PROSPECTUS AS FILED PURSUANT TO RULE 424(b)3
REGISTRATION NO. 333-132031
HQ SUSTAINABLE MARITIME INDUSTRIES, INC.
49,637,499 SHARES OF COMMON STOCK
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This prospectus relates to the resale by the selling stockholders of up to
49,637,499 shares of our common stock, including up to 17,416,666 (in addition
to sufficient shares of common stock to cover a contractual obligation to
register 175% of the number of shares of common stock underlying the convertible
notes, equaling an aggregate total of 30,479,166 shares of common stock)
underlying secured convertible notes in a principal amount of $5,225,000 and up
to 19,158,333 shares of common stock issuable upon the exercise of common stock
purchase warrants. The secured convertible notes are convertible into our common
stock at $.30. The selling stockholders may sell common stock from time to time
in the principal market on which the stock is traded at the prevailing market
price or in negotiated transactions. The selling stockholders may be deemed
underwriters of the shares of common stock, which they are offering. We will pay
the expenses of registering these shares.
Our common stock is registered under Section 15(d) of the Securities Exchange
Act of 1934 and is listed on the Over-The-Counter Bulletin Board under the
symbol "HQSM". The last reported sales price per share of our common stock as
reported by the Over-The-Counter Bulletin Board on April 19, 2006, was $0.32.
The selling stockholders and any broker-dealers or agents that are involved in
selling the shares may be deemed to be "underwriters" within the meaning of the
Securities Act in connection with such sales. In such event, any commissions
received by such broker-dealers or agents and any profit on the resale of the
shares purchased by them may be deemed to be underwriting commissions or
discounts under the Securities Act.
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The purchase of the securities offered through this prospectus involves a high
degree of risk. See section entitled "Risk Factors" on pages 11 through 24.
The Date of this Prospectus is: June 15, 2006.
All dealers that effect transactions in these securities whether or not
participating in this offering may be required to deliver a prospectus. This is
in addition to the dealer's obligation to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
4
Table of Contents
The following table of contents has been designed to help you find important
information contained in this prospectus. We have included subheadings to aid
you in searching for particular information to which you might want to return.
You should, however, read the entire prospectus carefully.
Prospectus Summary 6
Risk Factors 11
Use Of Proceeds 24
Market For Common Equity And Related Stockholder Matters 25
Management's Discussion And Analysis Of Financial Condition And
Results Of Operations 13
Dilution 25
Dividends 26
Selling shareholders 27
Plan Of Distribution 32
Legal Proceedings 33
Directors, Executive Officers, Promoters and Control Persons 33
Security Ownership Of Certain Beneficial Owners And Management 37
Description of Securities 38
Legal Matters 41
Experts 41
Disclosure of Commission Position of Indemnification for
Securities Act Liabilities;
Anti-takeover, Limited Liability and Indemnification Provisions 41
Organization within Last Five Years 42
Description of Business 45
Management's Discussion and Analysis of Financial Condition and
Results of Operations 57
Description Of Properties 65
Certain Relationships And Related Transactions 66
Executive Compensation 66
Financial Statements 71
Changes in and Disagreements With Accountants On Accounting and
Financial Disclosure 71
Available Information 71
5
PROSPECTUS SUMMARY
The following summary highlights selected information contained in this
prospectus. This summary does not contain all the information you should
consider before investing in the securities. Before making an investment
decision, you should read the entire prospectus carefully, including the "risk
factors" section, the financial statements and the notes to the financial
statements.
As used in this prospectus, "we", "us", "our", "HQSM" or "our company" refers to
HQ Sustainable Maritime Industries, Inc. and all of its subsidiaries and
affiliated companies.
About Our Company
HQ Sustainable Maritime Industries, Inc. 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 HQSM being the surviving entity in the merger and acquiring all the
assets and liabilities of Process Equipment, Inc. On August 17, 2004, we 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. 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 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 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
6
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 and its subsidiaries, collectively referred to in this report as 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 (wholly-owned subsidiary of Sealink) are
Shark Cartilage Capsule, Shark Liver Oil and Shark Liver (Soft gel). The major
market for these products is the PRC.
Our principal executive office is located at Melbourne Towers, 1511 Third Avenue
Seattle, suite 788, WA. 98101 USA Tel. 206-621-9888, Facsimile No.: 206-621-0318
The URL for our website is http://www.hqfish.com.
About Our Products
We have a series of tilapia, shrimp and other harvestable products mainly in the
following forms:
o Tilapia: whole round frozen tilapia; gutted and scaled tilapia;
boneless-skinless tilapia fillet as well as skin-on Tilapia fillet;
o Shrimp: head-on, shell-on; headless, shell-on; peeled, tail-on; peeled and
deveined; peeled and undeveined principally white leg shrimp and ocean caught
and ocean farmed shrimp (for instance, tiger shrimp); and
o Products harvested by others
and processed in the Company's plant: ribbonfish, mackerel, bream, squid and
prawns.
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The Resale Offering
Issuer HQ Sustainable Maritime Industries, Inc.
Securities Being Offered up to 30,479,166 shares of common stock
underlying secured convertible notes in the
principal amount of $5,225,000 (includes a good
faith estimate of the 175% of the shares
underlying secured convertible notes)
Class A Warrants up to 8,708,333 shares of common stock issuable
upon the exercise of Class A common stock
purchase warrants at an exercise price of $0.35
per share;
Class B Warrants up to 10,450,000 shares of common stock
issuable upon the exercise of Class A common
stock purchase warrants at an exercise price of
$0.40 per share
Common Stock issued Before the exercise of any warrants or
and outstanding conversion of the Notes: 117,095,225.
The selling shareholders are each contractually
limited in the number of shares of common stock
underlying the secured convertible notes and
warrants they can receive upon conversion in
that such selling shareholders would not result
in beneficial ownership by the selling
shareholders and its affiliates of more than
4.99% of the outstanding shares of common stock
of the Company on such conversion date.
Use of Proceeds We will not receive any proceeds from the sale
of our common stock by the Selling Shareholders
although we will receive proceeds from the
exercise of certain warrants (the underlying
shares of common stock are being registered in
this Prospectus).
EXPLANATORY NOTE: On January 25, 2006, we entered into a Securities Purchase
Agreement with certain accredited investors. Any issuance of shares of common
stock pursuant to the Securities Purchase Agreement and issuance of shares
underlying the Class A and Class B Warrants that would require us to issue
shares of common stock in excess of our authorized capital is contingent upon us
obtaining shareholder approval to increase our authorized shares of common stock
from and filing the certificate of amendment to our certificate of
incorporation.
8
SECURITIES PURCHASE AGREEMENT
To obtain funding for our ongoing operations, effective January 25, 2006, the
Company closed on a financing transaction with a group of private investors
("Investors") of $5,225,000. After deducting commissions and other costs of the
offering of $522,500, the Company shall receive proceeds of $4,702,500.00. The
financing consisted of two components: (a) promissory notes of the Company
("Note" or "Notes"), in the principal aggregate amount of $5,225,000, due
January 25, 2008, such Notes convertible into shares of the Company's common
stock, $0.001 par value (the "Common Stock") at a per share conversion price at
the rate of $0.30 per share of Common Stock; and (b) Class A and Class B
Warrants registered in the name of each Investor.
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 $0.30 per
share of Common Stock. The Notes shall accrue interest on the principal amount
of the Notes at a rate per annum of eight percent (8%) from January 25, 2006 and
shall be payable, in arrears, subject to the terms and conditions of the Notes,
together with principal amount payments, on January 25, 2008.
One Class A Warrant and one Class B Warrant will be 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 $0.30 per share
of Common Stock. The exercise price to acquire a share of Common Stock upon
exercise of a Class A Warrant shall be $0.35. The exercise price to acquire a
share of Common Stock upon exercise of a Class B Warrant shall be $0.40. 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 to certain Finders, Warrants to purchase 1,741,667 shares of
Common Stock similar to and carrying the same rights as the Class B Warrants
issuable to the Investors except that the exercise price shall be $0.35 per
Warrant Share.
Our selling shareholders have contractually agreed to restrict their ability to
convert or exercise their warrants and receive shares of our common stock such
that the number of shares of common stock held by them and their affiliates
after such conversion or exercise does not exceed 4.99% of the then issued and
outstanding shares of common stock.
9
SUMMARY OF FINANCIAL DATA
(in thousand, except per share amounts)
The summary of financial data as of and for the year ended December 31, 2004 and
December 31, 2005 is derived from and should be read in conjunction with our
audited financial statements for the year ended December 31, 2004 and December
31, 2005, including the notes to those financial statements, which are included
elsewhere in this registration statement along with the section titled
"Management's Discussion and Analysis or Plan of Operation". The summary of
financial data is derived from and should be read in conjunction with audited
financial statements and notes to financial statements for years ended December
31, 2004 and December 31, 2005 and the unaudited financial statements and notes
to financial statements for the three months ended March 31, 2006 and March 31,
2005.
December 31, December 31,
2005 2004
(Audited)
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Net sales $ 27,553,030 $ 21,191,492
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Costs and expenses
Costs of sales 16,002,911 16,082,992
General and Administrative 6,332,950 4,316,130
Depreciation 961,295 615,120
Interests expenses 360,782 406,840
Income taxes 640,994 216,544
Minority interests (Revenues) 0 (62,191)
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24,298,932 21,575,435
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Net income(Loss) $ 3,254,098 $ (383,943)
============ ============
Basic & diluted earnings per share $ 0.03 $ (0.01)
============ ============
Weighted average common shares
Basic 102,764,361 49,199,528
Diluted 103,312,264 49,199,528
March 31, March 31,
2006 2005
(Unaudited) (Unaudited)
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SALES $ 6,885,340 $ 3,016,886
COST OF SALES 4,353,455 1,299,166
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GROSS PROFIT 2,531,885 1,717,720
SELLING AND DISTRIBUTION EXPENSES 69,168 40,608
ADVERTISING 1,112,735 1,000,819
GENERAL AND ADMINISTRATIVE 1,003,470 626,941
EXPENSES
DEPRECIATION 234,448 240,272
PROVISION FOR DOUBTFUL ACCOUNTS 183,930 38,352
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(LOSS) FROM OPERATIONS (71,866) (229,272)
FINANCE COSTS 605,877 91,708
OTHER EXPENSES 36,167 67,126
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(LOSS) BEFORE INCOME TAXES (713,910) (388,106)
INCOME TAXES
CURRENT 83,385 32,819
DEFERRED 34,885 17,043
------------ ------------
NET LOSS ATTRIBUTABLE TO SHAREHOLDERS $ (832,180) (437,968)
============ ============
NET PROFIT PER SHARE $ (0.01) (0.00)
============ ============
WEIGHTED AVERAGE COMMON SHARE
OUTSTANDING 116,803,336 96,194,971
============ ============
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RISK FACTORS
In addition to the other information included in this Form SB-2, we are subject
to various risk factors. An investment in our common stock being offered for
resale by the selling shareholders is very risky. You should carefully consider
the risk factors described below, together with all other information in this
prospectus before making an investment decision. Additional risks and
uncertainties not presently foreseeable to us may also impair our business
operations. If any of the following risks actually occurs, our business,
financial condition or operating results could be materially adversely affected.
In such case, the trading price of our common stock could decline, and you may
lose all or part of your investment.
Risks Relating To Our Company
- -----------------------------
We have no long-term agreements with customers or distributors; should they
discontinue to do business with us, our business and profitability may be
adversely affected.
Currently, most of our immediate customers are distributors who resell our
products to other customers. Our sales arrangement with these distributors are
generally short-term in nature and we have not formed or engaged in any agency
or distributorship arrangements with such distributors. In the event that some
of these distributors cease to purchase our products, our business and
profitability may be adversely affected. Even if we are able to procure agency
or distributorship arrangements, there is no guarantee that such arrangements
will be exclusive in procuring the domestic and/or export sales of our products.
We rely on co-operative suppliers and any adverse changes in these relationships
may adversely affect us.
We have developed a co-operative network in Hainan Province for the supply of
tilapia and shrimp by entering into co-operative supply agreements with various
co-operative suppliers, who are aquaculture farmers in Hainan Province. Pursuant
to the co-operative supply agreements, HQOF is assured the necessary supply of
aquatic products from its cooperative suppliers. The continuance and smooth
operations of this co-operative network are essential in ensuring cost
efficiency and the timely fulfillment of our customer orders. Any adverse change
to the co-operative network, including any early termination or non-renewal of
any material supply agreement or any failure of the suppliers to fulfill the
obligations under the supply agreement, may result in a material adverse effect
on our business model, operation and competitiveness.
If we are not able to implement our strategies in achieving our business
objectives, our business operations and financial performance may be adversely
affected.
Our business plan is based on circumstances currently prevailing and the bases
and assumptions that certain circumstances will or will not occur, as well as
the inherent risks and uncertainties involved in various stages of development.
However, there is no assurance that we will be successful in implementing our
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strategies or that our strategies, even if implemented, will lead to the
successful achievement of our objectives. If we are not able to successfully
implement our strategies, our business operations and financial performance may
be adversely affected.
We depend on the availability of additional resources for future growth.
We are currently experiencing a period of significant growth in terms of sales
volume. We believe that our 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 operational and
financial resources. As the scale of our operations grows, we will have to
continually improve our management, operational and financial systems,
procedures and controls, and expand our workforce. The expansion of our business
operations may also involve co-operation, or development of new relationships,
with third parties, such as customers and suppliers. There can be no assurance
that our existing or future management, operational 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. There can also be no
assurance that we will be able to establish, develop or maintain the business
relationships beneficial to our operations. Failure to manage growth effectively
could have a material adverse effect on our business and the results of our
operations and financial condition.
We depend on key management personnel, and the loss of any of their services
could materially adversely affect us.
Our operations are dependent upon the experience and expertise of a small number
of key management personnel. Our future results will depend significantly upon
the efforts of these persons, in particular, Mr. Harry Wang, Ms. Lillian Wang Li
and Mr. Norbert Sporns. The loss of the service of any of them for any reason
could have a material adverse effect on the business, and the results of our
operation and financial condition.
We depend on supply of raw materials, and any adverse changes in such supply or
the costs of raw materials may adversely affect our operations.
We currently obtain all of our raw materials from various aquaculture farms in
Hainan Province and are, therefore, dependent on a stable and reliable supply of
such raw materials in the region. The supply of these raw materials can be
adversely affected by any material change in the climatic or environmental
conditions in the Hainan province, which may, in turn, have a material adverse
effect on the cost of our raw materials and on our operations.
We do not maintain any product liability insurance, and we could therefore be
adversely affected by product liability claims against us.
During the past four years, we have not purchased or maintained any liability
insurance for our tilapia or shrimp products. We believe that there are valid
reasons for not purchasing this liability insurance. However, our tilapia and
shrimp products are sold in the PRC domestic market as well as exported to
locations in the United States, Canada, Japan and some European countries. There
12
is a possibility that our customers, or the ultimate buyers of our products, may
have adverse reactions to the tilapia and shrimp products that we process and
sell. Any adverse reaction may result in actual or potential product liability
claims to the Group. Accordingly, any significant product liability claim may
have an adverse effect on our reputation and profitability.
We may never pay any dividends to our shareholders.
We did not declare any dividends for the year ended December 31, 2005. Our board
of directors does not intend to distribute dividends in the near future. The
declaration, payment and amount of any future dividends will be made at the
discretion of the board of directors, and will depend upon, among other things,
the results of our operations, cash flows and financial condition, operating and
capital requirements, and other factors as the board of directors considers
relevant. There is no assurance that future dividends will be paid, and if
dividends are paid, there is no assurance with respect to the amount of any such
dividend.
Risks Relating To The Aquaculture Industry
Our operating subsidiary must comply with environmental protection laws, which
could adversely affect our profitability.
The Company is required to comply with the environmental protection laws and
regulations promulgated by the national and local governments of the PRC. Some
of these regulations govern the level of fees payable to government entities
providing environmental protection services and the prescribed standards
relating to the discharge of effluent. Currently the plant treats all of its
waste effluent completely to level one (that is, consistent with releasing
potable water back to the environment), and there is currently no charge being
levied. In addition, these regulations further empower local governments to
impose penalties on those companies which fail to comply with the prescribed
standards. If we, through the Company, fail to comply with any of these
environmental laws and regulations in the PRC, depending on the types and
seriousness of the violation, we may be subject to, among other things, warning
from relevant authorities, imposition of fines, specific performance and/or
criminal liability, forfeiture of profit made, being ordered to close down our
business operations and suspension of relevant permits.
Although our production technologies allow us to efficiently control the level
of pollution resulting from our production process, and notwithstanding the fact
that we have received evidence of compliance with environmental protection
requirements from government authorities, due to the nature of our business,
effluent wastes are unavoidably generated in the aquaculture production
processes.
The national and the local governments may promulgate new regulations that may
require us to pay environmental protection fees or require us to upgrade our
environmental protection facilities. These regulations may impose additional
costs and may adversely affect our profitability.
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We could be adversely affected by the occurrence of natural disasters in Hainan
Province.
From time to time, Hainan Province, like other South China Sea destinations,
experiences typhoons, particularly during the third quarter of any calendar
year. Natural disasters could impede operations, damage infrastructure necessary
to our operations or adversely affect the logistical services to and from Hainan
Province. The occurrence of natural disasters in Hainan Province could adversely
affect our business, the results of our operations, prospects and financial
condition. We do not currently have any insurance against damage caused by
natural disasters, accidents or other similar events, nor do we have insurance
covering losses due to resulting business interruption. Should such losses
occur, our operations, revenue and profitability might be adversely affected.
We may be adversely affected by the fluctuation in raw material prices and
selling prices of our products.
The raw materials we use are aquaculture stocks and commodities that may
experience price volatility caused by events such as market fluctuations or
changes in governmental aquaculture programs. These price changes may ultimately
result in increases in the selling prices of our products, and may, in turn,
adversely affect our sales volume, revenue and operating profit.
Neither our products nor the raw materials required have, in general,
experienced any significant price fluctuations in the past, but there is no
assurance that the raw materials we require will not be subject to any
significant price fluctuations or pricing control in the future. The market
price of these raw materials may also experience significant upward adjustment,
if, for instance, there is a material under-supply or over-demand in the market.
Should this happen, our business and the results of our operations could be
adversely affected.
Our operations, revenue and profitability could be adversely affected by changes
in laws and regulations in the countries where we do business.
The governments of our exporting countries, including the United States, Japan
and other overseas markets, such as Europe and Canada, may, from time to time,
consider regulatory proposals relating to raw materials, food safety and market,
and environmental regulation, which, if adopted, could lead to disruptions in
supply of our products and/or increases in operational costs, which, in turn,
could affect our profitability. To the extent that we increase our product
prices as a result of such changes, our sales volume and revenues may be
adversely affected.
14
Furthermore, these governments may change certain regulations or impose
additional taxes or duties on certain Chinese imports from time to time. Such
regulations, if effected, may have a material adverse impact on our operations,
revenue and/or our profitability.
We could be adversely affected by contamination and disease resulting from our
purchases of raw materials from third parties.
We ceased our aquaculture farming operations in January 2003. Since that time,
we have been purchasing raw materials from contracted, cooperative, large-scale
local suppliers. If any contamination or outbreak of disease occurs, our supply
of raw materials may be jeopardized or disrupted, which, in turn, could
adversely affect our operations, revenue and/or profitability.
We may be unable to continue to take advantage of the seasonal pricing
fluctuation in sales of our products.
We have been experiencing seasonal fluctuation in sales in terms of pricing.
Pricing fluctuation occurs during the winter season when fish farms in northern
PRC suspend production due to cold weather conditions. With the lack of supply
from these farms in northern PRC, aquaculture products from other parts of the
PRC could customarily be sold at a premium during the winter season. However,
there can be no assurance that such premium or pricing could be maintained in
the future.
Our inability to successfully compete with our competitors in the aquaculture
industry may adversely affect us.
The aquaculture industry is open to competition from local and overseas
operators engaged in similar businesses and products to ours. There is no
assurance that we can consistently be successful in maintaining a competitive
advantage against our competitors. Any increase in competition may have an
adverse effect on both the sales and the pricing of our aquaculture products,
which, in turn, will have an adverse effect on our performance, profitability
and cash flow.
During late 2004, the USA government imposed heavy tariffs of more than 100
percent to some Chinese shrimp exporters. This action was intended to avoid the
dumping of Chinese exporters and goods.
The decisions were seen as a victory by the domestic shrimp industry, which has
suffered in recent years as cheap shrimp imports from Latin America and Asia
have increased supplies and dropped prices in the United States.
Foreign exporters and American importers argue that imported shrimp, which are
farm-raised rather than netted as most U.S. shrimp are, are simply produced more
efficiently. American shrimpers say their competitors are cheating by dumping
their product and selling it below cost to drive U.S. producers out of business.
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Last December, the alliance, which represents shrimpers in eight Southern
states, petitioned the Commerce Department to investigate possible dumping of
shrimp from China, Vietnam, Brazil, Ecuador, India and Thailand. Dumping is
illegal in the United States and is punished with tariffs to put law-abiding
companies on equal footing.
In July 2004, the Commerce Department issued preliminary anti-dumping tariff
determinations for the six countries, which last year provided 90 percent of the
shrimp consumed in the United States. While the U.S. shrimp industry and its
lawyers accurately predicted the Chinese tariffs last summer, the Vietnamese
tariffs were far below the roughly 90 percent rate they expected.
Risks Relating To The Health and Bio-product Industry
- -----------------------------------------------------
We may have difficulty defending our intellectual property from infringement
Since effective trademark, patent and trade secret protection may be unavailable
in every country in which we do or plan to do business, protection of our
intellectual property rights is uncertain and we may be unable to prevent others
from developing similar products or using our marks. We regard our service
marks, trademarks, trade secrets, patents and similar intellectual property as
critical to our success. We rely on trademark, patent and trade secret law, as
well as confidentiality and license agreements with our employees, customers,
partners and others to protect our proprietary rights. We have received
trademark and patent protection for our products in the People's Republic of
China. While presently we sell our products mainly in China and Eastern Europe,
we intend to enter the markets in the United States and possibly other
countries. However, effective trademark, service mark, patent and trade secret
protection may not be available in every country in which we sell or may in the
future sell our products due to our foreign currency constraint. Therefore, the
measures we take to protect our proprietary rights may be inadequate and we
cannot give you any assurance that our competitors will not independently
develop formulations and processes that are substantially equivalent or superior
to our own. We intend to take necessary actions toward protecting our
intellectual property rights upon the resolution of our foreign currency
constraints.
Intense competition from existing and new entities may adversely affect our
revenues and profitability
We compete with companies, many of whom are developing or can be expected to
develop products similar to ours. Our market is a large market with many
competitors. Many of our competitors are more established than we are, and have
significantly greater financial, technical, marketing and other resources than
we presently possess. Some of our competitors have greater name recognition and
a larger customer base. These competitors may be able to respond more quickly to
new or changing opportunities and customer requirements and may be able to
undertake more extensive promotional activities, offer more attractive terms to
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customers, and adopt more aggressive pricing policies. We intend to create
greater brand awareness for our brand name so that we can successfully compete
with our competitors. We cannot assure you that we will be able to compete
effectively with current or future competitors or that the competitive pressures
we face will not harm our business.
The products and the processes we use could expose us to substantial liability
Product liability could arise from claims by users of our products or of
products manufactured by processes we developed, or from manufacturers or others
selling our products, either directly or as a component of other products. To
date, we have not experienced any problems associated with claims by users of
our products. For this reason, we do not have any insurance coverage for these
risks at this time. Depending on our experience, we may decide to seek this type
of insurance coverage. When, and if, we acquire product liability insurance, we
cannot give you any assurance that it will be adequate to protect us or that the
insurance coverage will continue to be available to us on reasonable terms.
Unexpected Changes in the regulatory environment may negatively impact our
business.
The regulatory environment involving our products is subject to changes that may
be introduced either by the relevant governmental regulatory agencies or by
virtue of new regulation. Such changes may have a positive or negative impact on
the sale of our products. Such regulatory environment also covers any existing
or potential trade barriers in the form of import tariff and taxes that may make
it difficult for us to import our products to certain countries, which would
limit our international expansion.
