**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington
      DC 20549**





**FORM
      10 KSB**





(Mark
      One)





|X|
      ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF


1934
      For
      the fiscal year ended December 31, 2006





|_|
      TRANSITIONAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE


ACT
      OF
      1934 For the transitional period from to_____





Commission
      File Number 333-33134





**US
      ENERGY INITIATIVES CORPORATION**


(Name
      of
      Small Business Issuer in its charter)






**GEORGIA**
            **58-2267238**State
                of or other jurisdiction of incorporation
                or organization
            I.R.S.
                Employer Identification No.










12812
      Dupont Circle, Tampa, Florida 33626


(Address
      of principal executive offices)(Zip Code)





Issuer
      Telephone Number: 813-749-8745





Securities
      registered under Section 12(b) of the Exchange Act: None


Securities
      registered under Section 12(g) of the Exchange Act: None





Check
      whether the Issuer (i) has filed all reports required to be filed by Section
      13
      or 15d of the Exchange Act during the past twelve months (or for such shorter
      period that the registrant was required to file such reports), and; (ii) and
      has
      been subject to such filing requirements for the past 90 days. |X| Yes |_|
      No





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





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





Revenues
      for the fiscal year ended December 31, 2006 totaled $1,375,418 and for the
      fiscal year ended December 31, 2005 were $652,400.





As
      of
      March 31, 2007, the aggregate market value of the voting stock held by
      non-affiliates of the registrant (based upon the average of the closing bid
      and
      asked prices on such date) was approximately $6,587,382.




**APPLICABLE
      ONLY TO CORPORATE REGISTRANTS**





At
      April
      10 2007, the registrant had outstanding 42,215 Series A Preferred Shares and
      23,431 Series B Preferred Shares. At April 10, 2007, the Company had 210,599,983
      shares of its $0.001 par value common stock outstanding.





**DOCUMENTS
      INCORPORATED BY REFERENCE**


NONE.





Transitional
      Small Business Disclosure format (check one) Yes |_| No |X|








1


**US
      ENERGY INITIATIVES CORPORATION**





Form
      10KSB for the year ended December 31, 2006





Table
      of
      Contents








**Part
                  I**Item
                  1.
              Description
                  of BusinessItem
                  2.
              Description
                  of PropertyItem
                  3.
              Legal
                  ProceedingsItem
                  4.
              Submission
                  of Matters to a Vote of Security HoldersPart
                  IIItem
                  5.
              Market
                  for Common Equity and Related Stockholder MattersItem
                  6.
              Management's
                  Discussion and Analysis or Plan of OperationsItem
                  7.
              Financial
                  StatementsItem
                  8.
              Changes
                  in and Disagreements with Accountants on Accounting andFinancial
                  DisclosureItem
                  8A.
              Controls
                  and ProceduresItem
                  8B.
              Other
                  InformationPart
                  IIIItem
                  9.
              Directors,
                  Executive Officers, Promoters and Control Persons;
                  ComplianceWith
                  Section 16(a) of the Exchange ActItem
                  10.
              Executive
                  CompensationItem
                  11.
              Security
                  Ownership of Certain Beneficial Owners and Management andRelated
                  Stockholder MattersItem
                  12.
              Certain
                  Relationships and Related TransactionsItem
                  13.
              ExhibitsItem
                  14.
              Principal
                  Accountant Fees and ServicesSignatures







2


**US
      ENERGY INITIATIVES CORPORATION**





**PART
      I**





The
      information set forth in this Report on Form 10-KSB contains "forward looking
      statements" within the meaning of Section 27A of the Securities Act of 1933,
      as
      amended, and Section 21E of the Securities Exchange Act of 1934, as amended
      ("the Act"). The words "believes," "anticipates," "plans," "expects," "intends,"
      "estimates," and similar expressions are intended to identify forward-looking
      statements. In addition, any statements concerning future financial performance,
      ongoing business strategies or prospects, and possible future Company actions,
      which may be provided by management, are also forward-looking statements as
      defined by the Act. Such forward-looking statements involve known and unknown
      risks, uncertainties, and other factors, which may cause actual results,
      performance, or achievements of the Company to materially differ from any future
      results, performance, or achievements expressed or implied by such
      forward-looking statements and to vary significantly from reporting period
      to
      reporting period. Actual results may materially differ from those projected
      in
      the forward looking statements as a result of certain risks and uncertainties
      set forth in this report. Although management believes that the assumptions
      made
      and expectations reflected in the forward looking statements are reasonable,
      there is no assurance that the underlying assumptions will, in fact, prove
      to be
      correct or that actual future results will not be different from the
      expectations expressed in this report. The Company has no specific intention
      to
      update these statements.





**ITEM
      ONE - DESCRIPTION OF OUR BUSINESS**





Throughout
      this report, terms such as "we", "our", the "Company" or "US Energy" mean US
      Energy Initiatives Corporation, a Georgia company.





GENERAL





We
      were
      incorporated in the State of Georgia in 1996 and since that date have been
      in
      the business of manufacturing and marketing retrofit systems for the conversion
      of gasoline and diesel engines, stationary or vehicular, to non-petroleum based
      fuels such as compressed natural gas and liquefied natural gas. We hold a
      worldwide exclusive license to commercialize the technology embodied in five
      issued and one pending US patent. Since 1998, we have dedicated our research
      and
      development exclusively to conversion systems for diesel-powered engines. We
      currently offer a dual-fuel conversion system designed to convert medium and
      heavy-duty mobile diesel engines to operate in a natural gas/diesel dual-fuel
      mode.





During
      June 2006 we acquired Automated Engineering Corporation (AEC), an ISO 9001
      electronics manufacturing entity. AEC was formed in 1988 and since that date,
      has provided electronic component design and manufacturing. We primarily
      acquired AEC to manufacture the electronic control unit component which is
      the
      most important part in our patent dual-fuel system. Through our acquisition
      of
      AEC, we hope to realize a reduction in our cost of good and cost of
      manufacturing as well as accelerate the delivery time for any electronic
      component orders we place.





We
      introduced
      our dual fuel technology into the marketplace in the 1990's through the
      conversion of gasoline and diesel engines to operate in a dual fuel mode. During
      this period, we developed commercial versions of the fuel delivery system to
      fit
      many older, naturally aspirated, diesel engine types and placed conversion
      units
      into engines all around the world. The experiences gained during this period
      including conversions on a wide array of engines operating under different
      conditions with varying fuel requirements contributed significantly to the
      subsequent four patents and the Company's first market application referred
      to
      as conversion system.




During
      February 2006 the Environmental Protection Agency (EPA) issued us a Certificate
      of Conformity for our dual fuel system when used on a 2001 Mack
      engine.








3










OUR
      PATENT DUAL FUEL PRODUCT




We
      introduced
      our patent dual fuel technology in the 1990's through the conversion of gasoline
      and diesel engines. During this period, we developed commercial versions of
      the
      fuel delivery system to fit many older, naturally aspirated, diesel engines
      and
      placed conversion units into engines all around the world. The experiences
      gained during this period, including conversions on a wide array of engines
      operating under different conditions with varying fuel requirements, contributed
      significantly to the subsequent four patents and the Company's first market
      application.





The
      commercial version of our system allows a medium or heavy-duty diesel mobile
      engine to operate in a dual-fuel, diesel/natural gas mode. Systems installed
      in
      the field as well as measured in our development facility demonstrate our system
      allows a diesel engine to achieve 100% of the Original Equipment Manufacturer
      (OEMs) power and torque while operating in a Compressed Natural Gas (CNG) mode.
      There are three main components to our HFS system:





(i)
      the
      Electronic Control Unit or ECU,





(ii)
      the gas
      air mixing device and





(iii)
      the
      measuring, monitoring and reporting devices.





Our
      system can typically be installed in one to two days by qualified technicians.
      In addition to the installation of our system, our customers must also mount
      fuel storage tanks and linkage. Typically, it takes approximately one-half
      day
      to install fuel storage tanks and linkage.





The
      conversion of a vehicle to a dual fuel mode requires our system together with
      fuel storage tanks and linkage. In certain cases, a catalytic converter is
      also
      installed as a part of our system. The catalytic converter, fuel storage tanks
      and linkage are purchased by our customers either from approved vendors or
      on
      the open market. We do not sell the catalytic converter or fuel storage
      tanks.





NEW
      PLATFORM DEVELOPMENT





Diesel
      engines manufactured today are a highly precise coordination of mechanical
      and
      electronic systems. As a result, each diesel engine platform is a unique
      product. Our patent dual fuel system is likewise a precise coordination of
      mechanical and electronic systems. Therefore, each engine platform requires
      unique systems engineering in order to coordinate our patent dual fuel system
      with the OEM's engine platform.





We
      develop new engine platform systems at our facility in PeachTree City, Georgia.
      Our price for new systems development is typically $25,000 - $45,000. In
      general, our developmental process includes:





·
            Client
                acceptance of our scope of work and system objectives. The client
                is
                provided a timing schedule and a semi-weekly update throughout the
                development process;


·
            Client
                delivers either a vehicle or engine to our PeachTree City, Georgia
                facility;


·
            The
                engine is mounted on an engine cart and scheduled for time in our
                developmental dynamometer cell;


·
            The
                engine is placed in our developmental dynamometer cell and a unique
                program is written for the engine
                platform;


·
            The
                converted engine is measured for power, torque and a series of pertinent
                system factors;


·
            The
                converted engine is measured both with and without the emission system
                in
                tact;


·
            One
                or two prototype systems are installed by our technicians at the
                client's
                location;


·
            A
                field test is conducted independently by the
                client;


·
            The
                system is declared finished and a bill of materials is delivered
                for mass
                production; and


·
            In
                certain cases we will aid in the prosecution of an EPA certificate
                of
                conformity.


·
            New
                systems are typically developed in four to six weeks.








- -
 4





MARKETING





Our
      marketing strategy is to deliver our technology to the consumer principally
      through original equipment manufacturers and to a lesser extent, directly to
      fleets or governmental entities. To implement our strategy, we deploy our staff
      with specific targets of responsibility:





·
            Our
                Chief Executive Officer from our Tampa office primarily solicits
                interest
                from OEMs and manages our sub-licenses with WITCO Intl;





·
            Our
                PeachTree City-based Program Manager coordinates our developmental
                process
                and communicates with each OEM. In addition, our Program Manager
                responds
                directly to clients interested in licensing territories outside the
                continental US;





POSITIONING





In
      commercializing our technology, we position our system as a:





·
            Reduction
                in fuel costs - Our system permits the user to take advantage of
                lower
                priced natural gas verse diesel as a fuel
                source.


·
            Solution
                to harmful emissions - Domestically our system is positioned as an
                Emission Control Device. The use of our system together with a specialized
                catalytic converter has been demonstrated to lower the emissions
                on
                average of Nitrogen Oxides (NOx) by 20.03% and Particulate Matter
                (PM) by
                69.46%.


·
            An
                inexpensive and reliable alternative - Our HFS system is priced
                substantially less than the cost of alternative dedicated-engine
                dual-fuel
                technologies. The added cost to acquire a new natural gas powered
                medium
                and heavy-duty engine instead of a conventional diesel engine is
                approximately $20,000 to $30,000. The cost to convert an existing
                diesel
                engine to operate in a dual-fuel mode, commonly referred to as a
                repower,
                is approximately $40,000. The retail cost of our system is $4,500.
                In the
                case of all three approaches, the user would also have to purchase
                fuel
                storage tanks and a catalytic converter at a cost of approximately
                $5,000
                per vehicle. We believe this system price differential is a significant
                competitive factor.


·
            An
                economic and efficient improvement over diesel catalysts and emission
                traps - As discussed elsewhere in this annual report under the subheading
                "Competition", as an Emission Control Device, our HFS system is a
                superior
                means of reducing harmful atmospheric pollutants over Diesel Oxidation
                Catalysts and Diesel Particulate
                Filters.





THE
      DOMESTIC DIESEL DUAL-FUEL MARKETPLACE





The
      universe for our conversion system encompasses all medium and heavy-duty diesel
      powered trucks and buses. The number of vehicles which are eligible for our
      technology represent an estimated 3% or 3,660,000 units of the total population
      of medium and heavy-duty trucks and buses operating within the United
      States





According
      to the United States Department of Transportation, Federal Highway
      Administration (FHA) and the 2000 US Census there are a total of 83,800,000
      trucks and buses in the United States. The FHA further defines this segment
      to
      consist of 92% "light trucks" (74,000,000); 8% "medium trucks and buses"
      (4,400,000), and; 2% "heavy trucks and buses" (1,700,000). The vehicle
      manufacturer's truck classifications defines light trucks" as those with a
      weight of 0 - 14,000 lbs; "medium trucks and buses" as those with a weight
      of
      14,001 - 33,000, and; "heavy trucks and buses" as those with a weight of 33,001
      and higher.





The
      population of vehicles available for our HFS technology based on size consists
      of approximately 6,100,000 units or 8% of the total population of trucks and
      buses. We have no reliable data which provides an estimate about what percent
      of
      the 6,100,000 units are diesel or which operate on a host of other fuels such
      as
      gasoline, dedicated natural gas and hybrid vehicles. However, our experiences
      indicate that more than 60% or 6 out of 10 medium and heavy duty trucks and
      buses are dedicated diesel vehicles and therefore, immediately eligible for
      our
      technology.





5


As
      a
      result of the foregoing factors, we estimate the number of trucks and buses
      operating within the United States which are immediately eligible to benefit
      from our HFS technology are approximately 3,660,000 or 3% of the total US truck
      and bus population.





THE
      INTERNATIONAL DIESEL DUAL-FUEL MARKETPLACE





We
      have
      no reliable information on the total number of diesel vehicles worldwide.
      However, there are two factors which differentiate the foreign from the domestic
      market as it relates to the sale of our system. First, the price differential
      between diesel and compressed natural gas in certain foreign markets such as
      China, Korea and other Asian countries is significantly greater than domestic
      price differentials. As result, there is a greater economic incentive to convert
      from diesel to natural gas. Also, the domestic emission standards and
      requirements for certification are significantly more time consuming and
      expensive than in most foreign markets. As a result, we are able to market
      our
      technology immediately in many non-domestic locations based on a shorter return
      on investment and relaxed emission standards and requirements.





COMPETITION





There
      are
      relatively few alternative systems for converting medium and heavy-duty diesel
      engines to natural gas. The competing systems offered by competitors described
      below are more expensive than our technology or are limited in their application
      to specific engine lines. Competitors include:





IMPCO
      Technologies, Inc.





Clean
      Air
      Power formerly " Clean Air Partners





Westport
      Innovations Inc.





The
      Innovative Technology Group, Corp.





MANUFACTURING
      & INVENTORY





We
      currently utilize manufacturers and assemble the key components of our system
      through our wholly-owned subsidiary Automated Engineering Corporation. In order
      to operate converted vehicles on natural gas, natural gas storage tanks must
      be
      installed on the converted vehicle. We do not include gas storage tanks in
      our
      conversion system. The customer must purchase these separately from a number
      of
      companies who manufacture them, or from us at the customer's request. We intend
      to outsource the manufacturing of our components and to conduct final assembly
      and shipping at our PeachTree City, Georgia facility.





REGULATORY
      ENVIRONMENT





In
      addition to the fact that diesel gas is generally more expensive than natural
      gas, one of the primary disadvantages of a diesel engine is that it emits far
      more pollutants than its gasoline-fueled counterpart. Diesel exhaust contains
      particulate matter; visible as soot that contains unburned and partially burned
      fuel. These hydrocarbon emissions are a significant contributor to air pollution
      and to human respiratory difficulties. Also of significance is\ the fact that
      diesel fuel combustion produces Nitrogen Oxides (NOx), a toxin that is harmful
      to humans and the environment. NOx is a major known contributor to greenhouse
      gas formation resulting in global warming.





Increasingly,
      federal, state and local environmental legislation is being enacted which either
      require, or provide incentives, for the reduction of vehicle pollutants. For
      example, the Federal Clean Air Act was amended in 1990 (the "1990 Amendments")
      to, among other things, set emissions standards for stationary and mobile
      pollutant sources and establish targets, standards and procedures for reducing
      human and environmental exposure to a range of pollutants generated by industry
      in general and transportation in particular. Among other mandates, the 1990
      Amendments require businesses that maintain centrally fueled fleets of 10 or
      more vehicles in certain heavy smog locations to convert, either through new
      vehicle purchases or by converting existing vehicles, a portion of their fleet
      to clean burning alternative fuels. These laws specifically include the diesel
      and natural gas dual fuel system as an alternative fuel and specify actions
      that
      fleet operators must take in order to comply and timetables for doing
      so.





6


Similarly,
      the Energy Policy Act of 1992 (the "Energy Act") was created to accelerate
      the
      use of alternative fuels in the transportation sector. The Energy Act mandates
      the schedule by which Federal, state and municipal vehicle fleets must
      incorporate alternative fueled vehicles into their overall vehicle mix. This
      has
      significant ramifications for the military, which operates thousands of diesel
      vehicles, and for the state departments of transportation, which operates tens
      of thousands of diesel powered dump trucks and related highway service and
      repair vehicles, plus the tens of thousands of vehicles operated by the private
      contractors who support these agencies.





