HQ Sustainable Maritime Industries (HQSM) 10-Q/A 2008 Q1 Quarterly report (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

(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, 2008

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, 2008
Common stock, $0.001 par value	11,843,545

Amendment No. 1 to the Quarterly Report on Form 10-Q

For the Quarterly Period Ended March 31, 2008

EXPLANATORY NOTE

HQ Sustainable Maritime Industries, Inc. (the “Company”) is filing this Amendment No. 1 on Form 10-Q/A (this “Amendment”) to its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2008, which was originally filed on May 14, 2008 (the “Original Filing”), to amend Part I. Item 4 of the Original Filing.

In Part I. Item 4, we have added the following paragraph regarding the effectiveness of our internal control:

The Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this quarterly report on Form 10-Q for the Quarter ended March 31, 2008. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this quarterly report on Form 10-Q. There were no changes in internal control over financial reporting (as defined in Rule 13a-15(e) under the Exchange Act) that occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, this Amendment amends the Original Filing and contains new certifications pursuant to Section 302 and 906 of the Sarbanes-Oxley Act of 2002. This Amendment continues to speak as of the date of the Original Filing, and the Company has not updated the disclosure contained herein to reflect events that have occurred since the filing of the Original Filing. Accordingly, this Amendment should be read in conjunction with the Company’s other filings, if any, made with the United States Securities and Exchange Commission subsequent to the filing of the Original Filing, including the amendments to those filings, if any.

		Page Numbers
PART I - FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements	3
Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3	Quantitative and Qualitative Disclosures about Market Risk	16
Item 4.	Control and Procedures	16
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	17
Item 1A	Risk Factors	17
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	17
Item 3.	Defaults its Upon Senior Securities	17
Item 4.	Submission of Matters to a Vote of Security Holders	17
Item 5	Other Information	17
Item 6.	Exhibits	17

2

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE WITH LIMITED LIABILITY)

CONDENSED CONSOLIDATED BALANCE SHEETS

ASSETS

	March 31, 2008 (Unaudited)		December 31, 2007 (Audited)
CURRENT ASSETS
Cash and cash equivalents	$	44,721,983	$	46,959,908
Trade receivables, net of provisions		25,415,374		25,234,502
Inventories		1,468,991		877,716
Prepayments		415,564		350,116
Future income taxes		26,097		26,097
TOTAL CURRENT ASSETS		72,048,009		73,448,339
OTHER ASSETS
Deferred taxes		910,278		873,865
Deferred expenses		35,645		84,317
		945,923		958,182
PROPERTY, PLANT AND EQUIPMENT, NET		7,879,389		7,716,615
CONSTRUCTION IN PROGRESS		2,863,104		949,728
INTANGIBLE ASSETS		1,481,753		1,254,002
TOTAL ASSETS	$	85,218,178	$	84,326,866

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

LIABILITIES AND SHAREHOLDERS’ EQUITY

	March 31, 2008 (Unaudited)		December 31, 2007 (Audited)
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	5,445,561	$	8,935,928
Tax payable		114,691		956,289
Due to directors		1,151,934		1,544,350
Current portion of promissory notes		475,284		461,284
TOTAL CURRENT LIABILITIES		7,187,470		11,897,851
OTHER LIABILITIES
Convertible promissory notes, net of discount		3,772,173		3,653,352
TOTAL LIABILITIES		10,959,643		15,551,203
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, 11,843,545 and 11,511,317 shares issued and outstanding as of March 31, 2008 and December 31, 2007 respectively		11,511		11,511
Additional paid-in capital		60,935,343		57,142,204
Accumulated other comprehensive income		7,353,903		4,590,060
Retained earnings		1,167,624		2,373,825
Appropriation of retained earnings (Reserves)		4,790,054		4,657,963
TOTAL SHAREHOLDERS’ EQUITY		74,258,535		68,775,663
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	85,218,178	$	84,326,866

