Form 10-QSB Amendment

Check whether the issuer: (i) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

As of June 30, 2006, there were 118,535,706 shares of the registrant’s common stock outstanding.

The financial statements for the six months and the three months periods ended June 30, 2006 have been restated to reflect the methodology correction for the embedded conversion option of the convertible promissory notes that the Company issued in January 2006. The effective conversion price has been used to measure the intrinsic value of the embedded conversion option under EITF 00-27, the issue 98-5 model.

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

The financial statements for the six months and the three months period ended June 30, 2006 have been restated to reflect the methodology correction for the embedded conversion option of the convertible promissory notes that the Company issued in January 2006. The effective conversion price has been used to measure the intrinsic value of the embedded conversion option under EITF 00-27, the issue 98-5 model. The effect on net income, assets, liabilities and paid in capital is summarized as follows:

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.

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 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.

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.

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 earning per share are computed similar to basic earning per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were diluted.

The carrying value of financial instruments including cash and cash equivalents, receivables, accounts payable and accrued expenses and debt, approximates their fair value at June 30, 2006 and December 31, 2005 due to the relatively short-term nature of these instruments.

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.

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

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:

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

In April 2006, the bank loan was renewed until April 2007 at an interest bearing rate of approximately 7.6%.

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) convertible 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.

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 Company follows EITF 00-27, the issue 98-5 model in recording the convertible notes and warrants in its financial statements. 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 monthly, in arrears, subject to the terms and conditions of the Notes, together with principal amount payments, starting on April 25, 2006 through 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.

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

The Company evaluated the convertible debt and warrants under the guide EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and potentially Settled in, a Company’s Own Stock”, with regards to the control over the form of ultimate settlement of the instruments. As the Company used its best efforts to cause the related registration statement to become effective, and the registration statement did become effective on June 15, 2006, the Company classified the warrants as equity under the guide EITF 00-19. However, the Company incurred liquidating damages in the amount of $66,500 as a result of late approval of the registration statement.

No geographical segment analysis is provided for the three months and six months ended June 30, 2006 and 2005, respectively, as less than 10% of consolidated revenues and less than 10% of consolidated income from operations is attributable to the segment other than the Mainland China.

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, “Exchange 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 June 30, 2006.

In December 2004, the FASB issued SFAS No. 123 (Revised), “Share-based Payment”. This statement requires employers to expense costs related to share-based payment transactions with employees. With limited exceptions, SFAS No. 123 (Revised) requires that the fair value of share-based payments to employees be expensed over the period service is received. SFAS No. 123 (Revised) becomes effective for annual reporting periods that begin after December 15, 2005. Effective January 1, 2006, the Company adopted this standard using the modified prospective method of transition. SFAS No. 123 (Revised) allows the use of both closed form models (e.g. Black-Scholes Model) and open form models (e.g. lattice models) to measure the fair value of the share-based payment as long as the model is capable of incorporating all of the substantive characteristics unique to share-based awards. In accordance with the transition provisions of SFAS No. 123 (Revised), the expense attributable to an award will be measured in accordance with the Company’s measurement model of that award’s date of grant. The total expenses of stock based employee compensation recorded in future periods will depend on several variables, including the number of share-based awards that vest and the fair value of those vested awards.

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.

The Company has been named as a co-defendant in a lawsuit that has been brought by a debtor and its trustees against certain affiliates of the Company. The amount claimed is $1.5 million. The Company is vigorously defending this claim as it believes it is without merit. Consequently, no provision has been made in the financial statements.

