HQ Sustainable Maritime Industries (HQSM) 10-Q 2007 Q2 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 JUNE 30, 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 June 30, 2007
Common stock, $0.001 par value	8,033,073

		Page Numbers
PART I - FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Income and Comprehensive 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	13
Item 3	Quantitative and Qualitative Disclosures About Market Risk	17
Item 4.	Controls and Procedures	17
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	18
Item 1A	Risk Factors	18
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	19
Item 3.	Defaults Upon Senior Securities	19
Item 4.	Submission of Matters to a Vote of Security Holders	19
Item 5	Other information	19
Item 6.	Exhibits	19

2

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

	June 30, 2007 (Unaudited)		December 31, 2006 (Audited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	18,807,120	$	11,389,375
Trade receivables, net of provisions		17,350,433		17,957,521
Inventories		647,197		708,858
Prepayments		368,476		384,693
TOTAL CURRENT ASSETS		37,173,226		30,440,447
OTHER ASSETS
Deferred taxes		838,192		817,577
Deferred expenses		848,335		1,305,197
		1,686,527		2,122,774
PROPERTY, PLANT AND EQUIPMENT, NET		8,012,103		7,619,606
CONSTRUCTION IN PROGRESS		1,479,124		1,196,453
INTANGIBLE ASSETS		381,600		473,200
TOTAL ASSETS	$	48,732,580	$	41,852,480

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

3

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

	June 30, 2007 (Unaudited)			December 31, 2006 (Audited)
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	4,556,531		$	3,822,510
Bank loans		1,155,541			1,255,203
Tax payable		720,059			175,160
Due to related parties		152,490			198,553
Due to directors		1,671,031			1,698,265
Current portion of promissory notes		87,518			1,227,672
TOTAL CURRENT LIABILITIES		8,343,170			8,377,363
OTHER LIABILITIES
Convertible promissory notes, net of discount		3,403,328			3,869,382
TOTAL LIABILITIES		11,746,498			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, 8,033,073 and 6,416,856 shares issued and outstanding as of June 30, 2007 and December 31, 2006 respectively		8,033			6,417
Additional paid-in capital		32,692,274			25,441,626
Accumulated other comprehensive income		2,474,863			1,612,366
Retained earnings (deficit)		(1,834,583	)		(683,846	)
Appropriation of retained earnings (reserves)		3,645,395			3,229,072
TOTAL SHAREHOLDERS’ EQUITY		36,986,082			29,605,735
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	48,732,580		$	41,852,480

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

4

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30, 2007			June 30, 2006 (Restated)			June 30, 2007			June 30, 2006 (Restated)
SALES	$	13,660,698		$	9,574,081		$	21,510,428		$	16,459,421
COST OF SALES		7,135,365			4,929,634			12,394,649			9,283,089
GROSS PROFIT		6,525,333			4,644,447			9,115,779			7,176,332
SELLING AND DISTRIBUTION EXPENSES		246,366			139,660			344,979			208,828
MARKETING AND ADVERTISING		1,263,891			1,067,690			2,507,977			2,180,425
GENERAL AND ADMINISTRATIVE EXPENSES		1,343,993			1,060,709			2,316,930			1,907,237
DEPRECIATION AND AMORTIZATION		313,397			238,948			608,082			473,396
(RECOVERY OF) DOUBTFUL ACCOUNTS		284,441			(265,905	)		506,241			(81,975	)
INCOME/(LOSS) FROM OPERATIONS		3,073,245			2,403,345			2,831,570			2,488,421
FINANCE COSTS		1,545,397			1,433,359			2,813,602			2,607,301
OTHER (INCOME)/EXPENSES		(4,850	)		6,722			(14,047	)		42,889
INCOME/ (LOSS) BEFORE INCOME TAXES		1,532,698			963,264			32,015			(161,769	)
INCOME TAXES
CURRENT		700,617			286,498			766,429			369,883
DEFERRED		—			35,398			—			70,283
NET INCOME/(LOSS) ATTRIBUTABLE TO SHAREHOLDERS		832,081			641,368			(734,414	)		(601,935	)
OTHER COMPREHENSIVE INCOME
FOREIGN CURRENCY TRANSLATION LOSS		9,019			6,570			14,626			15,920
COMPREHENSIVE INCOME (LOSS)	$	823,062		$	634,798		$	(749,040	)	$	(617,855	)
NET INCOME/(LOSS) PER SHARE
BASIC (AFTER REVERSE SPLIT)	$	0.110		$	0.109		$	(0.103	)	$	(0.103	)
DILUTED (AFTER REVERSE SPLIT)	$	0.102		$	0.109		$	(0.103	)	$	(0.103	)
WEIGHTED AVERAGE COMMON SHARE OUTSTANDING
BASIC (AFTER REVERSE SPLIT)		7,556,129			5,867,467			7,120,337			5,855,135
DILUTED (AFTER REVERSE SPLIT)		8,792,712			5,867,467			7,120,337			5,855,135