We may suffer from political and economic instability in countries where we
operate
We are currently operating mainly in China, however, we expect to begin selling
our products in other countries in the future. Political and economic
instability in the countries in which we presently operate and may operate in
the future may negatively affect our sales, revenues and business operations.
We may experience currency fluctuation and longer exchange rate payment cycles
The local currencies in the countries in which we operate may fluctuate in value
in relation to other currencies. Such fluctuations may affect the costs of our
products sold and the value of our local currency profits. While we are not
conducting any meaningful operations in countries other than China at the
present time, we may expand to other countries and may then have an increased
risk of exposure of our business to currency fluctuation.
17
Risks Relating To The PRC
- -------------------------
There could be changes in government policies that may adversely affect our
business
The aquatic products industry in the PRC is subject to policies implemented by
the PRC government from time to time. The PRC government may, for instance,
impose control over aspects such as raw material distribution, product pricing
and sales. On the other hand, the PRC government may also make available
subsidies or preferential treatments (such as in the form of tax benefits or
favorable financing arrangements).
If the raw materials used by us or our products should become subject to any
form of government control, then depending on the nature and extent of such
control and our ability to make corresponding adjustments, there could be a
material adverse effect on our business and operating results.
Certain political and economic considerations relating to PRC could adversely
affect our company.
The PRC is passing from a planned economy to a market economy. While the PRC
government has pursued economic reforms since its adoption of the open-door
policy in 1978, a large portion of the PRC economy is still operating under
five-year plans and annual state plans. Through these plans and other economic
measures, such as control on foreign exchange, taxation and restrictions on
foreign participation in the domestic market of various industries, the PRC
government exerts considerable direct and indirect influence on the economy.
Many of the economic reforms carried out by the PRC government are unprecedented
or experimental, and are expected to be refined and improved. Other political,
economic and social factors can also lead to further readjustment of such
reforms. This refining and readjustment process may not necessarily have a
positive effect on our operations or future business development. Our operating
results may be adversely affected by changes in the PRC's economic and social
conditions as well as by changes in the policies of the PRC government, such as
changes in laws and regulations (or the official interpretation thereof),
measures which may be introduced to control inflation, changes in the rate or
method of taxation, and imposition of additional restrictions on currency
conversion.
The recent nature and uncertain application of many PRC laws applicable to us
create an uncertain environment for business operations and they could have a
negative effect on us.
The PRC legal system is a civil law system. Unlike the common law system, the
civil law system is based on written statutes in which decided legal cases have
little value as precedents. In 1979, the PRC began to promulgate a comprehensive
system of laws and has since introduced many laws and regulations to provide
general guidance on economic and business practices in the PRC and to regulate
foreign investment. Progress has been made in the promulgation of laws and
regulations dealing with economic matters such as corporate organization and
18
governance, foreign investment, commerce, taxation and trade. The promulgation
of new laws, changes of existing laws and the abrogation of local regulations by
national laws could have a negative impact on our business and business
prospects. In addition, as these laws, regulations and legal requirements are
relatively recent, their interpretation and enforcement involve significant
uncertainty.
Potential effects related to the PRC's WTO accession could have a material
adverse affect our company.
The PRC became a member of the WTO in December 2001. Pursuant to the bilateral
agreement entered into between the PRC and the United States on December 11,
1999, the PRC agreed to lower tariffs on imports by an average of approximately
17% and to eliminate quotas and other quantitative restrictions on food product
imports within two to five years. There is no assurance that such increased
competition will not have any material adverse effect on our business or
profitability.
Currency conversion and exchange rate volatility could adversely affect our
company
The PRC government imposes control over the conversion of Renminbi into foreign
currencies. Under the current unified floating exchange rate system, the
People's Bank of China publishes an exchange rate, which we refer to as the PBOC
exchange rate, based on the previous day's dealings in the inter-bank foreign
exchange market. Financial institutions authorized to deal in foreign currency
may enter into foreign exchange transactions at exchange rates within an
authorized range above or below the PBOC exchange rate according to market
conditions.
Pursuant to the Foreign Exchange Control Regulations of the PRC issued by the
State Council which came into effect on April 1, 1996, and the Regulations on
the Administration of Foreign Exchange Settlement, Sale and Payment of the PRC
which came into effect on July 1, 1996, regarding foreign exchange control,
conversion of Renminbi into foreign exchange by Foreign Investment Enterprises,
or FIEs, for use on current account items, including the distribution of
dividends and profits to foreign investors, is permissible. FIEs are permitted
to convert their after-tax dividends and profits to foreign exchange and remit
such foreign exchange to their foreign exchange bank accounts in the PRC.
Conversion of Renminbi into foreign currencies for capital account items,
including direct investment, loans, and security investment, is still under
certain restrictions. On January 14, 1997, the State Council amended the Foreign
Exchange Control Regulations and added, among other things, an important
provision, which provides that the PRC government shall not impose restrictions
on recurring international payments and transfers under current account items.
Enterprises in the PRC (including FIEs) which require foreign exchange for
transactions relating to current account items, may, without approval of the
State Administration of Foreign Exchange, or SAFE, effect payment from their
foreign exchange account or convert and pay at the designated foreign exchange
banks by providing valid receipts and proofs.
19
Convertibility of foreign exchange in respect of capital account items, such as
direct investment and capital contribution, is still subject to certain
restrictions, and prior approval from the SAFE or its relevant branches must be
sought.
Since 1994, the exchange rate for Renminbi against the United States dollars has
remained relatively stable, most of the time in the region of approximately
MB8.04 (as of February 19th 2006) to US$1.00. However, there can be no assurance
that Renminbi will not be subject to devaluation. We may not be able to hedge
effectively against Renminbi devaluation, so there can be no assurance that
future movements in the exchange rate of Renminbi and other currencies will not
have an adverse effect on our financial condition.
HQOF and Jiahua Marine, our principal operating subsidiaries, are wholly foreign
owned companies to which the Foreign Exchange Control Regulations are
applicable. There can be no assurance that we will be able to obtain sufficient
foreign exchange to pay dividends or satisfy other foreign exchange requirements
in the future.
Our dependence upon Chinese production facilities and raw material suppliers
could affect our company.
All of our processing facilities are located in the PRC and all the raw
materials we require are located in the PRC. Therefore, our operations and
performance are subject to changes in the economic and political environment in
the PRC and to the risks inherent in maintaining operations outside the United
States.
It may be difficult to effect service of process and enforcement of legal
judgments upon our company and our officers and directors because some of them
reside outside the United States.
As our operations are presently based in China and some of our key directors and
officers reside outside the United States, service of process on our company and
our key directors and officers may be difficult to effect within the United
States. Also, substantially all of our assets are located outside the United
States and any judgment obtained in the United States against us may not be
enforceable outside the United States. To mitigate these difficulties, we have
appointed Norbert Sporns, our Chief Executive Officer and President, as our
agent to receive service of process in any action against our company in the
United States.
20
Risks Relating to the Offering
There Are a Large Number of Shares Underlying Our Secured Convertible Notes and
Warrants That May be Available for Future Sale and the Sale of These Shares May
Depress the Market Price of Our Common Stock.
As of May 17, 2006, we had 117,095,225 shares of common stock issued and
outstanding. We also have secured convertible notes outstanding from the
securities purchase agreement, that may be converted into an estimated
17,416,666 shares of common stock and related warrants to purchase up to
19,158,333 shares of common stock for Class A and Class B warrants collectively.
All of the shares, including all of the shares issuable upon conversion of the
secured convertible notes and upon exercise of our warrants, may be sold without
restriction. The sale of these shares may adversely affect the market price of
our common stock.
The Issuance of Shares Upon Conversion of the Secured Convertible Notes and
Exercise of Outstanding Warrants May Cause Immediate and Substantial Dilution to
Our Existing Stockholders.
The issuance of shares upon conversion of the secured convertible notes and
exercise of warrants may result in substantial dilution to the interests of
other stockholders since the selling stockholders may ultimately convert and
sell the full amount issuable on conversion. Although the selling stockholders
may not convert their secured convertible notes and/or exercise their warrants
if such conversion or exercise would cause them to own more than 4.99% of our
outstanding common stock, this restriction does not prevent selling stockholders
from converting and/or exercising some of their holdings and then converting the
rest of their holdings. In this way, selling stockholders could sell more than
this limit while never holding more than this limit. There is no upper limit on
the number of shares that may be issued which will have the effect of further
diluting the proportionate equity interest and voting power of holders of our
common stock, including investors in this offering.
If an Event of Default Occurs under the Securities Purchase Agreement, Secured
Convertible Notes, Class A Warrants and Class B Warrants.
In connection with the Securities Purchase Agreements we entered into in January
25, 2006, we executed a Security Purchase Agreement in favor of the investors
granting them a first priority security interest in all of our goods, inventory,
contractual rights and general intangibles, receivables, documents, instruments,
chattel paper, and intellectual property. The Security Agreement states that if
an event of default occurs under the Secured Convertible Notes, the Investors
have the right to take possession of the collateral, to operate our business
using the collateral, and have the right to assign, sell, lease or otherwise
dispose of and deliver all or any part of the collateral, at public or private
sale or otherwise to satisfy our obligations under these agreements.
21
There could be future dilution of shareholders' interest in our company.
We may need to raise additional funds in the future to finance new developments
or expand existing operations. If we raise additional funds through the issuance
of new equity or equity-linked securities, other than on a pro rata basis to our
existing stockholders, the percentage ownership of the existing shareholders may
be reduced. Existing shareholders may experience subsequent dilution and/or such
newly issued securities may have rights, preferences and privileges senior to
those of the existing shareholders.
We have not independently verified the accuracy of certain facts and statistics
provided in this prospectus.
Certain information and statistics in this prospectus such as statistics
relating to the PRC aquaculture and seafood industry in the PRC as well as other
countries are derived from various public and private publications. While we
have taken reasonable care to ensure that the facts and statistics are
accurately reproduced from such sources, we have not independently verified the
information and do not guaranty that it is accurate, complete or up-to-date, and
therefore, we make no representation as to the accuracy of such facts and
statistics. Accordingly, such information should not be unduly relied upon.
The issuance of shares upon the exercise of outstanding warrants may cause
immediate and substantial dilution to our existing stockholders.
The issuance of shares upon the exercise of warrants may result in substantial
dilution to the interests of other stockholders since the selling stockholders
may ultimately convert and sell the full amount issuable on conversion. There is
no upper limit on the number of shares that may be issued which will have the
effect of further diluting the proportionate equity interest and voting power of
holders of our common stock, including investors in this offering.
We cannot guaranty the existence of an established public trading market.
Although our common stock trades on the NASD OTC Bulletin Board, a regular
trading market for our securities may not be sustained in the future. The NASD
has enacted recent changes that limit quotations on the OTC Bulletin Board to
securities of issuers that are current in their reports filed with the
Securities and Exchange Commission. We cannot determine the effect of these rule
changes and other proposed changes on the OTC Bulletin Board at this time. The
OTC Bulletin Board is an inter-dealer, over-the-counter market that provides
significantly less liquidity than the NASD's automated quotation system (the
"NASDAQ Stock Market"). Quotes for stocks included on the OTC Bulletin Board are
not listed in the financial sections of newspapers as are those for the NASDAQ
Stock Market. Therefore, prices for securities traded solely on the OTC Bulletin
Board may be difficult to obtain and holders of common stock may be unable to
resell their securities at or near their original offering price or at any
price. Market prices for our common stock will be influenced by a number of
factors, including:
o the issuance of new equity securities pursuant to an offering;
22
o changes in interest rates;
o competitive developments, including announcements by competitors of new
products or services or significant contracts, acquisitions, strategic
partnerships, joint ventures or capital commitments;
o variations in quarterly operating results;
o change in financial estimates by securities analysts;
o the depth and liquidity of the market for our common stock;
o investor perceptions of our company and the aquaculture industry generally;
and
o general economic and other national conditions.
Our common stock could be considered a "penny stock."
Our common stock could be considered to be a "penny stock" if it meets one or
more of the definitions in Rules 15g-2 through 15g-6 promulgated under Section
15(g) of the Securities Exchange Act of 1934, as amended. These include but are
not limited to the following: (i) the stock trades at a price less than $5.00
per share; (ii) it is NOT traded on a "recognized" national exchange; (iii) it
is NOT quoted on the NASDAQ Stock Market, or even if so, has a price less than
$5.00 per share; or (iv) it is issued by a company with net tangible assets less
than $2.0 million, if in business more than a continuous three years, or with
average revenues of less than $6.0 million for the past three years. The
principal result or effect of being designated a "penny stock" is that
securities broker-dealers cannot recommend the stock but must trade in it on an
unsolicited basis.
Broker-dealer requirements may affect the trading and liquidity of shares of our
common stock.
Section 15(g) of the Securities Exchange Act of 1934, as amended, and Rule 15g-2
promulgated thereunder by the SEC require broker-dealers dealing in penny stocks
to provide potential investors with a document disclosing the risks of penny
stocks and to obtain a manually signed and dated written receipt of the document
before effecting any transaction in a penny stock for the investor's account.
Potential investors in our common stock are urged to obtain and read such
disclosure carefully before purchasing any shares that are deemed to be "penny
stock." Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve
the account of any investor for transactions in such stocks before selling any
penny stock to that investor. This procedure requires the broker-dealer to (i)
obtain from the investor information concerning his or her financial situation,
investment experience and investment objectives; (ii) reasonably determine,
based on that information, that transactions in penny stocks are suitable for
the investor and that the investor has sufficient knowledge and experience as to
be reasonably capable of evaluating the risks of penny stock transactions; (iii)
provide the investor with a written statement setting forth the basis on which
the broker-dealer made the determination in (ii) above; and (iv) receive a
23
signed and dated copy of such statement from the investor, confirming that it
accurately reflects the investor's financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult for holders of our common stock to resell their shares to third
parties or to otherwise dispose of them in the market or otherwise.
If we fail to remain current on our reporting requirements, we could be removed
from the OTC bulletin board which would limit the ability of broker-dealers to
sell our securities and the ability of stockholders to sell their securities in
the secondary market.
Companies trading on the OTC Bulletin Board, such as ours, must be reporting
issuers under Section 12 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and must be current in their reports under Section 13, in order
to maintain price quotation privileges on the OTC Bulletin Board.
If we fail to remain current on our reporting requirements, we could be removed
from the OTC Bulletin Board. As a result, the market liquidity for our
securities could be severely adversely affected by limiting the ability of
broker-dealers to sell our securities and the ability of stockholders to sell
their securities in the secondary market.
Forward-Looking Statements
This prospectus includes forward-looking statements that involve risks and
uncertainties. These forward-looking statements include statements under the
captions "Prospectus Summary," "Risk Factors," "Use of Proceeds," "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business" and elsewhere in this prospectus. You should not rely on these
forward-looking statements which apply only as of the date of this prospectus.
These statements refer to our future plans, objectives, expectations and
intentions. We use words such as "believe," "anticipate," "expect," "intend,"
"estimate" and similar expressions to identify forward-looking statements. This
prospectus also contains forward-looking statements attributed to third parties
relating to their estimates regarding the growth of certain markets. You should
not place undue reliance on these forward-looking statements, which apply only
as of the date of this prospectus. Our actual results could differ materially
from those discussed in these forward-looking statements. Factors that could
contribute to these differences include those discussed in the preceding pages
and elsewhere in this prospectus.
Risks associated with forward-looking statements.
This prospectus contains certain forward-looking statements regarding
management's plans and objectives for future operations, including plans and
objectives relating to our planned marketing efforts and future economic
performance. The forward-looking statements and associated risks set forth in
this prospectus include or relate to:
(1) Our ability to obtain a meaningful degree of consumer
acceptance for our products now and in the future,
(2) Our ability to market our products on a global basis at
competitive prices now and in the future,
(3) Our ability to maintain brand-name recognition for our
products now and in the future,
(4) Our ability to maintain an effective distributors network,
(5) Our success in forecasting demand for our products now and in
the future,
(6) Our ability to maintain pricing and thereby maintain adequate
profit margins, and
(7) Our ability to obtain and retain sufficient capital for future
operations.
24
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be
offered and sold from time to time by the selling stockholders. We will not
receive any proceeds from the sale of shares of common stock in this offering.
However, we will receive the sale price of any common stock we sell to the
selling stockholder upon exercise of the warrants. We expect to use the proceeds
received from the exercise of the warrants, if any, for general working capital
purposes.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the OTC Bulletin Board under the symbol "HQSM."
For the periods indicated, the following table sets forth the high and low bid
prices per share of common stock. These prices represent inter-dealer quotations
without retail markup, markdown, or commission and may not necessarily represent
actual transactions.
High($) Low ($)
Fiscal Year ended April 30
First Quarter (May-July 2003) 0.17 0.16
Second Quarter (August-October 2003) 0.25 0.16
Third Quarter (November 2003-January 2004) 0.50 0.17
Fourth Quarter (February 2004-April 2004) 2.80 0.15
Fiscal Year ended December2004
First Quarter (May-June 2004) 1.15 0.56
Second Quarter (July - September 2004) 0.95 0.27
Third Quarter (October-December 2004) 0.38 0.18
Fiscal Year 2005
First Quarter (January-March 2005) 0.31 0.21
Second Quarter (April-June 2005) 0.175 0.16
Third Quarter (July-September 2005) 0.53 0.12
Fourth Quarter (October-December 2005) 0.58 0.29
Fiscal Year 2006
First Quarter (January-March 2006) 0.45 0.26
HOLDERS
As of May 17, 2006, we had approximately 1,219 holders of record of our common
stock. The number of record holders was determined from the records of our
transfer agent and does not include beneficial owners of common stock whose
shares are held in the names of various security brokers, dealers, and
registered clearing agencies. The transfer agent of our common stock is American
Stock Transfer & Trust Company, 59 Maiden Lane, Plaza Level, New York, NY 10038
25
We have never declared or paid any cash dividends on our common stock. We do not
anticipate paying any cash dividends to stockholders in the foreseeable future.
In addition, any future determination to pay cash dividends will be at the
discretion of the Board of Directors and will be dependent upon our financial
condition, results of operations, capital requirements, and such other factors
as the Board of Directors deem relevant.
DILUTION
Effect of Offering on Net Tangible Book Value Per Share
This offering is for sales of shares by the selling stockholder on a
continuous or delayed basis in the future. Sales of common stock by the selling
stockholder will not result in a change to the net tangible book value per share
before or after the distribution of shares by the selling stockholder. There
will be no change in the net book value per share attributable to cash payments
made by the purchasers of the shares being offered. Prospective investors should
be aware, however, that the market price of our shares may not bear any
relationship to net tangible book value per share.
DIVIDENDS
We do not anticipate paying cash dividends on our common shares in the
foreseeable future. We may not have enough funds to legally pay dividends. Even
if funds are legally available to pay dividends, we may nevertheless decide in
our sole discretion not to pay dividends.
26
Selling Shareholders
The following table presents information regarding the Selling Shareholders.
Unless otherwise stated below, to our knowledge no Selling Shareholders nor any
affiliate of such shareholder has held any position or office with, been
employed by, or otherwise has had any material relationship with us or our
affiliates, during the three years prior to the date of this prospectus.
None of the Selling Shareholders are members of the National Association of
Securities Dealers, Inc. The Selling Shareholders may be deemed to be
"underwriters" within the meaning of the Securities Act of 1933.
Any of the Selling Shareholders, acting alone or in concert with one another,
may be considered statutory underwriters under the Securities Act of 1933 in
they are directly or indirectly conducting an illegal distribution of the
securities on behalf of our corporation. For instance, an illegal distribution
may occur if any of the Selling Shareholders were to provide us with cash
proceeds from their sales of the securities. If any of the Selling Shareholders
are determined to be underwriters, they may be liable for securities violations
in connection with any material misrepresentations or omissions made in this
prospectus.
In addition, the Selling Shareholders and any brokers and dealers through whom
sales of the securities may be deemed to be "underwriters" within the meaning of
the Securities Act of 1933, and the commissions or discounts and other
compensation paid to such persons may be regarded as underwriters' compensation.
The number and percentage of shares beneficially owned before and after the
sales is determined in accordance with Rule 13d-3 and 13d-5 of the Exchange Act,
and the information is not necessarily indicative of beneficial ownership for
any other purpose. We believe that each individual or entity named has sole
investment and voting power with respect to the securities indicated as
beneficially owned by them, subject to community property laws, where
applicable, except where otherwise noted. The total number of common shares sold
under this prospectus may be adjusted to reflect adjustments due to stock
dividends, stock distributions, splits, combinations or recapitalizations.
The Selling Shareholders named in this prospectus are offering all of the shares
of common stock offered through this prospectus. These shares were acquired from
us in a private placement that was exempt from registration under Regulation D
of the Selling Shareholders are hereby advised that Regulation M of the General
Rules and Regulations promulgated under the Securities Exchange Act of 1934 will
be applicable to their sales of these shares of our common stock. These rules
contain various prohibitions against trading by persons interested in a
distribution and against so-called "stabilization" activities.
The following table provides information regarding the beneficial ownership of
our common stock held by each of the selling shareholders, including:
1. the number of shares owned by each prior to this offering;
27
2. the percentage owned prior to the offering;
3. the total number of shares that are to be offered for each;
4. the total number of shares that will be owned by each upon completion
of the offering; and
5. the percentage owned by each upon completion of the offering.
Shares of Shares of Shares of Shares of
common common common common
Stock owned Shares of Stock Stock stock,
prior common underlying underlying including
to offering stock to be Class A Class B shares Shares of
(including Percent of sold warrants warrants underlying common
shares Common underlying owned owned the Stock
underlying all Stock owned the Prior Prior warrants owned
convertible prior to promissory to the to the and notes, After
Name of selling stockholder securities)(2) offering(1) notes(2) offering offering to be sold offering(3)
- ------------------------------------------------------------------------------------------------------------------------------------
Castle Creek Technologies
Partners, LLC(4) 6,875,000 4.0% 4,375,000 1,250,000 1,250,000 6,875,000 -0-
Nite Capital, LP(5) 2,291,668 1.3% 1,458,334 416,667 416,667 2,291,668 -0-
Brio Capital, LP(6) 2,250,000 1.3% 875,000 250,000 250,000 2,250,000 -0-
Double U Master Fund, 4,583,331 2.7% 2,916,667 833,332 833,332 4,583,331 -0-
LP(7)
Michael P. Ross 916,667 * 583,333 166,667 166,667 916,667 -0-
Richard M. Ross 916,667 * 583,333 166,667 166,667 916,667 -0-
Vision Opportunity 7,333,331 4.3% 4,666,667 1,333,332 1,333,332 7,333,331 -0-
Master Fund, Ltd.(8)
First Mirage, Inc.(9) 916,667 * 583,333 166,667 166,667 916,667 -0-
Generation Capital 2,250,000 1.3% 875,000 250,000 250,000 2,250,000 -0-
Associate (10)
The Hart Organization 916,667 * 583,333 166,667 166,667 916,667 -0-
Corp. (11)
Omega Capital Smallcap 916,667 * 583,333 166,667 166,667 916,667 -0-
Fund, LP (12)
Professional Traders 916,667 * 583,333 166,667 166,667 916,667 -0-
Fund (13)
Solomon Strategic 458,335 * 291,667 83,334 83,334 458,335 -0-
Holdings, Inc. (14)
The Tail Wind Fund 7,418,668 4.3% 4,083,334 1,666,667 1,666,667 7,418,668 -0-
Ltd. (15)
Mordechai Vogel 229,167 * 145,833 41,667 41,667 229,167 -0-
Simon Vogel 229,167 * 145,833 41,667 41,667 229,167 -0-
28
Tower Paper Co. Inc. 229,167 * 145,833 41,667 41,667 229,167 -0-
Ret. Plan(16)
Chestnut Ridge Partners, 916,667 * 583,333 166,667 166,667 916,667 -0-
LP(17)
Netwise Holdings 4,583,331 2.7% 2,916,667 833,332 833,332 4,583,331 -0-
Limited(18)
Paragon Capital LP(19) 916,667 * 583,333 166,667 166,667 916,667 -0-
Camofi Master, LDC(20) 4,583,331 2.7% 2,916,667 833,332 833,332 4,583,331 -0-
Bursteine & Lindsay 1,714,667 * 1,714,667 1,714,667 -0-
Securities(21)
* less than one percent
(1) Based on 173,393,224 shares of common stock, consisting of 117,095,225
shares of common stock issued as of April 20, 2006, and 24,618,833
shares of common stock underlying our Warrants, 200,000 shares of
common stock underlying our preferred stock and 30,479,166 shares of
common stock underlying the convertible notes (which includes shares
issuable upon conversion of the equivalent of 175% of our secured
convertible notes).