The amounts due to related parties and from related parties are non-interest bearing and are without terms of maturity. They consist mainly of net advances from shareholders of the Company (Sino-Sult Canada (S.S.C.) Limited and Red Coral Group Limited) and are shown in the current assets and liabilities as management expects those advances to be repaid during the next year. The amounts due to directors consist mainly of unpaid remuneration to some of our directors in regards to their employment contracts with the Company.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS (RESTATED)

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

You should read the following discussion of our financial condition and operations in conjunction with the consolidated financial statements and the related notes included elsewhere in this quarterly report. This quarterly report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include statements about our expectations, beliefs, intentions or strategies for the future, which we indicate by words or phrases such as “anticipate,” “expect,” “intend,” “plan,” “will,” “we believe,” “our company believes,” “management believes” and similar language. The forward-looking statements are based on our current expectations and are subject to certain risks, uncertainties and assumptions, including our ability to (1) obtain sufficient capital or a strategic business arrangement to fund our expansion plans; (2) build the management and human resources infrastructure necessary to support the growth of our

business; (3) competitive factors and developments beyond our control; and (4) those other risk factors, uncertainties and assumptions that are set forth in the discussion under the headings captioned “Business,” “Risk Factors,” and “Management’s Discussion and Analysis”. Our actual results may differ materially from results anticipated in these forward-looking statements. We base the forward-looking statements on information currently available to us, and we assume no obligation to update or revise them, whether as a result of new information, future events or otherwise. In addition, our historical financial performance is not necessarily indicative of the results that may be expected in the future and we believe that such comparisons cannot be relied upon as indicators of future performance.

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

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 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.

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

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.

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.

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 – Three Months Ended June 30, 2006 as Compared to Three Months Ended June 30, 2005

One of our subsidiaries, Jiahua Marine is engaged in the manufacturing and selling of health and bio-products. During the three months ended June 30, 2006 and 2005, Jiahua Marine realized sales of $3,944,019 and $2,450,940 respectively, an increase of 61%. The gross profit ratio for this segment stood at 86% and 82% for the three months ended June 30, 2006 and 2005, and the major expense was advertising, corresponding to 27% and 34% of revenues for the three months ended June 30, 2006 and 2005 respectively. The net income contributed by this segment was $2,062,800 and $1,199,512 for the three months ended June 30, 2006 and 2005 respectively, mostly attributable to an increase in volume and improved gross profit margins.

The other principal activity in our Group is the manufacturing and selling of aquatic products. The revenue contributed by this segment was $5,630,062 in the second quarter of 2006 compared to $4,064,815 for the corresponding quarter of 2005, an improvement of 39%. The related gross profit ratio of this segment was 22% in 2006 compared to 18% for the three months ended June 30, 2005. This segment contributed $665,390 to net income in the second quarter of 2006 compared to a net income of $302,284 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 second quarter of 2006 compared to the same period of 2005.

For the three months ended June 30, 2006, revenue increased by $3,058,326 or 47% to $9,574,081. This improvement in sales resulted from a better performance from both segments in 2006. The sales from the health and bio-product segment increased by $1.5 million in the second quarter of 2006 compared to that of 2005, adding to an increase of $1.6 millions from the aquatic segment for the same period.

Cost of sales increased by $1,209,477 or 32.5% to $4,929,634 from $3,720,157 for the three months ended June 30, 2006, as compared to the corresponding period of the prior year. Approximately 87% of the increase was due to the increased activities in the aquatic product segment. The overall gross profit ratio increased from 43% in the second quarter of 2005 to 49% for the current quarter of 2006, due to improved profitability of both of our segments, as described above.

Selling and distribution expenses increased by $73,882 or 112% to $139,660 for the three months ended June 30, 2006, as compared to the corresponding period of the prior year. The increase was the result of higher volumes realized in the current quarter.

Advertising expenses increased by $237,507 or 29% from $830,183 to $1,067,690 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 sales of this particular segment increased by 61% in the current quarter compared to the same period of 2005.

General and administrative expenses increased by $530,595 to $1,060,709 as compared to the corresponding period of the previous year. Half of the increase is the result of additional traveling, marketing, investors’ relation and other head office expenses while the rest of the increase originates from the plants where additional activity was created in 2006 compared to 2005.

Depreciation decreased by $1,821 or 1% to $238,948 as compared to the corresponding period of prior year.