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

	Three Months Ended
	March 31, 2008			March 31, 2007
SALES	$	9,210,490		$	7,849,730
COST OF SALES		5,310,702			5,259,284
GROSS PROFIT		3,899,788			2,590,446
SELLING AND DISTRIBUTION EXPENSES		229,176			98,613
MARKETING AND ADVERTISING		1,164,518			1,244,086
GENERAL AND ADMINISTRATIVE EXPENSES		1,452,800			972,937
DEPRECIATION AND AMORTIZATION		339,755			294,685
(RECOVERY OF) / PROVISION FOR DOUBTFUL ACCOUNTS		(10,538	)		221,800
INCOME/(LOSS) FROM OPERATIONS		724,077			(241,675	)
FINANCE COSTS		1,639,405			1,268,205
OTHER EXPENSES/(INCOME)		1,765			(9,197	)
LOSS BEFORE INCOME TAXES		(917,093	)		(1,500,683	)
INCOME TAXES
CURRENT		112,350			65,812
DEFERRED		—			—
NET LOSS ATTRIBUTABLE TO SHAREHOLDERS	$	(1,029,443	)	$	(1,566,495	)
OTHER COMPREHENSIVE INCOME
Foreign currency translation gain		2,763,843			275,580
COMPREHENSIVE INCOME	$	1,734,400		$	(1,290,915	)
NET LOSS PER SHARE
BASIC	$	(0.089	)	$	(0.235	)
DILUTED (AFTER REVERSE SPLIT)	$	(0.089	)	$	(0.235	)
WEIGHTED AVERAGE COMMON SHARE OUTSTANDING
BASIC		11,572,458			6,676,826
DILUTED (AFTER REVERSE SPLIT)		11,572,458			6,676,826

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 THREE MONTHS ENDED MARCH 31, 2008 AND 2007

	2008			2007
OPERATING ACTIVITIES
Net loss	$	(1,029,443	)	$	(1,566,495	)
Non-cash items:
Depreciation and amortization		339,755			294,685
Loss of disposal of fixed assets		1,765			—
Financial and other non-cash services		1,908,580			1,188,505
Change in non–cash working capital items:
Inventories		(591,275	)		141,928
Trade receivables, net of provisions		(180,872	)		230,541
Prepayments		(65,448	)		(197,681	)
Accounts payables and accrued expenses		(1,541,200	)		(253,468	)
Tax payable		(841,598	)		(109,036	)
Cash flow used in operating activities		(1,999,736	)		(271,021	)
INVESTING ACTIVITIES
Acquisition of property, plant and equipment		(142,307	)		(39,457	)
Sales proceeds of disposal of fixed assets		2,375			—
Additions to construction in progress		(1,917,782	)		(299,441	)
Acquisition of intangible assets		(76,958	)		—
Cash flow used in investing activities		(2,134,672	)		(338,898	)
FINANCING ACTIVITIES
Cash proceeds from issuance of common stock		137,536			120,000
Due to directors		(392,416	)		(131,597	)
Receipts/(repayment) from related parties		—			67,603
Bank loan repayments		—			(52,750	)
Deferred expenses		—			137,270
Cash flow (used in)/generated from financing activities		(254,880	)		140,526
NET CHANGE IN CASH AND CASH EQUIVALENTS		(4,389,288	)		(469,393	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		2,151,363			252,177
Cash and cash equivalents, beginning of period		46,959,908			11,389,375
Cash and cash equivalents, end of period	$	44,721,983		$	11,172,159
SUPPLEMENTARY CASH FLOWS DISCLOSURES
Interest paid	$	—		$	17,593
Taxes paid	$	975,806		$	176,820
SUPPLEMENTARY DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Common shares issued for services	$	3,673,349		$	—

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

6

HQ SUSTAINABLE MARITIME INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

MARCH 31, 2008

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 Item 310(b) of Regulation S–K. 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, 2007 was derived from the audited consolidated financial statements included in the Company’s Annual Report Form 10–K. 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.

