10-K/A 1 d10ka.htm FORM 10-K AMENDMENT NO. 2 Form 10-K Amendment No. 2
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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K/A

Amendment No. 2

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

Commission file number: 001-33473

 

 

HQ SUSTAINABLE MARITIME INDUSTRIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   62-1407522
(State of incorporation)   (I.R.S. Employer Identification No.)

1511 Third Avenue, Suite 788,

Seattle, Washington 98101

(Address of principal executive offices)

(206) 621-9888

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title Of Each Class

 

Name of Exchange on which registered

Common Stock, Par Value $0.001 Per Share   American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ¨  Yes    x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨  Yes    x  No

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

The aggregate market value of the registrant’s voting stock (based on the closing sale price quoted on the American Stock Exchange) held by non-affiliates as of June 30, 2008 was approximately $113,100,000.

As of December 31, 2008, there were issued and outstanding 12,085,846 shares of common stock, $0.001 par value per share, and 100,000 shares of Series A preferred stock, $0.001 par value per share.

 

 

 


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Explanatory Note

This Amendment No. 2 on Form 10-K/A (this “Amendment”) to the Annual Report on Form 10-K for the year ended December 31, 2008 (the “Original Annual Report”), as amended by Amendment No. 1 (collectively with the Original Annual Report, the “Amended Annual Report”), of HQ Sustainable Maritime Industries, Inc. (the “Company”) is being filed to (i) amend and restate Items 3, 7, 11 and 13, (ii) include one amended sub-section under Item 1 and (iii) incorporate the Company’s income statement, statement of stockholders’ equity and statement of cash flows for the year ended December 31, 2006 into the financial statements presented under Item 8, make conforming changes to the notes to the financial statements and make conforming changes to the corresponding audit reports. In addition, the Company is including as exhibits to this Amendment the consents of the independent auditors and the certifications required pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002.

Except as described above, this Amendment does not attempt to modify or update any other disclosures set forth in the Company’s Amended Annual Report. Accordingly, the remainder of the Company’s Amended Annual Report remains unchanged and is not reproduced in this Amendment. This Amendment continues to speak as of March 12, 2009, the date of our initial filing of the Original Annual Report, and unless otherwise indicated herein, does not reflect information obtained after that date. Therefore, in conjunction with reading this Amendment, you also should read all other filings that we have made with the Securities and Exchange Commission since March 12, 2009.

 

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Cautionary Notice Regarding Forward-Looking Statements

We make certain statements in this Amendment and in other materials we file with the Securities and Exchange Commission (“SEC”) or otherwise make public that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). A forward-looking statement is a statement that is not a historical fact and includes, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and other words or phrases with similar meaning in connection with a discussion of future operating or financial performance. In particular, these include statements relating to future actions, trends in our businesses, prospective products, future performance or financial results. The Company claims the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the results contained in the forward-looking statements. The forward-looking statements we make are not guarantees of future performance and are subject to various assumptions, risks and other factors that could cause actual results to differ materially from those suggested by these forward-looking statements. These factors include, among others, those set forth in “Risk Factors” in our Original Annual Report on Form 10-K filed on March 12, 2009 and the risk factors and other cautionary statements in the other documents that we file with the SEC. There also are other factors that we may not describe (generally because we currently do not perceive them to be material) that could cause actual results to differ materially from our expectations. Moreover, we operate in a rapidly changing and competitive environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors. Further, it is not possible to assess the impact of all risk factors on the Company’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

 

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PART I

 

ITEM 1. BUSINESS

The disclosure below replaces the sub-section “Item 1. Business – Distribution Channels” that appeared in the Original Annual Report. Other than this change, the disclosure provided under “Item 1. Business” in the Original Annual Report remains unchanged and is not reproduced herein.

Distribution Channels

Our current sales activity is primarily directed to distributors within the People’s Republic of China (“PRC”), rather than within the U.S. At the present time, we sell more than 90% of our seafood products in China to Asian clients which are then distributed principally in the United States and Europe, and we sell all of our marine bio and healthcare products exclusively in the PRC. Through our Seattle office, we are able to work directly with wholesale and retail buyers. The programs established with retail distributors are rather different than with wholesalers. Retailers require product introduction and marketing support and pay differently than wholesalers. The latter generally take delivery of product ex-plant and pay through a letter of credit, while the former take delivery in the United States and pay on negotiated terms.

The Seattle office is charged with maintaining existing accounts and introducing our toxin free tilapia products to a new target market of retail and food service industry purchasers. We plan to introduce our family of products branded “Lillian’s Healthy Gourmet” throughout North America in 2009. We are currently selling our toxin free tilapia products to the European market through distributors and retailers. We are actively seeking to expand our distributor network in Europe for our TILOVEYA® brand.

Currently, all of our marine bio and healthcare products are sold in the PRC. Through our subsidiary Jiahua Marine, we currently sell a range of healthcare products under the brand name “Jiahua” in the PRC.

Our China sales are principally marketed through our offices in Wenchang to customers that include domestic supermarkets, airlines, hotels and local distributors. Direct sales of healthcare products target tourists in various popular destinations in China, such as Sanya, Beihai and the Three Gorges project. Seminars are organized for these tourists that usually result in the purchase of our products. These products are also sold in various chain stores, over the internet, and through mail order sales throughout China.