(2) Includes shares issuable upon conversion of the equivalent of 175% of
our secured convertible notes.
(3) Assumes the sale of all shares registered by each selling shareholder
(including shares issuable upon conversion of the equivalent of 175% of
our secured convertible notes).
(4) Castle Creek Technologies Partners, LLC . As investment manager under a
management agreement, Castle Creek Partners, LLC may exercise
dispositive and voting power with respect to the shares owned by Castle
Creek Technology Partners LLC. Castle Creek Partners, LLC disclaims
beneficial ownership of such shares. Daniel Asher is the managing
member of Castle Creek Partners, LLC. Mr. Asher disclaims beneficial
ownership of the shares owned by Castle Creek Technology Partners LLC.
(5) Nite Capital, LP. Keith Goodman, Manager of the General Partner of Nite
Capital, LP, is the control person for the shares owned by Nite
Capital, LP. Mr. Goodman disclaims beneficial ownership is the shares
owned by Nite Capital, LP.
(6) Brio Capital, LP is controlled by Shaye Hirsch.
(7) Double U Master Fund, LP. Double U Master Fund L.P. is a master fund in
a master-feeder structure with B&W Equities, LLC as its general
partner. Isaac Winehouse is the manager of B&W Equities, LLC and Mr.
Winehouse has ultimate responsibility of trading with respect to Double
U Master Fund L.P. Mr. Winehouse disclaims beneficial ownership of the
shares being registered hereunder.
29
(8) Vision Opportunity Master Fund, Ltd is controlled by its managing
member, Adam Benowitz
(9) First Mirage, Inc. Frank E. Hart, David A. Rapaport and Fred A. Brasch
exercise dispositive and voting power with respect to the shares of
common stock owned by First Mirage, Inc.
(10) Generation Capital Associate. Frank E. Hart, David A. Rapaport and Fred
A. Brasch exercise dispositive and voting power with respect to the
shares of common stock owned by Generation Capital Associates.
(11) The Hart Organization Corp. Frank E. Hart, David A. Rapaport and Fred
A. Brasch exercise dispositive and voting power with respect to the
shares of common stock owned by The Hart Organization Corp.
(12) Omega Capital Smallcap Fund, LP is controlled by Herman Segal.
(13) Professional Traders Fund is controlled by Mark Swickle.
(14) Solomon Strategic Holdings, Inc. Andrew P. Mackellar has been
authorized by the Board of Directors of Solomon Strategic Holdings,
Inc. ("SSH") to make voting and disposition decisions with respect to
the shares on behalf of SSH. By reason of such delegated authority, Mr.
Mackellar may be deemed to share dispositive power over the shares of
common stock owned by SSH. Mr. Mackellar expressly disclaims any
equitable or beneficial ownership of the shares being registered
hereunder and held by SSH, and he does not have any legal right to
maintain such delegated authority.
(15) The Tail Wind Fund Ltd. Tail Wind Advisory & Management Ltd., a UK
corporation authorized and regulated by the Financial Services
Authority of Great Britain ("TWAM"), is the investment manager for The
Tail Wind Fund Ltd., and David Crook is the CEO and controlling
shareholder of TWAM. Each of TWAM and David Crook expressly disclaims
any equitable or beneficial ownership of the shares being registered
hereunder and held by The Tail Wind Fund Ltd.
(16) Tower Paper Co. Inc. Ret. Plan is controlled by Simon Vogel.
(17) Chestnut Ridge Partners, LP is controlled by Kenneth Pasternack.
(18) Netwise Holdings Limited is controlled by Arthur Ashton.
(19) Paragon Capital LP is controlled by Alan P. Donefeld.
(20) Camofi Master, LDC is controlled by Richard Smithline.
(21) Bursteine & Lindsay Securities is controlled by Mosi Kraus
30
The named party beneficially owns and has sole voting and investment power over
all shares or rights to these shares. The numbers in this table assume that none
of the selling shareholders sells shares of common stock not being offered in
this prospectus or purchases additional shares of common stock, and assumes that
all shares offered are sold.
Except as disclosed below, none of the Selling Shareholders:
(a) has had a material relationship with us other than as a
shareholder at any time within the past three years; or
(b) has ever been one of our officers or directors.
Plan of Distribution
The selling stockholders and any of their respective pledgees, donees,
assignees and other successors-in-interest may, from time to time, sell any or
all of their shares of common stock on any stock exchange, market or trading
facility on which the shares are traded or in private transactions. These sales
may be at fixed or negotiated prices. The selling stockholders may use any one
or more of the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits the purchaser;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block
as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately-negotiated transactions;
o broker-dealers may agree with the selling stockholders to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale; and
o any other method permitted pursuant to applicable law.
The selling stockholders may also sell shares under Rule 144 under the
Securities Act, if available, or Regulation S, rather than under this
prospectus. The selling stockholders shall have the sole and absolute discretion
not to accept any purchase offer or make any sale of shares if they deem the
purchase price to be unsatisfactory at any particular time.
The selling stockholders or their respective pledgees, donees,
transferees or other successors in interest, may also sell the shares directly
to market makers acting as principals and/or broker-dealers acting as agents for
themselves or their customers. Such broker-dealers may receive compensation in
the form of discounts, concessions or commissions from the selling stockholders
and/or the purchasers of shares for whom such broker-dealers may act as agents
or to whom they sell as principal or both, which compensation as to a particular
broker-dealer might be in excess of customary commissions. Market makers and
block purchasers purchasing the shares will do so for their own account and at
their own risk. It is possible that a selling stockholder will attempt to sell
shares of common stock in block transactions to market makers or other
purchasers at a price per share which may be below the then market price. The
selling stockholders cannot assure that all or any of the shares offered in this
prospectus will be issued to, or sold by, the selling stockholders. The selling
stockholders and any brokers, dealers or agents, upon effecting the sale of any
of the shares offered in this prospectus, may be deemed to be "underwriters" as
that term is defined under the Securities Act of 1933, as amended, or the
31
Securities Exchange Act of 1934, as amended, or the rules and regulations under
such acts. In such event, any commissions received by such broker-dealers or
agents and any profit on the resale of the shares purchased by them may be
deemed to be underwriting commissions or discounts under the Securities Act.
We are required to pay all fees and expenses incident to the
registration of the shares, including fees and disbursements of counsel to the
selling stockholders, but excluding brokerage commissions or underwriter
discounts.
The selling stockholders, alternatively, may sell all or any part of
the shares offered in this prospectus through an underwriter. No selling
stockholder has entered into any agreement with a prospective underwriter and
there is no assurance that any such agreement will be entered into.
The selling stockholders may pledge their shares to their brokers under
the margin provisions of customer agreements. If a selling stockholders defaults
on a margin loan, the broker may, from time to time, offer and sell the pledged
shares. The selling stockholders and any other persons participating in the sale
or distribution of the shares will be subject to applicable provisions of the
Securities Exchange Act of 1934, as amended, and the rules and regulations under
such act, including, without limitation, Regulation M. These provisions may
restrict certain activities of, and limit the timing of purchases and sales of
any of the shares by, the selling stockholders or any other such person. In the
event that the selling stockholders are deemed affiliated purchasers or
distribution participants within the meaning of Regulation M, then the selling
stockholders will not be permitted to engage in short sales of common stock.
Furthermore, under Regulation M, persons engaged in a distribution of securities
are prohibited from simultaneously engaging in market making and certain other
activities with respect to such securities for a specified period of time prior
to the commencement of such distributions, subject to specified exceptions or
exemptions.
We have agreed to indemnify the selling stockholders, or their
transferees or assignees, against certain liabilities, including liabilities
under the Securities Act of 1933, as amended, or to contribute to payments the
selling stockholders or their respective pledgees, donees, transferees or other
successors in interest, may be required to make in respect of such liabilities.
If the selling stockholders notify us that they have a material
arrangement with a broker-dealer for the resale of the common stock, then we
would be required to amend the registration statement of which this prospectus
is a part, and file a prospectus supplement to describe the agreements between
the selling stockholders and the broker-dealer.
PENNY STOCK RULES / SECTION 15(G) OF THE EXCHANGE ACT
Our shares are covered by Section 15(g) of the Securities Exchange Act of 1934,
as amended, and Rules 15g-1 through 15g-6 promulgated thereunder. They impose
additional sales practice requirements on broker/dealers who sell our securities
to persons other than established customers and accredited investors who are
generally institutions with assets in excess of $5,000,000, or individuals with
net worth in excess of $1,000,000 or annual income exceeding $200,000, or
$300,000 jointly with their spouses.
Rule 15g-1 exempts a number of specific transactions from the scope of the penny
stock rules. Rule 15g-2 declares unlawful broker/dealer transactions in penny
stocks unless the broker/dealer has first provided to the customer a
standardized disclosure document.
Rule 15g-3 provides that it is unlawful for a broker/dealer to engage in a penny
stock transaction unless the broker/dealer first discloses, and subsequently
confirms to the customer, current quotation prices or similar market information
concerning the penny stock in question.
Rule 15g-4 prohibits broker/dealers from completing penny stock transactions for
a customer unless the broker/dealer first discloses to the customer the amount
of compensation or other remuneration received as a result of the penny stock
transaction.
32
Rule 15g-5 requires that a broker/dealer executing a penny stock transaction,
other than one exempt under Rule 15g-1, disclose to its customer, at the time
of, or prior to, the transaction, information about the sales persons
compensation.
Rule 15g-6 requires broker/dealers selling penny stocks to provide their
customers with monthly account statements.
Rule 15g-9 requires broker/dealers to approve the transaction for the customer's
account; obtain a written agreement from the customer setting forth the identity
and quantity of the stock being purchased; obtain from the customer information
regarding his investment experience; make a determination that the investment is
suitable for the investor; deliver to the customer a written statement for the
basis for the suitability determination; notify the customer of his rights and
remedies in cases of fraud in penny stock transactions; and, contact the NASD's
toll free telephone number and the central number of the North American
Administrators Association for information on the disciplinary history of
broker/dealers and their associated persons.
The application of the penny stock rules may affect your ability to resell your
shares due to broker-dealer reluctance to undertake the above described
regulatory burdens.
LEGAL PROCEEDINGS
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.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The following table sets forth the names and ages of our current directors and
executive officers, their principal offices and positions and the date each such
person became our director or executive officer. The executive officers are all
full time employees of HQSM.
The directors and executive officers of HQSM are as follows:
NAME AGE POSITION DATE OF APPOINTMENT
- --------------- --- ------------------------------------ ---------------------------
Lillian Wang Li 49 Director/Chairman of Board of March 25, 2004 as director;
Directors/ Secretary officer April 13, 2004 as executive
Harry Wang Hua 43 Director/Chief Operating Officer March 25, 2004
Norbert Sporns 52 Director/Chief Executive Officer/
President March 25, 2004
Jacques Vallee 54 Independent Non-executive Director June 15, 2004
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Fred Bild 69 Independent Non-executive Director June 15, 2004
Jean-Pierre Dallaire 54 Financial Controller April 13, 2004
Chief Financial Officer September 1, 2004
William Sujian 37 International Sales and Compliance July, 1, 2004
Officer
He Jian Bo 39 Manager Finance Dept. April 13, 2004
Wang Fu Hai 61 Chief Production Controller April 13, 2004
Fusheng Wang 72 Honorary Chairman and Director August 17, 2004
Daniel Too 54 Independent Non-executive Director September 2, 2004
Our directors are generally elected until the next annual meeting of
shareholders and until their successors are elected and qualified, or until
their earlier resignation or removal. We have recently appointed Fred Bild,
Jacques Vallee and Daniel Too as independent non-executive directors, effective
as of June 15, 2004, June 15, 2004 and September 2, 2004, respectively, pursuant
to Independent Non-Executive Director Agreements we entered into with each of
them. In consideration for their services, we agreed to pay each of Fred Bild,
Daniel Too and Jacques Vallee an annual salary of $15,000 and an annual bonus of
not less than $15,000 payable in shares of our common stock. This remuneration
is increased by 10% annually.
Our officers are generally elected annually by the board of directors and hold
office for a term of one year and until a successor is elected and qualified, or
until their earlier resignation or removal. All officers identified above serve
at the discretion of our board of directors.
Family Relationships
Lillian Wang Li and Harry Wang Hua are brother and sister and Ms. Wang is
married to Norbert Sporns.
Set forth below are the brief descriptions of the background and experience of
each of our officers and directors:
Lillian Wang Li - Chairman of Board of Directors and Secretary
Lillian Wang Li, age 49, is one of the founders of HQSM and is the chairman of
our board of directors. She is responsible for the general administration,
strategic planning and financial management of HQSM. Ms. Wang graduated from the
Beijing University majoring in European and Chinese Literature and holds a
certificate in business administration from Concordia University, Canada. She
has over twenty-five years experience in management of China and Canadian
businesses, particularly with respect to financial matters.
Harry Wang Hua - Director and Chief Operating
Officer Harry Wang Hua, age 43, is one of the founders of HQSM, and is our
director and chief operating officer. He is responsible for the establishment of
the production facilities and their operation in HQSM. He attended the Beijing
Industrial University majoring in civil engineering. Mr. Wang has over fifteen
years' experience in managing startup companies in China and in Canada and in
training middle managers in China to Western standards.
34
Norbert Sporns - Director, Chief Executive Officer and President
Norbert Sporns, age 52, is one of the founders of HQSM, and is our director,
chief executive officer and president. He has extensive experience in project
development and investment consultancy. He graduated from the University of
British Columbia, Canada, majoring in Philosophy. He also holds a Bachelor of
Civil Law degree and a Bachelor of English Common Law degree from McGill
University and a Certificate of Tax Law, a Certificate in Condominium Law and a
Diploma of Notarial Law from the University of Montreal. Mr. Sporns joined HQSM
in 1997.
Jacques Vallee -Independent Non-executive Director
Jacques Vallee, age 54 is an independent non-executive director. He is currently
in charge of Business Development and Financing with the Altitude Consulting
Group. In addition to an M.B.A. from the University of Sherbrooke and an
advanced Certificate in Business Administration from the University de Quebec a
Trois Rivieres, Mr. Vallee also holds a post-graduate level Advertising
Management Diploma from the Ecole des Hautes Etudes Commerciales, Montreal. He
has over 30 years of management experience at such notable Canadian institutions
as the Bank of Montreal, La Federation des Caisses Populaires Desjardins de
Richelieu-Yamaska, Le Fonds de Solidarite des Travailleurs du Quebec and
Altitude Consulting Group.
Fred Bild - Independent Non-executive Director
Fred Bild, age 69, is currently Visiting Professor at the University of
Montreal's Centre of East Asian Studies and is a private consultant on political
and economic relations with China and East Asia. Professor Bild received a B.A.
in Philosophy and Sociology from Sir George Williams University, a Diploma in
International Law from University College, London, and a Diplome de Stage from
the Ecole National d'Administration in Paris. Over the past nearly forty years,
Mr. Bild has served the Canadian Embassy in various functions including Cultural
Attache (Tokyo), Economic Counsel and Deputy Chief (Paris) and Ambassador to
Thailand and China.
Daniel Too - Independent Non-executive Director
Mr. Too, age 54, graduate of Hong Kong University and Polytechnic, has extensive
business experience in Asia and brings a keen understanding of the business
difficulties associated with working in China. He is currently the Managing
Director of Delta Elevator Far East and serves as Director of Voker Chemical
Paint Limited. He has been named to the compensation committee with another
Independent Non-Executive Director, Mr. Fred Bild, and the CEO, Norbert Sporns.
Jean-Pierre Dallaire - Financial Controller and Chief Financial Officer
35
Jean-Pierre Dallaire, age 55, is the financial controller and CFO of HQSM. He
has experience with Canada's largest engineering company where he was
responsible for cash flow projections and project financial supervision. He
holds a Master degree in Administration (Accounting) from the University of
Sherbrooke, Canada. He joined HQSM in 2000.
He Jian Bo - Manager Finance Department
He Jian Bo, age 39, is the manager of the finance department of HQSM. He holds a
Bachelor's and a Master degree in Economics from the Southwestern University of
Finance and Economics, the PRC. He joined HQSM in 1999.
Wang Fu Hai - Director and Chief Accounting and Finance Officer
Wang Fu Hai, age 62, is the Chief Production Controller and Engineer of HQSM. He
graduated from Post College in 1966. He was the manager of Project Department
Hainan Jiahua Ocean Organism Co., Ltd. He has solid experience in production
coordination and control. He joined HQSM in 1997.
William Sujian- International Sales and Compliance Officer
William Sujian, age 37, is the International Sales and Compliance Officer for
the Company. He Graduated from Beijing Second Foreign Language Institute, Major
in Business Administration. He has over 12 years of experience in international
trade and project development. He is familiar with western and Asian business
practices. His functions include the supervision of the China based sales team
and supervision of compliance with the Code of Ethics and Business Conduct He
joined HQSM in 2004.
Involvement in Certain Legal Proceedings
To the best of our knowledge, during the past five years, none of the following
occurred with respect to a present or former director or executive officer of
the Company: (1) any bankruptcy petition filed by or against any business of
which such person was a general partner or executive officer either at the time
of the bankruptcy or within two years prior to that time; (2) any conviction in
a criminal proceeding or being subject to a pending criminal proceeding
(excluding traffic violations and other minor offenses); (3) being subject to
any order, judgment or decree, not subsequently reversed, suspended or vacated,
of any court of any competent jurisdiction, permanently or temporarily
enjoining, barring, suspending or otherwise limiting his involvement in any type
of business, securities or banking activities; and (4) being found by a court of
competent jurisdiction (in a civil action), the Securities and Exchange
Commission or the commodities futures trading commission to have violated a
Federal or state securities or commodities law, and the judgment has not been
reversed, suspended or vacated.
36
Board Committees and Independence
All of the directors serve until the next annual meeting of common shareholders
and until their successors are elected and qualified by our common shareholders,
or until their earlier death, retirement, resignation or removal. Our Bylaws set
the authorized number of directors at not less than one nor more than nine, with
the actual number fixed by our board of directors. Our Bylaws authorized the
Board of Directors to designate from among its members one or more committees
and alternate members thereof, as they deem desirable, each consisting of one or
more of the directors, with such powers and authority (to the extent permitted
by law and these Bylaws) as may be provided in such resolution.
There are three independent directors; Jacques Vallee, Fred Bild and Daniel Too.
Our board of directors has established two committees to date, an Audit
Committee and a Compensation Committee. The principal functions of the Audit
Committee are to recommend the annual appointment of the Company's auditors
concerning the scope of the audit and the results of their examination, to
review and approve any material accounting policy changes affecting the
Company's operating results and to review the Company's internal control
procedures. The principal functions of the Compensation Committee are to review
and recommend compensation and benefits for the executives of the Company.
The Audit Committee consists of two independent members of the Board of
Directors, specifically Jacques Vallee and Daniel Too as well as Lillian Wang
Li. Jacques Vallee is the Chairperson of the Audit Committee and is considered a
financial expert as a consequence of his business development and financing
expertise.
The Compensation Committee consists of two independent members of the Board of
Directors, specifically Fred Bild and Daniel Too as well as Norbert Sporns.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AMOUNT OF PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER (1) OWNERSHIP(2) OF CLASS(3)
- ----------------------------------------- ------------ -----------
Norbert Sporns 16,938,564 10.68%
Lillian Wang Li 17,623,504 11.11%
Harry Wang Hua 35,431,946 22.35%
Jacques Vallee 12,500 *
Fred Bild 99,404 *
Daniel Too 81,547 *
All such directors and executive officers
as a group (6 persons) 70,187,465 44.27%
*less than 1%
37
(1) Unless otherwise indicated, the address of each beneficial owner is c/o
HQ Sustainable Maritime Industries, Inc., Melbourne Towers, 1511 Third
Avenue, Suite 788, Washington 98101.
(2) Under the rules of the Securities and Exchange Commission, a person is
deemed to be the beneficial owner of a security if that person,
directly or indirectly has or shares the powers to direct the voting of
the security or the power to dispose or direct the disposition of the
security. Accordingly, more than one person may be deemed to be a
beneficial owner of the same securities. A person is also deemed to be
a beneficial owner of any securities with respect to which that person
has the right to acquire beneficial ownership within 60 days of the
relevant date. Unless otherwise indicted by footnote, the named
individuals have sole voting and investment power with respect to the
shares of stock beneficially owned.
(3) Based on 158,830,724 shares of common stock, consisting of 116,595,225
shares of common stock issued as of April 20, 2006, and 24,618,833
shares of common stock underlying our Warrants, 200,000 shares of
common stock underlying our preferred stock and 17,416,666 shares of
common stock underlying the convertible notes (excluding shares
issuable upon conversion of the equivalent of 175% of our secured
convertible notes).
Changes in Control
We are not aware of any arrangements that may result in a change in control of
the Company.
Description of Securities
General
Our authorized capital stock consists of 200,000,000 shares of common stock, par
value $ .01, and 10,000,000 shares of preferred stock.
Common Stock
The shares of our common stock presently outstanding, and any shares of our
common stock issues upon exercise of stock options and/or warrants, will be
fully paid and non-assessable. Each holder of common stock is entitled to one
vote for each share owned on all matters voted upon by shareholders, and a
majority vote is required for all actions to be taken by shareholders. In the
event we liquidate, dissolve or wind-up our operations, the holders of the
common stock are entitled to share equally and ratably in our assets, if any,
remaining after the payment of all our debts and liabilities and the liquidation
preference of any shares of preferred stock that may then be outstanding. The
common stock has no preemptive rights, no cumulative voting rights, and no
redemption, sinking fund, or conversion provisions. Since the holders of common
stock do not have cumulative voting rights, holders of more than 50% of the
outstanding shares can elect all of our Directors, and the holders of the
remaining shares by themselves cannot elect any Directors. Holders of common
stock are entitled to receive dividends, if and when declared by the Board of
Directors, out of funds legally available for such purpose, subject to the
dividend and liquidation rights of any preferred stock that may then be
outstanding.
38
Preferred Stock
We are authorized to issue 10,000,000 shares of preferred stock, $.01 par value,
of which 100,000 are issued and outstanding as of April 20, 2006. Our preferred
stock converts at a ratio of two common shares for each one preferred share.
Dividend Policy
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain future earnings, if any, to finance the expansion of
our business. As a result, we do not anticipate paying any cash dividends in the
foreseeable future.
Share Purchase Warrants
Class A Warrants: The exercise price to acquire a share of Common Stock upon
exercise of a Class A Warrant shall be $0.35. The Class A Warrants shall be
exercisable until January 25, 2009.
Class B Warrants: The exercise price to acquire a share of Common Stock upon
exercise of a Class B Warrant shall be $0.40. The Class B Warrants shall be
exercisable until January 25, 2011.
Class C Warrants: The exercise price to acquire a share of Common Stock upon
exercise of a Class B Warrant shall be $0.42. The Class C Warrants shall be
exercisable until April, 2009.
Class D Warrants: The exercise price to acquire a share of Common Stock upon
exercise of a Class B Warrant shall be $0.84. The Class D Warrants shall be
exercisable until April, 2009.
The exercise price of the Class A and Class B Warrants and the number of shares
of Common Stock or other securities at the time issuable upon exercise of the
Warrants shall be appropriately adjusted to reflect any stock dividend, stock
split, combination of shares, reclassification, recapitalization or other
similar event affecting the number of outstanding shares of stock or securities.
In case of any consolidation or merger by us with or into any other corporation,
entity or person, or any other corporate reorganization, in which we shall not
be the continuing or surviving entity of such consolidation, merger or
reorganization (any such transaction being hereinafter referred to as a
"Reorganization"), then, in each case, the holder of the Warrants on exercise
any time after the consummation or effective date of such Reorganization (the
"Effective Date"), shall receive, in lieu of the shares of stock or other
securities at any time issuable upon the exercise of the Warrants issuable on
such exercise prior to the Effective Date, the stock and other securities and
property (including cash) to which such holder would have been entitled upon the
Effective Date if such holder had exercised this Warrant immediately prior
thereto.