In
      addition to the foregoing, a variety of legislative and related incentive
      programs relating to alternative fuel vehicle programs have been created,
      including:





·
            Clean
                Cities Program. Created by the Department of Energy, the Clean Cities
                Program coordinates voluntary efforts between locally based government
                and
                industry to accelerate the use of alternative fuels and expand the
                alternative fuel vehicle refueling infrastructure. Grants are available
                for natural gas fueling stations and vehicle conversions to natural
                gas.





·
            Alternative
                Fuel Vehicle Credits Program. Congress created this credits program
                to
                encourage fleets to increase the number of alternative fuel vehicles
                in
                their fleets early and aggressively. Credits are allocated to state
                fleet
                operators and cover alternative fuel provider fleet operators when
                alternative fuel vehicles are acquired over and above the amount
                required,
                or earlier than expected. Since credits can be traded and sold, fleets
                have the flexibility to acquire alternative fuel vehicles on the
                most
                cost-effective schedule.





·
            State
                Energy Program. States will promote the conservation of energy, reduce
                the
                rate of growth of energy consumption, and reduce dependence on imported
                oil through the development and implementation of a comprehensive
                State
                Energy Program. The State Energy Program is the result of the
                consolidation of two Federal formula-based grant programs - the State
                Energy Conservation Program and the Institutional Conservation Program.
                The State Energy Program includes provisions for financial assistance
                for
                a number of state-oriented special project activities. These activities
                specifically include programs to accelerate the use of alternative
                transportation fuels for government vehicles, fleet vehicles, taxis,
                mass
                transit, and individuals' privately owned
                vehicles.





·
            EPA's
                Clean School Bus USA, a program designed to reduce both children's
                exposure to diesel exhaust and the amount of air pollution created
                by
                diesel school buses.





INTELLECTUAL
      PROPERTY





Our
      success depends to a great extent on our ability to protect our intellectual
      property. We license our core intellectual property pursuant to a license
      agreement (see Item 12). We rely primarily on a combination of copyright and
      trade secret protection together with the protections under the Licensing
      Agreement and nondisclosure and confidentiality agreements to establish and
      protect our proprietary rights. The patent protection afforded to our licensed
      intellectual property is uncertain and may involve complex legal and factual
      issues.





We
      license patents that relate to a universal aftermarket fuel delivery system.
      The
      delivery system is compatible with any existing mobile or stationary combustion
      engine. The delivery system can regulate any type of alternative fuel with
      any
      conventional fuel. The patents that we license contain ninety-nine claims unique
      to our commercial product.





On
      September 23, 2006 we filed a U.S. Non-Provisional Patent Application No.
      10/668,589, titled Methods and Apparatus for Operation of Multiple Fuel Engines
      . This patent embodies the electronic version of our fuel delivery
      system.





7


EMPLOYEES





As
      of
      March 31, 2007, the Company had 32 employees and one technical consultant on
      a
      full-time basis, of which 6 were engaged in research and development, 5 were
      engaged in administrative, clerical and accounting functions, 1 was engaged
      in
      sales and marketing and 20 are employed as manufacturing or assembling personnel
      at our subsidiary Automated Engineering Corporation. We believe that the
      relationship with our employees is good and we are not a party to any collective
      bargaining agreement.





**ITEM
      TWO - DESCRIPTION OF PROPERTY**





We
      lease
      a 12,000 square foot stand alone facility in PeachTree City, Georgia at the
      rate
      of $5,648 per month. During the year ended December 31, 2005, the company
      extended its lease on the PeachTree City facility through December 31, 2015.
      We
      lease a 3,334 square foot facility to house our corporate offices and
      manufacturing facilities. The rate of our corporate office lease is $6,668
      per
      month.





**ITEM
      THREE - LEGAL PROCEEDINGS**





On
      November 14, 2003, Ambac International Corporation filed a lawsuit seeking
      $109,915 together with interest at the rate of 15% per annum. The suits stems
      from a contract for delivery of certain parts for use in the manufacturing
      of
      our systems from 2002. We maintain the parts were delivered substantially past
      the date of anticipated delivery and that the parts when received were
      defective. AMBAC has rescheduled the arbitration proceedings for in excess
      of a
      year. During the first quarter, 2007, the Arbitrator awarded AMBAC a total
      of $
      259,440 including interest and court costs. We intend to vigorously appeal
      this
      award.





There
      is
      no other pending litigation or other proceedings against the
      Company.





**ITEM
      FOUR - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**





None.





**PART
      II**





**ITEM
      FIVE - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND SMALL
      BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES**





Our
      securities are traded on the OTC Electronic Bulletin Board maintained by the
      National Association for Securities Dealers, Inc. (OTCBB) under the trading
      symbol " USEI".





The
      following table sets forth representative high and low bid prices by calendar
      quarters as reported in either the OTC Bulletin Board during the last two fiscal
      years. The level of trading in the Company's common stock has been limited
      and
      the bid prices reported may not be indicative of the value of the common stock
      or the existence of an active market. The OTC market quotations reflect
      inter-dealer prices without retail markup, mark-down, or other fees or
      commissions, and may not necessarily represent actual transactions.






8





**Quarter**
            **High
                Bid**
            **Low
                Bid**First
                Quarter 2007
            $0.127
            $0.055First
                Quarter 2006
            $0.40
            $0.17Second
                Quarter 2006
            $0.43
            $0.225Third
                Quarter 2006
            $0.29
            $0.147Fourth
                Quarter 2006
            $0.165
            $0.068First
                Quarter 2005
            $0.80
            $0.60Second
                Quarter 2005
            $0.80
            $0.30Third
                Quarter 2005
            $0.18
            $0.40Fourth
                Quarter 2005
            $0.25
            $0.50





At
      December 31, 2006, we had 198,146,858 shares of our $.001 par value common
      shares issued and outstanding and as of April 10, 2007, 210,599,983, shares
      of
      our $.001 par value common shares issued and outstanding. At December 31, 2006
      we had 42,215 shares of Series A Preferred Stock (which are convertible into
      an
      aggregate of 526,304 shares of common stock), and 23,431 shares of Series B
      Preferred Stock (which are convertible into 260,344 shares of common stock)
      issued and outstanding. As of April 10, 2007, we had 42,215 shares of Series
      A
      Preferred Stock (which are convertible into an aggregate of 526,304 shares
      of
      common stock), and 23,431 shares of Series B Preferred Stock (which are
      convertible into 260,344 shares of common stock) issued and
      outstanding.





SHAREHOLDERS





As
      of
      April 10, 2007, the number of holders of record of our common stock was 130
      with
      any shares held by persons or companies in street or nominee name counted only
      under such street or nominee name.





DIVIDENDS





We
      have
      not paid any cash dividends in the past and have no present intention of doing
      so. Payment of future cash dividends will be determined from time to time by
      our
      Board of Directors, based upon our future earnings (if any), financial
      condition, capital requirements and other factors, the company is not presently
      subject to any contractual or similar restriction on its present or future
      ability to pay such dividends, except that the Company cannot pay dividends
      on
      its common stock unless a dividend is paid on the outstanding Series A and
      Series B preferred shares on an as-converted basis.





RECENT
      SALES OF UNREGISTERED SECURITIES





None.





**ITEM
      SIX - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
      OPERATION**





The
      information in this report on Form 10-KSB contains forward-looking statements
      within the meaning of the Private Securities Litigation Reform Act of 1995.
      This
      Act provides a "safe harbor" for forward-looking statements to encourage
      companies to provide prospective information about themselves provided they
      identify these statements as forward looking and provide meaningful cautionary
      statements identifying important factors that could cause actual results to
      differ from the projected results. All statements other than statements of
      historical fact made in this report are forward looking. In particular, the
      statements herein regarding industry prospects and future results of operations
      or financial position are forward-looking statements. Forward-looking statements
      reflect management's current expectations and are inherently
      uncertain.





You
      should read the following discussion and analysis in conjunction with our
      financial statements and notes thereto, included herewith. This discussion
      should not be construed to imply that the results discussed herein will
      necessarily continue into the future, or that any conclusion reached herein
      will
      necessarily be indicative of actual operating results in the future. Such
      discussion represents only the best present assessment of
      management.





9


OVERVIEW





We
      were
      incorporated in the State of Georgia in 1996 to manufacture and market retrofit
      systems for the conversion of gasoline and diesel engines, stationary or
      vehicular, to non-petroleum based fuels such as compressed natural gas and
      liquefied natural gas. We hold a worldwide exclusive license to commercialize
      the technology embodied in five issued and one pending US patent. Since 1998,
      we
      have dedicated our research and development exclusively to conversion kits
      for
      diesel-powered engines. We currently offer the HFS dual-fuel conversion system
      designed to convert medium and heavy-duty mobile diesel engines to operate
      in a
      natural gas/diesel dual-fuel mode.





During
      2006:





·
            we
                executed our Memorandum of Understanding with General Motors Thailand
                (GMTh) in support of their C190 Colorado Pick-Up Program for model
                years
                2007 through 2009. During the third and fourth quarter 2006 into
                the first
                quarter 2007, we continued durability testing and engineering analysis
                with GMTh. We completed a number of new installations for GMTh during
                the
                fourth quarter 2006 and early 2007. GMTh notified the Company during
                March
                2007 they had completed their durability testing to their satisfaction
                and
                they are now prepared to proceed by offering our dual-fuel system
                as an
                option through their dealerships beginning in
                Thailand.





·
            we
                completed the acquisition of Automated Engineering Corporation (“AEC”). We
                acquired AEC to manufacture in-house the electronic control unit
                component. The core of our system is incorporated into our electronic
                control unit. Our ability to manufacture the device in-house has
                resulted
                in a lower cost of goods and allowed us to ensure our system is
                manufactured under the highest quality standards. With the current
                equipment, machinery and facilities we now have, the Company can
                manufacture approximately 2,000 systems per month. We believe this
                provides us ample capacity to react to the potential sales we are
                pursuing.





·
            we
                executed an agreement with PS Gas Company in Thailand for the conversion
                of diesel powered buses over a five year period. During the first
                quarter
                2007, we successfully field-tested a system in a bus provided by
                PSGas in
                Thailand. The converted bus was taken on a 100 kilometer road test.
                We are
                now working with PSGas to schedule the intial roll-out of our dual-fuel
                systems through their fleet.





·
            expanded
                our exclusive fulfillment license with WITCO Intl for a host of countries
                including China, India, Malaysia, Korea and several other Asian countries.
                WITCO has now opened a field office in China and during the first
                quarter
                2007, we shipped the ten production units to WeiChai Peterson Motors
                in
                China





·
            realized
                an increase in revenues from $652,400 at the year ended December
                31, 2005
                to $1,375,418 at the year-end 2006. Our loss to operations during
                the same
                periods were $(8,261,371) for the year ended 2005 and $(11,029,040)
                for
                the year ended 2006.





Uncertainties
      and challenges





For
      2006





Our
      business model is patterned around our core dual fuel diesel to natural gas
      conversion technology and contract electronic manufacturing. Our model was
      primarily developed as a result of our operating experiences, available assets
      and our opinion of the market place in general. We highlight certain challenges
      we faced during 2005 and the fundamental adjustments we've made in developing
      our resultant business.





·
            Determined
                that pursuing the sale of our dual fuel system exclusively to government
                municipalities and direct to consumers was sufficiently inconsistent
                as to
                retard our ability to achieve profitable operations. The appeal of
                our
                product is tied directly to the price differential between diesel
                and
                natural gas. When municipalities allocate funds to convert a vehicle
                or
                fleet of vehicles, the objective is to clean up emissions and not
                necessarily to justify a return on investment. When market factors
                beyond
                our control cause the price of diesel or gasoline to temporarily
                rise in
                price elevating the differential over natural gas, we would experience
                a
                temporary increase in demand for our conversion systems. However,
                we are
                unable to predict with certainty when government funds would become
                available or when the price of fuels would take an extraordinary
                shift in
                price. As a result, while we continue to pursue both government and
                consumer sales, we are predominantly focused on delivering our technology
                through an original equipment manufacturer. In our opinion, the OEM
                tends
                to purchase an annual minimum quantity of products similar to our
                conversion system and then resells the system in tandem with their
                vehicle
                sales.








10





·
            Determined
                that engineering and code writing for systems in a mobile setting
                would
                not allow us to achieve a level of precision and repeatability essential
                to maximizing our technology. Historically, we would conduct systems
                engineering in a mobile setting. While this technique is effective,
                it is
                time consuming, expensive and susceptible to error. As a result,
                we
                entered a ten year lease at our new 12,000 square foot facility in
                December 2004 and throughout 2005 into 2006, we incurred costs of
                approximately $750,000 in construction costs and equipment purchases.
                Since November, 2005, we been developing systems in a tightly controlled
                lab setting.





·
            Shortly
                after our acquisition of AEC during June 2006, we noted a number
                of
                operating discrepancies that could have prevented us from operating
                at
                full capacity. We adjusted the methods we use in production and in
                ordering component parts. We also anticipated an upsurge in electronics
                manufacturing during the fourth quarter which is consistent with
                that
                business segment. However, given that we were the new owners of AEC
                and
                had not yet matured our own internal selling procedures, we were
                not able
                to capitalize on this annual upsurge. We have now improved our selling
                techniques and we’ve established a number of new client relationships
                which we believe will allow us to take advantage of annual sale cycles.





For
      2007





Our
      business model is centered around our core dual fuel diesel to natural gas
      conversion technology and electronic manufacturing. The following items
      highlight some of the uncertainties relating to our model. However, there could
      be additional considerations such as those included in the section marked Risk
      Factors as well our financial statements which should be evaluated.





Organizing
      varied fulfillment relationships worldwide;





Dealing
      with customers in Asia;





Rapid
      rise in natural gas and/or a decrease in diesel fuel costs;





Maintaining
      our domestic network relationships;





Manufacturing
      electronic components and parts and performing electronic design work for
      various clients in a competitive manner;





YEAR
      ENDED DECEMBER 31, 2005 COMPARED TO DECEMBER 31, 2006





The
      following depicts our year-to-year financial condition comparing 2005 to
      2006.







11





BALANCE
      SHEET





ASSETS





For
      the
      year ended December 31, 2005, the Company had current assets of $2,358,239
      and
      total assets of $3,858,816. For the year ended December 31, 2006, current assets
      decreased 9% to $2,155,692 and total assets decreased 12% to $3,394,291. The
      decrease of approximately $464,526 was primarily the result of the companies
      cash position as of December 31, 2006





LIABILITIES





For
      the
      year ended December 31, 2005, the Company had current liabilities $4,130,393
      and
      total liabilities of $4,130,393. For the year ended December 31, 2006, current
      liabilities had increased by 1% to $4,180,444 and total liabilities had been
      increased by 1% to $4,108,444. The Company converted $2,411,252 of its
      convertible debt to stock as of December 31, 2006.





STOCKHOLDERS'
      DEFICIT





For
      the
      period ended December 31, 2005, the Company had $16,997,922 in paid-in capital
      and the Company had $105,905 of common stock and a total shareholder deficit
      totaling $(271,577). For the period ended December 31, 2006, paid-in capital
      increased by approximately 60% to $27,221,863 common stock increased by 87%
      to
      $198,146 and had $(786,153) in total shareholder deficit.





STATEMENT
      OF OPERATIONS





We
      derive
      our revenues from two business segment: the sale of our dual-fuel technology
      and; the operation of our electronic manufacturing. Overall we posted revenues
      at the year ended 2006 of $1,375,418 which was a 111% increase compared to
      our
      revenues at year end 2005 of $652,400. $544,640 or approximately 40% of our
      revenues were for the sale of our technology and $830,778 or approximately
      60%
      were revenues derived from our electronic manufacturing segment. We posted
      an
      increase in gross profit of 3,857% from $10,474 at year ended 2005 to $414,457
      at December 31, 2006. 58% or $242,580 of our gross profits was attributed to
      the
      sale of our dual fuel technology and 42% or $171,877 was attributed to our
      electronic manufacturing.





Operating
      expenses for the year ended 2006 were $7,915,920 which was a 29% increase over
      our 2005 total operating expenses of $6,119,524. Non-cash losses for the year
      ended December 31, 2006 were $3,527,577 compared to $2,152,321 for the year
      ended December 31, 2005. The non-cash portion of our losses for 2006 represent
      36% of our total losses of $(11,029,040) which was a 32% increase over our
      total
      losses for the year ended December 31, 2005 of $(8,261,371).





Overall
      basic and diluted loss per share decreased from $(0.09) at the year ended
      December 31, 2005 to $(0.09) at year ended December 31, 2006.





LIQUIDITY
      AND CAPITAL RESOURCES





Previously,
      we have met our cash needs through the sale of our common stock, loans from
      our
      principals. During 2005, we completed a registration statement relating to
      a
      $5,000,000 equity line. Under the terms of our equity line, we may draw down
      up
      to $100,000 per Put. We believe our ability to utilize this registered equity
      line and financing from our principals together with proceeds from the sale
      of
      our technology provides for all our capital needs for the foreseeable
      future.





