HQ Sustainable Maritime Industries (HQSM) 10-Q 2007 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-18980

HQ SUSTAINABLE MARITIME INDUSTRIES, INC.

(Exact name of Registrant as specified in its charter)

Delaware	000-18980	62-1407522
(State or jurisdiction of Incorporation or organization)	(Primary Std. Industrial Classification Code Number)	(IRS Employer ID Number)

1511 Third Avenue, Suite 788, Seattle, Washington	98101
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (206) 621-9888

Securities registered under Section 12(b) of the Exchange Act:

None

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, $0.001 par value per share

(Title of Class)

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

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

Large accelerated filer  ¨    Accelerated filer  ¨    Non–Accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act).    Yes  ¨    No  x

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

Class	Outstanding at March 31, 2007
Common stock, $0.001 par value	6,978,247

		Page Numbers
PART I - FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Income	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management Discussion & Analysis of Financial Condition and Results of Operations	11
Item 3	Quantitative and Qualitative Disclosures About Market Risk	14
Item 4.	Controls and Procedures	14
PART II - OTHER INFORMATION		15
Item 1.	Legal Proceedings	15
Item 1A	Risk Factors	15
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	18
Item 3.	Defaults Upon Senior Securities	18
Item 4.	Submission of Matters to a Vote of Security Holders	18
Item 5	Other Information	18
Item 6.	Exhibits	18

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

ASSETS

	March 31, 2007 (Unaudited)		December 31, 2006 (Audited)
CURRENT ASSETS
Cash and cash equivalents	$	11,172,159	$	11,389,375
Trade receivables, net of provisions		17,726,980		17,957,521
Inventories		566,930		708,858
Prepayments		582,374		384,693
TOTAL CURRENT ASSETS		30,048,443		30,440,447
OTHER ASSETS
Deferred taxes		825,327		817,577
Deferred expenses		1,167,927		1,305,197
		1,993,254		2,122,774
PROPERTY, PLANT AND EQUIPMENT, NET		7,480,555		7,619,606
CONSTRUCTION IN PROGRESS		1,495,894		1,196,453
INTANGIBLE ASSETS		427,400		473,200
TOTAL ASSETS	$	41,445,546	$	41,852,480

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

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

LIABILITIES AND SHAREHOLDERS’ EQUITY

	March 31, 2007 (Unaudited)			December 31, 2006 (Audited)
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	3,569,042		$	3,822,510
Bank loans		1,202,453			1,255,203
Tax payable		66,124			175,160
Due to related parties		266,156			198,553
Due to directors		1,566,668			1,698,265
Current portion of promissory notes		709,308			1,227,672
TOTAL CURRENT LIABILITIES		7,379,751			8,377,363
OTHER LIABILITIES
Convertible promissory notes, net of discount		3,772,173			3,869,382
TOTAL LIABILITIES		11,151,924			12,246,745
SHAREHOLDERS’ EQUITY
Preferred stock, $0.001 par value, 10,000,000 shares authorized, 100,000 shares issued and outstanding		100			100
Common stock, $0.001 par value, 200,000,000 shares authorized, 6,978,247 and 6,416,856 shares issued and outstanding as of March 31, 2007 and December 31, 2006 respectively		6,978			6,417
Additional paid-in capital		27,419,867			25,441,626
Accumulated other comprehensive income		1,887,946			1,612,366
Retained earnings (deficit)		(2,303,091	)		(683,846	)
Appropriation of retained earnings (reserves)		3,281,822			3,229,072
TOTAL SHAREHOLDERS’ EQUITY		30,293,622			29,605,735
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	41,445,546		$	41,852,480

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

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended
	March 31, 2007			March 31, 2006 (Restated)
SALES	$	7,849,730		$	6,885,340
COST OF SALES		5,259,284			4,353,455
GROSS PROFIT		2,590,446			2,531,885
SELLING AND DISTRIBUTION EXPENSES		98,613			69,168
MARKETING AND ADVERTISING		1,244,086			1,112,735
GENERAL AND ADMINISTRATIVE EXPENSES		972,937			1,003,470
DEPRECIATION AND AMORTIZATION		294,685			234,448
PROVISION FOR DOUBTFUL ACCOUNTS		221,800			183,930
LOSS FROM OPERATIONS		(241,675	)		(71,866	)
FINANCE COSTS		1,268,205			1,017,000
OTHER (INCOME)/EXPENSES		(9,197	)		36,167
LOSS BEFORE INCOME TAXES		(1,500,683	)		(1,125,033	)
INCOME TAXES
CURRENT		65,812			83,385
DEFERRED		—			34,885
NET LOSS ATTRIBUTABLE TO SHAREHOLDERS	$	(1,566,495	)	$	(1,243,303	)
NET INCOME PER SHARE
BASIC AND DILUTED (AFTER REVERSE SPLIT)	$	(0.23	)	$	(0.21	)
WEIGHTED AVERAGE COMMON SHARE OUTSTANDING
BASIC AND DILUTED (AFTER REVERSE SPLIT)		6,676,826			5,840,167

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

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006

(Unaudited)