39
As of May 17, 2006, 24,618,833, outstanding warrants to acquire shares of the
Company's common stock are as follows:
Number of Shares
Class of Warrants Exercise Price Expiration Date Reserved
- --------------------------------------------------------------------------------
Class A $0.35 January 25, 2009 8,708,333
Class B $0.40 January 25, 2011 10,450,000
Class C $0.42 April, 2009 2,116,500
Class D $0.84 April, 2009 3,344,000
Options
Under our Stock Option Plan (the "Stock Option Plan"), options to purchase an
aggregate of not more than 5,000,000 shares of common stock may be granted from
time to time to key employees (including officers), consultants and members.
Options shall be designated as Nonqualified Stock Options ("NQSOs"). The Stock
Option Plan is administered by a committee to administer the Stock Option Plan
consisting of the members of the Board of Directors (the "Committee"). The
Committee is generally empowered to interpret the Stock Option Plan; to
prescribe rules and regulations relating thereto; to determine the terms of the
option agreements; to amend the option agreements with the consent of the
optionee; to determine the key employees and directors to whom options are to be
granted; and to determine the number of shares subject to each option and the
exercise price thereof. The per share exercise price of options granted under
the Stock Option Plan will be not less than 100% of the fair market value per
share of common stock on the date the options are granted.
Convertible Securities
We issued promissory notes of the Company ("Note" or "Notes"), in the principal
aggregate amount of $5,225,000, due January 25, 2008, such Notes convertible
into shares of the Company's common stock, $0.001 par value (the "Common Stock")
at a per share conversion price at the rate of $0.30 per share of Common Stock
or 17,416,667. The Notes shall accrue interest on the principal amount of the
Notes at a rate per annum of eight percent (8%) from January 25, 2006 and shall
be payable, in arrears, subject to the terms and conditions of the Notes,
together with principal amount payments, on January 25, 2008.
40
Amendment of our Bylaws
Our bylaws may be adopted, amended or repealed by the affirmative vote of a
majority of our outstanding shares. Subject to applicable law, our bylaws also
may be adopted, amended or repealed by our board of directors.
Interest of Named Experts and Counsel
None of the experts named herein was or is a promoter, underwriter, voting
trustee, director, officer or employee of our company. Further, none of the
experts was hired on a contingent basis and none of the experts named herein
will receive a direct or indirect interest in our Company, except that the
Company has reserved 150,000 shares of common stock for Mr. Emas.
LEGAL MATTERS
Joseph I. Emas, Attorney at Law, Miami, Florida will issue an opinion with
respect to the validity of the shares of common stock being offered hereby.
EXPERTS
Rotenberg & Company, LLP, independent registered public accounting firm, have
audited, as set forth in their report thereon appearing elsewhere herein, our
financial statements at December 31, 2005 and for the two years then ended that
appear in the prospectus. The financial statements referred to above are
included in this prospectus with reliance upon the independent registered public
accounting firm's opinion based on its expertise in accounting and auditing.
DISCLOSURE OF COMMISSION POSITION OF INDEMNIFICATION FOR SECURITIES ACT
LIABILITIES; ANTI-TAKEOVER, LIMITED LIABILITY AND INDEMNIFICATION PROVISIONS
Certificate of Incorporation and Bylaws. Pursuant to our amended certificate of
incorporation, our board of directors may issue additional shares of common or
preferred stock. Any additional issuance of common stock could have the effect
of impeding or discouraging the acquisition of control of us by means of a
merger, tender offer, proxy contest or otherwise, including a transaction in
which our stockholders would receive a premium over the market price for their
shares, and thereby protects the continuity of our management. Specifically, if
in the due exercise of its fiduciary obligations, the board of directors were to
determine that a takeover proposal was not in our best interest, shares could be
issued by the board of directors without stockholder approval in one or more
transactions that might prevent or render more difficult or costly the
completion of the takeover by:
o diluting the voting or other rights of the proposed acquirer
or insurgent stockholder group;
o putting a substantial voting block in institutional or other
hands that might undertake to support the incumbent board of
directors; or
o effecting an acquisition that might complicate or preclude the
takeover.
Delaware Anti-Takeover Law. We are subject to the provisions of Section 203 of
the Delaware General Corporation Law concerning corporate takeovers. This
section prevents certain Delaware corporations from engaging in a business
41
combination with any interested stockholder, under certain circumstances. For
these purposes, a business combination includes a merger or sale of more than
10% of our assets, and an interested stockholder includes a stockholder who owns
15% or more of our outstanding voting stock, as well as affiliates and
associates of these persons. Under these provisions, this type of business
combination is prohibited for three years following the date that the
stockholder became an interested stockholder unless:
o the transaction in which the stockholder became an interested
stockholder is approved by the board of directors prior to the
date the interested stockholder attained such status;
o upon consummation of the transaction that resulted in the
stockholder's becoming an interested stockholder, the
interested stockholder owned at least 85% of the voting stock
of the corporation outstanding at the time the transaction was
commenced, excluding those shares owned by persons who are
directors and also officers; or
o on or subsequent to that date, the business combination is
approved by the board of directors and authorized at an annual
or special meeting of stockholders by the affirmative vote of
at least two-thirds of the outstanding voting stock that is
not owned by the interested stockholder.
This statute could prohibit or delay mergers or other takeover or
change-in-control attempts with respect to us and, accordingly, may discourage
attempts to acquire us.
Limited Liability and Indemnification. Our certificate of incorporation
eliminates the personal liability of our directors for monetary damages arising
from a breach of their fiduciary duty as directors to the fullest extent
permitted by Delaware law. This limitation does not affect the availability of
equitable remedies, such as injunctive relief or rescission. Our certificate of
incorporation requires us to indemnify our directors and officers to the fullest
extent permitted by Delaware law, including in circumstances in which
indemnification is otherwise discretionary under Delaware law.
Under Delaware law, we may indemnify our directors or officers or other persons
who were, are or are threatened to be made a named defendant or respondent in a
proceeding because the person is or was our director, officer, employee or
agent, if we determine that the person:
o conducted himself or herself in good faith;
o reasonably believed, in the case of conduct in his or her
official capacity as our director or officer, that his or her
conduct was in our best interests, and, in all other cases,
that his or her conduct was at least not opposed to our best
interests; and
o in the case of any criminal proceeding, had no reasonable
cause to believe that his or her conduct was unlawful.
These persons may be indemnified against expenses, including attorney fees,
judgments, fines, including excise taxes, and amounts paid in settlement,
actually and reasonably incurred, by the person in connection with the
proceeding. If the person is found liable to the corporation, no indemnification
shall be made unless the court in which the action was brought determines that
the person is fairly and reasonably entitled to indemnity in an amount that the
court will establish.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to our directors, officers, and controlling persons
pursuant to the foregoing provisions, or otherwise, we have been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable.
In the event that a claim for indemnification against such liabilities is
asserted by one of our directors, officers, or controlling persons in connection
with the securities being registered, we will, unless in the opinion of our
legal counsel the matter has been settled by controlling precedent, submit the
question of whether such indemnification is against public policy to court of
appropriate jurisdiction. We will then be governed by the court's decision.
42
Organization Within Five Years
Our company 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
HQSM being the surviving entity in the merger and acquiring all the assets and
liabilities of Process Equipment, Inc.
On May 19, 2004, in order to effect a reincorporation from Nevada to Delaware,
Process Equipment, Inc., a Nevada corporation, was merged with and into HQ
Sustainable Maritime Industries, Inc., a Delaware corporation. Prior to the
effective time of the reincorporation, HQ Sustainable Maritime Industries, Inc.
had been a wholly-owned subsidiary corporation of Process Equipment, Inc.
organized for the purposes of effecting the reincorporation. At the effective
time of the reincorporation, HQ Sustainable Maritime Industries, Inc. became the
surviving entity of the merger pursuant to which the reincorporation was
completed, as well as the registrant for reporting purposes under the federal
securities laws. The merged entity is governed by the Delaware General
Corporation Law and the certificate of incorporation and bylaws of HQ
Sustainable Maritime Industries, Inc.
The reincorporation was completed pursuant to an Agreement and Plan of Merger
dated as of May 19, 2004, by and between Process Equipment, Inc. and HQ
Sustainable Maritime Industries, Inc., and was approved by the holders of
approximately 73% of the issued and outstanding common stock of Process
Equipment, Inc. by written consent in lieu of a special meeting of the
stockholders of Process Equipment, Inc. (all as more fully described in the
Information Statement).
43
At the effective time of the reincorporation, the directors and executive
officers of Process Equipment, Inc. became the directors and executive officers
of HQ Sustainable Maritime Industries, Inc. HQ Sustainable Maritime Industries,
Inc.'s business, mailing address, principal executive offices and telephone
number are the same as those of Process Equipment, Inc.
At the effective time of the reincorporation, each outstanding share of common
stock, par value $.001 per share of Process Equipment, Inc. was automatically
converted into one share of common stock, par value $.001 per share of HQ
Sustainable Maritime Industries, Inc. Outstanding options and warrants to
purchase shares of Process Equipment, Inc. were automatically converted into
options and warrants to purchase the same number of shares of HQ Sustainable
Maritime Industries, Inc. Each employee stock plan and any other employee
benefit plan to which Process Equipment, Inc. was a party were assumed by HQ
Sustainable Maritime Industries, Inc. and, to the extent any such plans provided
for the issuance or purchase of Process Equipment, Inc. common stock, such plans
now provide for the issuance or purchase of HQ Sustainable Maritime Industries,
Inc. common stock.
On August 17, 2004, we 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 was filed as
an exhibit to our current report on Form 8-K 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. The
consideration of the acquisition is $20 million in terms of 12,698,078 shares
(equivalent to $8,888,655), $11,011,345 promissory note convertible to
15,732,493 Class A shares and $100,000 promissory note convertible to 100,000
Series A preferred stock with par value at $0.001 per share. Both promissory
notes accrue interest at the rate of 5% per annum. 12,698,078 shares were issued
to SSC on August 17, 2004 after the Purchase Agreement was signed. $11,011,345
of promissory notes were converted to 15,732,493 Class A shares on November 18,
2004.
Further, as previously disclosed in the above current report, effective from
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 Hainan Quebec Ocean Fishing Company Limited, 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
consideration of $5,695,145 was fully paid in cash on October 31, 2004.
44
On April 16, 2004, HQ Sustainable Maritime Marketing Inc. ("HQSM Marketing") was
formed and registered in USA, wholly owned by HQSM. This new subsidiary was
dormant during the year.
On June 15, 2004, HQ Sustainable Maritime Marketing (Canada) Inc ("HQSM Canada")
was formed in Canada and is wholly owned by HQSM. HQSM Canada commenced
operations in June 2004, and performs business development, sales and marketing
in the Canadian market.
Our principal executive office is located at Melbourne Towers, 1511 Third Avenue
Seattle, suite 788, WA. 98101 USA Tel. 206-621-9888. Fax. 206-621-0318 The URL
for our website is http://www.hqfish.com.
Description of Business
HQ Sustainable Maritime Industries, Inc., is principally engaged in the
vertically integrated business of aquaculture through co-operative supply
arrangements, ocean product harvesting, and processing and sales of farm-bred
and ocean harvested aquatic products, as well as the production and sale of
marine bio-products and healthcare products. The Group is committed to providing
a variety of high quality aquatic products and health products through an
integrated operation that covers value added key areas along the production
chain from a bio-secure and stable supply of tilapia and shrimp under
stringently monitored conditions, processed in accordance with internationally
recognized standards of hygiene. Since the Group acquired Sealink Wealth Limited
("Sealink" hereafter), The Group has also engaged in the production and sale of
marine bio-products and healthcare products in the PRC.
The principal products of Hainan Jiahua Marine Bio-Product Company Limited (100%
owned subsidiary of Sealink) are Shark Cartilage Capsule, Shark Liver Oil and
Shark Liver (Soft gel). The major market is in the PRC.
The Group has developed a co-operative supply network in Hainan Province, China
(for aquaculture products), which allows it to guarantee quality and quantity of
products for processing without engaging directly in farming operations and
having to deal with the associated capital costs and risks. The Group, through
the co-operative supply agreements, is active in the transfer of technology to
its suppliers and the constant monitoring of quality.
Manufacturing
Aquaculture Products
45
The Group's aquatic products processing plant is a Canadian designed facility
and is located in Hainan, the PRC. Prior to May 2004, the Group had two
production lines in aggregate and they are located in the same processing plant
in Hainan. From January to May, 2004 the plant was expanded to six production
lines. These six lines include two filleting lines, two whole round fish
processing lines (principally Tilapia which is gutted, scaled and gilled) and
two shrimp processing lines. The facility is capable of processing an average of
approximately 10,000 tons per year of whole round fish (principally Tilapia),
3,000 tons per year of fillet and 3,000 tons per year of shrimp. The plant
operates in two shifts for a total of 17 hours.
The Group's products have been awarded HACCP Certification for exporting aquatic
products to the US and Japan. HACCP is used by the US Food and Drug
Administration in controlling food safety and sanitary hazards. It is a
preventive system previously used by astronauts, focusing on preventing hazards
that could cause food-borne illnesses by applying science based controls, from
raw materials to finished products. The successful implementation of a HACCP
plan is dependent upon the design and performance of facilities and equipment,
combined with excellent quality control and hygiene practices, which can
minimize the occurrence of a hazard in a finished product.
Apart from the HACCP Certification, the Group has also been assigned an EU Code
for exporting aquatic products to the EU. The EU has designated only two
producers in Hainan Province. The code is highly coveted since very few new
attributions of code are being accepted. This increases the value of export to
the EU since buyers routinely pay more than their US counterparts. The Directors
believe the awards of the HACCP Certification and the assignment of the EU Code
have enabled the Group to export to the US and the EU respectively. The HACCP
Certification and EU Code assignment signify the Group's attainment of stringent
hygiene standards and enable the Group to better market and export its processed
aquatic products to overseas clients in the US and the EU.
The Group conducts sample laboratory testing on the Group's processed aquatic
products to ensure no forbidden substances are present in them. The laboratory
testing was initiated by the Group in compliance with strict quarantine
guidelines imposed by domestic export control government agencies and foreign
import control government agencies.
Health and Bio-products
Our production workshops consist of two production lines: the powder line and
the oil line. We have raw material treatment workshops, such as an extraction
workshop, a freezing and drying workshop, a powder distillation workshop and a
finished product workshop in powder line. We also have pre-treatment workshops,
such as a cooling and filtration workshop, a molecular distillation workshop, a
supplemental stuff workshop and a capsule workshop in oil line. The production
lines are equipped with a complete set of imported and domestic made devices,
including: a vacuum frozen dryer for bio-products, a molecular distillation
device, a micro-disintegrator, a packing machine and test instruments, etc.
46
The Products
The following are a brief description of our products.
Tilapia Products
Tilapia are native to Africa, but have been introduced in many countries around
the world. They are disease-resistant, reproduce easily, eat a wide variety of
foods and tolerate poor water quality with low dissolved oxygen levels. Most
will grow in brackish water and some will adapt to full strength sea water.
These characteristics make tilapia suitable for culture in most developing
countries. They are most often grown in ponds, cages and rice fields.
There are many tilapia species but only a few are cultured widely around the
world today. There are three common species which are reared commercially in
ponds from Japan, the Philippines down to Thailand and Indonesia, namely the
black or Nile tilapia (Oreochromis niloticus), the red tilapia (Oreochromis
mossambicus) and the blue tilapia (Oreochromis aureus), usually in the form of a
new hybrid based on the original strains.
Black or Nile Tilapia
The fry eat zooplankton and the adults eat zooplankton, phytoplankton, insects,
other bottom organisms and manufactured food. The optimum temperature to culture
black tilapia is 25 to 30 degrees centigrade and black tilapia can tolerate low
temperature of 11 degrees centigrade. Black tilapia can grow well in water up to
20 parts per thousand salinity.
Red Tilapia
The fry eat zooplankton and the adults eat zooplankton, phytoplankton and
manufactured food. The optimum temperature to culture red tilapia is 25 to 30
degrees centigrade and red tilapia can tolerate low temperature of 10 to 12
degrees centigrade. Red tilapia can grow well in full strength sea water.
Tilapia Market
In the 1960s and 1970s, tilapia culture was geared towards the production of
food for local consumption and for the diversification of rural activities
related to agriculture and animal husbandry. During the past 20 years,
commercially viable techniques have been developed to control overcrowding in
the different production systems, thereby permitting faster and more uniform
growth to larger sizes. Commercial production has become popular in many
countries around the world.
47
Tilapia aquaculture has grown impressively during the 1990s, and forecasts
indicate that the industry will continue to expand significantly in the years to
come. US is the world's largest consumer of tilapia. In 2005, more than 390
million USD of Tilapia was sold in the United States.(See American Tilapia
Association (See http://ag.arizona.edu/azaqua/ata.html). Due to limited
resources in domestic US tilapia production, tilapia imports to the US are
expected to increase. Imported tilapia already accounts for around 90% of total
consumption of tilapia in the US. We believe that the largest demand for tilapia
in the world will continue to be the US.
TABLE 6
Top ten species groups in aquaculture production: quantity and growth
Species group 2000 2002 Share of 2002 APR
total
(tonnes) (percent)
Top ten species groups in terms of quantity
Carps and other cyprinids 15 451 646 16 692 147 41.9 3.9
Oysters 3 997 394 4 317 380 10.8 3.9
Miscellaneous marine molluscs 2 864 199 3 739 702 9.4 14.3
Clams, cockles, arkshells 2 633 441 3 430 820 8.6 14.1
Salmons, trouts, smelts 1 545 149 1 799 383 4.5 7.9
Tilapias and other cichlids 1 274 389 1 505 804 3.8 8.7
Mussels 1 370 953 1 444 734 3.6 2.7
Miscellaneous marine molluscs 1 591 813 1 348 327 3.4 -8.0
Shrimps, prawns 1 143 774 1 292 476 3.2 6.3
Scallops, pectens 1 154 470 1 226 568 3.1 3.1
Top ten species groups in terms of growth
Cods, hakes, haddocks 169 1 445 192.4
Misc. demersal fishes 8 701 15 302 32.6
Misc. marine crustaceans 34 202 52 377 23.7
Flounders, halibuts, soles 26 309 38 909 21.6
Tunas, bonitos, billfishes 6 447 9 445 21.0
Freshwater crustaceans 411 458 591 983 19.9
Crabs, sea-spiders 140 235 194 131 17.7
Freshwater molluscs 10 220 13 414 14.6
Misc. freshwater fishes 2 864 199 3 739 702 14.3
Clams, cockles, arkshells 2 633 441 3 430 820 14.1
Note: Data exclude aquatic plants. APR refers to the average annual percentage
growth rate for 2000-2002.
(Source State of The World Fisheries and Aquaculture (FAO) 2004 Report Part 1
table 6 See http://www.fao.org/sof/sofia/index_en.htm)
In the US, consumption of tilapia has risen in the recent years. Tilapia now
ranks third after farm-raised shrimp and Atlantic salmon in terms of aquaculture
products imported into the US. In terms of volume, frozen whole round fish ranks
first, followed by frozen fillets, and lastly fresh fillets. Frozen whole round
fish and fillets originate primarily from Asia, and fresh fillets primarily from
Central America and the Caribbean.
48
Recently, with the increase in production of tilapia in the PRC and the growing
demand of tilapia in the international market, the export of tilapia from the
PRC has also increased. We believe that tilapia has great potential for market
growth.
Fresh Water Shrimp Products
Shrimp is a favorite seafood all over the world. The giant tiger prawn or black
tiger shrimp (Penaeus monodon) accounts for more than half of all farmed shrimp
and dominates production in Thailand, Indonesia, India and the Philippines. In
the PRC, the fleshy prawn or Chinese white shrimp (Penaeus chinensis) is
dominant, whereas in Latin America it is the white leg shrimp (Litopenaeus
Vannamei) which is the leading species. The Indian prawn (Penaeus indicus) is
also farmed in Asia.
Health products
The acquisition of Jiahua Marine provides HQ with the capacity to manufacture
nutraceuticals to enrich feed formulations for tilapia and shrimp farmed in the
Hainan area. These ingredients are directed at improving general health, growth,
feed conversion and meat quality of fish and shrimp. Such products boost the
immune system of shrimp to ward off common viruses and deliver various
functional food nutrients to humans through the fish and shrimp they eat. HQ is
working with leading technology providers throughout the world, in particular in
the United States, to deliver these new nutraceutical additives to the fish and
shrimp farming industry.
Jiahua Marine is also engaged in the production and sales of marine bio-products
and healthcare products in the PRC. It currently operates two activities, a
marine bio-products factory and research and development activity. The marine
bio-products factory is located in Wenchang City of Hainan Province, with a
ground floor area of 16,667 square meters and a construction area of
approximately 8,000 square meters. It operates two production lines: the
powder-product line and the oil-product line.
Jiahua Marine's second activity is related to research and development in
association with Marine Organism Research Institute, which is headed by a group
of experts specializing in the research and development of products derived from
marine organisms in China. Clinical trials and laboratory testing on Jiahua
Marine's various healthcare products have resulted in National Certification.
These products currently sold throughout China, are naturally derived from
ocean-harvested byproducts and are winners of Science and Technology Progress
Awards in China. Jiahua Marine also has established a long-term relationship
with the Qingdao University of Oceanography for production-research and
training.
Jiahua Marine production lines are ideally suited for the manufacture of
nutraceutical components. The plant is equipped with specific gravity molecular
separator and accessory equipment for the manufacture of nutraceutical products
that can serve as feed additives in the production of feed, including tilapia
and shrimp feed.
49
Jiahua Marine products provide leading ocean-sourced raw materials processed at
its own plant. Patented, laboratory and clinically tested products have resulted
from years of research and development administered through a partnership with
Qingtao Ocean University and its Marine Bioengineering Research Institute. Two
products are produced from refined shark cartilage and two from shark liver
(harvested from non-endangered shark species). These products are more fully
described below:
* Patent Number 460000X340-2001 -- Shark cartilage is highly alkalescent;
it contains chondroitin sulfate and calcium and impacts the human body
positively in the following ways:
-- Increases efficiency of immune system, activates NK cells
associated with combating cancer (sharks are cancer free);
-- Reduces blood acidity improving
-- Blood pressure
-- Apoplexy
-- Heart disease
-- Fertility
-- Osteoporosis
* Patent Number 460000X131-2001 -- Shark cartilage also contains
glycosaminoglycan, Amino Acids, and collagen proteins which have been
specially processed for absorption into the skin and impacts the human
body positively in the following ways:
-- Increases subcutaneous water content
-- Reduces wrinkles
-- Slows the visible effects of aging
* Patent Number 460000X338-2001 -- Shark Liver oil is rich in squalene
and other nutrients, to which we add vitamins D and E, and impacts the
human body positively in the following ways:
-- Improves absorption of oxygen in the body which is
particularly important for the brain which consumes 23% of the
oxygen used in the body
-- Eliminates fatigue
-- Improves health
* Patent Number 460000X342-2001 -- Shark liver oil contains 100 times
more Alkoxy-Glyceryl (AKGS) than mothers milk. It is also rich in omega
3 oils recommended for nursing mothers, and impacts the human body
positively in the following ways:
-- Improves resistance to disease;
-- Improves phosphate for brain cell production
50
The above products have been shown to be effective.
In 2003, Jiahua Marine commenced a sales strategy, which it believes will lead
to strong growth in the current and future years. A unique direct marketing
campaign has been introduced in conjunction with large scale tours organized
throughout China in prime tourist destinations -- Sanya, Beihai (China's
premiere tropical leisure vacation centers) and the Three Gorges project. These
tours are captive audiences learning the health advantages of the products
during an outing associated with their leisure activities. In addition, in 2003
sales have begun in Hualian Supermarket Co. Ltd., (one of the largest specialty
chains in China with well over 1200 outlets and sales of US$2 billion, the first
publicly listed supermarket retailer in China) as well as in health product and
pharmaceutical outlets throughout China.