OFF
      BALANCE SHEET ARRANGEMENTS





We
      do not
      have any off balance sheet arrangements that are reasonably likely to have
      a
      current or future effect on our financial condition, revenues, results of
      operations, liquidity, capital expenditures or capital resources.








12








FACILITIES





Since
      December 2004, we have conducted our systems development and product fulfillment
      at a 12,000 square foot facility in PeachTree City, Georgia. We operate from
      our
      development facility under a ten-year lease. We house our systems engineering
      and development and inventory management and control within our PeachTree City
      location.





During
      the first quarter 2007, we relocated our executive offices and manufacturing
      facility to a 10,000 square foot location in Tampa, Florida.





**RISK
      FACTORS**





The
      Company's liquidity, capital resources, and results of operations indicate
      that
      an investment in the Company remains speculative, involves a high degree of
      risk, and should not be made by persons who cannot afford the loss of their
      entire investment. Prospective investors in the Company should carefully
      consider all of the information contained in this Report before deciding whether
      to purchase securities of the Company, and, in particular, the factors set
      forth
      below.





RISKS
      ASSOCIATED WITH OUR COMPANY





WE
      HAVE A
      HISTORY OF LOSSES AND MAY NEVER ACHIEVE PROFITABILITY.





We
      have
      incurred net losses since our inception. At December 31, 2006, our accumulated
      deficit was $(28,206,818). We anticipate that we will continue to incur
      additional operating losses in the near term. Our losses to date have resulted
      principally from expenses incurred in our research and development programs,
      including beta testing, and from general and administrative and sales and
      marketing expenses. We cannot assure you that we will attain profitability
      or,
      if we do, that we will remain profitable on a quarterly or annual basis in
      the
      future.





OUR
      LIMITED SUCCESS MAKES IT DIFFICULT TO ANALYZE OUR PROSPECTS FOR FUTURE
      SUCCESS.





We
      were
      organized on April 1, 1996 and have conducted only limited operations to date,
      consisting of negotiating the license to use the patents, further research
      and
      development, including beta testing, and limited sales efforts. No assurances
      can be given that we will develop a marketing and sales program which will
      generate significant revenues from the sales of our dual fuel conversion
      systems. The likelihood of our success must be viewed in light of the delays,
      expenses, problems and difficulties frequently encountered by an enterprise
      in
      its development stage, many of which are beyond our control. We are subject
      to
      all the risks inherent in the development and marketing of new
      products.





TECHNOLOGICAL
      CHANGE MAY MAKE OUR PRODUCTS OBSOLETE OR DIFFICULT TO SELL AT A
      PROFIT.





To
      date,
      the market for alternative fuel technology systems and equipment has not, to
      our
      knowledge, been characterized by rapid changes in technology. However, there
      can
      be no assurance that new products or technologies, presently unknown to
      management, will not, at any time in the future and without warning, render
      our
      dual fuel technology less competitive or even obsolete. Major automobile and
      truck companies, academic and research institutions, or others, for example,
      could develop new fuels or new devices which could be installed at the original
      equipment manufacturer level and which could potentially render our systems
      obsolete. Moreover, the technology upon which our dual fuel systems are based
      could be susceptible to being analyzed and reconstructed by an existing or
      potential competitor. Although the Company is the license holder of certain
      United States patents respecting its proprietary dual fuel system, we may not
      have the financial resources to successfully defend such patent, were it to
      become necessary, by bringing patent infringement suits against parties that
      have substantially greater resources than those available to us.







13




In
      addition, competitors may develop technology and systems that can be sold and
      installed at a lower per unit cost. There can be no assurance that we will
      have
      the capital resources available to undertake the research which may be necessary
      to upgrade our equipment or develop new devices to meet the efficiencies of
      changing technologies. Our inability to adapt to technological change could
      have
      a materially adverse effect on our results of operations.





WE
      LICENSE OUR PROPRIETARY TECHNOLOGY FROM A RELATED THIRD PARTY AND SUCH
      TECHNOLOGY MAY NOT BE ADEQUATELY PROTECTED FROM UNAUTHORIZED USE BY OTHERS,
      WHICH COULD INCREASE OUR LITIGATION COSTS.





Our
      success depends to a great extent on our ability to protect our intellectual
      property. We license our core intellectual property pursuant to a license
      agreement between the Company and Electronic Controls Technology LLC ("ECT").
      Our ability to compete effectively will depend in part on our ability to develop
      and maintain proprietary aspects of our technology and either to operate without
      infringing the proprietary rights of others or to obtain rights to technology
      owned by third parties. Pursuant to the License Agreement, we have licensed
      certain patents from ECT. We cannot assure you that any of our licensed
      technology rights will offer protection against competitors with similar
      technology. We cannot assure you that the patents covered by the License
      Agreement will not be challenged, invalidated or circumvented in the future
      or
      that the rights created by those patents will provide a competitive advantage.
      We also rely on trade secrets, technical know-how and continuing invention
      to
      develop and maintain our competitive position. We cannot assure you that others
      will not independently develop substantially equivalent proprietary information
      and techniques or otherwise gain access to our trade secrets.





We
      cannot
      assure you that we will not become subject to patent infringement claims and
      litigation in the United States or other countries or interference proceedings
      conducted in the United States Patent and Trademark Office to determine the
      priority of inventions. The defense and prosecution of intellectual property
      suits, interference proceedings, and related legal and administrative
      proceedings are costly, time-consuming and distracting. We may also need to
      pursue litigation to enforce any patents issued to us or our collaborative
      partners, to protect trade secrets or know-how owned by us or our collaborative
      partners, or to determine the enforceability, scope and validity of the
      proprietary rights of others. Any litigation or interference proceeding will
      result in substantial expense to us and significant diversion of the efforts
      of
      our technical and management personnel. Any adverse determination in litigation
      or interference proceedings could subject us to significant liabilities to
      third
      parties. Further, as a result of litigation or other proceedings, we may be
      required to seek licenses from third parties which may not be available on
      commercially reasonable terms, if at all.





WE
      HAVE
      LIMITED MANUFACTURING EXPERIENCE AND WILL RELY UPON THIRD PARTY CONTRACT
      MANUFACTURERS WHO HAVE NOT YET BEEN CONTRACTUALLY SECURED





To
      be
      successful, we must manufacture, or contract with a third party for the
      manufacture of, our current and future products in sufficient quantities and
      on
      a timely basis, while maintaining product quality and acceptable manufacturing
      costs. Should we not timely secure a contract manufacturer, or for some reason
      we are no longer able to obtain key elements from a supplier, we will not be
      able to produce or will be delayed in producing conversion systems for sale
      or
      distribution, which could cause delays in our operation or sales or make
      continued operation or sales unprofitable.





THE
      SALE
      OF OUR FUEL 2(TM) SYSTEM MUST BE CONJUNCTION WITH COMPONENTS WE DO NOT OFFER





The
      conversion of a medium or heavy-duty mobile diesel engine requires three primary
      components: (i) our conversion system; (ii) fuel storage tanks, and; (iii)
      a
      specialized catalytic converter (for sales as an Emission Control Device).
      While
      we can control the pricing and delivery of our systems, we have no control
      over
      pricing, availability or delivery of fuel storage tanks or specialized catalytic
      converters. The costs of these items can potentially prevent us from selling
      our
      system either because the costs of these additional components make the
      conversion of a vehicle uneconomical or the due to lack of availability of
      either additional component. We believe fuel storage tanks are readily available
      on the open market at prices that will allow us to commercialize our system
      and
      we believe the specialized catalytic converters can be likewise acquired on
      the
      open market at prices that will allow us to commercialize our system. However,
      there can be no assurance given that our customers will be able to acquire
      these
      components at prices that permit us to sell our system as a fuel savings device
      because the upfront costs to acquire and install these components.





14


THE
      LIMITED AVAILABILITY OF ALTERNATIVE FUELS CAN HINDER OUR ABILITY TO MARKET OUR
      PRODUCTS.





Alternative
      fuel engines have been commercially available in the past; however, the most
      significant impediment to the growth in the market for alternative fuel vehicles
      traditionally has been the limited availability of alternative fuel sources,
      such as natural gas and propane. The success of engines based on alternative
      fuels will probably be directly affected by the development of the
      infrastructure of the natural gas industry and the widespread availability
      of
      such fuel sources. To some degree, this problem will remain at the forefront
      of,
      and be an impediment to, the success of alternative fuel power sources. However,
      we believe that with the development of the dual fuel conversion system,
      vehicles will not be tied exclusively to alternative fuels, but will have the
      option and ability to operate on standard diesel fuel alone. In all events,
      our
      business and the market for alternative fuel vehicles would benefit
      substantially from the growth of the infrastructure of the natural gas industry
      and the more widespread availability of alternative fuels. Conversely, our
      business and the market for alternative fuel vehicles would be substantially
      hurt by a diminished or lack of growth of the infrastructure of the natural
      gas
      industry and the less widespread availability of alternative fuels.





THE
      NATURE OF OUR PRODUCTS SUBJECTS US TO PRODUCT LIABILITY RISKS.





Our
      product and services relate to fuel system components which handle or come
      into
      contact with natural gas which is highly combustible. A malfunction of or design
      defect in certain of our products or improper design, construction, installation
      or servicing of facility and equipment infrastructure could result


in
      liability, tort or warranty claims. Although we attempt to reduce the risk
      of
      exposure from such claims through warranty disclaimers and liability limitation
      clauses in our sales agreements and by maintaining product liability insurance,
      we cannot assure you that these measures will be effective in limiting our
      liability for any damages. Any liability for damages resulting from product
      malfunctions or services provided could be substantial and could have a material
      adverse effect on our business and operating results. In addition, a
      well-publicized actual or perceived malfunction or impropriety involving our
      products or service could adversely affect the market's perception of our
      products in general, regardless of whether any malfunction or impropriety is
      attributable to our products or services. This could result in a decline in
      demand for our products and services, which would have a material adverse effect
      on our business and operating results.





COMPETITION
      FROM COMPANIES WITH ALREADY ESTABLISHED MARKETING LINKS TO OUR POTENTIAL
      CUSTOMERS MAY ADVERSELY EFFECT OUR ABILITY TO MARKET OUR PRODUCTS.





Current
      and potential competitors have longer operating histories, larger customer
      bases, greater brand name recognition and significantly greater financial,
      marketing and other resources than we have. Certain of our competitors may
      be
      able to secure product from vendors on more favorable terms, devote greater
      resources to marketing and promotional campaigns, and adopt more aggressive
      pricing or inventory availability policies, than we will. There can be no
      assurance that we will be able to compete successfully against current and
      future competitors, and competitive pressures faced by us are likely to have
      a
      materially adverse affect on our business, results of operations, financial
      condition and prospects.





RISKS
      ASSOCIATED WITH OUR SECURITIES





UNLESS
      AN
      ACTIVE PUBLIC TRADING MARKET DEVELOPS FOR OUR SECURITIES, YOU MAY NOT BE
      ABLE
      TO SELL YOUR SHARES





To
      date,
      there has been a very limited public market for our Common Stock. There can
      be
      no assurance that an active trading market will ever develop or, if developed,
      that it will be maintained. Failure to develop or maintain an active trading
      market could negatively affect the price of our securities.







15





OUR
      COMMON STOCK MAY BE SUBJECT TO PENNY STOCK REGULATION.





The
      Securities Enforcement and Penny Stock Reform Act of 1990 requires special
      disclosure relating to the market for penny stocks in connection with trades
      in
      any stock defined as a "penny stock". Securities Exchange Commission
      ("Commission") regulations generally define a penny stock to be an equity
      security that has a market price of less than $5.00 per share. These regulations
      subject all broker-dealer transactions involving such securities to the special
      "Penny Stock Rules" set forth in Rule 15g-9 of the Securities Exchange Act
      of
      1934 (the "34 Act"). These Rules affect the ability of broker-dealers to
      sell


the
      Company's securities and also may affect the ability of purchasers of the
      Company's common stock to sell their shares in the secondary market, if such
      a
      market should ever develop.





WE
      MAY
      ISSUE PREFERRED STOCK WITH CERTAIN PREFERENCES WHICH MAY DEPRESS MARKET PRICE
      OF
      THE COMMON STOCK.





The
      Board
      of Directors may designate additional series or classes of preferred shares
      without shareholder consent and those designations may give the holders of
      the
      preferred stock, if previously issued, voting control and other preferred rights
      such as to liquidation and dividends. The authority of the


Board
      of
      Directors to issue such stock without shareholder consent may have a depressive
      effect on the market price of our common stock even prior to any such
      designation or issuance of preferred stock.




















**The
      remainder of this page intentionally left blank**







16


**ITEM
      SEVEN - FINANCIAL STATEMENTS**


**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**








Board
      of
      Directors


U.S.
      Energy Initiatives Corporation





We
      have
      audited the accompanying consolidated balance sheets of U. S. Energy Initiatives
      Corporation and Subsidiaries as of December 31, 2006 and 2005 and the related
      consolidated statements of operations, changes in shareholders’ equity, and cash
      flows for the years then ended. These consolidated financial statements are
      the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these financial statements based on our audits.





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





The
      Company is not required to have, nor were we engaged to perform, an audit of
      its
      internal control over financial reporting. Our audit included consideration
      of
      internal control over financial reporting as a basis for designing audit
      procedures that are appropriate in the circumstances, but not for the purpose
      of
      expressing an opinion on the effectiveness of the Company’s internal control
      over financial reporting. Accordingly, we express no such opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of U. S. Energy
      Initiatives Corporation and Subsidiaries as of December 31, 2006 and 2005 and
      the consolidated results of operations and cash flows for the years ended
      December 31, 2006 and 2005, in conformity with accounting principles generally
      accepted in the United States of America.








*/s/
      BRIMMER, BUREK & KEELAN LLP*





Brimmer,
      Burek & Keelan LLP





Tampa,
      Florida


April
      26,
      2007









17




**US
      ENERGY INITIATIVES CORPORATION**




**CONSOLIDATED
      BALANCE SHEETS**




**FOR
      THE YEARS ENDED DECEMBER 31, 2006 AND 2005**


2006
              
              2005ASSETSCurrent
                  AssetsCash
              
              $
              3,937
              
              $
              818,557Accounts
                  Receivable, net of $72,800 and $12,000allowance
                  in 2006 and 2005, respectively.
              
              $
              300,163
              
              $
              370,777Other
                  assets
              
              $
              2,510
              
              $Prepaid
                  expenses and deposits
              
              $
              46,060
              
              $
              32,286Inventories
              
              $
              634,315
              
              $
              162,690Deferred
                  consulting
              
              $
              147,000
              
              $
              576,258Deferred
                  debt costs
              
              $
              1,021,707
              
              $
              397,671Total
                  current assets
              
              $
              2,155,692
              
              $
              2,358,239Property
                  Plant & Equipment, net
              
              $
              554,722
              
              $
              565,415Goodwill
              
              $
              -
              
              $
              61,820Purchase
                  Price subject to allocation
              
              $
              683,877
              
              $
              -Intellectual
                  property certifications, net of $365,514 and273,583
                  amortization, respectively
              
              $
              -
              
              $
              873,342Total
                  Assets
              
              $
              3,394,291
              
              $
              3,858,816LIABILITIES
                  AND STOCKHOLDERS' DEFICITCurrent
                  AssetsAccounts
                  Payable
              
              $
              972,016
              
              $
              526,001Accounts
                  Payable in settlement
              
              $
              259,440
              
              $
              109,868Due
                  to related parties
              
              $
              214,849
              
              $
              176,540Due
                  to related parties, convertible debt
              
              $
              11,424
              
              $
              1,080,752Notes
                  payable
              
              $
              2,079,869
              
              $
              1,630,293Discount
                  on Debt
              
              $
              (82,231
              )
              $
              (650,630
              )Derivative
                  liability
              
              $
              77,046
              
              $
              841,010Other
                  Current Liabilities
              
              $
              648,031
              
              $
              416,559Total
                  liabilities
              
              $
              4,180,444
              
              $
              4,130,393SHAREHOLDERS'
                  DEFICITPreferred
                  Stock (.01 par value, 5,000,000 and 996,778authorized,
                  respectively)Preferred
                  A stock ( 42,215 shares issued and outstanding)
              
              $
              422
              
              $
              422Preferred
                  B stock (23,431 and 195,209 shares issuedand
                  outstanding, respectively)
              
              $
              234
              
              $
              1,952Common
                  stock (.001 par value; 295,000,000 sharesauthorized
                  198,146,858 and 105,905,433 sharesissued
                  and outstanding, respectively)
              
              $
              198,146
              
              $
              105,905Additional
                  paid-in capital
              
              $
              27,221,863
              
              $
              16,997,922Deferred
                  compensation
              
              $
              -
              
              $
              (200,000
              )Accumulated
                  deficit
              
              $
              (28,206,818
              )
              $
              (17,177,778
              )Total
                  shareholders' deficit
              
              $
              (786,153
              )
              $
              (271,577
              )Total
                  liabilities and shareholders' deficit
              