	2007			2006
OPERATING ACTIVITIES
Net loss	$	(1,566,495	)	$	(1,243,303	)
Non-cash items :
Depreciation and amortization		294,685			234,448
Financial and other non-cash services		1,188,505			857,597
Change in non–cash working capital items:
Inventories		141,928			(443,149	)
Trade receivables, net of provisions		230,541			967,549
Prepayments		(197,681	)		(245,766	)
Deferred taxes		—			34,885
Accounts payables and accrued expenses		(253,468	)		(784,892	)
Taxes (recoverable)/payable		(109,036	)		10,139
Cash flow used in operating activities		(271,021	)		(612,492	)
INVESTING ACTIVITIES
Acquisition of property, plant and equipment		(39,457	)		(31,692	)
Construction in progress		(299,441	)		—
Cash flow used in investing activities		(338,898	)		(31,692	)
FINANCING ACTIVITIES
Proceeds from issuance of common stock		120,000			272,800
Convertible promissory notes issued, net of cash repayments		—			5,225,000
Due (to)/from directors		(131,597	)		194,458
Receipts/(repayment) from/(to) related parties		67,603			(170,864	)
Bank loan repayments		(52,750	)		(517,879	)
Deferred expenses		137,270			(450,938	)
Cash flow from financing activities		140,526			4,552,577
NET CHANGE IN CASH AND CASH EQUIVALENTS		(469,393	)		3,908,393
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		252,177			(8,130	)
Cash and cash equivalents, beginning of period		11,389,375			5,140,158
Cash and cash equivalents, end of period	$	11,172,159		$	9,040,421
SUPPLEMENTARY CASH FLOWS DISCLOSURES
Interest paid	$	17,593		$	33,351
Taxes paid	$	176,820		$	73,245
SUPPLEMENTARY DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Common shares issued for services	$	—		$	100,500

The accompanying notes are an integral part of the financial statements.

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HQ SUSTAINABLE MARTIME INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

MARCH 31, 2007

NOTE 1 - BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements of HQ Sustainable Maritime Industries, Inc., (HQSM), have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the requirements for reporting on Form 10–QS and Item 310(b) of Regulation S–B. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in United States of America for complete financial statements. However, such information reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full fiscal year. The condensed consolidated balance sheet information as of December 31, 2006 was derived from the audited consolidated financial statements included in the Company’s Annual Report Form 10–KSB. These interim financial statements should be read in conjunction with that report.

NOTE 2 - NATURE OF COMPANY

HQ Sustainable Maritime Industries, Inc. (“HQSM”) was initially incorporated as Sharon Capital Corporation, or Sharon, on September 21, 1989 under the laws of the State of Nevada. Sharon was a “blind pool/blank check” corporation organized for the purpose of purchasing, merging with or acquiring a business or assets from another company. In July 1990, Sharon was changed to PEI, Inc., which was subsequently changed to Process Equipment, Inc. in November 1990. On March 17, 2004, Process Equipment, Inc., Process Equipment Acquisition Corporation, a Nevada corporation and wholly–owned subsidiary of Process Equipment, Inc., or PEAC, and Jade Profit Investment Limited, or Jade, a British Virgin Islands limited liability corporation, entered into an agreement and plan of merger. Pursuant to that agreement, Process Equipment, Inc., through PEAC, acquired Jade, and 84.42% ownership in Jade’s subsidiary Hainan Quebec Ocean Fishing Co. Ltd, a People’s Republic of China, limited liability corporation, which we refer to as HQOF. As a result of that transaction, HQOF became our main operating subsidiary. In April of 2004, pursuant to the above agreement and plan of merger, the board of directors of Process Equipment, Inc. and a majority of the stockholders approved a name change and change of domicile of that company to Delaware via a merger with the newly formed wholly–owned Delaware subsidiary, HQSM. The name change, change of domicile and merger became effective on May 19, 2004, with HQSB being the surviving entity in the merger and acquiring all the assets and liabilities of Process Equipment, Inc. On August 17, 2004, we have entered into a Purchase Agreement with Sino–Sult Canada (S.S.C.) Limited, a Canadian limited liability corporation (“SSC”), whereby we acquired Sealink Wealth Limited (“Sealink”), SSC’s wholly owned subsidiary incorporated in the British Virgin Islands. That purchase agreement has been filed as an exhibit to our current report on Form 8K filed with the Commission on August 18, 2004. Sealink is the sole owner of Hainan Jiahua Marine Bio–Products Co. Ltd., a limited liability company existing in China (“Jiahua Marine”) which is primarily engaged in the production and sales of marine bio–products and healthcare products in the PRC, as described in more detail in the above current report. Also as previously disclosed, in the same current report, SSC is owned by three of our current directors and executive officers who are also, together, indirect beneficial owners of the majority of our capital stock.

Further, as previously disclosed in the above current report, effective August 17, 2004, HQSM caused Jade Profit Investment Limited, its wholly–owned subsidiary, to acquire the minority equity interest equal to 15.58% that Jade did not already own in HQOF, HQSM’s principal operating subsidiary. This purchase was effected by Jade pursuant to the Purchase Agreement, dated as of August 17, 2004, between Jade and Hainan Fuyuan Investment Company Limited, the holder of the minority equity interest of HQOF being acquired by Jade. Jade has previously obtained all requisite governmental approvals in the PRC in order to consummate this transaction.

The Group is principally engaged in the vertically integrated business of aquaculture through co–operative supply agreements, ocean product harvesting, and processing and sales of farm–bred and ocean harvested aquatic products. The principal products of HQOF are cross–bred hybrid of tilapia and white–legged shrimp exporting, directly and indirectly, to the United States, Canada, Japan and European countries. The major market is for export.

The Group has also engaged in the production and sales of marine bio–products and healthcare products in the PRC. The principal products of Hainan Jiahua Marine Bio–Product Company Limited (100% hold subsidiary of Sealink) is Shark Cartilage Capsule, Shark Liver Oil and Shark Liver (Soft gel). The major market is domestic in the PRC.

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NOTE 3 - USE OF ESTIMATES

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

NOTE 4 - EARNINGS PER SHARE

Basic earnings per share are computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share are computed similar to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were diluted.