Doubtful accounts contributed an amount of $ 265,905 of recovery in the second quarter of 2006, while there was no provision required in the corresponding quarter of 2005. The recovery in the current quarter came from the settlement of debtors in the health and bio-product segment.

Profit from operations more than doubled in the current quarter to $2,403,345 from $1,128,754 in the corresponding quarter of 2005. That significant improvement resulted from increased sales and gross profit margins from both segments as described above.

Finance costs increased to $1,433,359 from $90,274 for the three months ended June 30, 2006 as compared to the corresponding quarter of the previous year, an increase of $1,343,085. That significant increase was due mostly to the combination of additional financing costs arising from the amortization of the future conversion of warrants attributed to investors on the convertible promissory notes of $5,225,000 issued during the first quarter of 2006 (non-cash) and amortization of the embedded conversion option (also non-cash) related to the same notes. These two non-cash notes related financial costs (amounting to approximately $1,224,000) were recognized in accordance with FAS 123R and EITF 00-27, (which amortization will be repeated quarterly, on a prorata basis, until the first quarter of 2008). Finally, carrying interests on those notes amounting to approximately $105,000 were incurred during the current quarter. No such warrants amortization costs, embedded conversion option amortization and interests on notes were incurred in 2005.

Other expenses/(income). For the three months ended June 30, 2006, $6,722 was reported as other expenses while there was other income of $156,232 for the three months ended June 30, 2005.

Profit before income taxes decreased to $963,264 in the second quarter of 2006 from $1,194,712 in the corresponding quarter of prior year, a reduction of $231,448. That result is mainly due to increased profit from operations of $1,274,591 in the current quarter, which was offset by additional financing costs of $1,343,085 (mostly non-cash) as described above.

Current income taxes increased by $189,119 to $286,498 from $97,379 in the current period. In the second quarter 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.

Deferred income tax increased by $18,355 from $17,043 to $35,398 for the three months ended June 30, 2006. The increase was due to the income tax rate of the aquatic product segment that went from 7.5% to 15.0% after expiration of the tax holiday and concession periods.

As the Company intends to further develop its North American market in the near future, the overall Group’s tax burden should increase as the tax rates in the United States are higher than those experienced in Hainan, PRC.

The net income attributable to shareholders decreased to $641,368 for the three months ended June 30^th 2006, from $1,080,290 for the three months ended June 30, 2005. Although the Company realized higher sales and gross profit margins in both segments in the current quarter, generating a major increase in profit from operations of $1,275,000, that improvement was offset mostly by higher financing costs (mostly non cash) as described above.

Results of Operations – Six Months Ended June 30, 2006 as Compared to Six Months Ended June 30, 2005

One of our subsidiaries, Jiahua Marine is engaged in the manufacturing and selling of health and bio-products. During the six months ended June 30, 2006 and 2005, Jiahua Marine realized sales of $6,155,861 and $4,375,331 respectively, an increase of 41%. The gross profit ratio for this segment stood at 86% and 82% for the six months ended June 30, 2006 and 2005, respectively, and the major expense was advertising, corresponding to 35% and 41% of revenues for the six months ended June 30, 2006 and 2005 respectively. The net income contributed by this segment was $2,622,601 and $1,604,279 for the six months ended June 30, 2006 and 2005 respectively, mostly attributable to an increase in volume and improved gross profit margins.

The other principal activity in our Group is the manufacturing and selling of aquatic products. The revenue contributed by this segment doubled to $10,303,560 for the six months ended June 30, 2006 compared to $5,157,310 for the corresponding period of 2005. The related gross profit ratio of this segment was 18% in 2006 compared to 16% for the six months ended June 30, 2005. This segment contributed $673,423 to net income in the first six months of 2006 compared to a net loss of $93,685 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 six months of 2006 compared to the same period of 2005.