Marketing
Our sales and marketing team consists of nine members and is under the
supervision of Mr. Harry Wang, our Chief Operating Officer. The sales and
marketing team is responsible for establishing our sales and distribution
networks both domestically and internationally, promoting our image and product
awareness, and maintaining our customer relationships.
We believe that HQOF, one of our principal operating subsidiaries, is the only
vertically integrated PRC-based producer present at the International Seafood
Shows. This enables HQOF to establish high level and immediate contacts with
potential buyers. Buyer preferences and our response to these preferences as
well as prices and response to quality and quantity concerns can be immediately
addressed without the usual screening and middleman costs.
We have located the following as potential and prospective markets that we
intend to focus upon for expansion:
North America
The North American market for tilapia and shrimp is significant and is growing.
Competition from producers across the globe, ranging from Bangladesh to Chile,
is intense. Minimum quality is presumed as a pre-requisite and consumers tend to
be less educated as to the benefits of higher quality in this region. We plan to
continue to export to this market where our products are generally well
received.
People's Republic of China
Given the enormous demand and potential in the PRC market, we also consider it a
prospective market. The advantageous climatic conditions found in Hainan
Province allow year-round production, which differentiates it from other areas
in the PRC. With the PRC's accession to the WTO and the continued development of
51
our distribution network, opportunities should arise for us to establish
strategic linkages with foreign producers and suppliers seeking access to the
ever changing and modernizing Chinese market. We will consolidate this position
by being a producer of quality product and this strategy should also allow us to
decide and select strategic partners in the PRC in the future.
All health and bio-products of the group are sold in this geographic region. A
North American marketing initiative has been commenced by the signing of a
marketing and distribution agreement with American River Nutrition in March of
2005. The first step in this process is the re-testing of the products by
American laboratories to reproduce Chinese results and to make additional tests
to support more claims regarding the products.
Competition
Our company 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
co-operative supply agreements entered into between HQOF and selected tilapia
and shrimp farmers in Hainan Province secure the supply, quality and price of
raw materials for our Production. Through such arrangement, we believe that we
have a competitive advantage over our competitors in Hainan Province.
The PRC aquaculture industry is open to competition from local and overseas
operators engaged in aquaculture and from other captured fish producers. Our
major aquaculture products, tilapia and shrimp, are also facing competition from
some other domestic aquaculture producers. Some of the domestic aquaculture
processing companies in Hainan Province also obtain the same HACCP Certification
and EU Code assignment that we possess, which certifies that their products are
also in compliance to certain standards. However, we believe that the
competition from such producers is minimal because, to the best of our
knowledge, there is no competitor in Hainan Province that has a similar
operating scale and production capacity, or that has developed the vertically
integrated business model under which we operate.
Although there is no formal entry barrier for engaging in similar aquaculture
processing production and activities in the PRC, we believe that the high
infrastructure costs associated with developing and constructing processing
plants and facilities does pose a barrier to potential competitors. Accordingly,
competitors have to mobilize extensive resources in order to maintain a presence
similar to ours.
We believe that we are geographically well-positioned to capitalize on the
significant potentials of seafood markets both overseas and within the PRC. As
buying power increases in Asia, and developed countries gravitate towards
fishery products, seafood producers are under great pressure to respond to
increasing demands. We further believe that the following factors contribute to
our principal strengths and competitive advantages:
52
Integrated operations. We run a vertically integrated operation that covers key
areas along the production chain including sourcing, co-operative supply farming
and distribution. Co-operative supply agreements have been secured with several
producers who benefit from our extensive technology development program. Through
intensive monitoring and quality control of fish fry, pond environment and feed
supply, we are able to assure the supply of quality aquaculture products.
International and domestic sales and marketing efforts. We have a distribution
network for our export sales and domestic sales that is developed and maintained
through our marketing offices in Beijing and Shanghai, through our international
direct and indirect marketing efforts, and also by virtue of our presence and
participation at international seafood shows.
Strategic location of co-operative supply and production base. We are
geographically well-positioned in Hainan Province to leverage on the year-round
favorable climatic conditions, abundant water supply and pristine environment.
Such strategic location is a key attribute to the success of our co-operative
suppliers of locally farmed tilapia and shrimp, particularly white leg shrimp.
Co-operative supply and vertical integration. We have assured supply, quality
and price of raw materials for production through long term arrangements with
leading local suppliers of shrimp and tilapia. We actively monitor aquaculture
quality and provide technological support to our suppliers, which allows us to
concentrate our resources and minimize risks. Through intensive monitoring and
control of the growth of fish fry, shrimp larvae, pond environment and feed
supply, we are able to assure the supply of quality aquaculture products and to
enhance product differentiation.
An established track record and brand name in the industry. Since our inception,
we have established a track record of supplying high quality aquatic products to
our overseas and local customers.
Good quality control. Safe and hygienic processing of aquatic products is of
paramount importance, as any failure to carry out the processing of harvested
fish correctly could render the product unsuitable for human consumption. We
adopt and implement stringent quality control measures and procedures throughout
our production process. Our processing plant in Hainan Province has obtained
HACCP and EU Code assignment.
Low labor cost. We are operating in a labor intensive industry. Due to the lower
labor costs in China, we are able to achieve lower operating cost advantage when
compared to our competitors in North America and elsewhere.
Local government support. The policy of Hainan Provincial Government is to
encourage increased investment in aquaculture and increased export of farmed
aquatic products. In December 2001, HQOF, our main operating subsidiary, was
recognized as a "Leading Agriculture Enterprise" by Hainan Provincial
53
Government, and in April 2001 HQOF was recognized as a New and High Tech
Enterprise of Hainan Province. These recognitions will be a great asset when we
participate in annual trade shows including the International Boston Seafood
Show and European Seafood Exposition.
Reduction of production cost due to the benefit of economy of scale. Expansion
of facilities and current sales volumes allows our company to benefit from
significant economies of scale. Our research and quality control staff have been
able to monitor an increased number of operations without the need of further
hiring. Large buyers are able to sole source instead of having to group supply
from various producers, allowing long term supply agreements.
Awards we have received. In December 2001, the Company was recognized as a
"Leading Agriculture Enterprise" by Hainan Provincial Government, and in April
2001, the Company was awarded the "New/high tech Enterprise of Hainan Province"
by Hainan Provincial Technology Authorities. In January 2003, the Company was
awarded the Industrial Enterprise of the Province. In 2002, The Company was
named a Leading Agriculture Enterprise for both Hainan Province and Wenchang.
Our board of directors believes that these accreditations reflect our
achievements and contribution to the development of the PRC aquaculture
industry. In March 2005, the Company was awarded the prestigious China
Excellence Award, for health product excellence and advancement of China
business practices, by the China Association of Entrepreneur Foreign Investment
(CAEFI), a branch of the China Ministry of Commerce of the People's Republic of
China.
Production certification. We also have received HACCP Certification and EU Code
assignment, which demonstrates our commitment to providing a variety of high
quality aquatic products under stringent hygiene standards.
International management expertise. We have successfully achieved a vertically
integrated operation that enables us to capitalize on opportunities in the
domestic and international fishery markets. Such achievement can be attributed
to our founders and senior management who have contributed their international
management expertise and technical know-how to our development.
Government Regulation
Aquaculture producers in the PRC have to comply with the environmental
protection laws and regulations promulgated by the national and local
governments of the PRC. Such rules and regulations include, among others,
Environmental Protection Law of the PRC, Ocean Environmental Protection Law of
the PRC, Regulations on Administration over Dumping of Wastes in the Ocean of
the PRC, Ocean Aquatic Industry Administration Regulation, Fishing License
Administration Regulation, Regulations on Administration of Hygiene Registration
of Exported Food Manufacturers and Regulations on Administration of Quality
Control of Food Processors.
54
Our company complies with various national, provincial and local environmental
protection laws and regulations. In addition to statutory and regulatory
compliance, we actively ensure the environmental sustainability of our
operations. Our costs of compliance with applicable environmental laws are
minimal, since the design of the plan includes a state-of-the-art settling and
filtration system which is inexpensive to maintain. Penalties would be levied
upon us if we fail to adhere to and maintain this standard. Such failure has not
occurred in the past, and we generally do not anticipate that it may occur in
the future, although no assurance can be given in this regard.
Patents and Trade Secrets
The Company presently has the following patents on its products.
* Patent Number 460000X340-2001 -- Shark cartilage is highly alkalescent;
it contains chondroitin sulfate and calcium and impacts the human body
positively in the following ways:
-- Increases efficiency of immune system, activates NK cells
associated with combating cancer (sharks are cancer free);
-- Reduces blood acidity improving
-- Blood pressure
-- Apoplexy
-- Heart disease
-- Fertility
-- Osteoporosis
* Patent Number 460000X131-2001 -- Shark cartilage also contains
glycosaminoglycan, Amino Acids, and collagen proteins which have been
specially processed for absorption into the skin and impacts the human
body positively in the following ways:
-- Increases subcutaneous water content
-- Reduces wrinkles
-- Slows the visible effects of aging
* Patent Number 460000X338-2001 -- Shark Liver oil is rich in squalene
and other nutrients, to which we add vitamins D and E, and impacts the
human body positively in the following ways:
-- Improves absorption of oxygen in the body which is
particularly important for the brain which consumes 23% of the
oxygen used in the body
-- Eliminates fatigue
-- Improves health
55
* Patent Number 460000X342-2001 -- Shark liver oil contains 100 times
more Alkoxy-Glyceryl (AKGS) than mothers milk. It is also rich in omega
3 oils recommended for nursing mothers, and impacts the human body
positively in the following ways:
-- Improves resistance to disease;
-- Improves phosphate for brain cell production.
Intellectual Property
We currently market our products under the label HQ, our own brand. We have
registered under serial number 78/534739 the "Tiloveya" trademark in the United
States for branding of zero-toxin Tilapia.
Government Regulation
Aquaculture producers in the PRC have to comply with the environmental
protection laws and regulations promulgated by the national and local
governments of the PRC. Such rules and regulations include, among others,
Environmental Protection Law of the PRC, Ocean Environmental Protection Law of
the PRC, Regulations on Administration over Dumping of Wastes in the Ocean of
the PRC, Ocean Aquatic Industry Administration Regulation, Fishing License
Administration Regulation, Regulations on Administration of Hygiene Registration
of Exported Food Manufacturers and Regulations on Administration of Quality
Control of Food Processors. See also a description of our compliance with the
applicable US Food and Drug Administration requirements relating to food safety
and sanitary hazards under "Business--Aquatic Products Processing Facility."
Our company complies with various national, provincial and local environmental
protection laws and regulations. In addition to statutory and regulatory
compliance, we actively ensure the environmental sustainability of our
operations. Our costs of compliance with applicable environmental laws are
minimal, since the design of the plant includes a state-of-the-art settling and
filtration system which is inexpensive to maintain. Penalties would be levied
upon us if we fail to adhere to and maintain this standard. Such failure has not
occurred in the past, and we generally do not anticipate that it may occur in
the future, although no assurance can be given in this regard.
Announcements regarding Future Growth
The Company has made several announcements regarding future growth which
supplement the overall understanding of the Company.
56
American River Nutrition technology transfer Annoucnement
HQ Sustainable Maritime Marketing Inc. (HQMM), has finalised an agreement with
American River Nutrition Inc. (ARN) providing HQSM with leading nutraceutical
technology for its health products and nutraceutically enriched aquaculture feed
products business. The Agreement also sets the stage for distribution of Health
products produced by HQSM in the United States as well as introducing ARN
nutraceuticals into China through HQSM's marketing network there.
ARN has cutting edge technology to develop unique nutraceuticals for aquaculture
feeds. These ingredients are directed at improving general health, growth, feed
conversion and meat quality of fish and shrimp. ARN is currently developing a
product that can boost the immune system of shrimp to ward off common viruses.
The impact of access to these new technologies will be a significant boost in
developing proprietary technology within the company and an expected significant
boost in sales and profitability. Furthermore, the agreement will begin the
process of selling HQSM health products in the United States as well as the sale
of ARN products through HQSM's distribution network in China. The relevant
health products markets in both countries represent a multi-billion dollar
business and is expected to lead to the development and sale of many more such
products for these markets. Currently HQSM produces and sells shark liver oil
and shark cartilage products and sells these through a unique direct sales and
retail sales system in China. Currently ARN produces and sells its
patent-protected DeltaGold(R) vitamin E, primarily in the USA and Canada.
ARN will work with HQMM to develop and validate relevant technologies and
coordinate the application of nutraceutical feed ingredients in feed products
for Tilapia and Shrimp particularly developing Nutraceutical feed additives in
HQSM's Nutraceutical plant that are health oriented and environmentally sound.
Planned Feedmill Construction Announcement
The new plant represents an investment of USD 3.8 million producing 72,000 tons
of feed annually with a total projected sales value of USD 20 million. The feed
formulations will be prepared with the benefit of the latest American
technologies to assure a minimum of toxicity (for example the elimination of
fishmeal) and an optimum of health benefits for consumers. New floating feed
formulations will reduce waste in the aquaculture reservoirs thus reducing the
requirement for chemicals to stabilise reservoir health. The plant feasibility
report approved by HQSM's Board, shows strong profitability especially when
considered as an important component of the Group's vertically integrated
strategy.
57
Completed Nutraceutical Plant Acquisition Announcement
The acquisition was for $20 million and has been paid with shares and a note
convertible into shares. Because this was a related-party transaction, an
appraisal by Vigers was commissioned and the purchase price is 15% below the
evaluated value. The independent directors of HQ and its auditors approved this
method.
The acquisition of Jiahua provides HQ with the capacity to manufacture
nutraceuticals to enrich feed formulations for tilapia and shrimp farmed in the
Hainan area. These ingredients are directed at improving general health, growth,
feed conversion and meat quality of fish and shrimp. Such products boost the
immune system of shrimp to ward off common viruses and deliver various
functional food nutrients to humans through the fish and shrimp they eat. HQ is
working with leading technology providers throughout the world, in particular in
the United States, to deliver these new nutraceutical additives to the fish and
shrimp farming industry.
Jiahua is also engaged in the production and sales of marine bio-products and
healthcare products in the PRC. It currently holds two subsidiaries, a marine
bio-products factory and the Marine Organism Research Institute. The marine
bio-products factory is located in Wenchang City of Hainan Province, with a
ground floor area of 16,667 square meters and a construction area of
approximately 8,000 square meters. It operates two production lines: the
powder-product line and the oil-product line. The bio-products factory has
obtained HACCP certification from the CIQ (China Entry-Exit Inspection and
Quarantine Bureau). Jiahua currently sells six healthcare products under the
brand name "Jiahua." Sales in 2003 were over $7 million and after-tax net profit
was $2.7 million. Sales in 2004 presently outpace those of 2003.
Jiahua's second subsidiary, the Marine Organism Research Institute, is headed by
a group of experts specializing in the research and development of products
derived from marine organisms in China. Clinical trials and laboratory testing
on Jiahua's various healthcare products have resulted in National Certification.
These products, currently sold throughout China, are naturally derived from
ocean-harvested byproducts and are winners of Science and Technology Progress
Awards in China. Jiahua also has established a long-term relationship with the
Qingdao University of Oceanography for production-research and training.
Jiahua's production lines are ideally suited for the manufacture of
nutraceutical components. The specific gravity molecular separator and accessory
equipment in the plant are required for the manufacture of nutraceutical
products that can serve as feed additives in the production of feed, including
tilapia and shrimp feed
58
Amalgamated resources Loan Guarantees Announcement
On October 17, 2005, we executed a financial partnership agreement, dated
October 3, 2005, with Amalgamated Resources Holdings Inc. (Alps), a Florida
corporation, for loan guarantees of up to an aggregate of USD 70 million. Alps
estimates the guarantees when fully deployed over the next five years, will
translate into an 8 fold increase in market cap, a 7 fold increase in sales and
7 fold earnings per share increase.
The first round of funding of USD 10 million is now expected for the end of
October. No guarantees can be given that HQ will exercise its right to this
first round of funding. Pursuant to the terms and conditions of the financial
partnership agreement, we are obligated to appoint two directors, designated by
Alps, to our Board of Directors and Alps will receive, as collateral, a block of
control shares from our founders.
The funds are intended to be used to execute the roadmap announced earlier this
year by HQSM Chairman Lillian Wang. The first step will be the expansion of our
distribution marketing and branding initiatives in the United States. This will
coincide with the planned documentary intended to be broadcast this fall on
CNBC. No assurances can be given that the funds will be used precisely for this
purpose or that such funds will produce increased revenues or profits.
Our Facilities
Our products processing plant is located at Chinglan Town, Wenchang City, 70
miles away from Haikou City in the PRC. This property is under a long-term lease
with a department of local government. We believe that this facility is
adequately covered by insurance.
59
Our Employees
Through Hainan Quebec, our principal operating subsidiary, we currently employ
approximately 434 employees, all of whom are full-time employees. They are
located predominantly in Haikou, PRC, with the rest of them located in WenChang,
PRC. We have employment contracts with many of our employees. None of our
employees are covered by a collective bargaining agreement, and we believe our
employee relations are good.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Some of the information in this prospectus contains forward-looking statements
that involve substantial risks and uncertainties. You can identify these
statements by forward-looking words such as "may," "will," "expect,"
"anticipate," "believe," "estimate" and "continue," or similar words. You should
read statements that contain these words carefully because they:
o discuss our future expectations;
o contain projections of our future results of operations or of our
financial condition; and
o state other "forward-looking" information.
We believe it is important to communicate our expectations. However, there may
be events in the future that we are not able to accurately predict or over which
we have no control. Our actual results and the timing of certain events could
differ materially from those anticipated in these forward-looking statements as
a result of certain factors, including those set forth under "Risk Factors,"
"Business" and elsewhere in this prospectus. See "Risk Factors."
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
The Company prepares its 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. 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.
60
Income Taxes
- ------------
Taxes are calculated in accordance with taxation principles currently effective
in the PRC. 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.
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 the Company to significant
concentrations of credit risk consist primarily of trade accounts receivable.
The Company performs ongoing credit evaluations with respect to the financial
condition of its creditors, but does not require collateral. In order to
determine the value of the Company's accounts receivable, the Company records a
provision for doubtful accounts to cover probable credit losses. Management
reviews and adjusts this allowance periodically based on historical experience
and its evaluation of the collectibility of outstanding accounts receivable.
Results of Operations - Year Ended December 31, 2005 Compared to Year Ended
December 31, 2004
Segments
- --------
Manufacturing and selling of health and bio-product
- ---------------------------------------------------
One of our subsidiaries, Jiahua Marine (which was acquired in August 2004) was
engaged in manufacturing and selling of health and bio-products. During the year
ended December 31, 2005 and twelve months ended December 31, 2004, Jiahua Marine
contributed sales of $9,772,762 and $3,242,288 to the Group respectively. The
gross profit ratio for this segment was 85% and 83% for 12 months ended December
31, 2005 and 2004 respectively, and the major expense for this segment was
61
advertising, corresponding to about 37% and 52% of revenue for the year ended
December 31, 2005 and twelve months ended December 31, 2004 respectively. Net
income contributed by this segment was $4,116,399 and $1,005,557 for the year
ended December 31, 2005 and twelve months ended December 31, 2004 respectively.
The improvement of 2005 compared to 2004 was essentially due to the fact that in
2004, Jiahua Marine was part of our Group for 5 months only, while a full year
in 2005.
Manufacturing and selling of aquatic products
- ---------------------------------------------
The other principal activity of the Group was the manufacturing and selling of
aquatic products. The revenue contributed by this segment was $17,780,268 and
$17,949,204 for the year ended December 31, 2005 and twelve months ended
December 31, 2004, respectively. The gross profit ratio of this segment was at
18% and 13% for the year ended December 31, 2005 and twelve months ended
December 31, 2004, respectively. This segment contributed $1,003,857 and
$1,121,208 to net income for the year ended December 31, 2005 and twelve months
ended December 31, 2004, respectively. As the production temporarily ceased in
the first half of 2004 because of major renovations at the factory, this segment
actually suffered from a major operational loss in 2004. The rise in profit in
2004 was mainly caused by a substantial recovery of bad debt of $1,057,130
during that period. Without considering such recovery , the improvement in the
operating performance of that segment in 2005 was significant compared to 2004.
Operations
- ----------
Sales. For the year ended December 31, 2005 revenue increased by $6,361,538 or
30% to $27,553,030 from $21,191,492 for the twelve months ended December 31,
2004. The increase resulted from a better performance by the health and
bio-product segment, since its operations were acquired in August 2004, showing
five months' activities in our Group from that segment in 2004 compared to
twelve months' result for 2005. That segment saw its sales increase by $6.5
million compared to the corresponding period of 2004. The revenue from the
aquatic products segment slightly decreased by $0.2 million compared to the
corresponding period of 2004, as there was an increase in unit selling price of
about 16% during the year. That resulted in a higher profit margin for aquatic
products in 2005 than 2004.
Cost of sales slightly decreased by $80,081 to $16,002,911 from $16,082,992 for
the year ended December 31, 2005, as compared to the twelve months ended
December 31, 2004. The slight decrease in cost of sales, while a 30% increase in
revenue, was due to a combination of lower costs of sales in the aquatic product
segment with higher gross margins, and higher cost of sales in the health and
bio-product segment due to higher volume related to a full year's activity in
2005 compared to 5 months in 2004.
62
Both segments improved their gross profit contribution in 2005. The gross profit
ratio of the aquatic product segment improved from 13% to 18% for the year ended
December 31, 2005, compared to the twelve months ended December 31, 2004. The
gross profit of the health and bio-product segment increased significantly due
to a full year's activity in 2005 as compared to 5 months in 2004.
Selling and distribution expenses decreased by $82,472 or 21% to $301,630 for
the year ended December 31, 2005, as compared to the twelve months ended
December 31, 2004. The decrease resulted from the Company's decision in 2005 to
cancel its sales commission policy from the financial year of 2005.
Advertising expenses increased by $1,948,119 from $1,674,988 to $3,623,107 for
the year ended December 31, 2005 as compared to the twelve months ended December
31, 2004. The primary factor responsible for that increase was that Jiahua
Marine entered our Group in August 2004, showing 5 months of activities in 2004,
while in 2005, that segment was part of our Group for a full 12 months.
Furthermore, significant advertising expenditures for the promotion of our
bio-products to achieve customer recognition is consistent with industry
practices.
General and administrative expenses decreased by $610,160 or 20% to $2,421,781
as compared to the corresponding period of the prior year. Non-recurring costs
of 2004 related to our Company's going public in that year justify the major
portion of the decrease in 2005.
Depreciation increased by $346,175 to $961,295 as compared to the corresponding
period to the previous year. The increase in 2005 is due to a full year activity
of our bio-products segment in 2005 as Jiahua Marine integrated our Group in
August 2004 and also to the effect in 2005 of a full year's depreciation of
improvements and renovations that took place in the first half of 2004 in the
aquatic product segment.
Profit from operations, before considering the bad debt recovery for both
periods, improved significantly from a loss of $597,651 in 2004 to a profit of
$4,242,306 in 2005. That improvement in 2005 is mostly due to higher volume of
sales with higher gross profit from the bio-products segment and improved gross
profit ratio from the aquatic product segment compared to those of 2004.
Finance costs decreased to $360,782 from $406,840 for the year ended December
31, 2005 as compared to the twelve months ended December 31, 2004, an 11% or
$46,058 decrease. The decrease was attributable mostly to the reduction in
interest on debentures and promissory notes in 2005 since they were reimbursed
in the current year. Those debentures and promissory notes were the result of
the acquisition in 2004 of Jiahua Marine.
Other expenses increased from $282,229 for the twelve months ended December 31,
2004 to $327,059 for the year ended December 31, 2005, a 16% or $44,830
increase. Other expenses mainly included insurance for vessels, salaries for
sailors and loss on disposal of property, plant and equipment during the year.
The main reason for the increase was an incurred loss on disposal of motor
vehicles in 2005.
63
Profit before income taxes increased to $3,895,092 for the year ending December
31, 2005, from a loss of $229,590 for the twelve months ended December 31, 2004.
That significant improvement was due to higher sales volume and related margins
in 2005 from the bio-product segment, and about similar volumes with higher
margins from the aquatic products segment.