HQSM 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.

HQSM 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 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, 2008 and December 31, 2007 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, 2008 and December 31, 2007 are summarized as follows:

	March 31, 2008		December 31, 2007
Raw materials	$	226,033	$	288,656
Work-in-progress		93,164		106,756
Finished goods		1,149,794		482,304
	$	1,468,991	$	877,716

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.

We maintain our 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.

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 0% and 18%, respectively during this quarter, in accordance with new tax laws in the PRC effective January 2008.

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

8

NOTE 9—CONVERTIBLE PROMISSORY NOTES AND WARRANTS

Effective January 25, 2006, the Company completed 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 were due and totally repaid on January 25, 2008. The Notes were 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 were 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 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 10—SEGMENTS

No geographical segment analysis is provided for the three months ended March 31, 2008 and 2007, 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, 2008

	Aquaculture Product		Health and Bio-product		Unallocated Items		Consolidation
Sales to external customers	6,527,467		2,683,023		—		9,210,490
Selling and distribution expenses	122,911		106,265		—		229,176
Marketing and advertising	—		1,164,518		—		1,164,518
General and administrative expenses	146,286		142,472		1,164,042		1,452,800
Depreciation and amortization	173,877		103,240		62,638		339,755
(Recovery of)/provision of doubtful accounts	7,076		(17,614	)	—		(10,538	)
Finance costs	(18,514	)	(18,040	)	1,675,959		1,639,405
Income/(loss) before income taxes	1,319,393		549,250		(2,785,736	)	(917,093	)
Income taxes	—		112,350		—		112,350
Net Income/(loss) for the period	1,319,393		436,900		(2,785,736	)	(1,029,443	)
Segment assets	38,580,333		25,695,929		20,941,916		85,218,178
Segment liabilities	2,206,654		1,152,301		7,600,688		10,959,643

9

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
Selling and distribution expenses	56,337		42,276	—		98,613
Marketing and advertising	—		1,244,086	—		1,244,086
General and administrative expenses	126,643		63,916	782,378		972,937
Depreciation and amortization	165,695		75,877	53,113		294,685
(Recovery of)/Provision of doubtful accounts	(2,234	)	224,034	—		221,800
Finance costs	(5,495	)	11,460	1,262,240		1,268,205
Income/(loss) before income 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

NOTE 11: CAPITAL COMMITMENT

A. CAPITAL COMMITMENTS

As of March 31, 2008, there were capital commitments amounting to $3,034,354, mostly related to the construction work of the feed mill and machinery purchase for the aquaculture product factory.

B. LEASE COMMITMENTS

The Company has entered into operating leases, for rental of office space and other services, which expire on different dates. The minimum future payments under these commitments for the next five years are as follows:

2008	$	64,448
2009		64,448
2010		64,448
2011		64,448
2012		24,977
Total	$	282,769

NOTE 12—RECENT PRONOUNCEMENTS

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.

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations”. SFAS 141(R) establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, an any non controlling interest in the acquiree, recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2009. The Company is currently evaluating the impact of SFAS 141(R) on its consolidated financial statements but does not expect it to have a material effect.

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In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“SFAS”) No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2009. The Company is currently evaluating the impact of SFAS 160 on its consolidated financial statements but does not expect it to have a material effect.

NOTE 13—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 February 7, 2006, Westminster Securities Corp. (“Westminster”) and John O’Shea (“O’Shea”) filed a claim against us with the American Arbitration Association (“AAA”). Westminster claimed we violated an exclusivity provision of the letter agreement between Westminster and us which purportedly required us to use Westminster as our investment banking firm for all transactions for a period of three years. Westminster, alleged damages for a claimed breach of an April 2004 stock purchase agreement by our issuance of S-8 shares to certain other people. In January 2008, the AAA rendered a decision finding in favor of Westminster on certain claims and denying others. Consequently, the Company will be required to modify the strike price on the Series C and Series D warrants that were issued to Westminster and O’Shea.