For the six months ended June 30, 2006 revenue increased by $6,926,780 or 73% to $16,459,421. This improvement in sales resulted from a better performance of both segments in 2006. The sales from the health and bio product segment increased by $1.8 million in the first six months of 2006 compared to 2005, while the sales from the aquatic segment improved by $5.1 millions in the same comparative period.

Cost of sales increased by $4,263,766 or 85% to $9,283,089 from $5,019,323 for the six months ended June 30, 2006, as compared to the corresponding period of the prior year. Approximately 95% of the increase was due to the increased activities in the aquatic product segment. The gross profit ratio reduced from 47.4% for the six months ended June 30, 2005 to 43.6% for the same period of 2006. The overall gross profit ratio reduction in the current period is due to the mix of much higher volume from the aquatic product segment (with lesser percentage of gross profit than the other segment) compared to less additional volume from the health and bio product segment.

Selling and distribution expenses increased by $102,442 or 96% to $208,828 for the six months ended June 30, 2006, as compared to the corresponding period of the previous year. The increase was the result of higher volumes realized in the current period, leading to higher transportation costs in the first six months of 2006, compared to that of the corresponding period of 2005.

Advertising expenses increased by $349,423 or 19% from $1,831,002, to $2,180,425 as compared to the corresponding period of prior year. The primary factor responsible for the increase in the first six months of 2006 was that Jiahua Marine posted more advertisements to attract more customers for higher sales; the sales of this particular segment increased by 41% in the first six months of 2006 compared to the same period of 2005.

General and administrative expenses increased by $750,182 or 65% to $1,907,237 as compared to the corresponding period of the previous year. About two third of the increase results from additional traveling, marketing, investors’ relation and head office expenses while the rest of the increase originates from the plants where additional activity was created in 2006 compared to 2005.

Depreciation decreased by $7,645 or 2% to $473,396 as compared to the corresponding period of prior year.

Doubtful accounts contributed an amount of $81,975 of recovery for the six months ended June 30, 2006 compared to a provision of $38,352 for the corresponding period of 2005. The recovery was mainly from the settlement from debtors in the health and bio-product segment during the current quarter.

Profit from operations increased to $2,488,421 year-to-date from $899,482 for the corresponding period of previous year, a 177% improvement. That significant performance was the result of increased sales and gross profit margins from both segments during the first half 2006.

Finance costs increased to $2,607,301 from $181,982 for the six months ended June 30, 2006 as compared to the corresponding period of the previous year, an increase of $2,425,319. That increase was due mostly to the combination of amortization of the future conversion of warrants (non-cash) attributed to investors on the convertible promissory notes of $5,225,000 issued during the first quarter of 2006, added to amortization of the embedded conversion option (also non-cash) related to the same notes. Those two non-cash notes related financial costs (amounting approximately to $2,127,000) were recognized in accordance with FAS 123R and EITF 00-27, (which amortization will be repeated quarterly, on a prorata basis, until the first quarter of 2008). Finally, carrying interests on those notes amounting to approximately $216,000 were incurred during that period. No such warrants amortization costs, embedded conversion option amortization and interests on notes were incurred in 2005.

Other expenses/(income). For the six months ended June 30, 2006,$42,889 was reported as other expenses while there was other income of $89,106 for the corresponding period of 2005.

A loss before income taxes of $161,769 was realized in the first six months of 2006, compared to a profit before income taxes of $806,606 in the corresponding period of the prior year. The significant increase in profit from operations of $1,588,939 for the first half of 2006 as described above was offset by additional financing costs (mostly non-cash) of $2,425,319.

Current income taxes increased by $239,685 to $369,883 from $130,198 in the first six months of 2006. During the period, the aquatic product segment was profitable and taxable at a rate of 15% while it suffered a loss in the corresponding period of 2005.

Deferred income tax increased by $36,197 from $34,086 to $70,283 for the six months ended June 30, 2006. The increase was due to the income tax rate of the aquatic product segment that went from 7.5% to 15.0% after expiration of the tax holiday and concession periods.