              $
              3,394,291
              
              $
              3,858,816








18







**US
      ENERGY INITIATIVES CORPORATION**




**CONSOLIDATED
      STATEMENTS OF OPERATIONS**




**FOR
      THE YEARS ENDED DECEMBER 31, 2006 AND 2005**





2006
            
            2005RevenuesRevenues
                from product sales and related income
            
            $
            1,375,418
            
            $
            652,400Cost
                of product sales
            
            $
            960,961
            
            $
            641,926Gross
                Profit
            
            $
            414,457
            
            $
            10,474ExpensesOperating
                expensesConsulting
                and professional fees
            
            $
            1,885,184
            
            $
            952,464Research
                & development
            
            $
            93,313
            
            $
            113,658Compensation
            
            $
            3,990,828
            
            $
            1,333,515Amortization
                & Depreciation
            
            $
            182,642
            
            $
            319,119Loss
                on impairment of goodwill
            
            $
            61,820
            
            $Loss
                on impairment of intangibles
            
            $
            781,412
            
            $
            2,724,738Rent
            
            $
            193,965
            
            $
            77,481Insurance
            
            $
            259,406
            
            $
            69,992Licenses
            
            $
            2,341
            
            $
            257,312Other
                operating expenses
            
            $
            465,009
            
            $
            271,245Total
                expenses
            
            $
            7,915,920
            
            $
            6,119,524Loss
                from operations
            
            $
            (7,501,463
            )
            $
            (6,109,050
            )Other
                Expenses (income)Settlements
            
            $
            149,572
            
            $
            -Interest
                expense
            
            $
            3,909,658
            
            $
            2,607,526Gain
                on extinguishment of debt
            
            $
            (162,557
            )
            $
            -Other
                income
            
            $
            1,175
            
            $
            -Derivative
                Gain
            
            $
            (370,271
            )
            $
            (455,205
            )(Income)
                loss from other expenses
            
            $
            3,527,577
            
            $
            2,152,321Net
                loss
            
            $
            (11,029,040
            )
            $
            (8,261,371
            )Basic
                and diluted loss per share
            
            $
            (0.09
            )
            $
            (0.09
            )Basic
                and diluted weighted average number ofcommon
                shares outstanding
            
            
            121,737,383
            
            
            88,909,988













19


**US
      ENERGY INITIATIVES CORPORATION**




**CHANGES
      IN STOCKHOLDERS' EQUITY**




**FOR
      THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004**











Preferred
                Stock Series
            
            
            Common
                StockShare
            
            
            Amount
            
            
            Share
            
            
            AmountA
            
            
            A
            
            
            B
            
            
            B
            
            
            Shares
            
            
            AmountBalance
              12/31/04
            
            
            42,215
            
            $
            422
            
            
            195,209
            
            $
            1,952
            
            
            65,509,843
            
            $
            65,510Common
                Stock IssuedBonus
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            400,000
            
            $
            400Professional
                Services
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,778,000
            
            $
            3,777Conversion
                of Notes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            22,808,506
            
            $
            22,808Warrants
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            15,000
            
            $
            15Conversion
                onRelated
                Party AdvanceDiscounts
                of DebtStock
                for acquisition
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            11,752,903
            
            $
            11,752Amortization
                of deferredcompensationStock
                for conversions
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            45,000
            
            $
            45Shares
                issued with finance
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,598,181
            
            $
            1,598Net
                LossBalance
              12/31/05
            
            
            42,215
            
            $
            422
            
            
            195,209
            
            $
            1,952
            
            
            105,905,433
            
            $
            105,905Stock
                Issued ForBonus
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,600,000
            
            $
            1,600Professional
                Services
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,874,313
            
            $
            3,874Conversion
                of Notes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            11,155,312
            
            $
            11,155Conversion
                onrelated
                party advanceStock
                for acquisition
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            5,510,000
            
            $
            5,510Amortization
                of deferred
              compensationConvertible
                debt
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            60,243,800
            
            $
            60,244Shares
                issued with finance
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            7,858,000
            
            $
            7,858Conversion
                of series B
            
            
            
            
            
            
            
            
            (171,778
            )
            
            (1,718
            )
            
            2,000,000
            
            $
            2,000Preferred
                StockNet
                LossBalance
              12/31/06
            
            
            42,215
            
            
            422
            
            
            23,431
            
            
            234
            
            
            198,146,858
            
            $
            198,146









20


**US
      ENERGY INITIATIVES CORPORATION**


**CHANGES
      IN STOCKHOLDERS' EQUITY (continued)**




**FOR
      THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004**





Paid-In
            
            Accum
            
            Deferred
            
            Shareholders'Capital
            
            Deficit
            
            Comp
            
            DeficitBalance
              12/31/04
            
            $
            8,677,270
            
            $
            (8,916,407
            )
            $
            (500,000
            )
            $
            (671,253
            )Common
                Stock IssuedBonus
            
            $
            168,685
            
            
            
            
            
            
            
            $
            169,085Professional
                Services
            
            $
            802,054
            
            
            
            
            
            
            
            $
            805,830Conversion
                of Notes
            
            $
            928,712
            
            
            
            
            
            
            
            $
            951,520Warrants
            
            $
            135
            
            
            
            
            
            
            
            $
            150Conversion
                onRelated
                Party Advance
            
            $
            1,967,092
            
            
            
            
            
            
            
            $
            1,967,092Discounts
                of Debt
            
            $
            937,401
            
            
            
            
            
            
            
            $
            937,401Stock
                for acquisition
            
            $
            3,514,118
            
            
            
            
            
            
            
            $
            3,525,871Amortization
                of deferredcompensation
            
            
            
            
            
            
            
            $
            300,000
            
            $
            300,000Stock
                for conversions
            
            $
            2,455
            
            
            
            
            
            
            
            $
            2,500Shares
                issued with finance
            
            
            
            
            
            
            
            
            
            
            $
            1,598Net
                Loss
            
            
            
            
            $
            (8,261,371
            )
            
            
            
            $
            (8,261,371
            )Balance
              12/31/05
            
            $
            16,997,922
            
            $
            (17,177,778
            )
            $
            (200,000
            )
            $
            (271,577
            )Stock
                Issued ForBonus
            
            $
            346,400
            
            
            
            
            
            
            
            $
            348,000Professional
                Services
            
            $
            774,504
            
            
            
            
            
            
            
            $
            778,378Conversion
                of Notes
            
            $
            2,107,782
            
            
            
            
            
            
            
            $
            2,118,937Conversion
                onrelated
                party advance
            
            $
            1,276,339
            
            
            
            
            
            
            
            $
            1,276,339Stock
                for acquisition
            
            $
            1,509,740
            
            
            
            
            
            
            
            $
            1,515,250Amortization
                of deferred
              compensation$
            200,000
            
            $
            200,000Convertible
                debt
            
            $
            2,351,008
            
            
            
            
            
            
            
            $
            2,411,252Shares
                issued with finance
            
            $
            1,858,168
            
            
            
            
            
            
            
            $
            1,866,026Conversion
                of series B
            
            
            
            
            
            
            
            
            
            
            $
            282Preferred
                StockNet
                Loss
            
            
            
            
            $
            (11,029,040
            )
            
            
            
            $
            (11,029,040
            )Balance
              12/31/06
            
            $
            27,221,863
            
            $
            (28,206,818
            )
            
            
            
            $
            $
                (786,153
            )










21


**US
      ENERGY INTIATIVES CORPORATION**




**Statement
      of Cash Flows**




**for
      the years ended December 31, 2006 and 2005**








2006
            
            2005CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                loss
            
            $
            (11,029,040
            )
            $
            (8,261,371
            )Common
                stock issued for services and compensation
            
            $
            2,501,379
            
            $
            324,799Depreciation
            
            $
            90,711
            
            $
            45,536Amortization
                of deferred compensation
            
            $
            200,000
            
            $
            300,000Amortization
                of debt discount and
            
            $
            2,477,889deferred
                debt cost
            
            
            
            
            $
            297,096Amortization
                of deferred consulting
            
            $
            681,258
            
            $
            39,742Impairment
                of intangibles
            
            $
            843,232
            
            $
            2,724,738Amortization
                of intangibles
            
            $
            91,931
            
            $
            273,583Conversion
                benefit on related party advance
            
            $
            1,276,339
            
            $
            1,967,092Gain
                on extinguishment of debt
            
            $
            (162,557
            )Derivative
                Income or expense
            
            $
            (370,271
            )
            $
            (220,827
            )Change
                in operating assets and liabilitiesAccounts
                receivable
            
            $
            203,970
            
            $
            (218,447
            )Inventory
            
            $
            (319,549
            )
            $
            (78,635
            )Prepaid
                and deposits
            
            $
            (20,489
            )
            $
            (24,440
            )Other
                assets
            
            $
            (200
            )Accounts
                payable
            
            $
            286,517
            
            $
            356,921Related
                party payable
            
            
            
            
            $
            169,343Accrued
                liabilities & other current liabilities
            
            $
            352,370
            
            $
            165,534Net
                cash provided (used) by operating activities
            
            $
            (2,896,510
            )
            $
            (2,139,336
            )Cash
                flows from Investing ActivitiesPurchase
                of property and equipment
            
            $
            (48,582
            )
            $
            (541,504
            )Business
                acquisition
            
            $
            (292,635
            )
            $
            (200,000
            )Cash
                acquired in business acquisition
            
            $
            63,049
            
            
            -Net
                cash provided (used) by investing activities
            
            $
            (278,168
            )
            $
            (741,504
            )Cash
                flows from Financing ActivitiesLoans
                from related party
            
            $
            1,334,424
            
            $
            1,967,092Payment
                to related parties
            
            $
            (166,040
            )
            $
            -Payments
                on notes payable
            
            $
            (1,257,372
            )
            $
            (61,184
            )Payments
                on accounts payable in settlement
            
            
            -
            
            $
            (40,000
            )Payments
                on tax settlements
            
            $
            -
            
            $
            (58,536
            )Procededs
                from convertible debt
            
            $
            -
            
            $
            1,889,850Proceeds
                from notes payable
            
            $
            2,449,046
            
            $
            -Proceeds
                from sale of common stock
            
            $
            -
            
            $
            150Net
                cash provided (used) by financing activities
            
            $
            2,360,058
            
            $
            3,697,372Net
                decrease in cash and cash equivalents
            
            $
            (814,619
            )
            $
            816,532Beginning
                cash and cash equivalents
            
            $
            818,557
            
            $
            2,025Ending
                cash and cash equivalents
            
            $
            3,937
            
            $
            818,557





22







**US
      ENERGY INTIATIVES CORPORATION**


**Statement
      of Cash Flows (continued)**


**for
      the years ended December 31, 2006 and 2005**











Supplemental
                Disclosure of Cash Flow InformationCash
                Paid during the year for interest
            
            $
            50,256
            
            $
            37,614Cash
                Paid during the year for income taxes
            
            $
            -
            
            $
            -Common
                stock issued for services
            
            $
            2,501,379
            
            $
            616,000Common
                stock issued for reduction in debt
            
            $
            2,118,937
            
            $
            89,030Common
                stock issued for conversion of convertible note
            
            $
            2,411,252
            
            $
            954,074Common
                stock issued as debt discount
            
            $
            366,026
            
            $
            285,000Common
                stock issued as debt costs
            
            $
            1,500,000
            
            $
            -Amortization
                of Common stock issued for deferred compensation
            
            $
            200,000
            
            $
            -Common
                stock issued for acquisition
            
            $
            140,250
            
            $
            3,525,871
























**The
      remainder of this page intentionally left blank**













23


US
      ENERGY
      INITIATIVES CORPORATION


(formerly
      Hybrid Fuel Systems, Inc.)


NOTES
      TO
      CONSOLIDATED FINANCIAL STATEMENTS


DECEMBER
      31, 2005 AND 2006





NOTE
      1
      NATURE OF BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
      POLICIES





*Basis
      of presentation:*





The
      financial statements of U.S. Energy Initiatives, Corporation and its
      subsidiaries (“the Company”) that are included  have been prepared in
      accordance with accounting principles generally accepted in the United States
      of
      America, and include all the necessary adjustments to fairly present the results
      of the periods presented.





*Nature
      of business*





US
      Energy
      Initiatives Corporation (formerly Hybrid Fuel Systems, Inc.) (the "Company.")
      a
      Georgia Corporation formed in 1996 manufactures retrofit systems for the
      conversion of diesel engines to non-petroleum based fuels such as compressed
      natural gas. The Company manufactures and sells its systems to customers
      pursuant to a license agreement originally acquired on June 1, 1996 and again
      on
      August 31, 2004 with a related party. The Company has exclusive world-wide
      rights to all things which result from five issued and one pending U.S.
      Patent.





Automated
      Engineering Corporation a subsidiary of US Energy Initiatives specializes in
      electronic design and product manufacturing of electronic assemblies. Automated
      Engineering is an ISO-9001 certified manufacturer. Automated is currently
      manufacturing the boards for U.S. Energy Initiatives dual fuel systems.





*Cash
      and Cash Equivalents*





For
      purposes of the statement of cash flows, the Company considers all highly liquid
      debt instruments purchased with a maturity of three months or less to be cash
      equivalents.





*Accounts
      Receivable*





Accounts
      receivable, are stated at estimated net realizable value. Accounts receivable
      are comprised of balances due from customers. In determining collectibility,
      historical trends are evaluated and specific customer issues are reviewed to
      arrive at appropriate allowances.





*Inventories*





Inventories,
      are stated at the lower of cost or market. Cost is determined using the
      first-in, first-out method. Inventories consist of component parts used in
      the
      manufacture and assembly of retrofit systems for the conversion of gasoline
      and
      diesel engines to non-petroleum based fuels such as compressed natural gas
      and
      the electronic components used for a host of Automated Engineerings product
      lines.





*Property,
      Plant and Equipment*





Depreciation
      is provided for using the straight-line method, in amounts sufficient to relate
      the cost of depreciable assets to operations over their estimated service lives
      (asset categories range from three to seven years). Leasehold improvements
      are
      amortized using the straight-line method over the lives of the respective leases
      or the service lives of the improvements, whichever is shorter. Leased equipment
      under capital leases is amortized using the straight-line method over the lives
      of the respective leases or over the service lives of the assets for those
      leases that substantially transfer ownership. Accelerated methods are used
      for
      tax depreciation.










24





*Goodwill
      and other Intangible Assets*





The
      company accounts for goodwill and other intangible assets in accordance with
      the
      Statement of Financial Accounting Standards “Goodwill and Other Intangibles”
(SFAS 142), intangible assets with an indefinite life, namely goodwill, are
      not
      amortized. Intangible assets with a definite life are amortized on a
      straight-line basis over their estimated useful lives of ten years. Intangible
      assets with indefinite lives will be tested for impairment annually and will
      also be reviewed for impairment between annual tests, should an event occur
      or
      should circumstances change that would indicate that the carrying amount ,may
      be
      impaired.





*Impairment
      of Assets*





In
      accordance with Statement of Financial Accounting Standards No. 144 “Accounting
      for Impairment or Disposal of long -lived Assets” (“SFAS 144”) long-lived
      assets, such as property and equipment, and purchased intangibles subject to
      amortization, are reviewed for impairment whenever events or changes in
      circumstances indicate that the carrying amount of an asset may not be
      recoverable. When factors indicate that the assets should be evaluated for
      possible impairment, the company uses an estimate of related non discounted
      cash
      flows. A deficiency in these cash flows relative to the carrying amounts is
      an
      indication of the need for a write-down due to impairment. Losses on impairment
      are recognized by a charge to earnings. Factors considered in the valuation
      include current operating results, trends and anticipated undiscounted future
      cash flows.





*Income
      Taxes*





The
      Company utilizes the guidance provided by Statement of Financial Accounting
      Standards No. 109, " Accounting for Income Taxes." (SFAS 109). Under the
      liability method specified by SFAS 109, deferred tax assets and liabilities
      are
      determined based on the difference between the financial statement and tax
      bases
      of assets and liabilities as measured by the enacted tax rates which will be
      in
      effect when these differences reverse. Deferred tax expense is the result of
      changes in deferred tax assets and liabilities. Valuation allowances are
      provided if necessary to reduce deferred tax assets to the amount expected
      to be
      realized.





*Earnings
      (Loss) Per Common Share*





Earnings
      (loss) per share are computed using the basic and diluted calculations on the
      face of the statement of operations. Basic earnings (loss) per share are
      calculated by dividing net income (loss) by the weighted average number of
      shares of common stock outstanding for the period. Diluted earnings (loss)
      per
      share is calculated by dividing net income (loss) by the weighted average number
      of shares of common stock outstanding for the period, adjusted for the dilutive
      effect of common stock equivalents, using the treasury stock method. The
      warrants outstanding were determined to be antidilutive and therefore do not
      affect earnings per share.





*Use
      of Accounting Estimates*





The
      preparation of financial statements in conformity with generally accepted
      accounting principles, requires management to make estimates and assumptions
      that affect the reported amounts of assets and liabilities and disclosures
      of
      contingent assets and liabilities at December 31, 2006 and 2005, as well as
      the
      reported amounts of revenues and expenses for the years then ended. The actual
      results of the estimates could differ materially from the estimates and
      assumptions made in the preparation of the financial statements.