NOTE 5 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of financial instruments including cash and cash equivalents, receivables, accounts payable and accrued expenses and debt, approximates their fair value at March 31, 2007 and December 31, 2006 due to the relatively short-term nature of these instruments.

NOTE 6 - INVENTORIES

Inventories are stated at the lower of cost and net realizable value. Cost is calculated on the weighted average basis and includes all costs to acquire and other costs incurred in bringing the inventories to their present location and condition. We evaluate the net realizable value of inventories on a regular basis and record a provision for loss to reduce the computed weighted average cost if it exceeds the net realizable value.

The inventories at March 31, 2007 and December 31, 2006 are summarized as follows:

	March 31, 2007		December 31, 2006
Raw materials	$	71,706	$	62,560
Work-in-progress		69,362		109,859
Finished goods		425,862		536,439
	$	566,930	$	708,858

NOTE 7 - FOREIGN CURRENCY TRANSLATION

We follow SFAS No. 52, “Foreign Currency Translation”, for both the translation and re-measurement of balance sheet and income statement items into U.S. dollars. Resulting translation adjustments are reported as a separate component of accumulated comprehensive income (loss) in stockholders’ equity.

The Group maintains its books and accounting records in Renminbi (“RMB”), the PRC’s currency, being the functional currency. Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and liabilities denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the balance sheet date. Any translation gains (losses) are recorded in exchange reserve as a component of shareholders’ equity.

On January 1, 1994, the PRC government introduced a single rate of exchange as quoted daily by the People’s Bank of China (the “Unified Exchange Rate”). The quotation of the exchange rates does not imply free convertibility of RMB to other foreign currencies. All foreign exchange transactions continue to take place either through the Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the Bank of China or other institutions requires submitting a payment application form together with supplier’s invoices, shipping documents and signed contracts.

NOTE 8 - INCOME TAXES

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized.

The Company’s subsidiaries registered in the PRC are subject to state and local income taxes within the PRC at the applicable tax rates on the taxable income as reported in their PRC statutory financial statements in accordance with the relevant income tax laws applicable to foreign enterprises. HQOF and Jiahua Marine were subject to a tax rate of 15% and 7.5%, respectively during this quarter. HQOF and Jiahua Marine were entitled to a two–year tax exempted and three–year half tax rate holiday from 2001 and 2002 commencing with the first profit–making year, respectively.

The reconciliation of the effective income tax rate of the Company to the statutory income tax rate in the PRC for this quarter is as follows:

	HQOF		Jiahua Marine
Statutory tax rate	15.0	%	15.0	%
Tax holidays and concessions	—		(7.5	)%
Effective tax rate	15.0	%	7.5	%

Income taxes are calculated on a separate entity basis. Currently there is no tax benefit or burden recorded for the United States.

NOTE 9 - BANK LOAN

The outstanding bank loan is renewed until April 18, 2008, at a rate of approximately 6.4% per annum. The loans were secured by the pledge of certain fixed assets held by the Group and its subsidiaries.

NOTE 10 - CONVERTIBLE PROMISSORY NOTES AND WARRANTS

Effective January 25, 2006, the Company closed on a financing transaction with a group of private investors for an amount of $5,225,000. After deducting commissions and other costs of the offering of $522,500, the Company received net proceeds of $4,702,500.

The Notes are due January 25, 2008. The Notes are convertible into shares of the Company’s Common Stock at a per share conversion price at the rate of $6.00 per share of Common Stock. The Company follows EITF 00–27, the issue 98–5 model in recording the convertible notes and warrants in its financial statements. The Notes are accruing interest on the principal amount at a rate per annum of eight percent (8%) from January 25, 2006 payable in arrears, subject to the terms and conditions of the Notes, together with principal amount payments, up to January 25, 2008.

One Class A Warrant and one Class B Warrant were issued for each two shares of Common Stock which would be issued on the Closing Date assuming the

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complete conversion of the Note issued on the Closing Date at the rate of $6.00 per share of Common Stock. The exercise price to acquire a share of Common Stock upon exercise of a Class A or B Warrant shall be $6.00 . The Class A Warrants shall be exercisable until January 25, 2009 (three (3) years after the closing of the financing). The Class B Warrants shall be exercisable until January 25, 2011 (five (5) years after the closing of the financing). The Company also issued certain Finders’ Warrants to purchase 87,083 shares of Common Stock similar to and carrying the same rights as the Class B Warrants issuable to the Investors.

The offer and sale of the securities above were effected in reliance on the exemptions for sales of securities not involving a public offering, as set forth in Rule 506 promulgated under the Securities Act of 1933, as amended (the “Securities Act”) and in Section 4(2) and Section 4(6) of the Securities Act and/or Rule 506 of Regulation D.

The Company evaluated the convertible debt and warrants under the guide EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and potentially Settled in, a Company’s Own Stock”, with regards to the control over the form of ultimate settlement of the instruments. The Company classified the warrants as equity under the guide EITF 00-19. The related registration statement became effective on June 15, 2006.

Furthermore, effective November 8, 2006, the Company completed another financing transaction with a group of private investors for an amount of $5,000,000, bearing interest at 6.5% per annum. The financing consisted of two components: (a) promissory notes of the Company, in the principal aggregate amount of $5,000,000 due November 1, 2009 and (b) warrants registered in the name of each Investor to purchase an aggregate of up to 200,000 shares of our Common Stock. The Notes are convertible into shares of the Company’s$0.001 par value Common Stock at a per share conversion price of $5.00 per share. The Warrants expire on the fifth (5^th) anniversary of the effective date of the reverse stock split. The exercise price to acquire a share of Common Stock is equal to the Conversion Price under the Notes, currently at the rate of $5.00 per share of Common Stock.