Current income taxes increased from zero for the twelve months ended December
31, 2004 to $333,092 for the year ended December 31, 2005. Such increase is due
to the fact that Jiahua Marine and HQOF earned taxable incomes for the year
ended December 31, 2005, while the tax holiday for Jiahua Marine terminated in
2004 and HQOF experienced a tax loss for the twelve months ended December 31,
2004.
Deferred income tax increased by $91,358 from $216,544 to $307,902 for the year
ended December 31, 2005, as compared to twelve months ended December 31, 2004.
The increase was due to the elimination of temporary differences arising from
the recovery of provision for doubtful accounts recorded in the last quarter of
2005.
Minority interest decreased from $62,191 in 2004 to zero in 2005. That change
resulted from our Company's acquisition of all the minority interests in HQOF in
August 2004, therefore making HQOF a wholly-owned subsidiary from that date.
The net income attributable to shareholders was $3,254,098 for the year ended
December 31, 2005, compared with a net loss attributable to shareholders of
$383,943 for the twelve months ended December 31, 2004. That significant
improvement was the result of higher sales and related margins in the
bio-products segment in 2005 compared to 2004 as we acquired Jiahua Marine in
August 2004, and to higher profitability experienced in 2005 from the aquatic
product segment.
65
Results of Operations - Three Months Ended March 31, 2006 as Compared to Three
Months Ended March 31, 2005
One of our subsidiaries, Jiahua Marine is engaged in the manufacturing and
selling of health and bio-products. During the three months ended March 31, 2006
and 2005, Jiahua Marine realized sales of $2,211,842 and $1,924,391
respectively. The gross profit ratio for this segment stood at 85% and 84% for
the three months ended March 31, 2006 and 2005, and the major expense was
advertising, corresponding to 50% and 52% of revenues for the three months ended
March 31, 2006 and 2005 respectively. The net income contributed by this segment
was $559,801 and $404,766 for the three months ended March 31, 2006 and 2005
respectively., mostly attributable to an increase in volume.
The other principal activity in our Group is the manufacturing and selling of
aquatic products. The revenue contributed by this segment was $4,673,498 in the
first quarter of 2006 compared to $1,092,495 for the corresponding quarter of
2005. The related gross profit ratio of this segment was 15% in 2006 compared to
7% for the three months ended March 31, 2005. This segment contributed $8,033 to
net income in the first quarter of 2006 compared to a net loss of $395,969 for
the corresponding period of 2005. The increased activity of this segment in
2006, together with increased margins resulted in the improved profitability in
the first quarter of 2006 compared to the same period of 2005.
For the three months ended March 31, 2006 revenue increased by $3,868,454 or
128% to $6,885,340. This improvement in sales mainly resulted from a better
performance of the aquatic product segment in 2006. The sales of that segment
increased by $3.6 million in the first quarter of 2006 compared to 2005 while
the balance of the increase came from the health and bio-products segment. In
the first quarter of 2005, the Island of Hainan, where the Company holds its
processing plants, experienced severe weather conditions which affected the
performance of the aquatic product segment materially.
Cost of sales increased by $3,054,289 or 2.4 times to $4,353,455 from $1,299,166
for the three months ended March 31, 2006, as compared to the corresponding
period of the prior year. Approximately 99% of the increase was due to the
increased activities in the aquatic product segment as the turnover of this
segment increased by $3.6 million . The overall gross profit ratio decreased
from 57% in the first quarter of 2005 to 37% for the current quarter of 2006.
That decrease in the gross profit ratio is due to the mix of increased activity
from the aquatic product segment in 2006 (with less gross margin) and about
similar level of activity and margin in the health and bio-products segment. The
increased activity in the aquatic product segment is the main contributing
factor in the increase of the gross profit for the current quarter.
Selling and distribution expenses increased by $28,560 or 70% to $69,168 for the
three months ended March 31, 2006, as compared to the corresponding period of
the prior year. The increase was the result of higher turnover in the current
quarter.
66
Advertising expenses increased by $111,916 or 11% from $1,000,819 as compared to
the corresponding period of prior year. The primary factor responsible for the
increase in the current quarter is that Jiahua Marine made more advertisements
to attract customers in order to increase sales; the turnover of this particular
segment increased by 15% in the current quarter compared to the same period of
2005.
General and administrative expenses increased by $376,529 or 60% to $1,003,470
as compared to the corresponding period of the previous year. The increase
results mainly from traveling, marketing and investors relations' expenses
incurred in the first quarter of 2006 compared to 2005.
Depreciation decreased by $5,824 or 2% to $234,448 as compared to the
corresponding period of prior year. The decrease was caused by several assets
being fully depreciated, thus requiring less depreciation in 2006 compared to
the corresponding period of the 2005.
Doubtful accounts contributed an amount of $145,678 of additional expenses in
the first quarter of 2006 from the corresponding quarter of 2005. That was the
result of providing conservatively for the slower paying customers in
application of our Group's accounting policy.
Financing costs increased to $605,877 from $91,708 for the three months ended
March 31, 2006 as compared to the corresponding period of the previous year, an
increase of $514,169. The increase was due to a combination of additional
financing costs arising from the notes of $ 5,250,000 issued during the current
quarter, and a reduction in interest costs on bank loans reimbursed in the
period from April 1, 2005 to March 31, 2006. In accordance with US GAAP's, the
company recognized the financing costs related to the future conversion of
warrants attributed in the first quarter of 2006 to the new investors in the
Company; that financing costs amounted to approximately $445,000.
Other expenses decreased from $67,126 for the three months ended March 31, 2005
to $36,167 for the three months ended March 31, 2006, a 46% or $30,959 decrease.
The main reason of the decrease was improvement in cost control by management.
Loss before income taxes increased to $713,910 in the first quarter of 2006 from
$388,106 in the corresponding quarter of prior year. The increased activity and
gross profit recognized in the first quarter of 2006 was affected mainly by
increased financing costs ($514,000) and bad debts ($145,000) experienced in the
current quarter.
Current income taxes increased from $32,819 to $83,385 in the current period. In
the first uarter of 2006, the aquatic product segment was profitable and taxable
at a rate of 15% while it suffered a loss in the corresponding quarter of 2005.
67
Deferred income tax increased by $17,842 from $17,043 to $34,885 for the three
months ended March 31, 2006. The increase was due to the income tax rate of the
aquatic product segment which went from 7.5% to 15.0% after expiration of the
tax holiday period.
The net loss attributable to shareholders increased from $437,968 to $832,180
for the three months ended March 31, 2006. The deterioration, although
experiencing increased activity and gross profit in both our segments in the
2006 quarter compared to 2005, was affected by increased financing costs and bad
debts, as described above.
LIQUIDITY AND CAPITAL RESOURCES
The Group has in recent years financed its operations primarily with operating
revenues. The Group anticipates that revenues from its operations will be
sufficient to satisfy the Group's cash requirements for operations during the
foreseeable future, except to the extent that increasing orders and sales may
require temporary borrowings to finance such expansion and related costs of
employee compensation and inventory build-up. No assurance can be given,
however, that additional debt or equity financing will not be required or will
be available if required.
The current ratio increased from 1.2 times ($10,686,199/$9,214,238) at December
31, 2004 to 2.3 times ($14,989,554/$6,555,210) at December 31, 2005. The
increase was mainly due to the Group's improved operating results in 2005 and
repayment of approximately $2.7 million short-term loan during the same period.
Management believes that, from time to time, we may attempt to raise financing
through some combination of commercial bank borrowings or the private or public
sale of equity or debt securities, in an effort to ensure that we have access to
sufficient funds to meet our needs. However, future equity or debt financings
may not be available to us at all, or, if available, may not be on favorable
terms. We cannot assure you that these efforts, together with items described
above, will be sufficient to fund our growth, or that external funding will be
available to us at favorable interest rates or at all. 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.
68
Description of Properties
We currently lease corporate premises approximately 4170 square feet from
Doncaster Investments NV, Inc. for a five year period commencing November 22nd
2005 . The space is leased for $3,500 per month.. The property is in good
condition and sufficient to meet our needs at this time. We do not plan to
obtain additional space in the foreseeable future.
In addition to the above leased premises the company's fixed assets can be
summarized as follows;
Buildings and leasehold improvements 2,884,010
Plant and Machinery 8,336,665
Motor vehicles 55,993
Office equipment and furnishings 135,552
----------
TOTAL 11,412,220
Less: accumulated depreciation 3,411,717
Property and equipment are carried at cost. Maintenance, repairs and renewals
are expensed as incurred. Depreciation of property and equipment is provided for
over their estimated useful lives, which range from three to seven years, using
the straight-lined method.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There were no certain transactions or have there been any proposed transactions
during the last two years to which we were a party, or proposed to be a party,
in which certain persons had a direct or indirect material interest.
69
EXECUTIVE COMPENSATION
The following table sets forth for the years ended December 31, 2005 and from
March 17, 2004 (the date of the merger)through December 31, 2004 the
compensation awarded to, paid to, or earned by, our Chief Executive Officer and
our three other most highly compensated executive officers whose total
compensation during the last fiscal year exceeded $100,000. No other officer had
compensation of $100,000 or more for the years ended December 31, 2005 and from
March 17, 2004 (the date of the merger)through December 31, 2004.
Long Term Compensation
---------------------------------------------------------------------------------------------------------------
Annual Compensation Awards Payouts
---------------------------------------------------------------------------------------------------------------
Name and Securities All Other
Principal Other Annual Restricted Stock Underlying LTIP Compen-
Position Year Salary Bonus Compensation Award (s) Options/SARs (#) Payouts sation
- ------------------------------------------------------------------------------------------------------------------------------------
Norbert Sporns 2004 $112,500 $37,500 -- -- 500,000 -- --
Chief Executive options to purchase
Officer shares of
common stock
2005 $165,000 $55,000 -- -- -- -- --
Lillian Wang Li 2004 $112,500 $75,000 -- -- 500,000 -- --
Chairman of options to purchase
the Board of shares of
Directors common stock
2005 $165,000 $110,000 -- -- -- -- --
Harry Wang Hua 2004 $ 75,000 $ 75,000 -- -- 500,000 -- --
Chief Operating options to purchase
Officer shares of
common stock
2005 $110,000 $110,000 -- -- -- -- --
Jean-Pierre 2004 $ 41,700 $ 8,300 -- -- 200,000 -- --
Dallaire options to purchase
Principal shares of
Financial common stock (1)
Officer/
Principal 2005 $ 110,000 $ 27,500 -- -- -- -- --
Accounting
Officer
(1) Mr. Dallaire's options vest as follows: 100,000 vested 2004, 33,333 vested
in 2005, 33,333 will vest in year end 2006 and the remainder at year end 2007.
Unless otherwise restricted by the certificate of incorporation, the members of
board of directors have the authority to fix the compensation of directors. The
directors may be paid their expenses, if any, of attendance at each meeting of
the board of directors and may be paid a fixed sum for attendance at each
meeting of the board of directors or a stated salary as director. No such
payment shall preclude any director from serving the corporation in any other
capacity and receiving compensation thereafter. Members of special or standing
committees may be allowed, like, for example, compensation for attending
committee meetings.
70
Options/SAR Grants in Last Fiscal Year
- --------------------------------------
None.
Audit Committee Financial Expert
- --------------------------------
As stated above, we recently appointed three independent non-executive directors
to our board of directors. We consider one of our independent directors, Mr.
Jacques Vallee, to be an audit committee financial expert within the meaning of
the applicable Securities and Exchange Commission rules and regulations.
Employment Agreements
- ---------------------
In April 2004, we entered into employment agreements with our top executive
officers to secure their commitment to continued service to our company.
Lillian Wang Li's employment agreement has a term of five (5) years, commencing
on April 1, 2004, and provides for a base salary of $150,000 for the first year
of the term and an annual increase of 10%. The agreement also provides Ms. Wang
with an annual bonus of at least $100,000, and this amount may be increased
subject to the decision of our board of directors. The agreement also provides
for the grant of options to purchase shares of our common stock. The options
include an option to purchase an aggregate of twenty percent (20%) of the then
fully diluted shares of our common voting stock made available under the stock
option plan, and, at the beginning of each calendar quarter, an option to
purchase an aggregate of five percent (5%) of the then fully diluted shares of
our company's common voting stock made available under the stock option plan.
The options granted under the employment agreement will have an exercise price
of the fair market value per share of our common voting stock on the date the
option is granted. We can terminate Ms. Wang's employment with cause, or without
cause upon at least ninety written notice. In the event Ms. Wang's employment is
terminated without cause, she will be eligible to receive (1) monthly payments
at her then applicable monthly base salary for the rest of her term from the
date of termination of her employment; (2) an annual bonus of $50,000 for the
rest of her term from the date of termination of her employment; (3) the value
of any earned, but unused vacation days; (4) continued coverage under our
company's benefits plan; and (5) severance in an amount equal to her annual base
salary in effect immediately prior to her last date of employment.
Harry Wang's employment agreement has a term of five (5) years, commencing on
April 1, 2004, and provides for a base salary of $100,000 for the first year of
the term and an annual increase of 10%. The agreement also provides Mr. Wang
with an annual bonus of at least $100,000, and this amount may be increased
subject to the decision of our board of directors. The agreement also provides
for the grant of options to purchase shares of our common stock. The options
include an option to purchase an aggregate of twenty percent (20%) of the then
fully diluted shares of our common voting stock made available under the stock
option plan, and, at the beginning of each calendar quarter, an option to
purchase an aggregate of five percent (5%) of the then fully diluted shares of
our company's common voting stock made available under the stock option plan.
The options granted under the employment agreement will have an exercise price
71
of the fair market value per share of our common voting stock on the date the
option is granted. We can terminate Mr. Wang's employment with cause, or without
cause upon at least ninety written notice. In the event Mr. Wang's employment is
terminated without cause, he will be eligible to receive (1) monthly payments at
his then applicable monthly base salary for the rest of his term from the date
of termination of his employment; (2) an annual bonus of $50,000 for the rest of
his term from the date of termination of his employment; (3) the value of any
earned, but unused vacation days; (4) continued coverage under our company's
benefits plan; and (5) severance in an amount equal to his annual base salary in
effect immediately prior to his last date of employment.
Norbert Sporns' employment agreement has a term of five (5) years, commencing on
April 1, 2004, and provides for a base salary of $150,000 for the first year of
the term and an annual increase of 10%. The agreement also provides Mr. Sporns
with an annual bonus of at least $50,000, and this amount may be increased
subject to the decision of our board of directors. The agreement also provides
for the grant of options to purchase shares of our common stock. The options
include an option to purchase an aggregate of twenty percent (20%) of the then
fully diluted shares of our common voting stock made available under the stock
option plan, and, at the beginning of each calendar quarter, an option to
purchase an aggregate of five percent (5%) of the then fully diluted shares of
our company's common voting stock made available under the stock option plan.
The options granted under the employment agreement will have an exercise price
of the fair market value per share of our common voting stock on the date the
option is granted. We can terminate Mr. Sporns' employment with cause, or
without cause upon at least ninety written notice. In the event Mr. Sporns'
employment is terminated without cause, he will be eligible to receive (1)
monthly payments at his then applicable monthly base salary for the rest of his
term from the date of termination of his employment; (2) an annual bonus of
$50,000 for the rest of his term from the date of termination of his employment;
(3) the value of any earned, but unused vacation days; (4) continued coverage
under our company's benefits plan; and (5) severance in an amount equal to his
annual base salary in effect immediately prior to his last date of employment.
In September 2004, we entered into employment with our Chief Financial Officer
to secure its commitment to continued service to our company. Jean-Pierre
Dallaire's employment agreement has a term of five (5) years, commencing on
September 1, 2004, and provides for a base salary of $100,000 for the first year
of the term and an annual increase of 10%. The agreement also provides Mr.
Dallaire with an annual bonus of at least $25,000, and this amount may be
increased subject to the decision of our board of directors. The agreement also
provides for the grant of options to purchase shares of our common stock. The
options include an option to purchase an aggregate of twenty percent (10%) of
the then fully diluted shares of our common voting stock made available under
the stock option plan, and, at the beginning of each calendar quarter, an option
to purchase an aggregate of five percent (5%) of the then fully diluted shares
of our company's common voting stock made available under the stock option plan.
The options granted under the employment agreement will have an exercise price
of the fair market value per share of our common voting stock on the date the
option is granted. We can terminate Mr. Dallaire's employment with cause, or
72
without cause upon at least ninety written notice. In the event Mr. Dallaire's
employment is terminated without cause, he will be eligible to receive (1)
monthly payments at his then applicable monthly base salary for the rest of his
term from the date of termination of his employment; (2) an annual bonus of
$25,000 for the rest of his term from the date of termination of his employment;
(3) the value of any earned, but unused vacation days; (4) continued coverage
under our company's benefits plan; and (5) severance in an amount equal to his
annual base salary in effect immediately prior to his last date of employment.
Stock Incentive Plan
On April 14, 2004, our board of directors formally adopted the Process
Equipment, Inc. 2004 Stock Incentive Plan (the "Plan"). The holders of a
majority of our outstanding common stock have given their consent to approve the
adoption of this Plan. The purpose of the Plan is to increase our ability to
attract and retain talented employees, consultants and directors and thereby
enhance our growth and profitability. Under the Plan, options to purchase common
stock, including "incentive stock options", within the meaning of Section 422 of
the United States Internal Revenue Code of 1986, as amended, restricted stock
awards, non-qualified stock options and other equity-based compensation, may be
awarded to directors, officers, employees, consultants or other agents.
The board of directors or a committee of independent directors appointed by the
board of directors administers the Plan and selects those employees and others
who are eligible to participate. The total number of stock reserved and
available for grant and issuance pursuant to the Plan will be the lesser of (i)
8% of common stock outstanding (determined on a fully diluted basis exclusive of
common stock issued or issuable pursuant to options and other awards granted
under the Plan) or (ii) 8,000,000 shares of common stock.
As of the date of this prospectus, no options for shares of our common stock
have been granted under the Plan. However, our board of directors has authorized
the grants of options exercisable for an aggregate of 5,000,000 shares pursuant
to the Plan.
73
Financial Statements
The financial statements required by this Item, the accompanying notes thereto
and the reports of independent accountants are included as part of this Form
SB-2 immediately following the signature page.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
We have had no disagreements on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedures with
any of our accountants for the year ended December 31, 2004 or any interim
period. We have not had any other changes in nor have we had any disagreements,
whether or not resolved, with our accountants on accounting and financial
disclosures during our two recent fiscal years or any later interim period.
ADDITIONAL INFORMATION
We have filed with the Commission a registration statement on Form SB-2 under
the Securities Act with respect to the common stock offered hereby. This
prospectus constitutes the prospectus of HQ Sustainable Maritime Industries,
Inc., filed as part of the registration statement, and it does not contain all
of the information in the registration statement, as certain portions have been
omitted in accordance with the rules and regulations of the Securities and
Exchange Commission. For further information with respect to our company and
this offering, we refer you to the registration statement and exhibits filed as
part of it. You may inspect the registration statement, including the exhibits
thereto, without charge at the Public Reference Room of the Commission at 100 F.
Street N.E., Washington, D.C. 20549. You may obtain copies of all or any portion
of the registration statement from the Public Reference Room of the Commission
at 100 F. Street N.E., Washington, D.C. 20549, upon payment of the prescribed
fees. You may obtain information on the operation of the Public Reference Room
by calling the Commission at 1-800-SEC-0330. You may also access such material
electronically by means of the Commissions home page on the Internet at
http://www.sec.gov. Descriptions contained in this prospectus as to the contents
of a contract or other document filed as an exhibit to the registration
statement are not necessarily complete and each such description is qualified by
reference to such contract or document.
74
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. Indemnification Of Officers And Directors.
As permitted by the General Corporation Law of Delaware, our Bylaws provide that
we will indemnify our officers, directors, employees and agents. This includes
indemnification against expenses incurred by a director of HQSM in defending a
civil or criminal action, suit or proceeding by reason of the fact that he is or
was a director of HQSM (or was serving at HQSM's request as a director or
officer of another corporation). Such expenses shall be paid by HQSM in advance
of the final disposition of such action, suit or proceeding upon receipt of an
undertaking by or on behalf of such director to repay such amount if it shall
ultimately be determined that he is not entitled to be indemnified by HQSM as
authorized by relevant sections of the General Corporation Law of Delaware.
The indemnification and advances of expenses provided in our Bylaws shall not be
deemed exclusive of any other rights provided by any agreement, vote of
stockholders or disinterested directors or otherwise.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers or persons controlling our company pursuant
to the foregoing provisions, we have been informed that, in the opinion of the
Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Securities Act and is therefore unenforceable.
ITEM 25. Other Expenses Of Issuance And Distribution.
Expenses payable in connection with the registration and distribution of the
securities being registered hereunder, all of which will be borne by the
Registrant, are as follows:
Securities and Exchange Commission Fee
Accountants' Fees and Expenses
Legal Fees and Expenses
Blue Sky Fees and Expenses
Printing and Mailing Costs
Miscellaneous
TOTAL
*to be provided in the final prospectus
75
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005
INDEX TO FINANCIAL STATEMENTS
Independent Auditors' Report F-2
Consolidated Balance Sheets as of December 31, 2005 and 2004 F-3 - F-4
Consolidated Statements of Income for the years ended December 31,
2005 and 2004 F-5
Consolidated Statements of Changes in Shareholders' Equity for the
years ended December 31, 2005 and 2004 F-6
Consolidated Statement of Cash Flows for the years ended December 31,
2005 and 2004 F-7
Notes to Consolidated Financial Statements F-8 - F-23
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
HQ Sustainable Maritime Industries, Inc. and Subsidiaries in State of Delaware
We have audited the accompanying consolidated balance sheets of HQ Sustainable
Maritime Industries, Inc. and Subsidiaries as of December 31, 2005 and 2004, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with The Public Company Accounting
Oversight Board Standards (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2005 and 2004, and the results of its operations and its cash flows
for the years ended December 31, 2005 and 2004, in conformity with accounting
principles generally accepted in the United States of America.