The net income attributable to shareholders decreased from an income of $642,322 for the six months ended June 30^th 2005, to a loss of $601,935 for the six months ended June 30, 2006. Although the Company improved its sales and gross profit margins in the first half of 2006 in both segments, thus generating a much improved profit from operations of $1,588,939, that profit was offset by higher financing costs of $2,425,319 (mostly non-cash), as described above.

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 to 3.55 times ($21,252,285/$5,983,093) at June 30, 2006, from and 2.3 times ($14,989,554/6,555,210) at December 31, 2005.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as

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

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

During the Quarter ended June 30, 2006, there was no change in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

A complaint was filed in the Superior Court (Commercial Division) in Quebec, Canada requesting that the transfer of the assets of Upsilon International Commerce Marine (Suci Marine) Inc. to Hainan Fuyan Industrial Investments Company Ltd. and then to Jade Profit Investment Ltd. be voided (In the Matter of the Bankruptcy of: Upsilon International Commerce Marine (Suci Marine) Inc. (Debtor) and Andrew Dalgleish & Associates Inc. (Trustee), and Bank of China (Canada) (Creditor) v. Hainan Fuyan Industrial Investments Company Ltd., Jade Profit Investment Ltd. , Norbert Sporns, Lillian Wang, Hua Wang, HQ Sustainable Maritime Industries, Inc. and the United States Securities and Exchange Commission (impleded); Province of Quebec, Superior Court, District of Quebec, No. 500-11-021796-038). The Company believes that the case is without merit and shall be seeking damages in a countersuit.

During the period covered by this report, we have sold securities pursuant to the following transactions, all of which were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”). We plan to use the proceeds of all such issuances for working capital and general corporate purposes.

On April 7, 2006, we issued 50,000 of our common stock to Joseph I. Emas in consideration of legal service provided to us by him, amounting to $17,000. These securities were issued in reliance upon the exemption from registration provided in Section 4(2) of the Securities Act.

On May 23, 2006, we issued 250,000 shares of our common stock to Stanley Wunderlick in consideration of financial service provided to us by him, amounting to $77,500. These securities were issued in reliance upon the exemption from registration provided in Section 4(2) of the Securities Act.

On June 23, 2006, we issued 1,140,481 shares of our common stock as monthly repayment of capital and interest to the promissory notes holders for an equivalent consideration of $269,143.

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

Pursuant to the requirements of Section 13 or 15(b) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, Washington, on October 5, 2006


HQ SUSTAINABLE MARITIME INDUSTRIES, INC.

By:		/s/ Norbert Sporns
		Name: Norbert Sporns
		Title: Chief Executive Officer and President

		/s/ Jean-Pierre Dallaire
		Jean-Pierre Dallaire,
		Principal Financial and Accounting Officer


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


		Page Numbers
PART I - FINANCIAL INFORMATION

Item 1. Financial Statements
x Condensed Consolidated Balance Sheets		4-5
x Condensed Consolidated Statements of Income		6
x Condensed Consolidated Statements of Cash Flows		7
x Notes to Condensed Consolidated Financial Statements		8-11
Item 2. Management Discussion & Analysis		12-15
Item 3. Controls and Procedures		16

PART II - OTHER INFORMATION

Item 1. Legal Proceedings		17
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		17
Item 3. Defaults Upon Senior Securities		17
Item 4. Submission of Matters to a Vote of Security Holders		17
Item 5 Other Information		17
Item 6. Exhibits and Reports on Form 8-K		18


	June 30, 2006 (Unaudited) (Restated)		December 31, 2005 (Audited)
CURRENT ASSETS
Cash and cash equivalents	$	6,549,395	$	5,140,159
Trade receivables, net of provision		11,346,155		8,423,127
Inventory		2,183,274		557,464
Prepayments		415,550		131,864
Due from related parties, net of provision		706,534		526,195
Advance to employees		51,377		127,231
Tax recoverable		—		83,514