25


*Revenue
      Recognition*





In
      the
      sale of our dual-fuel conversion systems, if we install the system, revenues
      are
      recognized when the finished vehicle is retrieved by the customer. If our system
      is installed by a third-party, we recognize revenues on our systems and
      components when the merchandise is shipped to the customer, which is when title
      and risk of loss has passed to the customer.





In
      the
      sale of our custom electronic manufacturing products and services, we recognize
      revenues when the merchandise is shipped to the customer, which is when title
      and risk of loss has passed to the customer.





*Stock
      Based Compensation*





The
      Company has adopted SFAS No. 123R “Accounting for Stock Based compensation” as
      of January 1, 2006.. For the period ended December 31, 2005, the Company applied
      Accounting Principles Board Opinion No. 25 and related interpretations in
      accounting for options issued to employees. Under Opinion No. 25, the intrinsic
      method is used to determine compensation expense when the fair market value
      of
      the stock exceeds the exercise price on the date of grant. As of December 31,
      2006 and 2005, no options had been granted under the plan and therefore no
      compensation expense has been recognized.





*Research
      and Development Costs*





The
      Company charges research and development costs to expense as
      incurred.





*Fair
      Value of Financial Instruments*





The
      Company, in estimating its fair value disclosures for financial instruments,
      uses the following methods and assumptions:





·
            Cash,
                Accounts Receivable, Accounts Payable and Accrued Expenses: The carrying
                amounts reported in the balance sheet for cash, accounts receivable,
                accounts payable and accrued expenses approximate their fair value
                due to
                their relatively short maturity.





·
            Long-Term
                Obligations: The fair value of the Company's fixed-rate long-term
                obligations is estimated using discounted cash flow analyses, based
                on the
                Company's current incremental borrowing rates for similar types of
                borrowing arrangements. At December 31, 2006 and 2005, the Company
                did not
                have any long-term obligations.





*Accounting
      For Financial Instruments*





In
      May
      2003, the FASB issued Statement of financial Accounting Standards No. 150,
      "Accounting for Certain Financial Instruments with Characteristics of Both
      Liabilities and Equity" (SFAS 150). SFAS 150 requires that certain financial
      instruments, which under previous guidance were accounted for as equity, must
      now be accounted for as liabilities. The financial instruments affected include
      mandatory redeemable stock, certain financial instruments that require or may
      require the issuer to buy back some of its shares in exchange for cash or other
      assets and certain obligations that can be settled with shares of stock. SFAS
      150 is effective for all financial instruments entered into or modified after
      May 31, 2003, and otherwise is effective at the beginning of the first interim
      period beginning after June 15, 2003.





The
      Company adopted SFAS 150 and its related adoption provisions as reflected and
      as
      applicable to the April 1, 2005 convertible term note transaction with Alpha
      Capital, the convertible term note transaction dated November 22, with Dutchess
      Private Equities Fund, and the executed warrant dated November 8,
      2005.










26








*Principles
      of Consolidation*





The
      consolidated financial statements for the years ended December 31, 2006 and
      2005
      include the accounts of U.S. Energy Initiatives and its subsidiaries DRV Energy
      and Automated Engineering (collectively the "Company") . Significant
      intercompany balances and transactions have been eliminated in
      consolidation.





Going
      Concern:





The
      accompanying financial statements have been prepared assuming the Company will
      continue as a going concern. As reflected in the financial statements, the
      Company has negative working capital for the year ended December 31, 2006 and
      a
      loss from operations for the year 2006. These conditions raise substantial
      doubt
      about the Company's ability to continue as a going concern.





The
      Company has maintained an agreement with a certain accredited investor relating
      to a $5,000,000 equity line which was registered with the Securities and
      Exchange Commission and declared effective during December 2005. Under the
      terms
      of the equity line, the Company may draw  up to $100,000 per Put.





The
      company also has an agreement in place with White Knight a Related Party who
      continues to provide financing to date.





The
      Company believes that with 2007 sales and the available funding from the
      financing agreements it will be sufficient for the Company to continue
      operations for the next year.





NOTE
      2
      OPERATING LEASES





Rent
      expense for the years ended December 31, 2006 and 2005 was $193,965 and ,
      $77,481 respectively.





During
      the first quarter 2007, the Company entered a 5 year lease for a 10,000 square
      foot facility which houses our executive offices and manufacturing facility.
      The
      monthly base rental expense is $7,832.50 and the lease expires on February
      29,
      2012. The Company is required to pay the landlord monthly an estimated
      proportionate share of operating expenses. In addition to its monthly
      rent.





The
      company also has a lease for its research and development facility in Peachtree
      City, Georgia which was extended in 2005 to a ten year ter expiring on December
      31, 2015





For
      the
      year ended December 31, 2006 the company leased 3,334 office space in Tampa,
      Florida that was guaranteed by a related party. This office space has been
      occupied by the related party for 2007 and the company has no currently
      liability for the space.





The
      following is a schedule by years of the future minimum lease payments under
      these operating leases:




December
                31,2007
            
            $
            158,9972008
            
            $
            167,0952009
            
            $
            170,9802010
            
            $
            175,0212010
              and there after
            
            $
            519,106Total
              minimum lease payments
            
            $
            1,191,199






27




NOTE
      3
      RELATED PARTY TRANSACTIONS





License
      Agreement





The
      Company entered into a licensing agreement collectively with Frank Davis (a
      significant stockholder and consultant) and Engine Control Technology LLC (ECT).
      The license gives the Company the exclusive world-wide rights, to utilize and
      exploit five issued and one pending patents including marketing and selling
      products. The underlying patents were developed by Frank Davis and other family
      members who are employees of the Company and have since been assigned to ECT,
      the owner of which is Patricia Davis. Patricia Davis is the wife of Frank Davis
      our Chief Technical Consultant.





In
      addition, the Company has a consulting agreement with Frank Davis to provide
      various technical consulting services. The agreement expires in 2009 but is
      automatically renewable annually thereafter, if not terminated by written
      notice. During the term of the agreement, the consultant shall receive health
      and dental insurance for himself and his immediate family which includes his
      wife, the use of a vehicle and reimbursement of certain related
      expenses.





White
      Knight is a major stockholder and has officers who serve in management positions
      for the company. Per our agreement with WK, any funding provided by WK is to
      be
      repaid in common shares of stock at a conversion price of $0.04 per share.
      The
      conversion price was agreed upon in December, 2003, when the Company’s stock was
      at $0.03 per share. During the year ended December 31, 2006 an outstanding
      note
      payable was paid in full by a significant shareholder. The Company has recorded
      a liability to the shareholder for the amount paid.





NOTE
      4
      PROPERTY, PLANT AND EQUIPMENT, NET





At
      December 31, 2006and 2005, property, plant and equipment, net consist of the
      following:




2006
            
            2005Machinery
                and Equipment
            
            $
            461,564
            
            $
            401,187Furniture,
                Fixtures and Equipment
            
            $
            63,407
            
            $
            44,562Vehicles
            
            $
            41,335
            
            $
            41,335Leasehold
                Improvements
            
            
            222,588
            
            
            231,009Less
                accumulated depreciation and amortization
            
            $
            (234,172
            )
            $
            (152,678
            )Total
            
            $
            554,722
            
            $
            565,415




Depreciation
      expense charged to operations was $90,711 and $ 45,536 for the years ended
      December 31, 2006 and 2005, respectively.





NOTE
      5
      GOODWILL, NET





At
      December 31, 2006 and 2005, goodwill, consists of the following:





2006
            
            2005Goodwill
            
            $
            61,820
            
            $
            61,820Less
                accumulated amortization
            
            $
            0
            
            $
            0Less
                Impairment
            
            $
            (61,820
            )
            $
            0Total
            
            $
            0
            
            $
            61,820





Goodwill
      was analyzed on December 31, 2006 for impairment as it has an indeterminant
      life. Based on the Company's analysis performed, an impairment loss of $61,820
      was required to be recorded during the years ended December 31, 2006.





The
      impairment was determined in part by the company closing its Oklahoma Facility
      acquired with the DRV Energy Acquisition. The facility performed installation
      and service of gasoline conversion systems and sold various parts relating
      to
      these and other conversion systems. After reviewing the operations of the
      facility, management made an economical and financial decision to close our
      Oklahoma facility.





28


NOTE
      6
      INTANGIBLE ASSETS, NET





As
      of
      December 31, 2005 and 2006, intangible assets, net, consist of the
      following:





2006
            
            2005Intellectual
                Property - Certifications
            
            $
            873,342
            
            $
            1,146,925Less
                accumulated amortization
            
            $
            (91,931
            )
            $
            (273,583
            )Less
                Impairment
            
            $
            (781,411
            )
            $
            0Total
            
            $
            0
            
            $
            873,342





Amortization
      expense charged to operations was $91,931 and $273,583 for the years ended
      December 31, 2006 and 2005, respectively.





Based
      on
      the Company's analysis for impairment as of December 31, 2006, impairment losses
      of $781,411 were required to be recorded. The impairment was determined by
      the
      analysis of our current operating results, trends and undiscounted future cash
      flows.





Due
      to
      analysis of the companies gross profit for the certified gasoline systems the
      company revised it business model in 2006. The new model reflected the closing
      of the Installation and service facility in Oklahoma a selling and installing
      the gasoline conversions systems through our dealer network across the United
      States. After a further analysis of the operating results in 2006 the company
      determined it did not achieve the sales from the certified systems it expected
      through our dealer network.





In
      2007
      the company has changed its plan for the sales of these certified systems.
      Due
      to the operating results from 2006 and the unknown result of our plan for 2007
      management has been unable to forecast projected profits, therefore we have
      recorded the impairment on the assets as of December 31, 2006. The Company
      will
      continue to analyze and review sales and will try to improve on revenues and
      profits generated from these certifications.





NOTE
      7 -
      INCOME TAXES





Income
      tax expense (benefit) for the years ended December 31, 2005 and 2006 are as
      follows:





2006
            
            2005Current
                income tax expense (benefit)
            
            $
            0
            
            $
            0Deferred
                income tax expense (benefit) net operating loss carry
                forward
            
            $
            (3,556,578
            )
            $
            (1,847,465
            )Change
                in valuation allowance
            
            $
            3,556,578
            
            $
            1,847,465Income
                tax expense (benefit)
            
            $
            0
            
            $
            0





Income
      taxes for the years ended December 31, 2005 and 2006 differ from the amounts
      computed by applying the effective income tax rate of 37% to income before
      income taxes as a result of the change in the valuation allowance.







29





Temporary
      differences and carryforwards that give rise to deferred tax assets and
      liabilities as of December 31, 2006 and 2005 are as follows:





2006
            
            2005Computed
                tax expense at the statutory rate increase
              (decrease)
                in taxes resulting from:Net
                Loss
            
            $
            (3,749,875
            )
            $
            (2,808,855
            )Permanent
                differencesDerivative
                income
            
            
            (407,338
            )
            
            (482,916
            )Derivative
                expense
            
            
            
            
            
            328,146Derivative
                interest expense
            
            
            281,446
            
            
            95,923Amortization
                of certification
            
            
            31,256
            
            
            93,018Goodwill
                impairment
            
            
            286,698
            
            
            926,411Non
                deductible meals and entertainment (50%)
            
            
            1,235
            
            
            808193,297
            
            
            961,390Current
                income tax expense (benefit)
            
            
            (3,556,578
            )
            
            (1,847,465
            )





As
      of
      December 31, 2006, the Company has a net operating loss carry forward of
      approximately $24,146,257 available to offset taxable income through
      2025





2006
            
            2005Net
                operating loss carry forwards
            
            $
            8,209,727
            
            $
            4,653,308Valuation
                allowance
            
            $
            8,209,727
            
            $
            4,653,308




A
        valuation allowance has been recorded primarily related to tax benefits
        associated with income tax operating loss carryfowards. Adjustments to the
        valuation allowance will be made if there is a change in management's assessment
        of the amount of the deferred tax asset that is realizable.


NOTE
      8
      DEBT IN DEFAULT





The
      Company did not meet the payment terms on the note payable to Peachtree National
      Bank during the years ended December 31, 2005 and 2006. The note is secured
      by
      the common stock owned by Robby Davis and Ricky Davis, both employees of the
      Company. The provisions of the note allow for the note to become immediately
      and
      fully payable upon default of payments. While the bank had not initiated any
      remedy actions for the default as of December 31, 2005 or 2006, the full balance
      of the note has been reclassified as a current liability for both
      years.





For
      the
      year ended December 31, 2006, the remaining principal balance as of 12/31/06
      was
      approximately $44,000





The
      Company is delinquent in the payment of payroll taxes. The Company finalized
      payments in May 2006 on a payment schedule for delinquencies prior to 2004
      that
      was developed after negotiations with the taxing authorities. Current estimated
      delinquency, along with estimated penalties and interest are as follows, as
      of
      December 31, 2006 and 2005




2006
              
              2005Payroll
                and sales taxes
              
              $
              182,500
              
              $
              61,561Estimated
                and accruedPenalties
                and interest
              
              
              21,800
              
              
              13,238$
              204,300
              
              $
              74,799




NOTE
      9
      LITIGATION





The
      Company is, from time to time, involved in litigation relating to claims arising
      out of its operations in the ordinary course of business. The Company believes
      that none of the claims that were outstanding as of December 31, 2005 and 2006
      should have a material adverse impact on its financial condition or results
      of
      operations.





On
      November 14, 2003, Ambac International Corporation filed a lawsuit seeking
      $109,915 together with interest at the rate of 15% per annum. The suit stems
      from a contract for delivery of certain parts for use in the manufacturing
      of
      our systems from 2002. The Company maintains the parts were delivered
      substantially past the date of anticipated delivery and that the parts when
      received were defective. During the first quarter, 2007, the Arbitrator awarded
      AMBAC a total of $ 259,440 including interest and court costs. While the company
      intends to vigorously appeal this award, the full liability has been accrued
      as
      of December 31, 2006..






30





NOTE
      10
      STOCK OPTIONS AND WARRANTS





The
      Company's Stock Option Plan (" SOP.") was adopted in 2001 to provide for the
      grant to employees up to 2,000,000 incentive stock options within the meaning
      of
      Section 422 of the Internal Revenue Code. The SOP, which is administered by
      the
      Company's Board of Directors, is intended to provide incentives to directors,
      officers, and other key employees and enhance the Company's ability to attract
      and retain qualified employees. Stock options are granted for the purchase
      of
      common stock at a price not less than the 100% of fair market value of the
      Company's common stock on the date of the grant (110% for holders of more than
      10% of the total combined voting power of all classes of capital stock then
      outstanding). As of December 31, 2006 and 2005, no options had been granted
      under the plan.





Warrants





The
      Company has issued warrants to purchase shares of common stock to consultants
      and other non employees. The company uses the Black Scholes option pricing
      model
      to value warrants issued to non employees.





The
      following table summarizes the Company's warrant activity:




Number
                  of  Warrants
              
              
              Weighted
                  AverageExercise PriceBalance
                  as of December 31, 2004
              
              
              862,500
              
              $
              0.57Additions
              
              
              3,114,814ExercisedExpirations
              
              
              (62,500
              )Balance
                  as of December 31, 2005
              
              
              3,914,814
              
              $
              1.00AdditionsExercisedForfeited
              
              
              1,200,000Expirations
                  800,000Balance
                  as of December 31, 2006
              
              
              1,914,814
              
              $
              0.21





Outstanding
            
            ExercisableRange
                of
              Exercise
                Prices
            
            Weighted
              Average
              Warrants
              Numbers
              Outstanding
            
            Weighted
              Average
              Remaining
              Contractual
                Life
            
            Warrants
              Exercisable
              at
                Exercise
              Price
            
            Exercise
              Price
            
            Weighted
              Average$0.19
                - $0.27
            
            
            1,914,814
            
            
            3.55
            
            $
            0.21
            
            
            1,914,814
            
            $
            0.21








NOTE
      11
      DEBT FINANCING





On
      March
      28, 2006, we completed an offering of our $1,412,500 principal amount one-year
      promissory note (the "Note") to Dutchess Private Equity Fund, L.P. (the
      "Investor") for aggregate gross proceeds of $1,130,000. The Note bears no
      interest. Payments made by us in satisfaction of the Note shall be made from
      each put from the Equity Line of Credit with the Investor given by us to the
      Investor under that certain Investment Agreement dated as of November 4, 2005
      which we entered into with the Investor (the "Investment Agreement"). We shall
      make payments to the Investor in an amount equal to the greater of (1) 100%
      of
      each put to the Investor from us, or (2) $117,708.33 until the face amount
      is
      paid in full. Our initial payment will be due on May 1, 2006 and all subsequent
      payments will be made at the closing of every put to the Investor thereafter
      until the Note is paid in full, with a minimum amount of $117,708.33 per month.
      In the event that on the maturity date we have any remaining amounts unpaid
      on
      the Note, the Investor can exercise its right to increase the face amount by
      10%
      and an additional 2.5% per month, pro rata for partial periods, as liquated
      damages. In addition, our obligation to repay the principal and accrued interest
      under the Note, as well as our $1,362,500 principal amount one-year promissory
      note which we issued to the Investor and Dutchess Private Equities Fund, II,
      L.P. on December 20, 2005, is secured by all of our assets pursuant to a certain
      Security Agreement which we entered into with the Lender on March
      23,2006.






