providers; and

         o    the emergence of new competitive technologies and products.

     Certain   government   regulations   concerning   electrical  and  hydrogen
     generation,  delivery  and storage of fuels and other  related  matters may
     negatively impact our business.
     ---------------------------------------------------------------------------

         Our  business is subject to and affected by federal,  state,  local and
foreign  laws and  regulations.  These may  include  state and local  ordinances
relating to building codes, public safety,  electrical and hydrogen  production,
delivery and refueling infrastructure, hydrogen storage and related matters. The
use of hydrogen  inside a building will require  architectural  and  engineering
changes in the  building  to allow the  hydrogen to be handled  safely.  We have
received  approval  from  the Iowa  State  Fire  Marshall  for  limited  use the
dynamometer room where we intend to test our engines. However, full occupancy is
subject to final inspection once dynamometers, testing equipment and sensors are
installed.  As our engines and other new products are introduced into the market
commercially,  governments may impose new regulations. We do not know the extent
to which any such  regulations  may impact our business or the businesses of our
customers'  businesses.  Any new  regulation may increase costs and could reduce
our potential to be profitable.


                                      -44-
<PAGE>

     The industry in which we operate is highly competitive and such competition
     could affect our results of operations, which would make profitability even
     more difficult to achieve and sustain.
     ---------------------------------------------------------------------------

         The  power   generation  and   alternative   fuel  industry  is  highly
competitive and is marked by rapid technological  growth.  Other competitors and
potential  competitors  include H2Car Co., Cummins,  Daimler  Chrysler,  General
Motors, BMW, Mazda, Koehler and Generac. Many existing and potential competitors
have greater financial resources, larger market share, and larger production and
technology  research  capability,  which may enable them to establish a stronger
competitive   position  than  we  have,  in  part  through   greater   marketing
opportunities.  The governments of the United States,  Canada, Japan and certain
European  countries have provided  funding to promote the development and use of
fuel cells.  Tax  incentives  have also been  initiated in Japan,  and have been
proposed in the United  States and other  countries,  to stimulate the growth of
the fuel  cell  market  by  reducing  the cost of these  fuel  cell  systems  to
consumers.  Our business does not currently  enjoy any such  advantages and, for
that reason, may be at a competitive  disadvantage to the fuel cell industry. If
we fail to address competitive developments quickly and effectively, we will not
be able to grow.

     Our  business  could  be  adversely   affected  by  any  adverse   economic
     developments  in the  power  generation  industry  and/or  the  economy  in
     general.
     ---------------------------------------------------------------------------

         We depend on the perceived demand for the application of our technology
and resulting products. Our products are focused on reducing CO(2) emissions and
upon the use of alternative  fuels for industrial  uses,  such as ground support
vehicles,  and for the power  generation  business.  Therefore,  our business is
susceptible  to downturns in the airline  industry and the genset portion of the
distributed power industry and the economy in general.  Any significant downturn
in the market or in general economic conditions would likely hurt our business.

     We believe that we carry a reasonable  amount of  insurance.  However there
     can be no assurance that our existing  insurance coverage would be adequate
     in term and scope to protect us against material  financial  effects in the
     event of a successful claim.
     ---------------------------------------------------------------------------

         We could be subject to claims in  connection  with the products that we
sell.  There can be no  assurance  that we would have  sufficient  resources  to
satisfy any liability resulting from any such claim, or that we would be able to
have our customers indemnify or insure us against any such liability.  There can
be no assurance that our insurance  coverage would be adequate in term and scope
to protect us against material  financial  effects in the event of a successful.
claim. We currently do not carry directors and officers insurance. We may in the
future obtain such insurance,  provided it can be obtained at reasonable prices.
However,  there can be no assurance  that such coverage,  if obtained,  would be
adequate in term and scope to protect us.

     If we fail to keep up with changes affecting our technology and the markets
     that we will ultimately service, we will become less competitive and future
     financial performance would be adversely affected.
     ---------------------------------------------------------------------------

         In order to  remain  competitive  and  serve  our  potential  customers
effectively,  we must respond on a timely and cost-efficient basis to changes in


                                      -45-
<PAGE>

technology,  industry standards and procedures and customer preferences. We need
to  continuously  develop new  technology,  products and services to address new
technological  developments.  In some cases these changes may be significant and
the cost to comply with these changes may be  substantial.  We cannot assure you
that we will be able to adapt to any  changes in the future or that we will have
the financial  resources to keep up with changes in the  marketplace.  Also, the
cost of adapting our  technology,  products and services may have a material and
adverse effect on our operating results.

     Our business could be adversely  affected by local,  state,  national,  and
     international laws or regulations.
     ---------------------------------------------------------------------------

         Our future success depends in part on laws and regulations  that exist,
or are expected to be enacted around the world. Should these laws or regulations
take an adverse turn, this could negatively  affect our business and anticipated
revenues. We cannot guarantee a positive outcome in direction,  timing, or scope
of laws and regulations that may be enacted which will affect our business.