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

5

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006

(Unaudited)

	2007			2006 (Restated)
OPERATING ACTIVITIES
Net loss	$	(734,414	)	$	(601,935	)
Non-cash items :
Depreciation and amortization		608,082			473,396
Loss on disposal of fixed assets					2,350
Financial and other non-cash services		2,212,508			6,215,458
Change in non–cash working capital items:
Inventories		61,661			(1,625,810	)
Trade receivables, net of provisions		607,088			(2,923,028	)
Prepayments		16,217			(283,686	)
Deferred taxes					57,174
Accounts payables and accrued expenses		734,021			(474,432	)
Advance from employees					75,854
Taxes (recoverable)/payable		544,899			239,420
Cash flow used in operating activities		4,050,062			1,154,761
INVESTING ACTIVITIES
Acquisition of property, plant and equipment		(706,021	)		(82,951	)
Construction in progress		(282,671	)		—
Cash flow used in investing activities		(988,692	)		(82,951	)
FINANCING ACTIVITIES
Cash proceeds from issuance of common stock		4,075,000			—
Convertible promissory notes issued, net of cash repayments		—			4,512,571
Due (to)/from directors		(27,234	)		210,278
Receipts/(repayment) from/(to) related parties		(46,063	)		(222,958	)
Bank loan repayments		(99,662	)		(423,388	)
Deferred expenses		122,677			(4,086,893	)
Cash flow from financing activities		4,024,718			(10,390	)
NET CHANGE IN CASH AND CASH EQUIVALENTS		7,086,088			1,061,420
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		331,657			347,816
Cash and cash equivalents, beginning of period		11,389,375			5,140,159
Cash and cash equivalents, end of period	$	18,807,120		$	6,549,395
SUPPLEMENTARY CASH FLOWS DISCLOSURES
Interest paid	$	114,758		$	20,569
Taxes paid	$	714,490		$	121,538
SUPPLEMENTARY DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Common shares issued for services	$	158,000		$	195,000

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

6

HQ SUSTAINABLE MARTIME INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

JUNE 30, 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–Q and Rule 10-01 of Regulation S-X. 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.

7

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 common share is computed by adjusting the weighted average common shares outstanding assuming conversion of all potentially dilutive convertible securities.

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 June 30, 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. The Company evaluates 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 June 30, 2007 and December 31, 2006 are summarized as follows:

	June 30, 2007		December 31, 2006
Raw materials	$	116,805	$	62,560
Work-in-progress		137,740		109,859
Finished goods		392,652		536,439
	$	647,197	$	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. Income and expenditures are translated at the average exchange rate of the quarter.

	2007	2006
Quarter end RMB : US$ exchange rate	7.6155	7.9925
Average quarterly RMB : US$ exchange rate	7.6748	7.9925

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.

Commencing from July 21, 2005, China has adopted a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies. The exchange rate of the US dollar against the RMB was adjusted from approximately RMB 8.28 per US dollar to approximately RMB 8.11 per US dollar on July 21, 2005. Since then, the PBOC administers and regulates the exchange rate of US dollar against RMB taking into account demand and supply of RMB, as well as domestic and foreign economic and financial conditions.