On July 30, 2007, First Cosmos Investments Limited, Sunny Future Group Limited and Newluck International Limited filed suit against HQ Sustainable Maritime Industries, Inc., Jade Profit Investment Limited, Red Coral Group Limited, Harry Wang, Lillian Wang and Norbert Sporns in the Court of Chancery of the State of Delaware. The suit asserts claims against all of the defendants for alleged breaches of certain Subscription Agreements and Stamped Agreements entered into by the defendants, and accuses Harry Wang, Lillian Wang and Norbert Sporns of various alleged breaches of fiduciary duty. The plaintiffs are seeking compensable, general and consequential damages in an unspecified sum. We have reviewed the complaint and believe that there is neither procedural nor substantive merit to the lawsuit. We believe that the lawsuit is subject to dismissal for lack of personal and subject matter jurisdiction, for failure to state a claim upon which relief may be granted, and for failure to assert the claims in a timely manner.

ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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 tons 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. His 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 other current wholly-subsidiary Jiahua Marine which operates a marine bio and healthcare plant, including nutraceuticals, in Hainan Province, China.

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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.

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.

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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 1, 2008, a new PRC Enterprise Income Tax Law (EIT) became effective. That new Law provides, amongst other issues, that income derived from processing of fishery products and processing of agricultural products will be exempt from EIT taxes. Accordingly, our existing fish processing unit and our new feed mill (which is under construction) will both benefit from a “0%” tax rate in 2008 and after. With regards to our neutraceutical unit, the income tax rate increased from 15% in 2007 to 18% in 2008, and will increase yearly until it reaches 25% in 2012.

In January 2008, the Company received Chinese government “Organic” certification for its tilapia production, processing, labeling, marketing and management system.

In February 2008, the Company participated in the “International Boston Seafood Show,” and the Company’s CEO was a panelist on “Improving the Safety of Farmed Seafood,” part of the conference program.

In April 2008, the Company presented its range of recently certified organic tilapia products at the “All Things Organic & US Food Export Showcase” in Chicago, Illinois.

In April 2008, the Company presented its line of products that meet Aquaculture Certification Council (ACC) Best Aquaculture Practices (BAP) for tilapia aquaculture operations at the European Seafood Exposition.

Results of Operations – Three Months Ended March 31, 2008 as Compared to Three Months Ended March 31, 2007

Total sales for the three months ended March 31, 2008 increased by 17%, when compared to the same period of 2007. That increase originates mostly from the aquaculture segment, showing higher demand for our products. Income from operations for the same three months period increased from a loss of $241,675 in March 2007 to an income from operations of $724,077 in March 2008. Seasonality in the first quarter of each year continues to characterize our yearly results. Finance costs in the first quarter of 2008 for an amount of $1,639,405 were mostly related to the November 2006 convertible notes issued; the increase in finance costs in the amount of $371,200 from 2007 is related mostly to penalties for late filing of the registration statement of the underlying shares related to those convertible notes issued in November 2006. The potential conversion of warrants added to the embedded conversion option of the promissory notes continue to be recognized as non-cash finance charges in accordance with FAS 123R and EITF 00-27, until maturity of the underlying promissory notes.

By Segments

Manufacturing and Selling of aquatic products

HQ Ocean Fishing Co. Ltd (“HQOF”) is engaged in the manufacturing and selling of aquatic products. The sales contributed by this segment increased to $6,527,467 for the three months ended March 31, 2008 compared to $5,630,244 for the corresponding period of 2007, an improvement of 16%. The related gross profit ratio of this segment was 29% and 14% for the three months period ended March 31, 2008 and 2007 respectively. Such improvement in the gross profit ratio was due to the combination of overall selling price increases of our tilapia products in 2008 combined to increased volumes which generated average costs reductions. This segment contributed $1,319,393 and $405,734 to net income for the period ended March 31, 2008 and 2007 respectively. The increase in sales of this segment in 2008, with related gross profit margin led to such favorable improvement in the profitability in the first quarter of 2008, compared to the corresponding period 2007.