/s/ Rotenberg & Co., LLP
Rotenberg & Co., LLP
Certified Public Accountants
Rochester, New York
March 23, 2006
F-2
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2005 AND 2004
ASSETS
December 31, 2005 December 31, 2004
----------------- -----------------
CURRENT ASSETS
Cash and cash equivalents $ 5,140,159 $ 4,551,505
Trade receivables, net of provisions 8,423,127 5,406,172
Inventories 557,464 228,564
Prepayments 131,864 1,932
Due from related parties, net of provisions 526,195 388,506
Advances to employees 127,231 27,918
Tax recoverable 83,514 81,602
----------------- -----------------
TOTAL CURRENT ASSETS 14,989,554 10,686,199
----------------- -----------------
OTHER ASSETS
Deferred taxes 926,623 1,209,790
Deferred loan costs 500,000 --
----------------- -----------------
1,426,623 1,209,790
PROPERTY, PLANT AND EQUIPMENT,
NET 8,000,503 9,029,673
----------------- -----------------
TOTAL ASSETS $ 24,416,680 $ 20,925,662
================= =================
The accompanying notes are in integral part of the consolidated financial
statements
F-3
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2005 AND 2004
LIABILITIES AND SHAREHOLDERS' EQUITY
December 31, 2005 December 31, 2004
----------------- -----------------
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 2,617,446 $ 4,204,630
Bank loans 1,726,264 4,457,831
Taxes payable 73,245 --
Due to related parties 787,716 86,994
Due to directors 1,350,539 209,361
Convertible notes -- 255,422
----------------- -----------------
TOTAL CURRENT LIABILITIES 6,555,210 9,214,238
----------------- -----------------
OTHER LIABILITIES
Promissory note
-- 100,000
----------------- -----------------
TOTAL LIABILITIES 6,555,210 9,314,238
SHAREHOLDERS' EQUITY
Preferred stock 100 --
Common stock 116,105 95,055
Additional paid-in capital 15,574,752 13,099,205
Accumulated Other Comprehensive Income 499,251 --
Retained Earnings (Deficit) (314,583) (2,729,152)
Appropriation of Retained Earnings (Reserves) 1,985,845 1,146,316
----------------- -----------------
TOTAL SHAREHOLDERS' EQUITY 17,861,470 11,611,424
----------------- -----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 24,416,680 $ 20,925,662
================= =================
The accompanying notes are in integral part of the consolidated financial
statements
F-4
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
------------- -------------
SALES $ 27,553,030 $ 21,191,492
COST OF SALES 16,002,911 16,082,992
------------- -------------
GROSS PROFIT 11,550,119 5,108,500
SELLING AND DISTRIBUTION EXPENSES 301,630 384,102
ADVERTISING 3,623,107 1,674,988
GENERAL AND ADMINISTRATIVE EXPENSES 2,421,781 3,031,941
DEPRECIATION 961,295 615,120
PROVISION FOR DOUBTFUL ACCOUNTS (RECOVERY) (340,627) (1,057,130)
------------- -------------
INCOME FROM CONTINUING OPERATIONS 4,582,933 459,479
FINANCE COSTS 360,782 406,840
OTHER EXPENSES 327,059 282,229
------------- -------------
INCOME/(LOSS) BEFORE INCOME TAXES 3,895,092 (229,590)
INCOME TAXES
CURRENT 333,092 --
DEFERRED 307,902 216,544
------------- -------------
INCOME/(LOSS) BEFORE MINORITY INTEREST 3,254,098 (446,134)
MINORITY INTEREST -- 62,191
------------- -------------
INCOME/(LOSS) ATTRIBUTABLE TO SHAREHOLDERS $ 3,254,098 $ (383,943)
============= =============
NET INCOME/(LOSS) PER SHARE
BASIC AND DILUTED $ 0.03 $ (0.01)
============= =============
WEIGHTED AVERAGE COMMON SHARE OUTSTANDING - BASIC 102,764,361 49,199,528
============= =============
WEIGHTED AVERAGE COMMON SHARE OUTSTANDING - DILUTED 103,312,264 49,199,528
============= =============
The accompanying notes are in integral part of the consolidated financial
statement
F-5
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Common Stock Preferred Stock Additional
paid-in
Share Par value Share Par value capital
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2003 10,000 $ 100 -- $ -- $ 12,731,114
Issued 25,000,000 common stock at
$0.001 each 25,000,000 25,000 -- -- 390,000
Net income for the period of four
months -- -- -- -- --
Shares of subsidiary eliminated in
re-capitalization (10,000) (100) -- -- --
------------- ------------- ------------- ------------- -------------
Balance at April 30, 2004 25,000,000 25,000 -- -- 13,121,114
------------- ------------- ------------- ------------- -------------
Issued 70,055,123 common stock at
$0.001 each 70,055,123 70,055 -- -- 22,533,644
Net income for the period of
eight months -- -- -- -- --
Transfer to reserve -- -- -- -- --
Capital reserve accrued during
the period -- -- -- -- --
Adjustment from acquisition of
assets under cost basis -- -- -- -- (22,555,553)
------------- ------------- ------------- ------------- -------------
Balance at December 31, 2004 95,055,123 95,055 -- -- 13,099,205
------------- ------------- ------------- ------------- -------------
Issued 21,050,102 common stock at
$0.001 each net of cost of
raising capital 21,050,102 21,050 -- -- 2,375,647
Issued 100,000 preferred stock at
$0.001 each -- -- 100,000 100 99,900
Net income for the year -- -- -- -- --
Transfer to reserve -- -- -- -- --
Foreign currency translation
adjustment -- -- -- -- --
------------- ------------- ------------- ------------- -------------
116,105,225 $ 116,105 100,000 $ 100 $ 15,574,752
============= ============= ============= ============= =============
Appropriation Accumulated
of retained other Retained
earnings comprehensive earnings
(reserves) income (deficit) Total
------------- ------------- ------------- -------------
Balance at December 31, 2003 $ 957,656 $ -- (2,193,496) $ 11,495,374
Issued 25,000,000 common stock at
$0.001 each -- -- -- 415,000
Net income for the period of four
months -- -- (2,513,990) (2,513,990)
Shares of subsidiary eliminated i
re-capitalization -- -- -- (100)
------------- ------------- ------------- -------------
Balance at April 30, 2004 957,656 -- (4,707,486) 9,396,284
------------- ------------- ------------- -------------
Issued 70,055,123 common stock at
$0.001 each -- -- -- 22,603,699
Net income for the period of
eight months -- -- 2,130,047 2,130,047
Transfer to reserve 151,713 -- (151,713) --
Capital reserve accrued during
the period 36,947 -- -- 36,947
Adjustment from acquisition of
assets under cost basis -- -- -- (22,555,553)
------------- ------------- ------------- -------------
Balance at December 31, 2004 1,146,316 -- (2,729,152) 11,611,424
------------- ------------- ------------- -------------
Issued 21,050,102 common stock at
$0.001 each net of cost of
raising capital -- -- -- 2,396,697
Issued 100,000 preferred stock at
$0.001 each -- -- -- 100,000
Net income for the year -- -- 3,254,098 3,254,098
Transfer to reserve 839,529 -- (839,529) --
Foreign currency translation
adjustment -- 499,251 -- 499,251
------------- ------------- ------------- -------------
$ 1,985,845 $ 499,251 $ (314,583) $ 17,861,470
============= ============= ============= =============
The accompanying notes are in integral part of the consolidated financial
statements
F-6
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income/(loss) $ 3,254,098 $ (446,134)
Adjustments to reconcile net income to net cash provided by
operating activities :
Loss on disposal of fixed assets 105,476 --
Goodwill adjusted for reorganization process --
Depreciation 961,295 615,120
Provision for doubtful accounts (recovery) (340,627) (1,057,130)
(Increase)/decrease in assets:
Inventories (328,900) 239,775
Trade receivables, net of provisions (2,676,328) 3,977,348
Prepayment (129,932) 300,820
Advances to employees (99,313) (27,918)
Deferred taxes 283,167 216,544
Increase/(decrease) in liabilities:
Accounts payables and accrued expenses (1,587,184) 381,152
Deposit received from customers -- (28,663)
Promissory notes -- 100,000
Tax payable 71,334 --
------------ ------------
Net cash used in operating activities (486,914)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property, plant and equipment (15,401) (1,065,042)
Capital expenditure -- (5,966,633)
Purchase of minority interest from shareholders -- 162,904
Cash received from acquisition -- 1,205,193
------------ ------------
Net cash used in investing activities (15,401) (5,663,578)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from common stock, net of cost of raising capital 2,141,275 23,018,698
Received from directors 1,141,175 209,362
Received from related parties 563,035 498,943
Repayment of bank loans (2,731,567) (6,265,061)
Deferred loan guarantee (500,000) --
------------ ------------
Net cash provided by financing activities 613,918 17,461,942
------------ ------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 111,603 (6,486,275)
EFFECT OF CHANGES IN EXCHANGE RATE ON CASH AND CASH
EQUIVALENTS 477,051 --
Cash and cash equivalents, beginning of period 4,551,505 11,037,780
------------ ------------
Cash and cash equivalents, end of period $ 5,140,159 $ 4,551,505
============ ============
SUPPLEMENTARY CASH FLOWS DISCLOSURES
Interest paid $ 230,090 $ 313,881
============ ============
Taxes paid $ 260,749 $ --
============ ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES
Conversion of promissory note to preferred stock $ 100,000 $ --
============ ============
Conversion of convertible notes to common stock $ 255,422 $ --
============ ============
Common shares issued for services $ 2,098,596 $ --
============ ============
The accompanying notes are in integral part of the consolidated financial
statements
F-7
HQ SUSTAINABLE MARITIME INDUSTRIES, INC.
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005 AND 2004
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
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 HQSM 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 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.
F-8
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 Hainan Quebec Ocean Fishing Company Limited, 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 Jiahua Marine
Bio-Product Company Limited (100% hold subsidiary of Sealink) are Shark
Cartilage Capsule, Shark Liver Oil and Shark Liver (Soft gel). The major market
is domestic in the PRC.
2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of HQSM and all its
subsidiaries ("The Group"). All material inter-company accounts and transactions
have been eliminated. The consolidated financial statements are prepared in
accordance with generally accepted accounting principles used in the United
States of America.
3. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES
A. CASH AND CASH EQUIVALENTS
The Group considers cash and cash equivalents to include cash on hand and demand
deposits with banks with an original maturity of three months or less.
F-9
B. 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.
C. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are carried at cost. The cost of repairs and
maintenance is expensed as incurred; major replacements and improvements are
capitalized.
When assets are retired or disposed of, the cost and accumulated
depreciation are removed from the accounts, and any resulting gains or losses
are included in income in the year of disposition.
Depreciation is calculated on a straight-line basis over the estimated useful
life of the assets. The percentages applied are:
Buildings and leasehold improvement 2.25% - 9% (10 - 40 years)
Plant and machinery 9% - 18% (5 - 10 years)
Motor vehicles 18% (5 years)
Office equipment and furnishings 18% (5 years)
The Company owns 4 fully depreciated vessels which have been taken out of
service.
D. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of financial instruments including cash, receivables,
accounts payable and accrued expenses and debt, approximates their fair value at
December 31, 2005 and 2004 due to the relatively short-term nature of these
instruments.
F-10
E. INCOME TAXES
Taxes are calculated in accordance with taxation principles currently effective
in the PRC. 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.
F. GOVERNMENT SUBSIDIES
Subsidies from the government are recognized at their fair values when received
or there is reasonable assurance that they will be received, and all attached
conditions are complied with.
G. 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.
The Company conducts business with several related parties in the ordinary
course of business. All transactions have been recorded at fair market value of
the goods or services exchanged.
H. FOREIGN CURRENCY TRANSLATION
We follow SFAS No. 52, "Foreign Currency Translation", for both the translation
and remeasurement of balance sheet and income statement items into U.S. dollars.
Resulting translation adjustments are reported as a separate component of
accumulated comprehensive income (loss) in stockholders' equity.
The Group maintains its books and accounting records in Renminbi ("RMB"), the
PRC's currency, being the functional currency. Transactions denominated in
foreign currencies are translated into the functional currency at the exchange
rates prevailing on the transaction dates. Assets and liabilities denominated in
foreign currencies are translated into the functional currency at the exchange
rates prevailing at the balance sheet date. Any translation gains (losses) are
recorded in exchange reserve as a component of shareholders' equity.
On January 1, 1994, the PRC government introduced a single rate of exchange as
quoted daily by the People's Bank of China (the "Unified Exchange Rate"). The
quotation of the exchange rates does not imply free convertibility of RMB to
other foreign currencies. All foreign exchange transactions continue to take
place either through the Bank of China or other banks authorized to buy and sell
foreign currencies at the exchange rates quoted by the People's Bank of China.
Approval of foreign currency payments by the Bank of China or other institutions
requires submitting a payment application form together with supplier's
invoices, shipping documents and signed contracts.
F-11
I. 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.
J. REVENUE RECOGNITION
In accordance with the provisions of Staff Accounting Bulletin No. 101, revenue
is recognized when merchandise is shipped and title passes to the customer and
collectibility is reasonably assured.
K. EMPLOYEES' BENEFITS
Mandatory contributions are made to the Government's health, retirement benefit
and unemployment schemes at the statutory rates in force during the period,
based on gross salary payments. The cost of these payments is charged to the
statement of income in the same period as the related salary cost.
L. SEGMENTS
No geographical segment analysis is provided for the year ended December 31,
2005 and twelve months ended December 31, 2004, as less than 10% of consolidated
revenue and less than 10% consolidated income from operations is attributable to
the segment other than the Mainland China.
F-12
Business Segment for the year ended December 31, 2005
Aquaculture Health and Unallocated
Products Bio-products Items Consolidation
------------- ------------ ----------- -------------
Sales to external customers
17,780,268 9,772,762 -- 27,553,030
============================================================
General and administrative expenses 427,813 142,482 1,851,486 2,421,781
Depreciation 650,804 304,719 5,772 961,295
Selling expenses
157,570 144,060 -- 301,630
Advertising
-- 3,623,107 -- 3,623,107
Finance costs 227,701 124,173 8,908 360,782
Provision/(Recovery) of doubtful accounts 91,276 (431,903) -- (340,627)
Income/(loss) before income taxes 1,357,080 4,404,169 (1,866,157) 3,895,092
Income taxes
353,223 287,771 -- 640,994
Net income/(loss) for the year 1,003,857 4,116,398 (1,866,157) 3,254,098
============================================================
Segment assets 14,212,919 9,059,564 1,144,197 24,416,680
============================================================
Segment liabilities 3,070,504 2,106,884 1,377,823 6,555,210
============================================================
Business segment for the year ended December 31, 2004
Aquaculture Health and Unallocated
Products Bio-products Items Consolidation
------------- ------------ ----------- -------------
Sales to external customers 17,949,204 3,242,288 -- 21,191,492
============================================================
General and administrative expenses 2,260,417 -- 771,524 3,031,941
Depreciation 523,688 87,184 4,248 615,120
Selling expenses 355,894 28,208 -- 384,102
Advertising
-- 1,674,988 -- 1,674,988
Finance costs 162,403 50,088 194,349 406,840
Recovery of doubtful accounts 1,057,130 -- -- 1,057,130
Income/(loss) before income taxes 1,337,752 1,005,557 (2,572,899) (229,590)
Income taxes
216,544 -- -- 216,544
Net income/(loss) for the year 1,121,208 1,005,557 (2,572,899) (446,134)
============================================================
Segment assets 13,412,191 7,452,718 60,753 20,925,662
============================================================
Segment liabilities 4,809,501 2,932,717 1,472,020 9,214,238
============================================================
F-13
N. COMPREHENSIVE INCOME/(LOSS)
The Group has adopted the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No.
130 establishes standards for the reporting and display of comprehensive income,
its components and accumulated balances in a full set of general-purpose
financial statements. SFAS No. 130 defines comprehensive income (loss) to
include all changes in equity except those resulting from investments by owners
and distributions to owners, including adjustments to minimum pension
liabilities, accumulated foreign currency translation, and unrealized gains or
losses on marketable securities.
O. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of trade accounts receivable.
The Company performs ongoing credit evaluations with respect to the financial
condition of its customers, but does not require collateral. In order to
determine the value of the Company's accounts receivable, the Company records a
provision for doubtful accounts to cover probable credit losses. Management
reviews and adjusts this allowance periodically based on historical experience
and its evaluation of the collectibility of outstanding accounts receivable.
P. SHIPPING AND HANDLING COSTS
Shipping and handling costs are classified as cost of sales and are expensed as
incurred.
Q. ADVERTISING COSTS
Advertising costs are expensed as incurred.
R. NET INCOME PER COMMON SHARE
Net income per common share is computed in accordance with SFAS No. 128,
"Earnings Per Share". Basic earnings per common share is calculated by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for each period. Diluted earnings per common share is
calculated by adjusting the weighted-average shares outstanding assuming
conversion of all potentially dilutive convertible securities.
S. DEFERRED LOAN COST
Deferred loan costs represent deposits made to a potential guarantor that will
be returned in the event the Company is not provided the loan guaranty
T. RECENT PRONOUNCEMENTS
Prior to January 1, 2005, we accounted for stock-based compensation to
non-employees (directors, investors, consultants) in accordance with SFAS No.
123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure. Under the
fair value recognition provisions of SFAS No. 123, stock-based compensation cost
for all stock-based awards was measured at the grant date based on the value of
the award and was recognized as expense over the service period for awards that
were expected to vest.
Effective January 1, 2005, we adopted SFAS No. 123(R), Share-Based Payment,
using the modified prospective application transition method. Because the fair
value recognition provisions of SFAS No. 123 and SFAS No. 123(R) were materially
consistent under our equity plans, the adoption of SFAS No. 123(R) did not have
a significant impact on our financial position or our results of operations.
Prior to our adoption of SFAS No. 123(R), benefits of tax deductions in excess
of recognized compensation costs were reported as operating cash flows. SFAS No.
123(R) requires excess tax benefits be reported as a financing cash inflow
rather than as a reduction of taxes paid.
F-14
In November 2005, the FASB issued Staff Position ("FSP") FAS115-1/124-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments, which addresses the determination as to when an investment is
considered impaired, whether that impairment is other than temporary, and the
measurement of an impairment loss. This FSP also includes accounting
considerations subsequent to the recognition of an other-than-temporary
impairment and requires certain disclosures about unrealized losses that have
not been recognized as other-than-temporary impairments. The guidance in this
FSP amends FASB Statements No. 115, Accounting for Certain Investments in Debt
and Equity Securities, and No. 124, Accounting for Certain Investments Held by
Not-for-Profit Organizations , and APB Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock . This FSP is effective for reporting
periods beginning after December 15, 2005. We do not believe the adoption of
this FSP will have a material impact on our financial statements.
In November 2005, the FASB issued FSP FAS123(R)-3, Transition Election to
Accounting for the Tax Effects of Share-Based Payment Awards. This FSP requires
an entity to follow either the transition guidance for the
additional-paid-in-capital pool as prescribed in SFAS No. 123(R), Share-Based
Payment , or the alternative transition method as described in the FSP. An
entity that adopts SFAS No. 123(R) using the modified prospective application
may make a one-time election to adopt the transition method described in this
FSP. An entity may take up to one year from the later of its initial adoption of
SFAS No. 123(R) or the effective date of this FSP to evaluate its available
transition alternatives and make its one-time election. This FSP became
effective in November 2005. We continue to evaluate the impact that the adoption
of this FSP could have on our financial statements.
4. TRADE RECEIVABLES
The Group's trade receivables at December 31, 2005 and 2004 are summarized as
follows:
2005 2004
---------- ----------
Trade receivable $9,160,129 $6,463,031
Less: Allowance for doubtful accounts 737,002 1,056,859
-----------------------
$8,423,127 $5,406,172
=======================
The activity in the Group's allowance for doubtful accounts during the year
ended December 31, 2005 and twelve months ended December 31, 2004 is summarized
as follows:
2005 2004
----------- -----------
Balance at beginning of year $ 1,056,859 $ 829,716
Add: amount acquired from acquisition of Sealink -- 1,284,273
Less: recovery during the year (340,627) (1,057,130)
Exchange difference transfer to exchange reserve 20,770 --
--------------------------
Balance at end of year $ 737,002 $ 1,056,859
==========================
F-15
5. PROPERTY, PLANT AND EQUIPMENT
2005 2004
----------- -----------
Cost:-
Buildings and leasehold improvement $ 2,884,010 $ 2,817,990
Plant and machinery 8,336,665 8,461,585
Motor vehicles 55,993 68,580
Office equipment and furnishings 135,552 126,470
-------------------------
11,412,220 11,474,625
Less: Accumulated depreciation:-
Buildings and leasehold improvement 357,734 273,479
Plant and machinery 2,929,515 2,050,400
Motor vehicles 35,877 55,228
Office equipment and furnishings 88,591 65,845
-------------------------
3,411,717 2,444,952
-------------------------
Property, plant and equipment, net $ 8,000,503 $ 9,029,673
=========================
Depreciation expenses relating to property, plant and equipment was $961,295 and
$615,120 for the year ended December 31, 2005 and twelve months ended December
31, 2004, respectively.
6. INVENTORIES
The Group's inventories at December 31, 2005 and 2004 are summarized as follows:
2005 2004
-------- --------
Raw materials $ 63,822 $ 84,569
Work-in-progress 23,082 82,609
Finished goods 470,560 61,386
-------------------
Total Inventories $557,464 $228,564
===================
7. PREPAYMENT
The Group's prepayment at December 31, 2005 and 2004 are summarized as follows:
2005 2004
-------- --------
Advances to suppliers $ 1,888 $ 1,932
Prepaid expenses 129,976 --
-------------------
Total $131,864 $ 1,932
===================
F-16
8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses at December 31, 2005 and 2004 are
summarized as follows:
2005 2004
---------- ----------
Accounts payable $ 273,101 $ 146,026
Accrued expenses 2,344,345 4,058,604
-----------------------
$2,617,446 $4,204,630
=======================
9. BANK LOANS
As at December 31, 2005, the Group has an expired loan from bank at an amount of
$1,726,264 bearing an interest of 7.56% per annum. As at the date of the report,
the Group is in negotiation with the banker to extend the said loan and expects
to have the loan extended for not less than one year to December 2006. The loans
were secured by the pledge of certain fixed assets held by the Group and its
subsidiaries.
10. INCOME TAXES
HQOF, registered in the PRC, is subject to state and local income taxes within
the PRC at the applicable tax rate as reported in their PRC statutory financial
statements in accordance with the relevant income tax laws applicable to
wholly-owned foreign enterprises. HQOF was subject to a tax rate of 7.5% from
the years of 2003 to 2005. HQOF was entitled to a two-year tax free and
three-year half-tax holidays from 2001 commencing with its first profit-making
year. Furthermore, the other wholly-owned subsidiary Jiahua Marine enjoys the
two-year tax free and three-year half-tax holidays from 2003 commencing with its
first profit-marking year. The reconciliation of the effective income tax rate
of the Company to the statutory income tax rate in the PRC for the year ended
December 31, 2005 is as follows:
Statutory tax rate 15.0%
Tax holidays and concessions (7.5%)
------------
Effective tax rate 7.5%
============
F-17
The Group's income/(loss) before income taxes was comprised of the following for
the year ended December 31, 2005 and twelve months ended December 31, 2004,
respectively:
2005 2004
----------- -----------
United States $(1,657,206) $(1,694,305)
Canada (203,521) (182,637)
PRC 5,755,819 1,647,352
--------------------------
$ 3,895,092 $ (229,590)
==========================
Income taxes are calculated on a separate entity basis. There currently is no
tax benefit or burden recorded for the United States or Canada. The provisions
for income taxes for the year ended December 31, 2005 and twelve months ended
December 31, 2004, respectively, are summarized as follows:
PRC only: 2005 2004
-------- --------
Current $333,092 $ --
Deferred 307,902 216,544
-------------------
$640,994 $216,544
===================
Tax recoverable as at December 31, 2005 and 2004 comprise the following:
2005 2004
-------- --------
Balance at January 1 $ 81,602 $ 81,602
Income tax provided for the period of twelve months 45,321 --
Income tax paid during the period of twelve months (45,321) --
Exchange difference transfer to exchange reserve 1,912 --
--------------------
Balance at December 31 $ 83,514 $ 81,602
====================
Tax payable as at December 31, 2005 and 2004 comprise the following:
2005 2004
--------- ---------
Balance at January 1 $ -- $ --
Income tax provided for the period of twelve months 287,771 --
Income tax paid during the period of twelve months (215,428) --
Exchange difference transfer to exchange reserve 902 --
----------------------
Balance at December 31 $ 73,245 $ --
======================
F-18
11. DEFERRED TAX
Deferred tax assets as at December 31, 2005 and 2004 comprise the following:
2005 2004
----------- -----------
Balance at January 1 $ 1,209,790 $ 1,426,334
Deferred tax written off for the period of twelve months (307,902) (216,544)
Exchange difference transfer to exchange reserve 24,735 --
--------------------------
Balance at December 31 $ 926,623 $ 1,209,790
==========================
Deferred taxation is calculated under the liability method in respect of
taxation effect arising from all timing differences, which are expected with
reasonable probability to crystallize in the foreseeable future.
12. APPROPRIATED RETAINED EARNINGS (RESERVES)
The reserve funds are comprised of the following:
2005 2004
---------- ----------
Statutory surplus reserve fund $1,299,266 $ 739,580
Public welfare fund 649,633 369,790
Capital reserve 36,946 36,946
---------- ----------
$1,985,845 $1,146,316
========== ==========
The reserves are disclosed separately on the accompanying statements of
stockholders' equity and are considered an appropriation of retained earnings.
Pursuant to the relevant laws and regulations of Wholly Owned Foreign
Enterprises, the profits of the Company, which are based on their PRC statutory
financial statements, are available for distribution in the form of cash
dividends after they have satisfied all the PRC tax liabilities, provided for
losses of previous years, and made appropriations to reserve funds, as
determined by the Board of Directors in accordance with the PRC accounting
standards and regulations.
As stipulated by the relevant laws and regulations for enterprises operating in
the PRC, HQOF and Jiahua Marine (both wholly-owned foreign enterprises) are
required to make annual appropriations to two reserve funds, consisting of the
statutory surplus and public welfare funds. In accordance with the relevant PRC
regulations and the articles of association of the respective companies, the
companies are required to allocate a certain percentage of their profits after
taxation, as determined in accordance with the PRC accounting standards
applicable to the companies, to the statutory surplus reserve until such reserve
reaches 50% of the registered capital of the companies.