31





We
      used a
      portion of the proceeds from the Note to repay outstanding promissory notes,
      inclusive of accrued and unpaid interest and liquidated damages in the aggregate
      amount of $541,542, issued pursuant to that Subscription Agreement dated March
      31, 2005 (the "Subscription Agreement"). In addition, we entered into a
      Settlement Agreement and Release (the "Settlement Agreement") with the holders
      of the promissory notes on March 24, 2006 pursuant to which the holders and
      we
      agreed to release and discharge each other, and our respective officers,
      directors, principals, control persons, past and present employees, insurers,
      successors, agents and assigns from any and all actions, damages, judgments,
      claims, and demands existing or claimed to exist between the parties in
      connection with the promissory notes or the Subscription Agreement.





On
      March
      28, 2006, the Company rendered full satisfaction of the Remaining Debentures
      with ALPHA CAPITAL AKTIENGESELLSCHAFT, WHALEHAVEN CAPITAL FUND LIMITED, and
      ELLIS INTERNATIONAL LTD. rough the payment of $541,542.00 (the "Funds") by
      wire
      transfer to the bank and account as set forth on Exhibit A hereto, and (2)
      reduce the exercise price to $0.19 per share for the warrants on the attached
      Exhibit B. Each Investor, individually, hereby agrees that they will not
      exercise or sell more than sixty-seven thousand five hundred (67,500) shares
      underlying the Warrant in any thirty (30) day period unless Hybrid's common
      stock is trading above forty cents ($0.40) per share. Upon receipt of the Funds,
      the Investors shall return, via overnight delivery, the Remaining Debentures
      to
      Hybrid. The Company agrees to file all necessary paperwork with the SEC,
      including any post-effective amendments, for the Investors within seven (7)
      days. The Company shall agree to abide by all terms and conditions in the
      original Warrant with respect to registration and issuance of shares underlying
      the Warrant.





On
      July
      14, 2006, we completed an offering of our $845,000 principal amount 15-month
      promissory note (the "Note") to Dutchess Private Equities Fund, II, L.P. (the
      "Investor") for aggregate gross proceeds of $650,000. The Note bears interest
      at
      a rate equal to 12% per month. On or before July 31, 2006 through November
      30,
      2006, we shall make payments to the Investor in an amount equal to 100% of
      each
      put from the Equity Line of Credit with the Investor given by us to the Investor
      under that certain Investment Agreement dated as of November 4, 2005 which
      we
      entered into with the Investor (the "Investment Agreement"). Our initial payment
      will be due on July 31, 2006 and all subsequent payments will be made at the
      closing of every put to the Investor thereafter until the Note is paid in full.
      Commencing on December 31, 2006, we shall make payments to the Investor in
      an
      amount equal to the greater of (i) 100% of each put to the Investor from us,
      or
      (ii) 1/12th of the outstanding balances due on this Note and any notes currently
      outstanding between the Company and the Investor dated March 23, 2006 and
      December 20, 2005. In the event that on the maturity date we have any remaining
      amounts unpaid on the Note, the Investor can exercise its right to increase
      the
      face amount by 10% and an additional 2.5% per month, pro rata for partial
      periods, as liquated damages. In addition, our obligation to repay the principal
      and accrued interest under the Note, as well as our $1,412,500 principal amount
      one-year promissory note which we issued to Dutchess Private Equities Fund,
      L.P.
      on March 23, 2006, and our $1,362,500 principal amount one-year promissory
      note
      which we issued to the Investor on December 20, 2005, is secured by all of
      our
      assets pursuant to a certain Security Agreement which we entered into on March
      23, 2006.





We
      claim
      an exemption from the registration requirements of the Act for the private
      placement of these securities pursuant to Section 4(2) of the Act and/or
      Regulation D promulgated thereunder since, among other things, the transaction
      did not involve a public offering, the investors were accredited
      investors


and/or
      qualified institutional buyers, the investors had access to information about
      the company and their investment, the investors took the securities for
      investment and not resale, and we took appropriate measures to restrict the
      transfer of the securities.





32


On
      November 30, 2006, we completed an offering of our $210,000 principal amount
      30
      day promissory note (the “Note”)) to Dutchess Private Equity Fund, L.P. (the
“Investor”) for aggregate gross proceeds of $175,000. The note bears no
      interest. The company was to make payments to the Holder in the amount of the
      greater of a) one hundred percent (100%) of each put (as defined in the
      Investment Agreement between the Company and the Investor dated November 4,
      2005) given to the Investor from the Company, (the “Payment Amount”) until the
      face amount is paid in full, minus any fees due. The First Payment will be
      due at the closing of each Put (“Payment Date” or “Payment Dates”) until
      this Note is paid in full. Notwithstanding any provision to the contrary in
      this
      Note, the Company may pay in full to the Holder the Face amount, or any balance
      remaining thereon, in readily available funds at any time and from time to
      time
      with out penalty. In the event that on the Maturity Date the company has any
      remaining amounts unpaid on this Note (the “Residual Amount”), the Holder can
      exercise its right to increase the Face amount by ten percent (10%) as an
      initial penaly and an additional two and one-half pecent (2.5%) per month paid,
      pro rata for partial periods, compounded daily, as liquidated damages
      (“Liquidated Damages”). If a Residual Amount remains, the company is in Default.
      As of December 31, 2006, the company had not paid the full principal balance.
      Subsequent to the year then ended the company paid the balance in
      full.





NOTE
      12
      SHAREHOLDERS EQUITY





Preferred
      Stock





Effective
      December 6, 2006, the Company increased its designated shares of previously
      undesignated preferred stock to 5,000,000 shares authorized.





Series
      A
      Preferred Stock is convertible, at the option of the holder, at any time, into
      shares of the Company's common stock as determined by dividing $.19 by a
      conversion price determined on the date the related certificate is surrendered.
      The conversion price is subject to periodic adjustment and is initially
      established at $.01632. Series A Preferred Stock is automatically convertible
      into shares of the Company's common stock upon (i) the date specified by vote
      or
      written consent or agreement of holders of at least three quarters of the shares
      of Series A Preferred outstanding, or (ii) upon the closing of the sale of
      the
      company's common stock in a firm commitment, underwritten public offering
      registered under the Securities Act in which the Company receives gross proceeds
      of no less than $20 million. Series A Preferred Stock has a liquidation
      preference of the greater of $.19 per share or the amount that such share would
      be entitled to upon liquidation or distribution. The Series A Preferred Stock
      has voting rights, except as to the election of debtors, equal to the number
      of
      shares of common stock into which the Series A Preferred Stock is convertible.
      The Series A preferred Stockholders have the right to elect one director of
      the
      Company.





Series
      B
      Preferred Stock is convertible, at the option of the holder at any time, into
      shares of the Company's common stock as determined by dividing the lower of
      $.09
      or the price per share paid by the holder of the Series B Preferred Stock by
      a
      conversion price determined on the date the related certificate is surrendered.
      The conversion price is subject to periodic adjustment and is initially
      established at $.00773. Series B Preferred Stock is automatically convertible
      into shares of the Company's common stock upon (i) the date specified by vote
      or
      written consent or agreement of holders of at least three quarters of the shares
      of Series B Preferred Stock outstanding, or (ii) upon the closing of the sale
      of
      Company's common stock in a firm commitment, underwritten public offering
      registered under the Securities Act in which the Company receives gross proceeds
      of no less than $20 Million. Series B Preferred Stock has a liquidation
      preference of the greater of $.09 per share or the amount that such share would
      be entitled to upon liquidation or distribution. The Series B Preferred Stock
      has voting rights, except as to the election of directors, equal to the number
      of shares of common stock into which the Series B Preferred Stock is
      convertible. The Series B Preferred Stockholders have the right to elect one
      director of the Company.





On
      September 28, 2006, the Holders of the Series B Preferred Shares converted
      171,778 of their 195,209 Series B Preferred Shares held into 2,000,000 shares
      of
      our common stock. This left a balance of 23,431 Series B Preferred Shares and
      42,215 Series A Preferred Shares outstanding.





33


NOTE
      13
      SHORT TERM OBLIGATIONS





Short-term
      obligations consist of the following at December 31, 2005 and 2006:




2006
                
                2005Convertible
                    Note payable, collateralized by all assets, interest due in monthlyPayments
                    at Wall Street Journal prime plus 3.00% and principal paymentscommencing
                    on August 1, 2005. (face value $600,000)
                
                
                
                
                $
                209,378Convertible
                    Note Payable, collateralized by all assets, Interest due in monthlypayments
                    of $3,369.46 at 12% annum, starting in the fourth month monthlypayments
                    of $40,498.44 per month including principle. (face value) $340,000
                
                
                
                
                $
                101,267Convertible
                    Note Payable, collateralized by all assets, due in monthlypayments
                    $113,541.64. (face value $1,362,500)
                
                $
                793,334
                
                $
                1,059,722Note
                    Payable, unsecured, due in monthly payments of $3,800, includinginterest
                    at 6.28%, through September 2006
                
                
                
                
                $
                190,320Note
                    Payable, unsecured due in monthly payments of $6,627.31including
                    interest at 9.25% through November 2006
                
                
                
                
                $
                69,606Note
                    Payable collateralized by all assets, due in the amount equal
                    to the
                    greaterof
                    100% of each put to the investor from our credit line or $117,708
                    per
                    month.
                
                $
                858,729Note
                    Payable collateralized by all assets, due in the amount equl
                    to 100% of
                    Putto
                    the investor from our line of credit until the note is paid in
                    full,
                    Commencing onDecember
                    20, 2006, including interest at 12% per month
                
                $
                160,173Note
                    Payable collateralized by all assets, Interest due in monthly
                    payments
                
                $
                109,706Note
                    Payable collateralized by (40) signed put notices for the equity
                    line of
                    Credit,due
                    in the amount of the greater of 100% of each put until the face
                    amount is
                    paid in full.
                
                $
                157,927$
                2,079,869
                
                $
                1,630,293Debt
                    Discount
                
                $
                (82,231
                )
                $
                (650,630
                )Total
                
                $
                1,997,638
                
                $
                979,663




NOTE
      14
      EARNINGS (LOSS) PER SHARE





The
      following sets forth the computation of basic and diluted net earnings per
      common share:





Convertible
      debt and warrants were determined to be antidilutive and therefore did not
      affect earnings per share.




2006
            
            2005Numerator:Net
              loss
            
            $
            (11,029,040
            )
            $
            (8,261,371
            )Less
              preferred stock dividends
            
            
            --
            
            
            --Net
              loss available to common shareholders
            
            $
            (11,029,040
            )
            $
            (8,261,371
            )Denominator:Weighted
              average shares
              outstanding
            
            
            121,737,383
            
            
            88,909,988Effect
              of dilutive securities:Stock
              Options
            
            
            --Convertible
              debt
            
            
            --Stock
              Warrants
            
            
            --Weighted
              average fully diluted shares outstanding
            
            
            121,737,383
            
            
            88,909,988Net
              earnings (loss) per common shareBasic
            
            
            (0.09
            )
            
            (0.09
            )Diluted
            
            
            (0.09
            )
            
            (0.09
            )






NOTE
      15
      DERIVATIVE FINANCIAL INSTRUMENTS





The
      captions derivative financial instruments consist of (a) the embedded conversion
      feature bifurcated from the Convertible Debentures, (b) the Warrants issued
      in
      connection with the Convertible Debts, and (c) put options. These derivative
      financial instruments are indexed to an aggregate of 10,168,674 shares at
      December 31, 2006 and are carried at fair value.





At
      December 31, 2006 the following derivative liabilities related to common stock
      options and warrants and embedded derivative instruments were
      outstanding:





**Issue
                Date**
            **Expiration
                Date**
            **Instrument**
            **Exercise
                Price Per Share**
            **Value
                at Issue Date**
            **Value
                at 12/31/06**3/5/2005
            3/5/2010
            1,600,000
                warrants issued to Alpha Capital
            $0.55
            $
                928,000
            $
                57,60011/4/2005
            11/4/2010
            314,815
                warrants issued to Dutchess Priveate Equities
            $0.27
            $
                85,000
            $
                9,130


Fair
      Value of freestanding derivative instrument liabilities for options and
      warrants  $66,730





**Issue
                Date**
            **Expiration**
              **Date**
            **Instrument**
            **Exercise
                Price**
              **Per
                Share**
            **Value
                at Issue**
              **Date**
            **Value
                At**
              **12/31/06**12/20/2005
            12/21/2006
            Dutchess
                $1,362,500 term note
            $0.27
            $
                302,778
            $
                4,1103/23/2006
            3/23/2007
            Dutchess
                $ 1,412,500 term note
            $0.27
            $
                470,833
            $
                3947/13/2006
            10/13/2007
            Dutchess
                $845,000 term note
            $0.27
            $338,169
            $5,811




Fair
                value of  derivative instrument
                liabilities for term notes
              
              $
              10,315Total
                fair value of derivative
                instrument liabilities
              
              $
              77,045




The
      financial derivatives are accounted for as a liability according to the guidance
      of EITF 00-19 and FAS 133 and the fair values have been determined using the
      Black Scholes valuation model with the assumptions listed in the table
      below




Expected
                term ranging from.25 to 3.75 yearsStock
                Price at December 31, 2006 $0.072Expected
                dividend yieldExpected
                stock price volatility 103%Risk-free
                interest rate ranging from 4.74% to
                5.09%








34





The
      instruments were reduced for the embedded conversion features and warrants
      with
      the remaining balance being accreted back to their face amount using the
      effective interest rate method using an effective interest rate of approximately
      300%. The actual accretion is straight line as it approximates the effective
      interest rate amount.





The
      derivative for the embedded conversion Feature of the Dutchess term note dated
      July 14, 2006 is valued using the projected stock price over the term of the
      instrument based on a historical weighted average stock price for a similar
      term
      to determine the conversion amounts and then a Black-Scholes valuation model
      for
      the resulting conversion share amounts.








NOTE
      16
      ACQUISITIONS





On
      June
      9, 2006 the company entered into a “Stock Purchase Agreement” for 100 percent of
      the outstanding common shares of Automated Engineering Corporation. The
      aggregate purchase price was $350,000, and was consummated by a cash payment
      in
      the amount of $292,635 to the shareholders of 83.6% of the outstanding shares.
      The balance of $57,365, representing a minority interest shareholder is included
      in accrued expenses as of December 31, 2006.





As
      this
      transaction occurred in the middle of a reporting period, the Company has
      designated the acquisition date for accounting purposes to be the end of the
      month of June. Therefore, operational results for this acquired entity will
      commence in the month of July 2006.





The
      Company is in the process of verifying the values of the assets acquired as
      well
      as certain intangible assets; thus the amount of the purchase price subject
      to
      allocation carried on the balance sheet as of June 30, 2006 is calculated as
      follows:




Purchase
              Price
            
            $
            350,000Less:
              values currently assigned to
              assetsCash
            
            
            (63,049
            )Accounts
              Receivable net
            
            
            (133,357
            )Inventory
            
            
            (153,003
            )Fixed
              Assets net
            
            
            (60,285
            )Other
              assets
            
            
            (2,310
            )Plus:
              values currently assigned to liabilitiesAccounts
              Payable and accrued expense
            
            
            205,501Credit
              Line Payable
            
            
            400,130Purchase
              price subject to allocation
            
            $
            543,627







The
      unaudited pro forma effect of the acquisition of Automated Engineering
      Corporation on the Company’s revenues, gross profit and net income had the
      acquisition occurred on January 1, 2005 is as follows;





For
                the year
              ended
              Dicember
                31,
              2006
            
            For
                the year
              Ended
              December
                31,
              2005(unaudited)
            
            (unaudited)Revenue
            
            
            1,720,431
            
            
            2,511,233Gross
              Profit
            
            
            834,294
            
            
            1,109,295Net
              Loss
            
            
            (10,706,004
            )
            
            (8,253,932
            )







35




The
      acquisition of DRV Energy was accounted for as a purchase. The results of
      operations of DRV Energy have been included in the Company’s result of
      operations since the date of acquisition,




Assumption
              of liabilities
            
            $
            652,956Cash
              paid
            
            
            200,000Common
              stock issued
            
            
            3,525,871$
            4,378,827The
              aggregate purchase price was allocated as follows:Accounts
              Receivable
            
            $
            134,895Inventory
            
            
            47,432Property
              and equipment
            
            
            60,941Other
              assets
            
            
            2,075Goodwill
&
Intangible
              Assets
            
            
            4,133,484$
            4,378,827




On
      August
      11, 2005 Hybrid Fuel Systems completed the closing of a Share Exchange Agreement
      (the “Agreement”) with DRV Energy, Inc., an Oklahoma corporation (“DRV” and the
      sole shareholder of DRV, Sheri Vanhooser (the “DRV Shareholder”) that was
      entered into on June 29, 2005. Hybrid issued an aggregate of 11,612,903
      unregistered shares of HYFS common stock, par value $0.001 per share, and
      payment of $200,000 in cash. Pursuant to the Agreement, we acquired all of
      the
      outstanding equity stock of DRV from the DRV Shareholder





DRV
      Energy, Inc., an Oklahoma corporation was formed November 30, 1994 to engage
      in
      alternative fuels industry through the sales and services of vehicle conversions
      system. DRV is a small volume manufacturer of EPA Certified bi-fuel and
      dedicated natural gas and propane turnkey conversion systems. DRV Energy also
      has a full service alternative fuels center with slow/fast fill stations as
      well
      as compressor installation and maintenance capabilities.