         Our  distributors  will not be able to offer  our  engines  for sale to
original equipment  manufacturers for mobile applications until the engines have
passed  U.S.  Emissions  Regulations  which  are  defined  and  enforced  by the
Environmental Protection Agency and California Air Resources Board. Stand-by and
replacement  engines  are not  subject  to  these  requirements.  We  anticipate
beginning  the  emissions  certification  process of our 4.9L engine  during the
first  quarter of 2007.  It will cost  approximately  $1,000,000 to certify each
engine in our product  line.  We also  anticipate  beginning  the  certification
process for our 7.5L and 2.45L engines in 2007.

     The hydrogen and power generation  business may expose us to certain safety
     risks and potential liability claims.
     ---------------------------------------------------------------------------

         Our business will expose us to potential  product liability claims that
are inherent in hydrogen and products that use hydrogen. Hydrogen is a flammable
gas and therefore a potentially  dangerous product.  Any accidents involving our
engines or other  hydrogen-using  products could  materially  impede  widespread
market acceptance and demand for our hydrogen-fueled  engines.  In addition,  we
might  be held  responsible  for  damages  beyond  the  scope  of our  insurance
coverage.  We also  cannot  predict  whether  we will  be able to  maintain  our
insurance coverage on acceptable terms, or at all.

     We may be unable to protect our  intellectual  property  adequately or cost
     effectively, which may cause us to lose market share or reduce prices.
     ---------------------------------------------------------------------------

         Our  future  success  depends in part on our  ability  to  protect  and
preserve  our  proprietary  rights  related  to  our  technology  and  resulting
products.  We cannot  assure you that we will be able to prevent  third  parties
from  using  our  intellectual   property  rights  and  technology  without  our
authorization.  We do not  currently  own any  patents,  although  one patent is
pending related to our technology.  We anticipate making patent  applications in
the future. We rely on trade secrets,  common law trademark rights and trademark
registrations. We intend to protect our intellectual property via non-disclosure

                                      -46-
<PAGE>

agreements,   contracts,  and  limited  information  distribution,  as  well  as
confidentiality  and  work  for  hire,  development,   assignment,  and  license
agreements with our employees,  consultants,  third party developers,  licensees
and customers. However, these measures afford only limited protection and may be
flawed or inadequate.  Also,  enforcing  intellectual  property  rights could be
costly  and  time-consuming  and  could  distract  management's  attention  from
operating business matters.

     Our intellectual  property may infringe on the rights of others,  resulting
     in costly litigation.
     ---------------------------------------------------------------------------

         In recent years,  there has been  significant  litigation in the United
States involving patents and other intellectual  property rights. In particular,
there has been an  increase  in the  filing of suits  alleging  infringement  of
intellectual property rights, which pressure defendants into entering settlement
arrangements quickly to dispose of such suits, regardless of their merits. Other
companies  or  individuals  may allege that we  infringe  on their  intellectual
property rights.  Litigation,  particularly in the area of intellectual property
rights,  is costly and the outcome is inherently  uncertain.  In the event of an
adverse result, we could be liable for substantial  damages and we may be forced
to discontinue  our use of the subject matter in question or obtain a license to
use those rights or develop  non-infringing  alternatives.  Any of these results
would  increase  our  cash  expenditures,   adversely  affecting  our  financial
condition.

     Being a public company involves increased administrative costs, which could
     result in lower net income and make it more difficult for us to attract and
     retain key personnel.
     ---------------------------------------------------------------------------

         As a public company,  we incur significant legal,  accounting and other
expenses  that HEC Iowa did not incur as a private  company.  In  addition,  the
Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the
SEC,  have  required  changes  in  corporate   governance  practices  of  public
companies.  We expect that these new rules and  regulations  will  increase  our
legal  and  financial  compliance  costs  and make  some  activities  more  time
consuming.  For example,  in connection with being a public company, we may have
to create several board committees,  implement  additional internal controls and
disclose controls and procedures, retain a transfer agent and financial printer,
adopt an insider  trading  policy and incur  costs  relating  to  preparing  and
distributing  periodic public reports in compliance  with our obligations  under
securities  laws.  These  new  rules  and  regulations  could  also make it more
difficult  for us to  attract  and  retain  qualified  members  of our  board of
directors, particularly to serve on our audit committee, and qualified executive
officers.

     We do not anticipate paying dividends in the foreseeable future. This could
     make our stock less attractive to potential investors.
     ---------------------------------------------------------------------------

         We  anticipate  that we will retain any future  earnings and other cash
resources for future operation and development of our business and do not intend
to declare  or pay any cash  dividends  in the  foreseeable  future.  Any future
payment of cash  dividends  will be at the  discretion of our board of directors
after  taking into  account  many  factors,  including  our  operating  results,
financial  condition and capital  requirements.  Corporations that pay dividends
may be viewed as a better investment than corporations that do not.