8

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 15%, 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	—		—
Effective tax rate	15.0	%	15.0	%

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 LOANS

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.

9

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 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 and six months ended June 30, 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 June 30, 2007

	Aquaculture Product			Health and Bio-product		Unallocated Items			Consolidation
Sales to external customers	$	8,837,657		$	4,823,041	$	—		$	13,660,698
General and administrative expenses		149,712			60,726		1,133,555			1,343,993
Depreciation and amortization		167,888			92,396		53,113			313,397
Selling and distribution expenses		101,190			145,176		—			246,366
Marketing and advertising		—			1,263,891		—			1,263,891
Finance costs		(1,461	)		14,949		1,531,909			1,545,397
Doubtful accounts		7,319			277,122		—			284,441
Income/(loss) before taxes		2,074,780			2,271,228		(2,813,310	)		1,532,698
Income taxes		307,834			406,655		(13,872	)		700,617
Net Income/(loss) for the period		1,766,946			1,864,573		(2,799,438	)		832,081
Segment assets	$	27,640,829		$	18,862,142	$	2,229,609		$	48,732,580
Segment liabilities	$	2,263,566		$	2,631,667	$	6,851,265		$	11,746,498

Business segment for the three months ended June 30, 2006

	Aquaculture Product			Health and Bio-product			Unallocated Items			Consolidation
Sales to external customers	$	5,630,062		$	3,944,019		$	—		$	9,574,081
General and administrative expenses		210,719			195,185			654,805			1,060,709
Depreciation and amortization		156,670			78,542			3,736			238,948
Selling and distribution expenses		56,579			86,081			—			139,660
Marketing and advertising		—			1,067,690			—			1,067,690
Finance costs		(2,427	)		17,505			1,418,281			1,433,359
(Recovery of) Doubtful accounts		(10,105	)		(255,800	)		—			(265,905	)
Income/(loss) before taxes		828,961			2,211,125			(2,076,822	)		963,264
Income taxes		163,571			148,325			10,000			321,896
Net income (loss) for the period		665,390			2,062,800			(2,086,822	)		641,368
Segment assets	$	16,645,537		$	11,706,989		$	2,759,791		$	31,112,317
Segment liabilities	$	2,820,591		$	2,019,810		$	2,341,670		$	7,182,071

10

Business segment for the six months ended June 30, 2007

	Aquaculture Product			Health and Bio-product		Unallocated Items			Consolidation
Sales to external customers	$	14,467,901		$	7,042,527	$	—		$	21,510,428
General and administrative expenses		276,355			124,642		1,915,933			2,316,930
Depreciation and amortization		333,583			168,273		106,226			608,082
Selling and distribution expenses		157,527			187,452		—			344,979
Marketing and advertising		—			2,507,977		—			2,507,977
Finance costs		(6,956	)		26,409		2,794,149			2,813,602
Doubtful accounts		5,085			501,156		—			506,241
Income/(loss) before taxes		2,514,090			2,419,448		(4,901,523	)		32,015
Income taxes		341,410			438,891		(13,872	)		766,429
Net Income/(loss) for the period		2,172,680			1,980,557		(4,887,651	)		(734,414	)
Segment assets	$	27,640,829		$	18,862,142	$	2,229,609		$	48,732,580
Segment liabilities	$	2,263,566		$	2,631,667	$	6,851,265		$	11,746,498

Business segment for the six months ended June 30, 2006

	Aquaculture Product		Health and Bio-product			Unallocated Items			Consolidation
Sales to external customers	$	10,303,560	$	6,155,861		$	—		$	16,459,421
General and administrative expenses		366,285		217,806			1,323,145			1,907,237
Depreciation and amortization		310,593		156,470			6,333			473,396
Selling and distribution expenses		103,086		105,742			—			208,828
Marketing and advertising		—		2,180,425			—			2,180,425
Finance costs		816		47,983			2,558,502			2,607,301
Doubtful accounts (Recovery)		161,853		(243,828	)		—			(81,975	)
Income/(loss) before taxes		908,732		2,817,458			(3,887,959	)		(161,769	)
Income taxes		235,309		194,857			10,000			440,166
Net income (loss) for the period		673,423		2,622,601			(3,897,959	)		(601,935	)
Segment assets	$	16,645,537	$	11,706,989		$	2,759,791		$	31,112,317
Segment liabilities	$	2,820,591	$	2,019,810		$	2,341,670		$	7,182,071