NOTE 11 - SEGMENTS

No geographical segment analysis is provided for the three months ended March 31, 2007 and 2006, respectively, as less than 10% of consolidated revenues and less than 10% of consolidated income from operations is attributable to the segment other than the Mainland China.

Business segment for the three months ended March 31, 2007

	Aquaculture Product		Health and Bio-product	Unallocated Items		Consolidation
Sales to external customers	5,630,244		2,219,486	—		7,849,730
General and administrative expenses	126,643		63,916	782,378		972,937
Depreciation and amortization	165,695		75,877	53,113		294,685
Selling and distribution expenses	56,337		42,276	—		98,613
Marketing and advertising	—		1,244,086	—		1,244,086
Finance costs	(5,495	)	11,460	1,262,240		1,268,205
(Recovery)/provision of doubtful accounts	(2,234	)	224,034	—		221,800
Income/(loss) before taxes	439,310		148,220	(2,088,213	)	(1,500,683	)
Income taxes	33,576		32,236	—		65,812
Net Income/(loss) for the period	405,734		115,984	(2,088,213	)	(1,566,495	)
Segment assets	24,970,607		16,176,596	298,343		41,445,546
Segment liabilities	1,917,004		2,047,028	7,187,892		11,151,924

Business segment for the three months ended March 31, 2006

	Aquaculture Product	Health and Bio-product	Unallocated Items		Consolidation
Sales to external customers	4,673,498	2,211,842	—		6,885,340
General and administrative expenses	155,566	22,621	825,283		1,003,470
Depreciation and amortization	153,923	77,928	2,597		234,448
Selling and distribution expenses	49,507	19,661	—		69,168
Marketing and advertising	—	1,112,735	—		1,112,735
Finance costs	3,244	30,478	983,278		1,017,000
Provision of doubtful accounts	171,958	11,972	—		183,930
Income/(loss) before taxes	79,771	606,333	(1,811,137	)	(1,125,033	)
Income taxes	71,738	46,532	—		118,270
Net income (loss) for the period	8,033	559,801	(1,811,137	)	(1,243,303	)
Segment assets	14,991,215	9,221,777	8,986,020		33,199,012
Segment liabilities	2,699,070	1,709,294	6,195,646		10,604,010

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NOTE 12 - CAPITAL COMMITMENT

As of March 31, 2007, the Group has capital commitments amounting to $211,704 for upgrading and improving the marine bio and health product factory. For feed mill, there is capital commitments amounting to $129,296 for the purchase of land use right.

NOTE 13 - RECENT PRONOUNCEMENTS

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statement No. 133 and 140” (“SFAS 155”). SFAS 155 resolves issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” SFAS 155 is effective for all financial instruments acquired or issued after the beginning of the first fiscal year that begins after September 15, 2006. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2007. The Company is currently evaluating the impact of SFAS 155 on its consolidated financial statements.

In March 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 amends FASB Statement No. 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practical. SFAS 156 is effective as of the beginning of the first fiscal year that begins after September 15, 2006. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2007. The Company is currently evaluating the impact of SFAS 156 on its consolidated financial statements.

In June 2006, the FASB issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109) (“FIN 48”), which clarifies the relevant criteria and approach for the recognition, de–recognition and measurement of uncertain tax positions. FIN 48 will be effective for the Company beginning January 1, 2007. We do not expect the adoption of FIN 48 to have a material impact on our Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 will be effective for the Company beginning January 1, 2008. We are currently in the process of assessing the provisions of SFAS No. 157 and determining how this framework for measuring fair value will affect our current accounting policies and procedures and our financial statements. We have not determined whether the adoption of SFAS No. 157 will have a material impact on our consolidated financial statements.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”). SFAS 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 is effective for an employer with publicly traded equity securities as of the end of the first fiscal year ending after December 15, 2006. SFAS 158 also requires an employer to measure the funded status of a plan as of the date of its year–end statement of financial position, effective for fiscal years ending after December 15, 2008. As such, the Company is required to recognize the funded status of its defined benefit postretirement plan and to provide the required disclosures at the beginning of the fiscal year ended June 30, 2009. The Company is currently evaluating the impact of SFAS 158 on its financial statements.

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115”. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. This Statement applies to all entities, including not-for-profit organizations. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2008. The Company is currently evaluating the impact of SFAS 159 on its consolidated financial statements.

NOTE 15 - LEGAL PROCEEDINGS

With the exception of the proceeding described below, we are currently not involved in any litigation that we believe could have a materially adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self–regulatory organization or body pending or, to the knowledge of the executive officers of our company or any of our subsidiaries, threatened against or affecting our company, our common stock, any of our subsidiaries or of our company’s or our company’s subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.

On June 1, 2006, a complaint was filed by Bank of China in the Superior Court (Commercial Division) in Quebec, Canada, against certain affiliates of our company in which we were named as a co-defendant in this lawsuit. This complaint has been terminated by an “Agreement of receipt, mutual release and discharge” signed on May 14, 2007, which was filed with the Superior Court (Commercial Division) in Quebec, Canada. This was completed for an amount settled by the Directors of the Company and has no material impact on the Company.

Furthermore, on February 22, 2007 Stag Management Canada Ltd. served an action for recovery of “consulting fees” against HQ Sustainable Maritime Industries Inc, based upon a service agreement. The action was filed in the Quebec Superior Court. The claim is for the sum of US$ 4.75 Million. We will vigorously defend this action as management believes it is without merit. Consequently, no provision has been made in the financial statements in that respect.

The company is in an arbitration proceeding with an advisor of one of its subsidiaries for dispute on certain expenses reimbursements and fees.