Manufacturing and Selling of Marine Bio and Healthcare products

Our other wholly-owned subsidiary, Jiahua Marine is engaged in the manufacturing and selling of Marine Bio and Healthcare products. During the three months ended March 31, 2008 and 2007, Jiahua Marine realized sales of $2,683,023 and $2,219,486 respectively, an increase of 21%. The gross profit ratio from this segment was 76% and 82% for the three months ended March 31, 2008 and 2007 respectively, due to a different mix of sales realized in 2008. Furthermore, the major expense of this segment continues to be advertising, corresponding to 43% and 56% of revenues for the three months ended March 31, 2008 and 2007,

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respectively. The net income attributed to this segment was $436,900 for the three months period ended in March 2008 compared to a net income of $115,984 for the three months ended March 31 2007. The increase in net income in 2008 was caused by a combination of higher sales, reduction of marketing and advertising and bad debt recovery.

By Operations

Sales. For the three months ended March 31, 2008, sales increased by $1,360,760 or 17% to $9,210,490. This improvement in sales resulted from a better performance of both segments in 2008, mostly the aquatic segment which saw an increase of $897,223. The health and bio–product segment also improved its sales by $463,537 in the first quarter of 2008 compared to the same period of 2007.

Cost of Sales. Cost of sales increased by $51,418 or 1% to $5,310,702 from $5,259,284 for the three months ended March 31, 2008, as compared to the corresponding period of the prior year. The overall gross profit margin increased from 33% for the three month period ended March 31, 2007 to 42% for the corresponding period of 2008, mostly originating from increased selling prices and volumes in the aquaculture segment during 2008.

Selling and Distribution Expenses. Selling and distribution expenses increased by $130,563 to $229,176 for the three months ended March 31, 2008, as compared to the corresponding period of the previous year. The increase originated from higher volume of sales realized in the current period from both of our segments.

Marketing and advertising Expenses. Marketing and advertising expenses decreased by $79,568 or 6% from $1,244,086 to $1,164,518 as compared to the corresponding period for the prior year. The first quarter of each year continues to show the highest percentage of marketing and advertising expenses in relation to bio-products sales. In the first three months of 2008, the 43% proportion of marketing and advertising expenses to bio-products sales is comparable with the same percentage for the first quarter of 2007 (56% in that first quarter) that ultimately resulted in the yearly average of 27% for fiscal 2007. Since bio-products sales in the three month period ended March 31, 2008 increased compared to 2007, the ratio of marketing expenses to sales leaned closer to the yearly average. . Furthermore, significant advertising expenditures for the promotion of our bio-products to achieve customer recognition are consistent with industry practices. Finally, we expect the yearly percentage of marketing and advertising expenses to bio-products sales to remain approximately at the 30% level in 2008 as it did in 2007.

General and administrative expenses.General and administrative expenses increased by $479,863 to $1,452,800 in the current three month period ended March 31, 2008, from $972,937 in the corresponding period of 2007. The increase in the current period is mostly attributable to additional legal fees incurred in 2008 on the registration of the underlying shares related to the November 2006 promissory notes coupled with additional State of Delaware yearly franchise tax increase following the capital reorganization made in 2007.

Depreciation and amortization. Depreciation and amortization increased by $45,070 to $339,755 in the current quarter when compared to the same quarter of 2007, mainly as a result of acquisition of fixed assets in 2007 and 2008, which triggered additional depreciation in the current three month period ended in March 31, 2008.

(Recovery of)/provision for Doubtful Accounts. In the first three months of 2008, we recognized a net recovery of doubtful accounts of $10,538 compared to an estimated loss of $221,800 in the corresponding period of 2007. The 2008 net recovery originated from a recovery of $17,614 in the bio-product segment and an expense of $7,076 in the aquaculture product segment.