NOTE 12 - CAPITAL COMMITMENT

As of June 30, 2007, there were capital commitments amounting to $65,656 for the purchase of land use right and $25,474 for purchase of motor vehicle in Feedmill.

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. Management does not believe this standard to have a significant impact 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. Management does believe this standard to have a significant impact 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. Management does not believe the adoption of FIN 48 to have a material impact on its 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.

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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 14 - 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.

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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.

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

At that time, we owned 84.4% of Hainan Quebec Ocean Fishing Co. Ltd., a company organized in PRC (“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, since May 2007, the Company is listed on the American Stock Exchange.

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 (See http://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.

In May 2007, we commenced sales of our “TiLoveYa”(TM) brand of frozen fillets through the QFC chain of the Kroger Company within its chain of stores in the states of Washington and Oregon. Headquartered in Cincinnati, Ohio, Kroger is one of the nation’s largest grocery retailers.

Results of Operations – Three Months Ended June 30, 2007 as Compared to Three Months Ended June 30, 2006

Total sales for the three months ended June 30, 2007 increased by 43% to $13,660,698, when compared to the same period of 2006, generating an increase of gross profit of 40%. That increase originates mostly from the aquaculture segment, showing higher demand for our products. Income from operations for the three months ended June 30, 2007 increased by 28% to $3,073,245, when compared the corresponding period of 2006; the current three months period was affected mostly by bad debts of $284,441 incurred in the health and bio-products segment to provide for potential collection risks. Net income was affected in the three months period ended June 30, 2007 by finance costs of $1,545,397, an increase of $112,038 or 8% over the corresponding period of 2006. That increase in finance costs is mostly attributable to a non-recurring provision for penalty on late filing of the registration of the underlying shares related to the convertible secured promissory notes issued in November 2006. The warrants amortization costs (non–cash) related to the promissory notes and the amortization of the related embedded conversion option (also non–cash), make-up the major part of the balance of financial fees and are recognized as such in accordance with FAS 123R and EITF 00–27. Notwithstanding the above increases in bad debts and finance cost, net income improved by 30% in the three months period ended June 30, 2007 when compared to the corresponding period of 2006.

By Segments

Manufacturing and Selling of Marine Bio and Healthcare products

Jiahua Marine is engaged in the manufacturing and selling of Marine Bio and Health-care products. During the three months ended June 30, 2007 and 2006, Jiahua Marine realized sales of $4,823,041 and $3,944,019 respectively, an increase of 22%. The gross profit ratio from this segment was stable at around 86% for the three months ended June 30, 2007 and 2006, respectively. Furthermore, the major expense of this segment remains to be advertising, corresponding to 26% and 27% of revenues for the three months ended June 30, 2007 and 2006, respectively. The net income contributed by this segment was $1,864,573 and $2,062,800 for the three months ended June 30, 2007 and 2006 respectively. The reduction in net income was caused by a sharp increase in doubtful accounts of $532,922 to provide for potential collection risks, combined with increased income taxes due to the end of the holiday tax break from January 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 $8,837,657 for the three months ended June 30, 2007 compared to $5,630,062 for the corresponding period of 2006, an improvement of 57%. The related gross profit ratio of this segment was 28% and 22% for the three months ended June 30, 2007 and 2006. This segment contributed $1,766,946 to net income in the three months period ended June 30, 2007, as compared to a net income of $665,390 for the corresponding period of 2006. The increased activity of this segment in 2007, together with increased margin led to the improved profitability in the second quarter of 2007 compared to the same period of 2006.