NOTE 16 – SUBSEQUENT EVENTS

American Stock Exchange (AMEX) has approved the application of HQ Maritime Industries, Inc. for the listing of a total of 13,966,226 shares of common stock, $0.001 par value. The trading of the Company’s shares is scheduled to commence on May 17, 2007.

The outstanding bank loan was renewed until April 18, 2008, at a rate of approximately 6.4% per annum. The loan is secured by the pledge of certain fixed assets held by the Group and its subsidiaries.

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ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

GENERAL OVERVIEW

We are a leader in toxin free integrated aquaculture and aquatic product processing, with processing facilities located in Hainan, PRC. We market our products in Asia, America and Europe. We have two processing plants in Hainan, one that processes aquatic products providing toxin–free tilapia and other aquatic products, and the other one that processes marine bio and healthcare products. We seek to expand our operations through additional processing facilities in China and marketing efforts throughout North America and Europe.

Recently, we announced that we had entered into a conditional agreement with the government of Tayang Town in the Province of Hainan, PRC, in order to work with the cooperative farms capable of producing some 20,000 tonnes of live weight tilapia. We expect this agreement to result in doubling the farming capacity available to us. This agreement is conditional on the completion of a financing for the construction of a new feed mill and processing plant in the immediate vicinity of the farms.

Furthermore, we also announced that we strengthened our sales force in the United States by recruiting Mr. Trond Ringstad as our Executive Vice–President Sales and Distribution and Mr. Robert Emel, as our Retail Sales Manager, to oversee our retail and value–added sales and branding. Their experience in servicing the fish industry will impact significantly on the demand for our products.

In addition, from the first quarter of 2004, following our reverse merger with Process Equipment, Inc., we have been operating under the name of HQSM.

At that time, we owned 84.4% of HQOF, currently our principal operating subsidiary that processes our seafood products; in August 2004 we acquired the remaining ownership interest that we did not already own in HQOF. The fiscal year–end of Process Equipment prior to the reverse merger was April 30, which was changed to December 31 following the reverse merger. In August 2004, we acquired 100% interest in our current subsidiary Jiahua Marine which operates a marine bio and healthcare plant, including nutraceuticals, in Hainan Province, China.

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand our Group. MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes (“Notes”).

Our principal executive office is located at 1511, Third Avenue, Suite 788, Seattle, Washington, and our telephone number is (206) 621 9888. The URL for our website is http://www.hqfish.com.

PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

You should read the following discussion of our financial condition and operations in conjunction with the consolidated financial statements and the related notes included elsewhere in this quarterly report. This quarterly report contains forward–looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include statements about our expectations, beliefs, intentions or strategies for the future, which we indicate by words or phrases such as “anticipate,” “expect,” “intend,” “plan,” “will,” “we believe,” “our company believes,” “management believes” and similar language. The forward–looking statements are based on our current expectations and are subject to certain risks, uncertainties and assumptions, including our ability to (1) obtain sufficient capital or a strategic business arrangement to fund our expansion plans; (2) build the management and human resources infrastructure necessary to support the growth of our business; (3) competitive factors and developments beyond our control; and (4) those other risk factors, uncertainties and assumptions that are set forth in the discussion under the headings captioned “Business,” “Risk Factors,” and “Management’s Discussion and Analysis”. Our actual results may differ materially from results anticipated in these forward–looking statements. We base the forward–looking statements on information currently available to us, and we assume no obligation to update or revise them, whether as a result of new information, future events or otherwise. In addition, our historical financial performance is not necessarily indicative of the results that may be expected in the future and we believe that such comparisons cannot be relied upon as indicators of future performance.

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes thereto and other financial information contained elsewhere in this Form 10–Q.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Our management periodically evaluates the estimates and judgments made. Management bases its estimates and judgments on historical experience and on various factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates as a result of different assumptions or conditions.

The following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s consolidated financial statements.

Inventories

Inventories are stated at the lower of cost and net realizable value. Cost is calculated on the weighted average basis and includes all costs to acquire and other costs incurred in bringing the inventories to their present location and condition. The Company evaluates the net realizable value of its inventories on a regular basis and records a provision for loss to reduce the computed weighted average cost if it exceeds the net realizable value.

Income Taxes

Taxes are calculated in accordance with taxation principles currently effective in the PRC. The Company accounts for income taxes under the provision of Statements of Financial Accounting Standards No. 109, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. The Company accounts for income taxes using the liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. A valuation allowance is provided for the amount of deferred tax assets that, based on available evidence, are not expected to be realized.

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Related Parties

Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operational decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Related parties may be individuals or corporate entities.

Revenue Recognition

In accordance with the provisions of Staff Accounting Bulletin No. 103, revenue is recognized when merchandise is shipped and title passes to the customer and collectibility is reasonably assured.

Concentration of Credit Risk

Financial instruments that potentially subject our company to significant concentrations of credit risk consist primarily of trade accounts receivable. We perform ongoing credit evaluations with respect to the financial condition of its creditors, but do not require collateral. In order to determine the value of our accounts receivable, we record a provision for doubtful accounts to cover probable credit losses. Our management reviews and adjusts this allowance periodically based on historical experience and its evaluation of the collectibility of outstanding accounts receivable

Recent developments

On January 31, 2007, we completed a 1–for–20 reverse stock split. Furthermore, we have applied to be listed on the American Stock Exchange and we expect our shares to trade on that Board by the end May 2007.