NOTE
      17
      SEGMENT INFORMATION





Commencing
      with the Company’s acquisition of Automated Engineering Corporation in the
      second quarter of 2006 the Company operates in two business segments. The
      Natural gas vehicle conversion system segment operates development of natural
      gas conversion systems for light and heavy duty vehicles. The Electronic
      Manufacturing segment is electronic design, production and ability to proto-type
      and produce electronic control devices.





SEGMENT
      INFORMATION FOR THE YEAR ENDED DECEMBER 31, 2006 IS AS FOLLOWS:


Hybrid
                Fuels
              
              
              Manufacturing
              
              
              TotalRevenues
              
              
              544,640
              
              
              830,778
              
              
              1,375,418Cost
                  of Sales
              
              
              302,059
              
              
              658,902
              
              
              960,961Gross
                  Profit
              
              
              242,581
              
              
              171,876
              
              
              414,457Operating
                  expensesConsulting
                  and Professional
              
              
              1,852,972
              
              
              32,212
              
              
              1,885,184Research
                  & Develop
              
              
              92,062
              
              
              1,251
              
              
              93,313Compensation
              
              
              2,365,293
              
              
              1,625,535
              
              
              3,990,828Depreciation
                  & Amortization
              
              
              174,772
              
              
              7,870
              
              
              182,642Rent
              
              
              163,182
              
              
              30,783
              
              
              193,965Insurance
              
              
              233,018
              
              
              26,388
              
              
              259,406Other
                  operating expenses
              
              
              1,276,661
              
              
              33,921
              
              
              1,310,5826,157,960
              
              
              1,757,960
              
              
              7,915,920Loss
                  from operations
              
              
              (5,915,379
              )
              
              (1,586,084
              )
              
              (7,501,463
              )Other
                  expense (income)Derivative
                  gain
              
              
              (370,271
              )
              
              
              
              
              (370,271
              )Interest
                  expense
              
              
              3,895,063
              
              
              14,595
              
              
              3,909,658Extinguishment
                  of debt
              
              
              (162,557
              )
              
              
              
              
              (162,557
              )Settlements
              
              
              149,572
              
              
              
              
              
              149,572Misc
              
              
              1,175
              
              
              
              
              
              1,1753,512,982
              
              
              14,595
              
              
              3,527,577Loss
                  from continuing operations
              
              
              (9,428,361
              )
              
              (1,600,679
              )
              
              (11,029,040
              )Net
                  loss for reportable segments
              
              
              (9,428,361
              )
              
              (1,600,679
              )
              
              (11,029,040
              )Total
                  Assets
              
              
              2,310,395
              
              
              1,083,896
              
              
              3,394,291








36


Reconciliation
      of Segment Amounts Reported to Condensed


Consolidated
      Amounts





RevenueTotal
              revenues for reportable
              segments
            
            
            1,375,418Total
              consolidated revenue
            
            
            1,375,418Net
              lossNet
              loss for reportable
              segments
            
            
            11,029,040Net
              loss consolidated
            
            
            11,029,040










NOTE
      18
      RECENT ACCOUNTING PRONOUNCEMENTS





In
      February
      2006, FASB issued SFAS 155. This accounting standard permits fair value
      re-measurement for any hybrid financial instrument containing an embedded
      derivative that otherwise would require bifurcation; clarifies which
      interest-only strips and principal-only strips are not subject to the
      requirements of SFAS No. 133; establishes a requirement to evaluate interests
      in
      securitized financial assets to identify them as freestanding derivatives or
      as
      hybrid financial instruments containing an embedded derivative requiring
      bifurcation; clarifies that concentrations of credit risk in form of
      subordination are not embedded derivatives; and amends SFAS No. 140 to eliminate
      the prohibition on a qualifying special-purpose entity from holding a derivative
      financial instrument pertaining to a beneficial interest other than another
      derivative financial instrument. SFAS No. 155 is effective for all financial
      instruments acquired or issued after the beginning of an entity’s first fiscal
      year beginning after September 15, 2006. Management currently does not believe
      that SFAS No. 155 will have a material effect on our results of operations
      and
      financial position.





In
      March 2006
      2006, the FASB issued SFAS No. 156, which addresses the accounting for servicing
      assets and liabilities. SFAS No. 156 is effective at the beginning of an
      entity’s first fiscal year beginning after September 15, 2006. Management does
      not expect SFAS No. 156 to have a material effect on our results of operations
      or financial position.





In
      July 2006,
      the FASB issued Interpretation No. 48, “ Accounting for Uncertainty in Income
      Taxes” (FIN48), effective for fiscal years beginning after December 15, 2006.
      FIN 48 requires a two-step approach to determine how to recognize tax benefits
      in the financial statements where recognition and measurement of a tax benefit
      must be evaluated separately. A tax benefit will be recognized only if it meets
      a “more-likely-than-not” recognition threshold. For tax positions that meet this
      threshold, the tax benefit recognized is based on the largest amount of tax
      benefit that is greater than 50 percent likely of being realized upon ultimate
      settlement with the taxing authority. We are currently evaluating the impact
      of
      adopting FIN 48.





In
      September
      2006, the Financial Accounting Standards Board issued Statement of Financial
      Accounting Standards (“SFAS”) No 157, “fair Value Measurements.” SFAS No. 157
      clarifies the principle that fair value should be based on the assumptions
      market participants would use when pricing an asset or liability and establishes
      a fair value hierarchy that prioritizes the information used to develop those
      assumptions. Under the standard, far value measurements would be separately
      disclosed by level within the fair value hierarchy. SFAS No. 157 is effective
      for financial statements issued for fiscal years beginning after November 15,
      2007 and interim periods within those fiscal years, with early adoption
      permitted. The Company does not expect the adoption of SFAS No. 157 to
      materially impact its financial statements.





37


In
      September
      2006, the Securities and Exchange Commission issued Staff Accounting “bulletin
      (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when
      Quantifying Current Year Misstatements.” SAB No. 108 requires analysis of
      misstatements using both an income statement (rollover) approach and a balance
      sheet (iron curtain) approach in assessing materiality and provides a one-time
      cumulative effect trasition adjustment. SAB NO. 108 is effective for the
      Company’s 2006 annual financial statements. The adoption of  SAB No. 108
 is not expected to materially impact the financial statements.








NOTE
      19
      SUBSEQUENT EVENTS





On
      April
      1, 2007 our Board of Directors appointed Mr. Philip M. Rappa as our Chief
      Executive Officer, There are no understandings or arrangements between Mr.
      Rappa
      and any other person pursuant to which Mr. Rappa was selected as Chief Executive
      Officer. Mr. Rappa does not have any family relationship with any director,
      executive officer or person nominated or chosen by us to become a director
      or
      executive officer.





M.
      Philip
      M. Rappa, B.A.M.B.A., has 34 years experience in executive level and operations
      management in a variety of industries ranging from healthcare to high
      technology. From start-up organizations to challenged companies and high growth,
      multi-national corporations, he rose within the ranks of the German/Swiss
      conglomerate, Asea Brown, Boveri and built a start-up ABB Ceag Power Supplies,
      Inc. from $400,000 in annual sales to over $202 million in just under 7 years.
      While serving in various capacities, including President/CEO and chairman,
      Phil
      has lead multiple organizations toward success and profitability. His knowledge
      of turnaround management is critical to the restructuring process. Additionally,
      he provides operational, financial, and cash management expertise in all phases
      of the business.





**ITEM
      EIGHT - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND** **FINANCIAL
      DISCLOSURE** .





None.





**ITEM
      EIGHT A - CONTROLS AND PROCEDURES**





(a)
      EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES





As
      of the
      end of the period covered by this report, we conducted an evaluation, under
      the
      supervision and with the participation of our chief executive officer and chief
      financial officer of our disclosure controls and procedures (as defined in
      Rule
      13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation,
      our chief executive officer and chief financial officer concluded that our
      disclosure controls and procedures are effective to ensure that information
      required to be disclosed by us in the reports that we file or submit under
      the
      Exchange Act is recorded, processed, summarized and reported, within the time
      periods specified in the Commission's rules and forms.





(b)
      CHANGES IN INTERNAL CONTROLS





There
      was
      no change in our internal controls or in other factors that could affect these
      controls during our last fiscal quarter that has materially affected, or is
      reasonably likely to materially affect, our internal control over financial
      reporting.





**ITEM
      EIGHT B - OTHER INFORMATION**





None.




38


**PART
      III**





**ITEM
      NINE - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
      WITH SECTION 16(A) OF THE EXCHANGE ACT** .






NAME
            
            AGE
            
            POSITION/OFFICE
              HELDJohn Stanton
            
            58
            
            Chairman of the Board of
              DirectorsMark Clancy
            
            51
            
            Chief Executive OfficerDirectorMichele Hamilton
            
            38
            
            Chief
              Financial Officer





John
      Stanton
      - Chairman of the Board of Directors. Since December 23, 2003, John Stanton
      has
      served as our Chairman of the Board of Directors. Mr. Stanton is also the Chief
      Executive Officer and Chairman of the Board of Directors of Pangea Corporation
      (formerly White Knight). From 1987 through the present, Mr. Stanton has served
      as the President and Chief Executive Officer of Florida Engineered Construction
      Products Corporation. Mr. Stanton has served as Chairman and President of
      several public and private companies. Since the early 1990's, Mr. Stanton has
      been, and continues to be, involved in turn-around management for financially
      distressed companies, providing both management guidance and financing. Mr.
      Stanton worked with the international professional services firm that is now
      known as Ernst & Young, LLP from 1973 through 1981. Mr. Stanton, a Vietnam
      veteran of the United States Army, graduated from the University of South
      Florida with a Bachelors Degree in Marketing and Accounting in 1972, and with
      an
      MBA in 1973. Mr. Stanton earned the designation of Certified Public Accountant
      in 1974 and was a Sells Award winner in the CPA examination. Mr. Stanton is
      a
      lifetime resident of Tampa, Florida.





Mark
      Clancy -
      Chief Executive Officer, and Director. Since December 23, 2003, Mark Clancy
      has
      served as our Chief Executive Officer and our Chief Financial Officer and as
      a
      Director . Mr. Clancy is also the President of Pangea Corporation. Since 2000,
      Mr. Clancy has participated in turn-around management for financially distressed
      companies. From November 1997 through April 2000, Mr. Clancy was co-founder,
      Director and Executive Vice President of publicly traded EarthFirst
      Technologies, Inc. Mr. Clancy has been an advisor to the Chairman of the Board
      of EarthFirst since that company's sale in May 2000. From 1992 through 1997,
      Mr.
      Clancy served as the Chief Compliance Officer for a Largo, Florida based
      boutique investment banking firm. Mr. Clancy was honorably discharged after
      six
      years of service with the United States Marine Corps. Mr. Clancy was born in
      Massachusetts and has resided in Florida since 1982. Mr. Clancy holds a
      Bachelors Degree in History from the University of South Florida and is a
      lifetime member of various academic honor societies including Phi Theta Kappa,
      Phi Alpha Theta and USF Arts and Sciences Honor Society.





Ms.
      Hamilton
      has served as our comptroller since 2004. Ms. Hamilton has 15 years diverse
      accounting and business management experience. Previously, Ms. Hamilton was
      engaged in financial management for financially distressed companies with a
      focus on forensic audits. In 1998, Ms. Hamilton served as the Senior Finance
      Manager for Numed Home Health Care. Remaining within the same management group,
      during June 2004 Ms. Hamilton assumed additional responsibilities auditing
      financially distressed healthcare organizations and consulting with senior
      management for turnaround of such organizations. Ms. Hamilton attended college
      in Long Island.





All
      directors
      hold office until the next annual meeting of our stockholders and until their
      successors have been duly elected and qualified. Our executive officers are
      elected by, and serve at the designation and appointment of the board of
      directors. Some of our directors and executive officers also serve in various
      capacities with our subsidiaries. There are no family relationships among any
      of
      our directors and executive officers.





39


CODE
      OF
      ETHICS





The
      Company has adopted a Code of Ethics and has posted our Code of Ethics on our
      Internet web site at hybridfuelsystems.com. Our Code of Ethics applies to all
      our employees and those doing business with our Company and specifically applies
      to our Chief Executive Officer, Chief Financial Officer and all persons serving
      in similar capacities.





EXECUTIVE
      OFFICERS OF THE COMPANY





Officers
      are appointed to serve at the discretion of the Board of Directors. None of
      our
      executive officers or directors has a family relationship with any other of
      our
      executive officers or directors.





COMMITTEES
      OF THE BOARD OF DIRECTORS





We
      currently do not have any committees of our board of directors.





SECTION
      16(A) BENEFICIAL OWNERSHIP COMPLIANCE





Based
      solely upon our review of copies of Forms 3, 4 and 5, and any subsequent
      amendments thereto, furnished to the Company by our directors, officers and
      beneficial owners of more than ten percent of our common stock, we are not
      aware
      of any Forms 3, 4 and/or 5 which certain of our directors, officers or
      beneficial owners of more than ten percent of our common stock that, during
      our
      fiscal year ended December 31, 2006, failed to file on a timely basis reports
      required by Section 16(a) of the Securities Exchange Act of 1934.





Mr.
      Stanton,
      Mr. Clancy and Ms. Hamilton failed to file their initial report on Form 3 for
      the year ended 2006. The Form 3's were subsequently filed during April 2007.
      Mr.
      Stanton, Mr. Clancy and Ms. Hamilton have not sold any of the shares they own
      in
      our company.





**ITEM
      10 - EXECUTIVE COMPENSATION**





EXECUTIVE
      COMPENSATION





The
      following table sets forth information concerning the annual and long-term
      compensation of our Chief Executive Officer and the other named executive
      officers, for services as executive officers for the fiscal years ended December
      31, 2005 and 2006.


Annual
                  Compensation
              
              
              Long
                  Term CompensationSalary
              
              
              Other
                  annual
                Bonus
              
              
              Restricted
                Stock Awards compensation
              
              
              Securities
                underlying
              
              
              LTIP
                options
              
              
              All other
                Payouts
              
              
              CompensationName
                and Principal Position
              
              
              Year
              
              
              ($)
              
              
              ($)
              
              
              ($)
              
              
              ($)
              
              
              (#)
              
              
              ($)
              
              
              ($)John
                  Stanton
              
              
              2005
              
              $
              --
              
              $
              --
              
              $
              --
              
              $
              300,000
              
              
              0
              
              $
              --
              
              $
              --Chairman
                  of the Board
              
              
              2006
              
              $
              --
              
              $
              --
              
              
              
              
              $
              --
              
              
              0
              
              $
              --
              
              $
              --Mark
                  Clancy
              
              
              2005
              
              $
              90,.000
              
              $
              --
              
              $
              --
              
              $
              300,000
              
              
              0
              
              $
              --
              
              $
              --Chief
                  Executive Officer
              
              
              2006
              
              $
              240,000
              
              $
              --
              
              $
              --
              
              $
              --
              
              
              0
              
              $
              --
              
              $
              --Chief
                  Financial OfficerDirectorMichele
                  Hamilton
              
              
              2006
              
              $
              79,000
              
              $
              --
              
              $
              --
              
              $
              --
              
              
              0
              
              $
              --
              
              $
              --


COMPENSATION
      OF DIRECTORS





Members
      of our Board of Directors do not receive cash compensation for their services
      as
      Directors, although some Directors are reimbursed for reasonable expenses
      incurred in attending Board or committee meetings. Directors do receive stock
      compensation for services.





40


OPTIONS/SAR
      GRANTS IN THE LAST FISCAL YEAR





No
      individual grants of stock options, whether or not in tandem with stock
      appreciation rights ("SARs") and freestanding SARs have been made by executive
      officer or any director during our fiscal year ended December 31,
      2006.





AGGREGATED
      OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION/SAR
      VALUES





No
      individual exercises of stock options, whether or not in tandem with stock
      appreciation rights ("SARs") and freestanding SARs have been made by executive
      officer or any director during our fiscal year ended December 31,
      2006.







LONG-TERM
      INCENTIVE PLANS - AWARDS IN LAST FISCAL YEAR





We
      had no
      long-term incentive plans and made no stock awards during our fiscal year ended
      December 31, 2006.





EMPLOYMENT
      AGREEMENT





None.





**ITEM
      ELEVEN - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
      RELATED STOCKHOLDER MATTERS.**





The
      following table sets forth, as of April 20, 2007, the beneficial ownership
      of
      the Company's Securities by (i) each current member of the Board of Directors
      of
      the Company, (ii) the executive officer named in the Section entitled "Executive
      Compensation," above; (iii) all persons or entities known by us who own more
      than 5% of our voting common stock, and; (iv) all current directors and
      executive officers of the Company as a group. On April 20, 2007, the Company
      had
      210,599,983 shares of common stock issued and outstanding.