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By Operations

Sales.For the three months ended June 30, 2007 revenue increased by $4,086,617 or 43% to $13,660,698. This improvement in sales resulted from a better performance of both segments in 2007, mostly the aquatic segment which experienced an increase of $3,207,595 or 57% compared to the same period of 2006. The health and bio–product segment improved its sales by $879,022 or 22% in the second quarter of 2007 compared to the same period of 2006.

Cost of Sales.Cost of sales increased by $2,205,731 or 45% to $7,135,365 from $4,929,634 for the three months ended June 30, 2007, as compared to the corresponding period of the prior year. Approximately 93% of the increase was due to the increased activities in the aquaculture product segment. The overall gross profit ratio remained stable at around 48% for the three months ended June 30, 2006 and 2007.

Selling and Distribution Expenses.Selling and distribution expenses increased by $106,706 or 76% to $246,366 for the three months ended June 30, 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.

Marketing and Advertising Expenses.Marketing and advertising expenses increased by $196,201 or 18% from $1,067,690 to $1,263,891 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.

General and Administrative Expenses.General and administrative expenses increased by $283,284 or 27% to $1,343,993 from $1,060,709 as compared to the corresponding period of the previous year. Most of the increase is the result of branding–related expenses, investors’ relations and U.S. headquarters expenses while the rest of the increase originates from additional general and administrative expenses in the subsidiaries where additional activity was created in 2007 compared to 2006.

Depreciation and Amortization.Depreciation and amortization increased by $74,449 to $313,397 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. Furthermore, acquisition of fixed assets of $676,098 in the health and bio-product segment in the second quarter of 2007 triggered additional depreciation.

Doubtful Accounts (Recovery).Doubtful accounts amounted to $284,441 for the three months ended June 30, 2007 compared to a recovery of $265,905 for the corresponding period of 2006. The provision was incurred mainly in the health and bio–product segment during the current quarter of 2007 to provide for potential collection risks on outstanding receivables at the end of the period.

Income from Operations.Income from operations increased to $3,073,245 in the second quarter of 2007 from $2,403,345 in the corresponding quarter of the prior year, an increase of $669,900. The significant improvement was the result of increased sales and gross profit from both segments, mainly the increased margin from the aquaculture product segment during the three months period of 2007; that additional gross profit was partially offset by doubtful accounts incurred in the current quarter to provide for potential collection risks. Without considering the effect of the doubtful account expenses on the current and comparative results, income from operations improved by 57% in the current 2007 quarter compared the same quarter of 2006.

Finance Costs.Finance costs increased to $1,545,397 from $1,433,359 for the three months ended June 30, 2007 as compared to the corresponding period of the previous year, an increase of $112,038. Included in the 2007 finance costs are the carrying interests on the notes added 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. The increase in finance costs in the current quarter of 2007 compared to 2006 is due to essentially two factors: (1) a non-recurring $400,000 provision for penalty on late filing of the registration of the underlying shares related to the promissory notes issued in November 2006; and (2) an overall reduction of about $290,000 of non-cash costs of embedded derivatives and warrants conversion on the promissory notes issued in 2006. The above non–cash related financial costs were recognized in accordance with FAS 123R and EITF 00–27. Such amortization will be repeated quarterly, on a pro–rata basis, until maturity of the notes.

Other (Income)/Expenses.For the three months ended June 30, 2007, $4,850 was reported as other income while there were other expenses of $6,722 for the three months ended June 30, 2006.

Income before Income Taxes.Income before income taxes increased by $569,434 or 59% to $1,532,698 in the second quarter of 2007, compared to $963,264 for the corresponding period of 2006. The increased volume and gross profit from both segments experienced during the current quarter of 2007 compared to 2006 was the support of such improvement. That increase was affected mostly by a non-recurring provision for penalty of $400,000 on late filing of the registration statement underlying the shares related to the promissory notes issued in November 2006. Had it not been for such non-recurring penalty, income before income taxes would have more than doubled in the current quarter when compared to the same quarter of 2006.