On February 12, 2007, HQSM announced that it will begin direct sales of its “TiLoveYa”(TM) toxin–free brand through the internet. “Ultimate Entrée” is a leader in direct marketing through the internet of superior seafood and meat products. The success as “an event food Headquarters,” as seen through their recent “Super Bowl Special,” works well with the sale of ‘tailgate party’ marketed products such as HQ’s “TailGate TiLoveYa,”(TM) a skin–on boneless TiLoveYa toxin–free product sold by HQSM, ideally suited for barbecue. Regular 1 pound and 1.5 pound bags of HQSM’s boneless skinless fillet will also be marketed on the site and available directly online to Ultimate Entrée’s and HQSM’s clients.

On February 13, 2007, HQSM has agreed to work with the Beijing division of Newly Weds^® Foods, Inc. to introduce an exclusive, innovative line of battered and breaded flavored TiLoveYa(TM) fillet products to Chinese consumers. The new product line will use the vast international taste technology of Newly Weds^® Foods, Inc., as developed in its China operations, to manufacture value–added breaded TiLoveYa(TM) toxin–free fillet products to consumers in China. Most breaded value–added fish products currently marketed in China and the West suffer in quality from multiple rounds of freezing, deteriorating the taste, juiciness, texture and quality of the product.

On April 2^nd, 2007 HQSM signed an agreement with Grocery Outlet to commence sales of its branded “TiLoveYa”(TM) products to its nearly 150 stores on the West Coast. The Grocery Outlet chain (Seehttp://www.groceryoutlets.com/home.aspx) is headquartered in Berkeley, California, and has annual revenues exceeding $600 million. The agreement allows The Grocery Outlet to sell HQ’s brand of frozen fillets within its chain of stores in the states of California, Washington, Oregon, Nevada, Idaho and Hawaii.

On Monday April 23, HQSM signed an agreement with Sam’s Club to commence online sales of various formats of its branded “TiLoveYa(TM)” tilapia products on the Sam’s Club website. Sam’s Club is a division of Wal-Mart Stores, Inc. and ranks as one of the nation’s largest warehouse clubs with more than 47 million U.S. members. The first Sam’s Club opened its doors in Midwest City, Oklahoma in 1983. Sam’s Club offers exceptional values on merchandise and services for business owners and consumers. Online merchandise and Club information is available atwww.samsclub.com.

Results of Operations – Three Months Ended March 31, 2007 as Compared to Three Months Ended March 31, 2006

Total sales for the three months ended March 31, 2007 increased by 14%, when compared to the same period of 2006. That increase originates mostly from the aquaculture segment, showing higher demand for our products. The loss from operations for that three months period increased from $71,866 in March 2006 to $241,675 in March 2007. Seasonality in the first quarter of each year continues to characterize our yearly results. Net loss in the first three months of 2007 was affected by finance costs of $1,268,205, an increase of $251,205 over the corresponding period of 2006. That increase was the result of having a full quarter of amortization of the future conversion of warrants added to the embedded conversion option on the convertible promissory notes which were issued in January and November 2006. Those amortization and non-cash financing costs must be recognized as such in accordance with FAS 123R and EITF 00-27.

By Segments

Manufacturing and Selling of Marine Bio and Healthcare products

Jiahua Marine is engaged in the manufacturing and selling of Marine Bio and Healthcare products. During the three months ended March 31, 2007 and 2006, Jiahua Marine realized sales of $2,219,486 and $2,211,842 respectively, an increase of 0.3%. The gross profit ratio from this segment was 82% and 85% for the three months ended March 31, 2007 and 2006, respectively, due to a different mix of sales realized in 2007. Furthermore, the major expense of this segment continues to be advertising, corresponding to 56% and 50% of revenues for the three months ended March 31, 2007 and 2006, respectively. The net income contributed by this segment was $115,984 and $559,801 for the three months ended March 31, 2007 and 2006 respectively. The reduction in net income was caused by the combination of lower gross profit margin, higher marketing expenses and a sharp increase in provision for doubtful accounts of $212,062 encountered in 2007.

Manufacturing and Selling of aquatic products

Our other subsidiary, HQOF, is engaged in the manufacturing and selling of aquatic products. The revenue contributed by this segment increased to $5,630,244 for the three months ended March 31, 2007 compared to $4,673,498 for the corresponding period of 2006, an improvement of 20%. The related gross profit ratio of this segment was stable at around 13.9% for both quarterly periods ended March 31, 2007 and 2006. This segment contributed $405,734 to net income in the three months period ended March 31, 2007, as compared to a net income of $8,033 for the corresponding period of 2006. The increase in the net profit for the three months ended in March 2007 was mainly caused by higher volumes of sales in the first quarter of 2007 compared to 2006, combined to lower provision for doubtful accounts of $171,958 in the same corresponding periods.

By Operations

Sales.For the three months ended March 31, 2007 revenue increased by $964,390 or 14% to $7,849,730. This improvement in sales resulted from a better performance of both segments in 2007, mostly the aquatic segment which saw an increase of $956,746, or 20% compared to the same period of 2006. The health and bio–product segment slightly improved its sales by $7,644 in the first quarter of 2007 compared to the same period of 2006.

Cost of Sales.Cost of sales increased by $905,829 or 21% to $5,259,284 from $4,353,455 for the three months ended March 31, 2007, as compared to the corresponding period of the prior year. Approximately 91% of the increase was due to the increased activities in the aquaculture product segment. The average gross profit ratio decreased from 37% for the three months ended March 31, 2006 to 33% for the current quarter in 2007. The overall gross profit ratio reduction in the current quarter is due to the mix of much higher volume from the aquatic product segment (with lesser percentage of gross profit than the other segment)

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added to reduction in gross profit margin from the health and bio product segment.

Selling and Distribution Expenses.Selling and distribution expenses increased by $29,445 or 43% to $98,613 for the three months ended March 31, 2007, as compared to the corresponding period of the previous year. The increase originated mostly from higher volume of sales realized in the current period, mostly in the aquatic segment.