                                      -47-
<PAGE>

     Future sales or the potential for sale of a substantial number of shares of
     our common  stock could cause our market  value to decline and could impair
     our ability to raise capital through subsequent equity offerings.
     ---------------------------------------------------------------------------

         During  2006,  we expect to  register  some or all of the  unregistered
outstanding  shares of our Common Stock. Sales of a substantial number of shares
of our common stock in the public  markets,  or the perception  that these sales
may occur, could cause the market price of our common stock to decline and could
materially  impair our ability to raise  capital  through the sale of additional
equity securities. In addition to the shares of our common stock actually issued
and  outstanding,  as of June 30, 2006 another  700,334  shares are reserved for
issuance under our new incentive compensation plan.

     The authorization  and issuance of blank-check  preferred stock may prevent
     or discourage a change in our management.
     ---------------------------------------------------------------------------

         Our  amended  certificate  of  incorporation  authorizes  the  board of
directors  to  issue  up  to  10  million  shares  of  preferred  stock  without
stockholder  approval  having  terms,   conditions,   rights,   preferences  and
designations as the board may determine. The rights of the holders of our common
stock will be subject to, and may be  adversely  affected  by, the rights of the
holders of any preferred stock that may be issued in the future. The issuance of
preferred  stock,  while  providing  desirable  flexibility  in connection  with
possible  acquisitions  and other corporate  purposes,  could have the effect of
discouraging a person from acquiring a majority of our outstanding common stock.

     It may be difficult for a third party to acquire us, and this could depress
     our stock price.
     ---------------------------------------------------------------------------

         Nevada  corporate law includes  provisions  that could delay,  defer or
prevent a change in control of our company or our management.  These  provisions
could  discourage  information  contests and make it more  difficult for you and
other  stockholders to elect directors and take other  corporate  actions.  As a
result, these provisions could limit the price that investors are willing to pay
in the future for shares of our common stock. For example:

         o    Without prior stockholder approval, the board of directors has the
              authority  to issue one or more  classes of  preferred  stock with
              rights  senior  to those of  common  stock  and to  determine  the
              rights, privileges and preferences of that preferred stock;

         o    There is no cumulative voting in the election of directors; and

         o    Stockholders cannot call a special meeting of stockholders.



                                      -48-
<PAGE>

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

         During the  quarter  ended June 30,  2006,  the Company  issued  77,000
shares to employees under the Company's 2005 Incentive Compensation Plan. During
fiscal  year 2005 the  Company  issued  426,000  shares of  restricted  stock to
officers and directors  under the Company's  2005 Incentive  Compensation  Plan.
Further  information about awards under the 2005 Incentive  Compensation Plan is
included in our Annual Report on Form 10-KSB filed with the  Commission on March
31,  2006,  which  report  is  incorporated  herein  by  reference.  Information
regarding  unregistered sales of other equity securities under our First Private
Offering and use of proceeds is included in our Current Report on Form 8-K filed
with the  Commission  on  September  6, 2005,  and amended on September 7, 2005,
which report is incorporated herein by reference.  On May 22, 2006, we commenced
our Second  Private  Placement,  through  which,  as of August 1, 2006,  we have
received gross  subscriptions  of  approximately  $2.9 million,  all of which is
available  to the  Company.  The Second  Private  Offering  is ongoing and could
include debt securities as well as shares of convertible preferred stock.



                                      -49-

<PAGE>


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

Exhibit No.           Description

31.1      Certification  pursuant  to Item  601(b)(31)  of  Regulation  S-B,  as
          adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002, by
          Theodore G. Hollinger, the Company's Chief Executive Officer.

31.2      Certification  pursuant  to Item  601(b)(31)  of  Regulation  S-B,  as
          adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002, by
          Sandra Batt, the Company's Chief Financial Officer.

32.1      Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant
          to Section  906 of the  Sarbanes-Oxley  Act of 2002,  by  Theodore  G.
          Hollinger, the Company's Chief Executive Officer.

32.2      Certification  pursuant to 18 U.S.C. Section 1350, as adopted pursuant
          to Section 906 of the  Sarbanes-Oxley Act of 2002, by Sandra Batt, the
          Company's Chief Financial Officer.

----------------


NOTES ABOUT FORWARD-LOOKING STATEMENTS

         Statements  contained in this current  report which are not  historical
facts,  including some  statements  regarding the effects of the Merger,  may be
considered "forward-looking  statements" under the Private Securities Litigation
Reform Act of 1995. Forward-looking statements are based on current expectations
and  the  current   economic   environment.   We  caution   readers   that  such
forward-looking  statements  are not guarantees of future  performance.  Unknown
risks and uncertainties as well as other uncontrollable or unknown factors could
cause  actual  results to  materially  differ from the results,  performance  or
expectations expressed or implied by such forward-looking statements.



                                      -50-
<PAGE>

                                   SIGNATURES

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


                                       HYDROGEN ENGINE CENTER, INC.


Date:  August 14, 2006        By         /s/ THEODORE G. HOLLINGER
                                 -----------------------------------------------
                                           Theodore G. Hollinger
                                           President and Chief Executive Officer



Date:  August 14, 2006        By         /s/ Sandra Batt
                                 -----------------------------------------------
                                              Sandra Batt
                                           Chief Financial Officer


                                      -51-