TOTAL CURRENT ASSETS		21,252,285		14,989,554

OTHER ASSETS
Deferred taxes		869,449		926,623
Deferred cost		1,273,300		500,000

TOTAL OTHER ASSETS		2,142,749		1,426,623

PROPERTY, PLANT AND EQUIPMENT, NET		7,717,283		8,000,503

TOTAL ASSETS	$	31,112,317	$	24,416,680


	June 30, 2006 (Unaudited) (Restated)			December 31, 2005 (Audited)
CURRENT LIABILITIES
Accounts payable and accrued expenses	$	2,143,014		$	2,617,446
Bank loans		1,302,876			1,726,264
Tax payable		229,151			73,245
Due to related parties		745,097			787,716
Due to directors		1,562,955			1,350,539

TOTAL CURRENT LIABILITIES		5,983,093			6,555,210

LONG TERM LIABILITIES
Convertible promissory notes		1,198,978			—

TOTAL LIABILITIES		7,182,071			6,555,210

SHAREHOLDERS’ EQUITY
Preferred stock		100			100
Common stock		118,536			116,105
Additional paid-in capital		21,787,779			15,574,752
Accumulated other comprehensive income		875,768			499,251
Retained Earnings (Deficit)		(1,419,538	)		(314,583	)
Appropriation of retained earnings (Reserves)		2,567,601			1,985,845

TOTAL SHAREHOLDERS’ EQUITY		23,930,246			17,861,470

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	31,112,317		$	24,416,680


	Three Months Ended						Six Months Ended
	June 30, 2006 (Restated)			June 30, 2005			June 30, 2006 (Restated)			June 30, 2005
SALES	$	9,574,081		$	6,515,755		$	16,459,421		$	9,532,641
COST OF SALES		4,929,634			3,720,157			9,283,089			5,019,323

GROSS PROFIT		4,644,447			2,795,598			7,176,332			4,513,318
SELLING AND DISTRIBUTION EXPENSES		139,660			65,778			208,828			106,386
ADVERTISING		1,067,690			830,183			2,180,425			1,831,002
GENERAL AND ADMINISTRATIVE EXPENSES		1,060,709			530,114			1,907,237			1,157,055
DEPRECIATION		238,948			240,769			473,396			481,041
(RECOVERY)/PROVISION FOR DOUBTFUL ACCOUNTS		(265,905	)		—			(81,975	)		38,352

PROFIT FROM OPERATIONS		2,403,345			1,128,754			2,488,421			899,482
FINANCE COSTS		1,433,359			90,274			2,607,301			181,982
OTHER EXPENSES/(INCOME)		6,722			(156,232	)		42,889			(89,106	)

PROFIT (LOSS) BEFORE INCOME TAXES		963,264			1,194,712			(161,769	)		806,606
INCOME TAXES
CURRENT		286,498			97,379			369,883			130,198
DEFERRED		35,398			17,043			70,283			34,086

NET PROFIT (LOSS) ATTRIBUTABLE TO SHAREHOLDERS	$	641,368		$	1,080,290		$	(601,935	)	$	642,322

NET INCOME (LOSS) PER SHARE
BASIC AND DILUTED	$	0.005		$	0.010		$	(0.005	)	$	0.010

WEIGHTED AVERAGE COMMON SHARE OUTSTANDING		117,349,333			99,320,179			117,102,705			97,766,208

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	2006 (Restated)			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	(601,935	)	$	642,322
Adjustments to reconcile net income to net cash provided by operating activities:
Loss on disposal of fixed assets		2,350			—
Common stock issued/to be issued for services		6,215,458			619,425
Depreciation and amortization		473,396			481,041
(Increase)/decrease in assets:
Inventory		(1,625,810	)		(113,733	)
Trade receivables, net of provisions		(2,923,028	)		(1,531,749	)
Prepayment		(283,686	)		—
Advance to employees		—			(191,760	)
Deferred taxes		57,174			34,087
Increase/(decrease) in liabilities:
Accounts payables and accrued expenses		(474,432	)		(625,600	)
Advance from employees		75,854			—
Taxes payable		239,420			130,198