Income/(loss) from Operation.Income from operations increased to $724,077 in the first quarter of 2008 from the loss from operations of $241,675 recorded in the corresponding quarter of the prior year, a substantial improvement of $965,752. The increase in the current quarter of 2008 is mostly the result of increased sales and related gross profit from aquaculture product segment.

Finance Costs. Finance costs increased to $1,639,405 from $1,268,205 for the three month period ended March 31, 2008 as compared to the corresponding period of the previous year, an increase of $371,200. Included in the 2007 and 2008 finance 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 notes of $10,225,000 issued in 2006, and to the amortization of the embedded conversion option (non–cash) related to the same notes. Those non-cash financing costs were recognized in accordance with FAS 123R and EITF 00-27. Such amortization will be repeated, on a pro-rata basis, until maturity of the underlying notes. The increase in finance costs amounting to $371,200 is mostly related to penalties on late filing of the registration statement relating to the underlying shares of the convertible notes issued in November 2006.

Other Expenses/(income). For the three months ended March 31, 2008, $1,765 was reported as other expenses as compared to other income of $9,197 for the three months ended March 31, 2007.

Loss before Income Taxes. Loss before income taxes decreased to $917,093 in the first quarter of 2008, compared to a loss of $1,500,683 for the corresponding period of 2007, an improvement of $583,590. That improvement is essentially the result of increased sales and related gross profit from the aquaculture product segment offset by additional finance costs and general and administrative expenses as described above.

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Current Income Taxes. Current income taxes increased by $46,538 to $112,350 in the current three month period ended March 31, 2008, from $65,812 in the corresponding period of 2007. The increase was mainly due to the higher taxable income experienced in 2008 from health and bio-products segment. Beginning in January 2008, our aquaculture segment is income tax free.

Deferred Income Taxes. There was no deferred income tax recognized in both periods as there was no material timing differences to justify recognition of such deferred tax expenses.

Net Loss Attributable to Shareholders.Net loss attributable to shareholders decreased from $1,566,495 in the first quarter of 2007 to $1,029,443 for the three months ended March 31, 2008. Such improvement in the first three months of 2008 was essentially the result of higher sales and gross profit from the aquaculture segment coupled with the recovery of doubtful accounts, offset by additional finance costs and general and administrative expenses incurred in 2008, as described above.

LIQUIDITY AND CAPITAL RESOURCES

Our cash and cash equivalents remain solid at $44,721,983 at March 31, 2008, down from $46,959,908 at December 31, 2007. As of March 31, 2008, working capital was $64,860,539 compared to $61,550,488 at December 31, 2007. The funds generated by the operating and financing activities during 2008 were used mainly to support the increase in our business volume, more specifically our receivables and inventories levels.

Total assets increased by $891,312, or 1%, to $85,218,178 at March 31, 2008, from $84,326,866 as of December 31, 2007. Shareholders equity increased by $5,482,872, or 8%, to $74,258,535 at March 31, 2008, from $68,775,663 as of December 31, 2007.

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 $6.00 until January 2009; 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 $6.00 until January 2011. 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. As of March 31, 2008, that financing was totally repaid.

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.

In December 2007, we completed a follow-on offering by issuing 3,450,000 new shares of Common Stock to two underwriters (including the over-allotment of 450,000 shares) for a total gross consideration of $26,910,000 (corresponding to a net proceeds of approximately $23,800,000). The Company intends to use this financing for the purpose of completing its new feed plant expected to be in operation in the second half of 2008, to build a new processing plant expected to be in operation in the second half of 2009 and to use the balance for general working capital purposes.

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.

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At present, over 41% 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 ratio of current assets to current liabilities increased to 10 times ($72,048,009/$7,187,470) at March 31, 2008, from and 6.2 times ($73,448,339/$11,897,851) at December 31, 2007.

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.