F-19
Net income as reported in the US GAAP financial statements differs from that as
reported in the PRC statutory financial statements. In accordance with the
relevant laws and regulations in the PRC, the profits available for distribution
are based on the statutory financial statements. If HQOF has foreign currency
available after meeting its operational needs, HQOF may make its profit
distributions in foreign currency to the extent foreign currency is available.
Otherwise, it is necessary to obtain approval and convert such distributions at
an authorized bank.
13. EMPLOYEE STOCK OPTION PLAN
On December 2004, our Board of Directors ratified grants of non-qualified stock
options to purchase shares of our common stock under our Stock Option Plan to
some of our executive officers and directors, who qualify as employees for
valuation purposes, as well as to several of our employees. Each of these new
stock options have up to a ten-year term, are subject to the terms and
conditions of the Plan, and have an exercise price of $0.28.
Specifically, Norbert Sporns, our Chief Executive Officer, President and
director, received 500,000 stock options. Lillian Wang, the Chairman of our
Board of Directors, received 500,000 stock options. Harry Wang, our Chief
Operating Officer, director and brother of Ms. Wang, received 500,000 stock
options; and Fusheng Wang, our director, Honorary Chairman and father of Ms.
Wang, received 1,000,000 stock options. Together, Norbert Sporns, Harry Wang and
Lillian Wang also indirectly control the majority of capital stock of HQSM. The
stock options granted to each of them, as well as to Fusheng Wang, were fully
vested when granted. In addition, our Chief Financial Officer, Jean-Pierre
Dallaire, received 200,000 stock options. Mr. Dallaire's options were vested in
2004 as to 50% of the grant , with the remaining 50% vesting as follows: 1/3 on
June 16, 2005, 1/3 on June 16, 2006, and the remaining 1/3 on June 16, 2007.
Further, at the same date, our Board of Directors ratified grants of stock
options to thirteen other employees of HQSM. These stock options were vested
then as to 50% of each individual grant, with the remaining 50% vesting as
follows: 1/3 on June 16, 2005, 1/3 on June 16, 2006, and the remaining 1/3 on
June 16, 2007. In the case of one of the employees, the stock options were fully
vested when granted.
Our Board of Directors believes that these stock option grants will help our
company to continue to attract, retain and motivate our employees, directors and
executive officers. In connection with these grants, our board of directors
reserved 5,000,000 shares for issuance under the Plan. In addition, pursuant to
the provisions of the Plan, our Board of Directors delegated the full power and
authority to administer the Plan, in accordance with its terms, to our
Compensation Committee presently consisting of Norbert Sporns, Fred Bild, an
independent director, and Daniel Too, also an independent director of HQSM.
The Company has elected to follow Accounting Principles Board Opinion (APBO) No.
25 and related interpretations in accounting for its stock-based compensation
made to its employees. APBO No. 25 requires no recognition of compensation
expense for most of the stock-based compensation arrangements provided by the
Company, namely, broad-based employee stock purchase plans and option grants
where the exercise price is equal to or less than the market value at the date
of grant. However, APBO No. 25 requires recognition of compensation expense for
variable award plans over the vesting periods of such plans, based upon the
then-current market values of the underlying stock. In contrast, Statement of
Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based
Compensation", as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123", requires recognition of compensation expense for grants of stock, stock
options, and other equity instruments, over the vesting periods of such grants,
based on the estimated grant-date fair values of those grants. The Company
generally uses the straight-line method of amortization for stock-based
compensation. Had compensation cost for these plans been determined consistent
with SFAS No. 123, the Company's net loss and net loss per share would have been
increased to the following pro forma amounts:
For the years ended
December 31,
------------------------
2005 2004
---------- ----------
Net income (loss)
As reported $3,254,098 $ (383,943)
Pro forma $3,254,098 $ (383,943)
Earnings per share
As reported $ 0.03 $ (0.01)
Pro forma $ 0.03 $ (0.01)
F-20
14. SIGNIFICANT CONCENTRATION
The Group grants credit to its customers, generally on an open account basis.
The Group's five largest customers accounted for 62.6% of the consolidated sales
for the year ended December 31, 2005. Of those five customers, three are in
excess of 10% of consolidated sales, with 17.0%, 14.6% and 13.7% of consolidated
sales, or an aggregate of 45.3%.
At December 31, 2005, approximately 55.4% of trade receivables were from trade
transactions with the aforementioned five largest customers.
15. WARRANTIES The Group did not incur any warranty costs for the year ended
December 31, 2005, and for the twelve months ended December 31, 2004
16. COMMITMENTS AND CONTINGENCIES A. CAPITAL COMMITMENTS
As of December 31, 2005, the Group has no significant capital commitments
required for disclosure.
B. LEASE COMMITMENTS
The lease commitments of the Group as at December 31, 2005 and 2004 were as
follows:
2005 2004
-------- --------
Within 1 year $ 20,645 $ 22,102
1-2 years 62,045 --
2-3 years 62,045 --
Over 3 years 183,755 --
-------------------
Total $328,490 $ 22,102
===================
C. LEGAL PROCEEDINGS
The Group is not currently a party to any threatened or pending legal
proceedings.
17. CAPITAL STRUCTURE
Common stock consists of authorized shares of 200,000,000 with a stated par
value of $0.001 per share. Common stock issued and outstanding as of December
31, 2005 and 2004 was 116,105,225 and 95,055,123, respectively. Preferred stock
consists of authorized shares of 10,000,000 with a par value of $0.001 per
share.
Preferred shares amounting to 100,000 have been designated as Series A preferred
stock. The Series A preferred stock is entitled to superior voting rights and is
also convertible into common shares.
During the years ended December 31, 2005 and 2004, the Company issued common
shares amounting to 21,050,102 and 70,055,123 with net proceeds of $2,396,697
and $22,603,699, respectively. The amounts recorded in the accompanying
financial statements are net of costs incurred in raising capital.
18. EARNINGS PER SHARE
The following is a reconciliation of the numerators and the denominators of the
basic and diluted earnings per share (EPS) computation at December 31, 2005.
2005
----
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- -----------
Basic EPS
Income available to common shareholders $ 3,254,098 102,764,361 $ .03
Effect of dilutive securities stock options
issued to employees -- 547,903 --
-----------------------------------------
Diluted EPS
Income available to common stockholders plus
assumed conversions $ 3,254,908 103,312,264 $ .03
=========================================
F-21
19. CURRENT VULNERABILITY DUE TO CERTAIN CONCENTRATIONS
The Group faces a number of risks and challenges since its operations are in the
PRC. The Group's operations in the PRC are subject to special considerations and
significant risks not typically associated with companies in North America and
Western Europe. The Group's results may be adversely affected by changes in the
political and social conditions in the PRC, and by changes in governmental
policies with respect to laws and regulations, anti-inflationary measures,
currency conversion and remittance abroad, and rates and methods of taxation,
among other things.
20. UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (for
comparative purposes only)
On August 17, 2004, HQSM and Sealink, as the parent and management company of
Jiahua Marine Bio-products Company Limited. ("Jiahua Marine"), consummated a
Purchase Agreement whereby HQSM acquired all of the issued and outstanding
capital stock of Sealink at a consideration payable by HQSM in the following
manner: (i) $8,888,655 in the form of 12,698,078 shares of HQSM's common stock,
$0.001 par value per share, to be delivered to SSC at closing, and (ii) the
remaining balance of $11,111,345 payable in the form of a convertible promissory
note issued by HQSM to SSC. This note is included as Exhibit B to the
Nutraceutical Purchase Agreement. The note accrued interest at the rate of 5%
per annum and was converted into: (a) one hundred thousand US Dollars
(US$100,000) for 100,000 shares of HQSM's Series A preferred stock, $0.001 par
value per share, the proposed terms of which are described below and are fully
subject to receipt of all necessary shareholder consents and approvals, and (b)
the remaining principal amount of the note equal to US$11,011,345 into
15,730,493 shares of HQSM's common stock. The note was converted upon completion
of an audit of HQSM's acquisition of Sealink and Jiahua Marine, performed to the
satisfaction of HQSM and receipt of all necessary shareholder consents and
approvals.
The Purchase Agreement is being accounted for as a recapitalization of Sealink
whereby the historical financial information of Sealink becomes the historical
financial information of the Registrant.
The accompanying Unaudited Pro Forma Condensed Consolidated Statement of Income
for the twelve months December 31, 2004, has been prepared to reflect the
acquisition as if it had occurred as of January 1, 2004.
F-22
The accompanying pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the financial position or results of
operations which would actually have been reported had the merger been in effect
during the periods presented, or which may be reported in the future.
2004
-----------
(`000)
Sales $ 26,126
Profit from operation $ 776
Profit for the period of twelve months $ 776
===========
Weighted average outstanding number of shares as at December
31, 2004 69,770,366
Earnings per share $ 0.01
21. SUBSEQUENT EVENT
On January 25, 2006, the Company issued convertible notes in the amount of
$5,225,000, maturing January 25, 2008, to a group of private investors. After
deducting commissions and other costs, the Company received net proceeds of
$4,681,250. Those notes are convertible into shares of the Company's common
stock at a per share conversion price of $0.30. The notes shall accrue interest
at 8% yearly.
On February 24, 2006, the Company filed a form SB-2 related to the above
convertible notes. That prospectus related to the resale by the selling
stockholders of up to 49,637,499 shares of our common stock, including up to
17,416,666 (in addition to sufficient shares of common stock to cover a
contractual obligation to register 175% of the number of shares of common stock
underlying the convertible notes, equaling an aggregate total of 30,479,166
shares of common stock) underlying secured convertible notes in a principal
amount of $5,225,000 and up to 19,158,333 shares of common stock issuable upon
the exercise of common stock purchase warrants. The secured convertible notes
are convertible into our common stock at $0.30.
F-23
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
------
March 31, 2006 December 31, 2005
(Unaudited) (Audited)
----------------- -----------------
CURRENT ASSETS
Cash and cash equivalents $ 9,040,421 $ 5,140,159
Trade receivables, net of provision 7,539,335 8,423,127
Inventory 1,000,613 557,464
Prepayments 377,630 131,864
Due from related parties, net of provision 655,885 526,195
Advance to employees 43,475 127,231
Tax recoverable 46,661 83,514
----------------- -----------------
TOTAL CURRENT ASSETS 18,704,020 14,989,554
----------------- -----------------
OTHER ASSETS
Deferred taxes 891,738 926,623
Deferred cost 1,399,562 500,000
----------------- -----------------
TOTAL OTHER ASSETS 2,291,300 1,426,623
----------------- -----------------
PROPERTY, PLANT AND EQUIPMENT, NET 7,795,505 8,000,503
----------------- -----------------
TOTAL ASSETS $ 28,790,825 $ 24,416,680
================= =================
The accompanying notes are in integral part of the consolidated financial
statements.
F-24
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, 2006 December 31, 2005
(Unaudited) (Audited)
----------------- -----------------
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 1,832,554 $ 2,617,446
Bank loans 1,208,385 1,726,264
Tax payable 46,532 73,245
Due to related parties 746,542 787,716
Due to directors 1,544,997 1,350,539
Current portion of promissory note 2,850,000 --
----------------- -----------------
TOTAL CURRENT LIABILITIES 8,229,010 6,555,210
----------------- -----------------
LONG TERM LIABILITIES
Promissory note, net of discount 145,200 --
----------------- -----------------
TOTAL LIABILITIES 8,374,210 6,555,210
----------------- -----------------
SHAREHOLDERS' EQUITY
Preferred stock 100 100
Common stock 117,095 116,105
Additional paid-in capital 18,971,460 15,574,752
Accumulated Other Comprehensive Income 443,342 499,251
Retained Earnings (Deficit) (1,232,856) (314,583)
Appropriation of Retained Earnings (Reserves) 2,117,474 1,985,845
----------------- -----------------
TOTAL SHAREHOLDERS' EQUITY 20,416,615 17,861,470
----------------- -----------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 28,790,825 $ 24,416,680
================= =================
The accompanying notes are in integral part of the consolidated financial
statements.
F-25
HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES
(INCORPORATED IN THE STATE OF DELAWARE
WITH LIMITED LIABILITY)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended
March 31, 2006 March 31, 2005
-------------- --------------
SALES $ 6,885,340 $ 3,016,886
COST OF SALES 4,353,455 1,299,166
-------------- --------------
GROSS PROFIT 2,531,885 1,717,720
SELLING AND DISTRIBUTION EXPENSES 69,168 40,608
ADVERTISING 1,112,735 1,000,819
GENERAL AND ADMINISTRATIVE 1,003,470 626,941
EXPENSES
DEPRECIATION 234,448 240,272
PROVISION FOR DOUBTFUL ACCOUNTS 183,930 38,352
-------------- --------------
(LOSS) FROM OPERATIONS (71,866) (229,272)
FINANCE COSTS 605,877 91,708
OTHER EXPENSES 36,167 67,126
-------------- --------------
(LOSS) BEFORE INCOME TAXES (713,910) (388,106)
INCOME TAXES
CURRENT 83,385 32,819
DEFERRED 34,885 17,043
-------------- --------------
NET LOSS ATTRIBUTABLE TO SHAREHOLDERS $ (832,180) (437,968)
============== ==============
NET PROFIT PER SHARE $ (0.01) (0.00)
============== ==============
WEIGHTED AVERAGE COMMON SHARE
OUTSTANDING 116,803,336 96,194,971
============== ==============
The accompanying notes are in integral part of the consolidated financial
statements.
F-26
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, 2006 AND 2005
(UNAUDITED)
2006 2005
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ (832,180) $ (437,968)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation 234,448 240,272
Financing expense 446,474
(Increase)/decrease in assets:
Inventory (443,149) (8,115)
Trade receivables, net of provisions 883,792 (291,705)
Prepayment (245,766) --
Advance to employee 83,757 (1,414)
Deferred taxes 34,885 17,044
Increase/(decrease) in liabilities:
Accounts payables and accrued expenses (784,892) (811,905)
Deposit received from customers -- --
Taxes payable 10,139 32,873
----------- -----------
Net cash from by operating activities (612,492) (1,260,918)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property, plant and equipment and construction
in progress (31,692) --
----------- -----------
Net cash from by investing activities (31,692) --
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from common stock 272,800 408,411
Promissory note 5,225,000 --
Received from directors 194,458 2,287
(Payment)/Receive from related parties (170,864) 251,533
Deferred Finders and legal fees (450,938) --
Repayment of bank loans (517,879) --
----------- -----------
Net cash from by financing activities 4,552,577 662,231
----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS 3,908,393 (598,687)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND
CASH EQUIVALENTS (8,130) --
Cash and cash equivalents, beginning of period 5,140,158 4,551,505
----------- -----------
Cash and cash equivalents, end of period $ 9,040,421 $ 3,952,818
=========== ===========
SUPPLEMENTARY CASH FLOWS DISCLOSURES
Interest paid $ 33,351 $ 62,848
=========== ===========
Taxes paid $ 73,245 $ --
=========== ===========
SUPPLEMENTARY DISCLOSURE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES
Common shares issued for services $ 100,500 $ --
=========== ===========
Note payable in connection with acquisition of Jiahua Marine $ -- $ 100,000
=========== ===========
The accompanying notes are in integral part of the financial statements.
F-27
HQ SUSTAINABLE MARTIME INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED
MARCH 31, 2006
--------------------------------------------
NOTE 1 - BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements of HQ Sustainable
Maritime Industries, Inc., or 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-QSB and Item 310(b) of
Regulation S-B. Accordingly, they do not include all the information and
footnotes required by accounting principles generally accepted in United States
of America for complete financial statements. However, such information reflects
all adjustments (consisting solely of normal recurring adjustments), which are,
in the opinion of management, necessary for a fair statement of results for the
interim periods. Results shown for interim periods are not necessarily
indicative of the results to be obtained for a full fiscal year. The condensed
consolidated balance sheet information as of December 31, 2005 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 HQSM 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
F-28
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) are Shark
Cartilage Capsule, Shark Liver Oil and Shark Liver (Soft gel). The major market
is domestic in the PRC.
NOTE 3 - USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and 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 not calculated as HQSM are suffering
loss during the three months ended March 31, 2006 and 2005.
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, 2006 and December 31, 2005 due to the relatively
short-term nature of these instruments.
F-29
NOTE 6 - FOREIGN CURRENCY CONVERSION
The Company's financial information is presented in US dollars. The Group uses
the average exchange rate for the period and the exchange rate at the balance
sheet date to translate its operating results and financial position
respectively. Any translation gains and losses are recorded in accumulated other
comprehensive income as a component of shareholders' equity.
NOTE 7 - INCOME TAXES
Taxes are calculated in accordance with taxation rates currently effective in
the PRC. 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.
The Company's subsidiaries registered in the PRC are subject to state and local
income taxes within the PRC at the applicable tax rates on the taxable income as
reported in their PRC statutory financial statements in accordance with the
relevant income tax laws applicable to foreign enterprises. HQOF and Jiahua
Marine were subject to a tax rate of 15% and 7.5%, respectively during this
quarter. HQOF and Jiahua Marine were entitled to a two-year tax exempted and
three-year half tax rate holiday from 2001 and 2002 commencing with the first
profit-making year, respectively.
The reconciliation of the effective income tax rate of the Company to the
statutory income tax rate in the PRC for this quarter is as follows:
HQOF Jiahua Marine
Statutory tax rate 15.0% 15.0%
Tax holidays and concessions (7.5%)
---------------------------------
Effective tax rate 15.0% 7.5%
=================================
Income taxes are calculated on a separate entity basis. Currently there is no
tax benefit or burden recorded for the United States.
NOTE 8 - PROMISSORY NOTE 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 $4,702,500.00. The financing consisted of two components: (a)
promissory notes of the Company, in the principal amount of $5,225,000, due
January 25, 2008, such Notes convertible into shares of the Company's common
stock, $0.001 par value (the "Common Stock") at a per share conversion price at
the rate of $0.30 per share of Common Stock; and (b) Class A and Class B
Warrants registered in the name of each Investor.
F-30
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 $0.30 per
share of Common Stock. The Notes shall accrue interest on the principal amount
at a rate per annum of eight percent (8%) from January 25, 2006 and shall be
payable, in arrears, subject to the terms and conditions of the Notes, together
with principal amount payments, on January 25, 2008.
One Class A Warrant and one Class B Warrant will be 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 $0.30 per share
of Common Stock. The exercise price to acquire a share of Common Stock upon
exercise of a Class A Warrant shall be $0.35. The exercise price to acquire a
share of Common Stock upon exercise of a Class B Warrant shall be $0.40. 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 to certain Finders' Warrants to purchase 1,741,667 shares of
Common Stock similar to and carrying the same rights as the Class B Warrants
issuable to the Investors except that the exercise price shall be $0.35 per
Warrant Share.
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.
F-31
The shares of Common Stock underlying the securities sold in this financing
transaction will be registered for resale on a Registration Statement to be
filed by the Company in accordance with terms and conditions the subscription
agreement. .
NOTE 9 - SEGMENTS
No geographical segment analysis is provided for the three months ended March
31, 2006 and 2005, 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, 2006
Aquaculture Health and Unallocated
Product Bio-product Items Consolidation
----------- ----------- ----------- -------------
Sales to external customers 4,673,498 2,211,842 -- 6,885,340
=========================================================
General and administrative expenses 155,566 22,621 825,283 1,003,470
Depreciation 153,923 77,928 2,598 234,448
Selling expenses 49,507 19,661 -- 69,168
Advertising -- 1,112,735 -- 1,112,735
Finance costs 3,244 30,478 572,155 605,877
Provision for doubtful accounts 171,958 11,972 -- 183,930
Profit / (Loss) before taxation 79,771 606,333 (1,400,014) (713,910)
Income taxes 71,738 46,532 -- 118,270
Profit / (Loss) for the period 8,033 559,801 (1,400,014) (832,180)
=========================================================
Segment assets 14,991,215 9,221,777 4,577,833 28,790,825
=========================================================
Segment liabilities 2,699,070 1,709,294 3,965,846 8,374,210
=========================================================
Business segment for the three months ended March 31, 2005
Aquaculture Health and Unallocated
Product Bio-product Items Consolidation
----------- ----------- ----------- -------------
Sales to external customers 1,092,495 1,924,391 -- 3,016,886
=========================================================
General and administrative expenses 147,682 36,078 443,181 626,941
Depreciation 163,824 75,311 1,137 240,272
Selling expenses 20,535 20,073 -- 40,608
Advertising -- 1,000,819 -- 1,000,819
Finance costs 57,778 31,220 2,710 91,708
Provision for doubtful accounts -- 38,352 -- 38,352
(Loss) / Profit before taxation (378,926) 437,585 (446,765) (388,106)
Income taxes 17,043 32,819 -- 49,862
(Loss) / Profit for the period (395,969) 404,766 (446,765) (437,968)
=========================================================
Segment assets 12,764,745 7,156,065 245,562 20,166,372
=========================================================
Segment liabilities 4,162,120 2,480,794 1,941,591 8,584,505
=========================================================
F-32
NOTE 10 - RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 151 "Inventory Costs -
an amendment of ARB No. 43, Chapter 4" ("SFAS 151"). This statement amends the
guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). SFAS 151 requires that those items be
recognized as current-period charges. In addition, this Statement requires that
allocation of fixed production overheads to costs of conversion be based upon
the normal capacity of the production facilities. The provisions of SFAS 151 are
effective for fiscal years beginning after June 15, 2005. As such, the Company
is required to adopt these provisions at the beginning of the fiscal year ended
December 31, 2006. The Company has adopted SFAS 151 and believes that the impact
on its consolidated financial statements is immaterial for the quarter ended
March 31, 2006.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets
- - an amendment of APB Opinion No. 29" ("SFAS 153"). SFAS 153 replaces the
exception from fair value measurement in APB Opinion No. 29 for nonmonetary
exchanges of similar productive assets with a general exception from fair value
measurement for exchanges of nonmonetary assets that do not have commercial
substance. A nonmonetary exchange has commercial substance if the future cash
flows of the entity are expected to change significantly as a result of the
exchange. SFAS 153 is effective for fiscal years beginning after June 15, 2005.
As such, the Company is required to adopt these provisions at the beginning of
the fiscal year ended December 31, 2006. The Company has adopted SFAS 153 and
believes that the impact on its consolidated financial statements is immaterial
for the quarter ended March 31, 2006.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS 154"). SFAS 154 changes the requirements for the accounting for and
reporting of a change in accounting principle. These requirements apply to all
voluntary changes and changes required by an accounting pronouncement in the
unusual instance that the pronouncement does not include specific transition
provisions. SFAS 154 is effective for fiscal years beginning after December 15,
2005. As such, the Company is required to adopt these provisions at the
beginning of the fiscal year ended December 31, 2006. The Company has adopted
SFAS 154 and believes that the impact on its consolidated financial statements
is immaterial for the quarter ended March 31, 2006.
In February 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 155, "Accounting for
Certain Hybrid Financial Instruments - an amendment of FASB Statement No. 133
and 140" ("SFAS 155"). SFAS 155 resolves issues addressed in Statement 133
Implementation Issue No. D1, "Application of Statement 133 to Beneficial
Interests in Securitized Financial Assets." SFAS 155 is effective for all
financial instruments acquired or issued after the beginning of the first fiscal
year that begins after September 15, 2006. As such, the Company is required to
adopt these provisions at the beginning of the fiscal year ended December 31,
2007. The Company is currently evaluating the impact of SFAS 155 on its
consolidated financial statements.
In March 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 156, "Accounting for
Servicing of Financial Assets - an amendment of FASB Statement No. 140" ("SFAS
156"). SFAS 156 amends FASB Statement No. 140 with respect to the accounting for
separately recognized servicing assets and servicing liabilities. SFAS 156
requires all separately recognized servicing assets and servicing liabilities to
be initially measured at fair value, if practical. SFAS 156 is effective as of
the beginning of the first fiscal year that begins after September 15, 2006. As
such, the Company is required to adopt these provisions at the beginning of the
fiscal year ended December 31, 2007. The Company is currently evaluating the
impact of SFAS 156 on its consolidated financial statements.
F-33
PROSPECTUS
HQ SUSTAINABLE MARITIME
INDUSTRIES, INC.
The date of this Prospectus in June 15, 2006