Net cash from (by) operating activities		1,154,761			(555,769	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property, plant and equipment and construction in progress		(82,951	)		—

Net cash from (by) investing activities		(82,951	)		—

CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of convertible promissory notes		4,512,571			—
Received/(payment) from/to directors		210,278			(10,217	)
(Payment to)/receive from related parties		(222,958	)		367,726
Deferred financial costs		(4,086,893	)		—
Repayment of bank loans		(423,388	)

Net cash from (by) financing activities		(10,390	)		357,509

NET CHANGE IN CASH AND CASH EQUIVALENTS		1,061,420			(198,260	)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS		347,816			—
Cash and cash equivalents, beginning of period		5,140,159			4,551,505

Cash and cash equivalents, end of period	$	6,549,395		$	4,353,245

SUPPLEMENTARY CASH FLOWS DISCLOSURES
Interest paid	$	20,569		$	158,982

Taxes paid	$	121,538		$	—

SUPPLEMENTARY DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Common shares issued for services	$	195,000		$	—

Note payable in connection with acquisition of Jiahua Marine	$	—		$	100,000


	Net Income (loss) for the quarter ended June 30, 2006		Earnings (loss) per share, for the quarter ended June 30, 2006		Long-term liabilities as of June 30, 2006		Additional Paid In Capital as of June 30, 2006
As previously stated	1,192,165		0.010		2,826,568		19,198,269
Embedded conversion option (On notes)
Embedded conversion option (On notes) As of March 31, 2006					(2,589,510	)	2,589,510
Amortization of embedded conversion option	(550,797	)	(0.005	)	961,920

Restated	641,368		0.005		1,198,978		21,787,779


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

Effective tax rate	15.0	%	7.5	%


	Aquaculture Product		Health and Bio-product		Unallocated Items		Consolidation
Sales to external customers	5,630,062		3,944,019		—		9,574,081

General and administrative expenses	210,719		195,185		654,805		1,060,709
Depreciation	156,670		78,542		3,736		238,948
Selling expenses	53,579		86,081		—		139,660
Advertising	—		1,067,690		—		1,067,690
Finance costs	(2,427	)	17,505		1,418,281		1,433,359
Recovery for doubtful accounts	(10,105	)	(255,800	)	—		(265,905	)
Profit (Loss) before taxation	828,961		2,211,125		(2,076,822	)	963,264
Income taxes	163,571		148,325		10,000		321,896
Profit (Loss) for the period	665,390		2,062,800		(2,086,822	)	641,368

Segment assets	16,645,537		11,706,989		6,073,384		34,425,910

Segment liabilities	2,820,591		2,019,810		5,655,263		10,495,664


	Aquaculture Product	Health and Bio-product	Unallocated Items		Consolidation
Sales to external customers	4,064,815	2,450,940	—		6,515,755

General and administrative expenses	98,984	16,705	414,425		530,114
Depreciation	163,824	75,310	1,635		240,769
Selling expenses	48,582	17,196	—		65,778
Advertising	—	830,183	—		830,183
Finance costs	58,706	30,810	758		90,274
Profit (Loss) before taxation	319,327	1,296,891	(421,506	)	1,194,712
Income taxes	17,043	97,379	—		114,422
Profit (Loss) for the period	302,284	1,199,512	(421,506	)	1,080,290

Segment assets	13,304,542	8,318,610	507,804		22,130,956

Segment liabilities	5,562,967	2,303,695	1,391,124		9,257,786


31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

31.2		Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

32.1		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.

32.2		Certification of Principal Financial and Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.


Exhibit Number		Description
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

31.2		Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

32.1		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.

32.2		Certification of Principal Financial and Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act.