Current Income Taxes.Current income taxes increased by $414,119 to $700,617 from $286,498 in the current three months of 2007. The increase was mainly due to the higher volumes and gross profits for both segments, and to the termination of the tax rate holiday in health and bio-product segment as of December 31, 2006. The actual tax rate for that segment is 15% in 2007 and was 7.5% for the corresponding period of 2006.

Deferred Income Taxes.Deferred income tax decreased from $35,398 to zero in the current period ended June 30, 2007. There was no requirement of recognizing the deferred tax expenses in the aquaculture product segment in the current quarter.

The Net Income Attributable to Shareholders.The net income attributable to shareholders increased from $641,368 in the second quarter of 2006 to $832,081 in the corresponding period of 2007, a 30% improvement. Notwithstanding the non-recurring penalty described above, the increased activity and gross profit from both segments in the second quarter of 2007 compared to 2006 triggered such growth in the 2007 period.

Results of Operations – Six Months Ended June 30, 2007 as Compared to Six Months Ended June 30, 2006

Total sales for the six months ended June 30, 2007 increased by 31%, when compared to the same period of 2006. That increase in sales originates mostly from the aquaculture segment, showing higher demand for our products. Income from operations for the current six months period improved by 14% when compared to the corresponding six months period of 2006; income from operations for the current six months period was affected mostly by bad debts of $506,241 incurred in the health and bio-product segment to provide for potential collection risks. Net income was affected in the six months period ended June 30, 2007 by finance costs of $2,813,602, an increase of $206,301 or 8% over the corresponding period of 2006. That increase in finance costs is mostly attributable to a non-recurring penalty for late filing of the registration of underlying shares related to the convertible secured promissory notes issued in November 2006. The warrants amortization costs (non–cash) related to the convertible secured promissory notes issued in 2006, added to amortization of the embedded conversion option related to the same notes (also non–cash), and related interests on those notes make up the major part of the balance of financial fees, and are recognized as such in accordance with FAS 123R and EITF 00–27.

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Segments

Manufacturing and Selling of Marine Bio and Healthcare products

One of our subsidiaries, Jiahua Marine, is engaged in the manufacturing and selling of marine bio and health-care products. During the six months ended June 30, 2007 and 2006, Jiahua Marine realized sales of $7,042,527 and $6,155,861 respectively, an increase of $886,666 or 14%. The gross profit ratio from this segment was 84% and 86% for the six months ended June 30, 2007 and 2006, respectively, and the major expense was advertising, corresponding to 36% and 35% of revenues for the six months ended June 30, 2007 and 2006, respectively. The net income contributed by this segment was $1,980,557 and $2,622,601 for the six months ended June 30, 2007 and 2006, respectively. The reduction in net income was caused mostly by increased doubtful accounts of $744,983 to provide for potential collection risks, combined with increased income taxes due to the end of the holiday tax break from January 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 by $4,164,341 or 40% to $14,467,901 for the six months ended June 30, 2007 compared to $10,303,560 for the corresponding period of 2006. The related gross profit ratio of this segment was 23% and 18% for the six months ended June 30, 2007 and 2006, respectively. This segment contributed $2,172,680 to net income in the first six months of 2007, as compared to net income of $673,423 for the corresponding period of 2006. The increased activity of this segment in 2007, together with the increased margin resulted in the improved profitability in that period of 2007 compared to the same period of 2006.

Operations

Sales.For the six months ended June 30, 2007 revenue increased by $5,051,007 or 31% to $21,510,428. This improvement in sales resulted from increased activities of both segments in 2007. The sales from the health and bio product segment increased by $886,666 or 14% in the first six months of 2007 compared to 2006, while the sales from the aquatic segment improved by $4,164,341 or 40% in the same comparative period.