NAME
                OF BENEFICIAL OWNER
              
              
              NUMBER
                  SHARES
              
              
              OF
                  %CLASSJohn
                  Stanton
              
              
              87,835,758
              
              
              41,70
              %Chairman
                  of the BoardMark
                  Clancy
              
              
              26,101,035
              
              
              12.39
              %Chief
                  Executive OfficerDirectorMichele
                  Hamilton
              
              
              1,000,000
              
              
              0.47
              %Chief
                  Financial OfficerFrank
                  Davis
              
              
              1,708,000
              
              
              0.81
              %Chief
                  Technical ConsultantSheri
                  Vanhooser
              
              
              11,612,903
              
              
              5.51
              %Vice
                  President Business DevelopmentOfficers
                  and Directors as a group (3 persons)
              
              
              28,809,035
              
              
              13.67
              %





SECURITIES
      AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS





None
      of
      the Company's securities are authorized for issuance under equity compensation
      plans.





**ITEM
      12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**





The
      following summarizes pertinent agreements relating to our operations including
      our Technology License Agreement.





41


OUR
      TECHNOLOGY LICENSE





All
      of
      the technology, know-how, devices and apparatus embodied in the patents and
      incorporated into the various products sold by us were developed and patented
      by
      Frank Davis or Frank Davis and Robby E. Davis. Previously we licensed the
      worldwide rights to commercialize the Dual-Fuel Technology from a Trust
      established for the Davis family. In the course of reorganizing our enterprise,
      we have negotiated a new License Agreement to embody all of our technology
      and
      know how into one comprehensive, world-wide exclusive agreement We executed
      our
      license agreement August 31, 2004 between Hybrid Fuel Systems, Inc. and
      Electronic Control Units, LLP ("ECT") ("License Agreement."). ECT is owned
      by
      Frank Davis the technology inventor and holder of the patents. The following
      details the License Agreement.





Under
      the
      terms of the License Agreement, Hybrid has the worldwide exclusive right to
      use,
      manufacture, lease and/or sell products and/or systems embodying the following
      patents and related technical know-how:





1.
            U.S.
                Patent Serial No. 5,083,547, dated January 28, 1992 for a natural
                gas and
                air mixing device, as assigned to Licensor; any divisions or continuations
                in whole or in part thereof; any U.S. patents or applications that
                are
                later added to this license; any patents issuing on any of such
                applications; any reissues or extensions or reexaminations of any
                such
                patents; and





2.
            U.S.
                Patent Serial No. 5,408,978, dated April 25, 1995, for a natural
                gas and
                air mixing device, as assigned to Licensor; any divisions or continuations
                in whole or in part thereof; any U.S. patent or applications that
                are
                later added to this license; any patents issuing on any of such
                applications; any reissues or extensions or reexaminations 'of any
                such
                patents; and





3.
            U.S.
                Patent Serial No. 5,370,097, dated December 6, 1994, for a dual fuel
                control system which controls the flow of liquid fuel alone or in
                combination with a gaseous fuel, as assigned to Licensor; any divisions
                or
                continuations in whole or in part thereof; any U.S. patent or applications
                that are later added to this license; any patents issuing on any
                of such
                applications; any reissues or extensions or reexaminations of any
                such
                patents; and





4.
            U.S.
                Patent Serial No. 5,103,795, dated April 14, 1992 for a natural gas
                and
                air mixing device, as assigned to Licensor; any divisions or continuations
                in whole or in part thereof; any U.S. patent or applications that
                are
                later added to this license; any patents issuing on any of such
                applications; any reissues or extensions or reexaminations of any
                such
                patents; and





5.
            U.S.
                Patent Serial No. 4,479,466, dated October 30, 1984 for a natural
                gas and
                air mixing device, as signed to Licensor; any divisions or continuations
                in whole or in part thereof.; any U.S. patent or applications that
                are
                later added to this license; any patents issuing on any of such
                applications; any reissues or extensions or reexaminations. of any
                such
                patents;





6.
            U.S.
                Non-Provisional Application No. 10/668,589, METHODS AND APPARATUS
                FOR
                OPERATION OF MULTIPLE FUEL ENGINES, Filed September 23, 2003, Priority
                based on U.S. Provisional Application No. 60/413,269, ELECTRONIC
                FUEL
                CONTROL SYSTEMS, Filed September 24, 2002 PCT Application No.
                PCT/US03/29914, METHODS AND APPARATUS FOR OPERATION OF MULTIPLE FUEL
                ENGINES, Filed September 23, 2003, Priority based on U.S. Provisional
                Application No. 60/413,269, ELECTRONIC FUEL CONTROL SYSTEMS, Filed
                September 24, 2002.





The
      term
      of the license shall expire upon the later of (i) the expiration of the
      last-expiring patent covered, including any extensions, or (ii) ten (10) years
      from the date of execution of the License Agreement. In exchange for the
      worldwide exclusive rights described above, we are required to make a one-time
      license acquisition payment of $250,000 (two hundred and fifty thousand dollars
      which amount would be due and payable (i) the first anniversary of the execution
      of the License Agreement, (ii) the Company's closing on an equity or debt
      financing, or a combination thereof, following the date of the License Agreement
      in which we receive gross aggregate proceeds in an amount no less than USD$1
      million, or (iii) the sale of the 100th Unit. During 2005, we paid $100,000
      of
      our required licensee fee and during the first quarter 2006, we completed the
      payment of $250,000 for the license fee.





42


Following
      the one-time fee, we are required to pay $250.00 per Unit sold (we estimate
      at
      this time our Units will range in price from $3,500 to $4,500 each) with a
      minimum royalty of $250.00 and maximum royalty of $1,000 for Unit. We are
      further obligated to pay a royalty rate of 3.5% for any items which are not
      included in the per system royalty calculation such as spare parts and
      consulting services. Under the terms of the License Agreement, we are obligated
      to sell a minimum of 750 Units during 2005 and 2,500 Units during 2006 and
      for
      each subsequent year during the term of the License.





ECT
      shall
      have the right to immediately terminate the License Agreement by giving written
      notice to the Company in the event Hybrid:





1.
      is
      adjudicated bankrupt or insolvent, enters into a composition with creditors,
      makes an assignment of all or substantially all of its assets for the benefit
      of
      its creditors, or if a receiver is appointed for its


assets;





2.
      fails
      to produce, manufacture, sell, market, or distribute or cause to be produced,
      manufactured, sold, marketed, or distributed the Units;





3.
      or its
      Affiliates, agents, distributors or sublicenses is in material breach or default
      of any provision of the Proposed License Agreement which default or breach
      is
      not cured within the applicable time period;




4.
      fails
      to pay the royalty when and as it becomes due and payable;





5.
      or its
      Affiliates, agents, distributors or sublicensees pledge, lien, mortgage, secure
      or otherwise encumber the Licensed Patents in any manner, whether arising by
      contract, as a matter of law, by judicial process or otherwise;





6.
      experiences a material adverse effect in the financial condition, operations,
      assets, business, properties or prospects of the Company. " Material adverse
      effect." means any event, change, violation, inaccuracy, circumstance or effect
      that is or is reasonably likely to be, individually or in the aggregate,
      materially adverse to the condition (financial or otherwise), capitalization,
      operations or business of the Company;





7.
      fails
      to maintain its status as a public company.





Our
      Chief
      Technology Consulting Agreement





In
      order
      to ensure ourselves of the employment continuation of the technology inventor
      Mr. Frank Davis, we have entered a Consulting Agreement between the Company
      and
      Electronic Controls Technology LLC (the " Consulting Agreement."). Under the
      terms of the Consulting Agreement, we are to compensate Electronic Fuel
      Technology LLC $7,000 per month until we complete our current verification
      after
      which we are to remit $12,000 per month. In exchange for such compensation,
      Electronic Controls Technology LLC . We opted to increase the monthly payment
      from $7,000 to $12,000 effective January 1, 2005. The Consulting Agreement
      further requires we provide health insurance to Mr. Frank Davis and his wife
      which was effective January 1, 2005. Under the terms of the Consulting
      Agreement, ECT shall:





1.
            provide
                general advice, guidance and counsel to, and consult with, senior
                management of Hybrid with respect to all aspects of Hybrid's business;
                and





2.
            shall
                explain to senior management of Hybrid, in such detail as may be
                reasonably requested by Hybrid, the current condition, history and
                prospects of Hybrid and its predecessors, including with respect
                to
                operating, financial and organizational matters; manufacturing, marketing,
                planning and other activities; inventions, patents, patent applications,
                and other intellectual property rights and interests; relationships
                with
                stockholders, subsidiaries, affiliates, employees, suppliers, customers,
                advisers, consultants and others; transactions; and other matters
                as may
                be reasonably requested by Hybrid;
                and








43





3.
            deliver
                to Hybrid, in good condition, all Confidential Information and all
                files,
                documents and other books and records, in whatever form or media,
                relating
                to Hybrid's business or its history, prospects, financial condition
                or
                results of operations; and





4.
            shall
                maintain a regular, ongoing and routine physical presence at the
                Atlanta
                area research, development, and distribution center of
                Hybrid.





**ITEM
      13 - EXHIBITS**





Exhibits





The
      following exhibits are filed as a part of, or are incorporated by reference
      into, this Report on Form 10-KSB:








Exhibit
              
              Description2.1
              
              Asset
                  Purchase Agreement between the Company and New York State Electric
&
                  Gas Corporation, dated as of October 29, 2001, incorporated by
reference
                  to Exhibit 2.1 of the 8-K filed on December 26,
                  2001.2.2
              
              Secured
                  Promissory Note in favor of New York State Electric & Gas Corporation,
                  dated as of December 11, 2001, incorporated by reference to Exhibit
                  2.2 of the 8-K filed on December 26,
                  2001.2.3
              
              Security
                  Agreement between the Company and New York State Electric & Gas Corporation,
                  dated as of December 11, 2001, incorporated by reference to Exhibit
                  2.3 of the 8-K filed on December 26,
                  2001.2.4
              
              Guaranty
                  from the Company in favor of New York State Electric & Gas Corporation,
                  dated as of December 11, 2001, incorporated by reference to Exhibit
                  2.4 of the 8-K filed on December 26,
                  2001.3.1
              
              Articles
                  of Incorporation of Save On Energy, Inc., incorporated by reference
                  to Exhibit 3.1 to the SB-2 filed on March 23,
                  2000.3.2
              
              Amendment
                  to Articles of Incorporation of Save On Energy, Inc., incorporated
                  by reference to Exhibit 3.2 to the SB-2 filed on March 23, 2000.3.3
              
              By-laws
                  of Save On Energy, Inc., incorporated by reference to Exhibit 3.3
                  to the SB-2 filed on March 23, 2000.4.1
              
              Certificate
                  of Designation of Series A Preferred Stock filed with theSecretary
                  of State on February 19th, 2002 [incorporated by reference toExhibit
                  4.1 to the 10-KSB filed on May 30, 2002.*4.2
              
              Certificate
                  of Designation of Series B Preferred Stock filed with theSecretary
                  of State on May 7th, 2002 [incorporated by reference toexhibit
                  4.2 to the 10-KSB filed on May 30, 2002.*4.3
              
              Subscription
                  Agreement, dated March 31, 2005, by and among Hybrid Fuel incorporated
                  by reference to Exhibit 4.1 to the 8-K filed on April 5, 2005.4.4
              
              Form
                  of Convertible Note of Hybrid Fuel Systems, Inc. issued to investors
                  named on the signature pages thereto incorporated by reference
to
                  Exhibit 4.2 to the 8-K filed on April 5,
                  2005.4.5
              
              Form
                  of Class A Common Stock Purchase Warrant of Hybrid Fuel Systems,
Inc.
                  issued to the investors named on the signature pages thereto incorporated
                  by reference to Exhibit 4.3 to the 8-K filed on April 5, 2005.4.6
              
              Form
                  of Security Agreement by and between Hybrid Fuel Systems, Inc.
                  and Barbara
                  Mittman as collateral agent incorporated by reference to Exhibit
4.4
                  to the 8-K filed on April 5, 2005.4.7
              
              Form
                  of Collateral Agent Agreement among Barbara R. Mittman, as collateral
                  agent, and the Lenders as defined therein incorporated by reference
                  to Exhibit 4.5 to the 8-K filed on April 5,
                  2005.10.1
              
              License
                  Agreement by and between the Davis Family Trust and Electronic
Fuel
                  Control, Inc. dated May 13, 1996, incorporated by reference to
Exhibit
                  10.1 to the SB-2 filed on March 23, 2000.10.2
              
              Amendment
                  to License Agreement by and between the Davis Family Trust and
Electronic
                  Fuel Control, Inc, dated June 18, 1998, incorporated by reference
                  to Exhibit 10.2 to the SB-2 filed on March 23,
                  2000.10.3
              
              Amendment
                  to License Agreement by and between the Davis Family Trust and
Electronic
                  Fuel Control, Inc. dated January 3, 2000, incorporated by reference
                  to Exhibit 10.3 to the SB-2 filed on March 23,
                  2000.10.4
              
              Consulting
                  Agreement between Save on Energy, Inc. and MBO, Inc. dated November
                  23, 1999, Trust and Electronic Fuel Control, Inc, incorporated
by
                  reference to Exhibit 10.4 to the SB-2 filed on March 23,
                  2000.10.5
              
              Exclusive
                  Supply Agreement between Ambac International Corporation and Electronic
                  Fuel Control, Inc. dated April 29, 1996, incorporated by reference
                  to Exhibit 10.5 to the SB-2 filed on March 23,
                  2000.10.6
              
              Agreement
                  re: International Fuel Systems, Inc. and Davenport, dated January
                  7, 2000, incorporated by reference to Exhibit 10.6 to the SB-2
filed
                  on March 23, 2000.10.7
              
              Employment
                  Agreement with Robert Stiles, dated July 17, 2001, incorporated
                  by reference to Exhibit 10.1 of the 10-QSB filed on November
                  19, 2001.10.8
              
              2001
                  Stock Option Plan - Incorporated by reference to the 2001 Annual
Proxy
                  Statement filed October 1, 2001.10.9
              
              Stock
                  Purchase Agreement between the Company and SWI Holdings, Limited,
dated
                  as of December 10, 2001 (Composite Version), incorporated by reference
                  to Exhibit 10.1 of the 8-K filed on December 26,
                  2001.10.10
              
              Security
                  Agreement between the Company and SWI Holdings, Limited, dated
as
                  of December 10, 2001, incorporated by reference to Exhibit 10.2
                  of the
                  8-K filed on December 26, 2001.10.11
              
              Convertible
                  Secured Promissory Note issued to SWI Holdings, Limited, dated
                  April 23, 2002 incorporated by reference to Exhibit 10.11 to the
10-KSB
                  filed on May 30, 2002.*10.12
              
              Security
                  Agreement between the Company and SWI Holdings, Limited, dated
as
                  of April 23, 2002 incorporated by reference to Exhibit 10.10 to
                  the 10-KSB
                  filed on May 30, 2002.*10.13
              
              Agreement
                  re: White Knight SST, Inc. and Hybrid Fuel Systems, Inc. (formerly
                  Save On Energy, Inc.) dated December 22, 2003 incorporated by reference
                  to Exhibit 10.13 to the 10-KSB filed on August 16,
                  2004.31.1
              
              Certification
                  by Chief Executive Officer and Chief Financial Officer pursuant
                  to Sarbanes-Oxley Section 302 (filed herewith).31.2
              
              Certification
                  by Chief Executive Officer and Chief Financial Officer pursuant
                  to 18 U.S.C. Section 1350 (filed herewith).








44





**ITEM
      14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES.**





Audit
      Fees: The aggregate fees billed by BBK for professional services rendered for
      the audits of the Company's annual financial statements for the years ended
      December 31, 2006 and 2005 were approximately  $185,000 and $65,000
      andrespectively.





Audit
      Related Fees. The Company did not engage BBK to provide professional services
      to
      the Company regarding audit related matters during the years ended December
      31,
      2005 and 2006.





Tax
      Fees.
      The Company did not engage BBK for professional services regarding tax advice
      or
      return preparation.





All
      Other
      Fees. There were no fees billed by BBK for services rendered to the Company,
      other than the services covered above for the years ended December 31, 2005
      and
      2006.





SIGNATURES





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the Registrant has duly caused this report to be signed on its behalf
      by
      the undersigned; thereunto duly authorized, on this 26 day of April,
      2007.




Hybrid
                Fuel Systems, Inc.By:
            /s/ Mark
              ClancyMark
              ClancyChief
              Executive Officer


Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of Registrant and in the
      capacities indicated on April 26, 2007.




/s/ John
              StantonJohn
                StantonChairman
              of the Board of Directors /s/ Mark
              ClancyMark
              ClancyChief
              Executive Officer (Principal Executive Officer) and
              Director /s/ Michele
              HamiltonMichele
              HamiltionChief
              Financial Officer (Principal Financial
              Officer)







45