Marketing and advertising Expenses.Marketing and advertising expenses increased by $131,351 or 12% from $1,112,735 to $1,244,086 as compared to the corresponding period of prior year. The primary factor responsible for that increase in the current quarter of 2007 was that Jiahua Marine posted more advertisements to maintain its market share in a more competitive and developed market. Furthermore, significant advertising expenditures for the promotion of our bio-products to achieve customer recognition are consistent with industry practices.

Depreciation and amortization.Depreciation and amortization increased by $60,237 to $294,685 in the current quarter when compared to the same quarter of 2006, mainly as a result of the amortization of intangible assets related to the purchase of a U.S. distribution network in the third quarter of 2006.

Provision for Doubtful Accounts.Doubtful accounts increased by $37,870 to $221,800 in the current quarter when compared to the same quarter of 2006. The increase was mainly from a normal provision made in the health and bio-product segment during the current quarter of 2007 to provide for a potential collection risk.

Loss from Operationincreased to $241,675 in the first quarter of 2007 from $71,866 in the corresponding quarter of prior year, an increase of $169,809. The increased activity and gross profit recognized in the first quarter of 2007 compared to the first quarter of 2006 was offset mainly by increased marketing and advertising expenses of $131,351, and additional bad debt of $37,870.

Finance Costs.Finance costs increased to $1,268,205 from $1,017,000 for the three months ended March 31, 2007 as compared to the corresponding period of the previous year, an increase of $251,205. That increase was due mostly to the continued combination of amortization of the future conversion of warrants (non–cash) attributed to investors on the convertible promissory notes of $5,225,000 issued during the first quarter of 2006 and of $5,000,000 issued in the last quarter of 2006, added to the amortization of the embedded conversion option (also non–cash) related to the same notes. Those two non–cash related financial costs, amounting to approximately $1,119,000 in the current three months period were recognized in accordance with FAS 123R and EITF 00–27. Such amortization will be repeated quarterly, on a pro–rata basis, until repayment of the notes. . Finally, carrying interests on those notes, amounting to approximately $150,000 were incurred during the same current period.

Other (Income)/expenses.For the three months ended March 31, 2007, $9,197 was reported as other income while there were other expenses of $36,167 for the three months ended March 31, 2006.

Loss before Income Taxes.Loss before income taxes increased to $1,500,683 in the first quarter of 2007, compared to $1,125,033 for the corresponding period of 2006. The increased activity and gross profit recognized in the first quarter of 2007 compared to the first quarter of 2006 was affected mainly by increased finance costs of $251,205, and increased marketing and advertising expenses of $131,351 experienced in the current quarter.

Current Income Taxes.Current income taxes decreased by $17,573 to $65,812 from $83,385 in the current three months of 2007. The decrease was mainly due to the higher operating expenses for both segments

Deferred Income Taxes.Deferred income tax decreased from $34,885 to zero in the current period ended March 31, 2007. There was no requirement of recognizing the deferred tax expenses in the aquaculture product segment in the current quarter.

The Net Loss Attributable to Shareholdersincreased from $1,243,303 in the first quarter of 2006 to $1,566,495 for the three months ended March 31, 2007. Although experiencing increased activity and gross profit in the aquaculture segment in the first quarter of 2007 compared to 2006, the 2007 results were affected by increased finance costs (mostly non-cash) and marketing and advertising expenses, as described above.

LIQUIDITY AND CAPITAL RESOURCES

Our cash and cash equivalents decreased by $217,216, or 2%, to $11,172,159 at March 31, 2007, from $11,389,375 at December 31, 2006. As at March 31, 2007, working capital was $22,668,692 compared to $22,063,084 at December 31, 2006. The funds generated by the operating and financing activities during 2007 were used mainly to support the increase in our business volume, more specifically our receivables and inventories levels.

Total assets decreased by $406,934, or 1%, to $41,445,546 at March 31, 2007, from $41,852,480 as of December 31, 2006. Shareholders equity increased by $687,887, or 2.32%, to $30,293,622 at March 31, 2007, from $29,605,735 as of December 31, 2006.

To date, we have financed our operations through the combination of our operating revenues, equity and debt financing (in connection with which we have at times incurred significant costs), short-term bank loans, and the use of shares of our common stock issued as payment for services rendered to us by third parties. In the past, we issued shares of our common stock and warrants in private placement transactions to help finance our operations, and to pay for professional services (such as financial consulting, market development, legal services and public relations services). We recognized these services on our books as operating or deferred expenses and amortized over their estimated useful life. The number of shares we issued for these purposes were determined as of the dates of invoices relating to such services, and the shares were valued at their market prices on those respective dates. In addition, as required by PRC laws, we establish yearly reserves shown in the shareholders’ equity section of our balance sheet. Those reserves, which are created by a transfer from the retained earnings account, limit our capacity to pay dividends to shareholders until the retained earnings become positive. As we are in an expansion phase, we do not intend to pay dividends to shareholders in the foreseeable future. To date, we have not paid any dividends.

We also completed a financing in January 2006, in which we issued to a group of twenty one investors, in a private placement, (1) convertible secured promissory notes bearing interest at 8% per year and maturing on January 25, 2008, in the aggregate principal amount of $5,225,000; (2) Class A warrants, with each warrant giving the right to the holder to purchase one share of our common stock at the exercise price of $0.35 until January 2009 (repriced @ $0.30); and (3) Class B warrants, with each warrant giving the right to the holder to purchase one share of our common stock at the exercise price of $0.40 until January 2011 (repriced @ $0.30). The net proceeds of this financing to us were $4,702,500, after deducting commissions and other costs of this transaction equal to $522,500. At March 31, 2007, the balance due to those investors amounted to $1,677,225. Under the terms of the convertible secured promissory notes, we must repay these notes on a monthly basis until January 25, 2008. We have the option of repaying the notes in cash or in shares of our common stock. As of March 31, 2007, twelve monthly repayments have been made, repaying 68% of the originally issued convertible secured promissory notes.