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Management is required to base its assessment of the effectiveness of our internal control over financial reporting on a suitable, recognized control framework, such as the framework developed by the Committee of Sponsoring Organizations (COSO). The COSO framework, published in Internal Control-Integrated Framework, is known as the COSO Report. Our Management has chosen the COSO framework on which to base its assessment. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of March 31, 2008.

The Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this quarterly report on Form 10-Q for the Quarter ended March 31, 2008. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this quarterly report on Form 10-Q. There were no changes in internal control over financial reporting (as defined in Rule 13a-15(e) under the Exchange Act) that occurred during the period covered by this quarterly report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

It should be noted that any system of controls, however well designed and operated, can provide only reasonable and not absolute assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of certain events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

b) Changes in Internal Control over Financial Reporting.

During the Quarter ended March 31, 2008, 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

With the exception of the proceedings 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 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 as stated by the plaintiff is for the sum of US $4.75 Million. On November 29, 2007, the proceedings were settled outside the court in the sum payment of Canadian $106,000 by us, without admission of any liability or of any state of fact or law.

On February 7, 2006, Westminster Securities Corp. (“Westminster”) and John O’Shea (“O’Shea”) filed a claim against us with the American Arbitration Association. Westminster claims we violated an exclusivity provision of the letter agreement between Westminster and us which purportedly required us to use Westminster as our investment banking firm for all transactions for a period of three years. Westminster alleged damages for a claimed breach of an April 2004 stock purchase agreement by our issuance of S-8 shares to certain other people. In January 2008, the AAA rendered a decision finding in favor of Westminster on certain claims and denying others. Consequently, the Company will be required to modify the strike price on the Series C and Series D warrants that were issued to Westminster and O’Shea.

On July 30, 2007, First Cosmos Investments Limited, Sunny Future Group Limited and Newluck International Limited filed suit against HQ Sustainable Maritime Industries, Inc., Jade Profit Investment Limited, Red Coral Group Limited, Harry Wang, Lillian Wang and Norbert Sporns in the Court of Chancery of the State of Delaware. The suit asserts claims against all of the defendants for alleged breaches of certain Subscription Agreements and Stamped Agreements entered into by the defendants, and accuses Harry Wang, Lillian Wang and Norbert Sporns of various alleged breaches of fiduciary duty. The plaintiffs are seeking compensable, general and consequential damages in an unspecified sum. We have reviewed the complaint and believed that there is neither procedural nor substantive merit to the lawsuit. We believe that the lawsuit is subject to dismissal for lack of personal and subject matter jurisdiction, for failure to state a claim upon which relief may be granted, and for failure to assert the claims in a timely manner.

ITEM 1A—Risk Factors

We have updated the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10–K for the year ended December 31, 2007, which was filed with the Securities and Exchange Commission on March 31, 2008 (the “Fiscal 2007 10–K”). We believe there are no changes that constitute material changes from the risk factors previously disclosed in the Fiscal 2007 10–K.

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

On February 21, 2008, we issued 2,526 shares to our three independent non-executive directors, Jacques Vallee, Fred Bild and Daniel Too, to satisfy our obligations to pay each such director an annual bonus in shares of our common stock pursuant to our independent non-executive director agreements with them. All of these shares were issued pursuant to the exemption provided by Section 4 (2) under the Securities Act for a transaction not involving a public offering.

On March 12, 2008, we issued 6,046 shares of our Common Stock to Lucky Ventures Limited in consideration of financial consulting services rendered to us by that company. All of these shares were issued pursuant to the exemption provided by Section 4 (2) under the Securities Act for a transaction not involving a public offering.

On March 18, 2008, we issued 300,000 shares of our Common Stock to two investors, namely The Tail Wind Fund Ltd and Solomon Strategic Holdings, Inc in relation to a waiver agreement related to payment of penalties and interests on the notes issued to those two investors in November 2006. All of these shares were issued pursuant to the exemption provided by Section 4 (2) under the Securities Act for a transaction not involving a public offering

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: July 1, 2008

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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