Cost of Sales.Cost of sales increased by $3,111,560 or 34% to $12,394,649 from $9,283,089 for the six months ended June 30, 2007, as compared to the corresponding period of the prior year. Approximately 92% of the increase was due to the increased activities in the aquaculture product segment. The gross profit ratio reduced from 43.6% for the six months ended June 30, 2006 to 42.4% for the same period of 2007. The overall gross profit ratio reduction in the current period is due to the mix of much higher volume from the aquaculture product segment (with lesser percentage of gross profit than the other segment) compared to less additional volume from the marine bio and healthcare product segment.

Selling and Distribution Expenses.Selling and distribution expenses increased by $136,151 or 65% from $208,828 to $344,979 for the six months ended June 30, 2007, as compared to the corresponding period of the prior year. The increase was the result of higher sales volumes realized in the current period, leading to higher transportation costs in the first six months of 2007, as compared to that of the corresponding period of 2006.

Marketing and Advertising Expenses.Marketing and advertising expenses increased by $327,552 or 15% from $2,180,425, to $2,507,977, as compared to the corresponding period of prior year. The primary factor responsible for the increase in the first six months of 2007 was that the health and bio-product segment posted more advertisements to attract more customers for higher sales; the sales of this particular segment increased by 14% in the first six months of 2007 compared to the same period of 2006.

General and Administrative Expenses.General and administrative expenses increased by $409,693 or 21% to $2,316,930 from $1,907,237 as compared to the corresponding period of the previous year. Most of the increase results from additional branding-related expenses, investors’ relations and U.S. headquarters expenses while the rest of the increase originates from additional general and administrative expenses in the subsidiaries where additional activity was created in 2007 compared to 2006.

Depreciation and Amortization.Depreciation and amortization increased by $134,686 or 28% to $608,082 as compared to the corresponding period of prior year, 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. Furthermore, acquisition of fixed assets of $676,098 in health and bio-product segment during the current period of 2007 triggered additional depreciation

Doubtful Accounts (Recovery).Doubtful accounts amounted to $506,241 for the six months ended June 30, 2007 compared to a recovery of $81,975 for the corresponding period of 2006. The provision was incurred mainly from a normal provision made in the health and bio–product segment during the current quarter of 2007 to provide for potential collection risks on outstanding receivables at the end of the period.

Income from Operations.Income from operations increased to $2,831,570 for the six months ended June 30, 2007 from $2,488,421 for the corresponding period of prior year, a 14% improvement. The improvement was the result of increased sales and gross profit from both segments, mainly the aquaculture product segment during the current period of 2007; that additional profit was partially offset by doubtful accounts of $506,241 incurred in the current period. Before the effect of doubtful accounts expenses in the current and comparative periods, income from operations improved by 39% in the current 2007 period compared to 2006.

Finance Costs.Finance costs increased to $2,813,602 from $2,607,301 for the six months period ended June 30, 2007 as compared to the corresponding period of the prior year, an increase of $206,301. Included in the 2007 financing costs are the carrying interests on the promissory notes issued in 2006 added to the continued combination of amortization of the future conversion of warrants (non–cash) attributed to investors on those convertible promissory notes, and the amortization of the embedded conversion option (also non–cash) related to the same notes. Those non–cash related financial costs were recognized in accordance with FAS 123R and EITF 00–27. Such amortization will be repeated quarterly, on a pro–rata basis, until maturity of the underlying notes. Furthermore, the increase in financing costs in the current 2007 period is mostly attributable to a non-recurring $400,000 provision for penalty on late filing of the registration of the underlying shares related to the promissory notes issued in November 2006.

Other Expenses. For the six months ended June 30, 2007, $14,047 was reported as other income while there were other expenses of $42,889 for the six months ended June 30, 2006.

Income Before Income Taxes.Income before income taxes reached $32,015 in the first six months of 2007, from a loss of $161,769 for the corresponding period of 2006. Although we experienced significant increased sales and gross profit from both segments in 2007, doubtful accounts of $506,241 added to the non-recurring $400,000 provision for penalty on late filing of the registration statement related to the November 2004 financing reduced substantially its effect on income.

Current Income Taxes.Current income taxes increased by $396,546 to $766,429 from $369,883 in the first six months of 2007. During the current period, both the aquatic product segment and health bio-product segment were profitable and taxable at a rate of 15%, while the tax rate for both segments was 15% and 7.5%, respectively, in the corresponding period of 2006.