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We completed another financing in November 2006, in which we issued to two investors, in a private placement, (1) convertible promissory notes bearing interest at 6.5% and maturing in November 1, 2009, in the principal aggregate amount of $5,000,000 with the conversion price of $5.00 after reverse split and (2) warrants registered in the name of each investor to purchase an aggregate of up to 200,000 of our common stock, after reverse split, with each warrant giving the right to the holder to purchase one share of our common stock at the exercise price of $5.00 until the fifth anniversary of the effective date of the reverse stock split effectuated. The net proceed of this financing to us were $4,932,500, after deducting commissions and other costs of this transaction equal to $67,500. The notes are due on November 1, 2009.

We are currently in the process of examining various financing opportunities to obtain additional liquidities to help finance our operations, as well as support our additional cash requirements related to volume increases that we anticipate might occur in the future, specifically in the inventory and receivables build-up. As of March 31, 2007, we had a loan from a bank in the outstanding principal amount of $1,202,453 bearing an interest rate of 6.4% per annum. We extended the maturity of the outstanding loan balance to April 18, 2008. The loan is secured by a pledge of certain fixed assets held by us and our subsidiaries and is used to support working capital items related to production in China. No assurances can be given that additional debt or equity financing we may require will be available to us or, even if available, that such financing will be on terms favorable to us.

At present, over 60% of our consolidated sales are derived from our five largest clients, and our results of operations therefore depend on a small number of clients. As part of our short and medium-term business plan, including our current efforts to raise funds to support the anticipated expansion of our operations, we intend to invest in our infrastructure to construct a new processing plant and our own organic feed mill. We expect that this will allow us to meet forecasted incremental demand for our products in the United States and Europe. As a result, we plan to develop and serve new clients, which should reduce our dependence on individual clients to more acceptable levels.

In order to ensure sufficient funds to meet our future needs for capital, management believes that, from time to time, we will continue to evaluate opportunities to raise financing through some combination of commercial bank borrowings, the private or public sale of equity, or issuance of debt securities. However, future equity or debt financing may not be available to us at all, or if available, may not be on terms acceptable to us. If we are unable to obtain financing in the future, we will continue to develop our business on a reduced scale based on our existing capital resources.

The current ratio improved to 4.07 times ($30,048,443/$7,379,751) at March 31, 2007, from and 3.63 times ($30,440,447/$8,377,363) at December 31, 2006.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not hold any derivative instruments and do not engage in any hedging activities. Because most of our purchases and sales are made in RMB, any exchange rate change affecting the value of the RMB relative to the U.S. dollar could have an effect on our financial results as reported in U.S. dollars. If the RMB were to depreciate against the U.S. dollar, amounts reported in U.S. dollars would be correspondingly reduced. If the RMB were to appreciate against the U.S. dollar, amounts reported in U.S. dollars would be correspondingly increased.

ITEM 4. CONTROL AND PROCEDURES.

a) Evaluation of Disclosure Controls and Procedures.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act). Disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the Securities and Exchange Commission under the Exchange Act. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

(b) Changes in Internal Control over Financial Reporting.

During the Quarter ended March 31, 2007, there was no change in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

On June 1, 2006, a complaint was filed by Bank of China in the Superior Court (Commercial Division) in Quebec, Canada, against certain affiliates of our company in which we were named as a co-defendant in this lawsuit This complaint has been terminated by an “Agreement of receipt, mutual release and discharge” signed on May 14, 2007, which was filed with the Superior Court (Commercial Division) in Quebec, Canada. This was completed for an amount settled by the Directors of the Company and has no material impact on the Company.

Furthermore, on February 22, 2007, the Company was served an action for recovery of consulting fees from a service supplier. The amount claimed by that supplier is $4.75 Million. The Company will vigorously defend this action as management believes it is without merit. Consequently, no provision has been made in the financial statements in that respect.

The Company is in arbitration proceeding with an advisor of one of its subsidiaries for dispute on certain expenses reimbursements and fees.

ITEM 1A -Risk Factors

We have updated the risk factors previously disclosed in Part II, Item 6 of our Annual Report on Form 10–K for the year ended December 31, 2006, which was filed with the Securities and Exchange Commission on March 20, 2007 (the “Fiscal 2006 10–K”). We believe there is no change that constitute material changes from the risk factors previously disclosed in the Fiscal 2006 10–K.

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

During the period covered by this report, we did not sell securities pursuant to registration requirements of the Securities Act of 1933, as amended (the “Securities Act”).

ITEM 3 - DEFAULTS UPON SENIOR SECURITES

There have been no material defaults.

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters have been submitted to a vote of security holders during the period covered by this report.

ITEM 5 - OTHER INFORMATION

None.

ITEM 6 - EXHIBITS

31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2	Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.
32.2	Certification of Principal Financial and Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(b) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, Washington.

Dated : May 15, 2007

HQ SUSTAINABLE MARITIME INDUSTRIES, INC.
By:	/s/ Norbert Sporns
Name:	Norbert Sporns
Title:	Chief Executive Officer and President

/s/ Jean-Pierre Dallaire

Jean-Pierre Dallaire,

Principal Financial and Accounting Officer

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Exhibit Index

Exhibit Number	Description
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2	Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.
32.2	Certification of Principal Financial and Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.

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