Deferred Income Taxes.Deferred income tax decreased from $70,283 to zero in the current period ended June 30, 2007. There was no requirement of recognizing the deferred tax expenses in the aquaculture product segment in the current quarter.

Net (Loss)/Income Attributable To Shareholders.The net loss attributable to shareholders increased from $601,935 for the six months ended June 30, 2006, to a net loss of $734,414 for the corresponding period of 2007. Although the Company realized higher sales and gross profit from both segments in the current period, that improvement was offset mostly by higher finance costs, provision for doubtful accounts and current income taxes as described above.

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LIQUIDITY AND CAPITAL RESOURCES

Our cash and cash equivalents increased by $7,417,745 or 65%, to $18,807,120 at June 30, 2007, from $11,389,375 at December 31, 2006. As at June 30, 2007, working capital was $28,830,056 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 increased by $6,880,100, or 16%, to $48,732,580 at June 30, 2007, from $41,852,480 as of December 31, 2006. Shareholders equity increased by $7,380,347, or 25%, to $36,986,082 at June 30, 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 June 30, 2007, the balance due to those investors amounted to $87,519. 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 June 30, 2007, fifteen monthly repayments have been made, along with note conversions repaying 98.3% of the originally issued convertible secured promissory notes.

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 June 30, 2007, we had a loan from a bank in the outstanding principal amount of $1,155,541 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 42% 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 4.46 times ($37,173,226/$8,343,170) at June 30, 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 June 30, 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–KSB for the year ended December 31, 2006, which was filed with the Securities and Exchange Commission on March 20, 2007 (the “Fiscal 2006 10–KSB”). The information below provides updates to the previously disclosed risk factors and should be read in conjunction with the risk factors and information disclosed in the Fiscal 2006 10-KSB.

We depend on the availability of additional human resources for future growth.

We are currently experiencing a period of significant growth in our sales volume. We believe that continued expansion is essential for us to remain competitive and to capitalize on the growth potential of our business. Such expansion may place a significant strain on our management and operations and financial resources. As our operations continue to grow, we will have to continually improve our management, operational and financial systems, procedures and controls, and other resources infrastructure, and expand our workforce. There can be no assurance that our existing or future management, operating and financial systems, procedures and controls will be adequate to support our operations, or that we will be able to recruit, retain and motivate our personnel. Further, there can be no assurance that we will be able to establish, develop or maintain the business relationships beneficial to our operations, or to do so or to implement any of the above activities in a timely manner. Failure to manage our growth effectively could have a material adverse effect on our business and the results of our operations and financial condition.

We may be unable to continue to take advantage of the seasonal pricing fluctuation in sales of our products, and we may be adversely affected by the seasonal fluctuation in the prices we earn for our products.

We have experienced seasonal fluctuation in the prices we earn for our products, generally in the range of 15 to 20%. Pricing fluctuation occurs during the winter season when fish farms in the northern part of the PRC suspend production due to cold weather conditions. These weather related disruptions in supply permit us to increase the sales prices of our tilapia products. However, there can be no assurance that such premium pricing, benefiting our profitability, can be maintained in the future. Other factors, such as an increase in the cost of feed, might adversely impact on the cost of fish and lessen our margins and profitability.

U.S. Food and Drug Administration report may adversely impact our business

In June 2007, the U.S. Food and Drug Administration issued an alert report regarding the sale of five types of farm-raised seafood from China in the United States because of unapproved chemical residues. The five types of farm-raised seafood are shrimp, catfish, eel, basa and dace. As a result, the seafood can be sold in the United States providing importers provide independent testing that shows the seafood does not contain the unapproved residues. Although tilapia is not included in the list and we believe our main seafood product, which is tilapia, does not contain any of the unapproved residues, it is possible that our business may be adversely impacted as a result of the recent negative public reports on seafood imported from China.

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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 SECURITIES

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 : August 3, 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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