 

ITEM 3. LEGAL PROCEEDINGS

During the first half of 2008, a final judgment from the American Arbitration Association was imposed on us to pay to Westminster Securities and John O’Shea an amount of approximately $699,000 as unpaid commissions to the plaintiffs. As those unpaid commissions related to financing activities, we recognized such payments in the finance costs in our income statement for the year ended December 31, 2008.

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.

 

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PART II

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes forward-looking statements. We have based these forward-looking statements on our current plans, expectations and beliefs about future events. There are risks that our actual experience will differ materially from the expectations and beliefs reflected in the forward-looking statements in this section. See “Cautionary Notice Regarding Forward-Looking Statements.”

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 Amendment and the Annual Report.

General overview

We are a leader in toxin-free vertically integrated aquaculture and aquatic product processing and we have processing facilities located in Hainan, PRC. We have two processing plants in Hainan, one that processes aquatic products providing toxin-free tilapia and other aquatic products, and the other processes marine bio and healthcare products. We market our products in Asia, America and Europe. We seek to expand our operations by providing additional processing facilities in China such as the construction of our third facility in early 2009, which will process extruded feed, and increasing our marketing efforts throughout North America and Europe. Our current sales activity is primarily directed to distributors within PRC, rather than within the U.S.

Recently, we announced that we had entered into a conditional agreement with the government of Tayang Town in the Province of Hainan, PRC in order to work with their cooperative farms, which can produce about 20,000 tons of live weight tilapia. We expect this agreement to result in doubling the farming capacity available to us. Currently, there is no financial commitment for the Company since the agreement with the government of Tayang Town is conditioned upon the Company’s investing in the construction of a new feed mill and processing plant in the immediate vicinity of the cooperative farms in Qionghai City and this has not happened yet.

In addition, you should consider the following information as you read the below results of operations discussion and our financial statements and related notes included elsewhere in this Amendment. From the first quarter of 2004, following our reverse merger with Process Equipment, Inc., we have been operating under the name of HQS. At that time, we owned 84.4 percent of Hainan Quebec Ocean Fishing Co. Ltd. (“HQOF”), currently our principal operating subsidiary that processes our seafood products. In August 2004, we acquired the remaining ownership interest in HQOF. The fiscal year-end of Process Equipment Inc. was changed from April 30 to December 31 following the reverse merger. In August 2004, we acquired a 100 percent interest in our current subsidiary Jiahua Marine, which operates a marine bio and healthcare plant, including nutraceuticals, in Hainan Province, China. In the first half of 2005, our aquatic processing plant stopped production in order to add production lines and increase its production capacity to properly meet forecasted incremental demand, which affected some of our operating results during that period.

Our business operations consist of two segments, the marine bio and healthcare product segment and the aquaculture product segment. Since the acquisition of Jiahua Marine, which represents the marine bio and healthcare product segment, those product sales have represented a significant contribution to the net income of the Company and currently are higher profit margin products than our aquaculture products. The Company expects the sales and contribution to net income to continue during the next year in similar proportions. However, as the marketing efforts increase in connection with the aquaculture product segment and the investment in the feed mill plant and equipment for new processing capacity of extruded feed is completed, the Company expects that the aquaculture product segment will begin to contribute a greater portion of income and a higher profit margin in the future.

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

Critical accounting policies and estimates

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

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

 

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Inventories

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

Income taxes

Taxes are calculated in accordance with taxation principles currently effective in the PRC. The Company accounts for income taxes under the provision of Statements of Financial Accounting Standards No. 109, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. We account 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

The Company recognizes revenue when the significant risks and rewards of ownership have been transferred to the customer, including factors such as when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is probable. The Company recognizes sales when the merchandise is shipped, title has passed to the customers and collectibility is reasonably assured.

Concentration of credit risk

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

Recent developments

Results of Operations—Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Total sales for the year ended December 31, 2008 increased by $12,753,072, or 23 percent compared to the same period of 2007. The aquaculture product segment’s sales increased by $9,121,963, or 25 percent while the health and bio-products segment’s sales increased by $3,631,109 or 19 percent. Income from operations for the year ended December 31, 2008 increased by 17 percent when compared to 2007; that improvement was due mostly to the higher sales and gross profit of 2008 originating from both of our segments. A net income of $10,040,688 was generated in 2008, increasing from $4,486,562 in 2007, an increase of 124 percent in 2008. That significant increase in 2008 is attributable to the increased sales and gross profit of 2008 from both our segments, coupled to a reduction of financing costs in 2008 and no income taxes from our aquaculture products segment since January 2008. Financing costs have decreased by $3,194,383 or 55 percent to $2,662,734 as compared to $5,857,117 for 2007. Financing costs will continue to decrease in 2009 as the maturity of the promissory notes, triggering the warrants amortization costs (non-cash) and the related amortization of the embedded conversion option (also non-cash), will occur in November 2009. Those financing costs are recognized as such in accordance with FAS 123R and EITF 00-27.

Segments

Manufacturing and selling of aquatic products

Hainan Quebec Ocean Fishing Co. Ltd. is engaged in the processing and selling of aquatic products. The revenue contributed by this segment was $45,370,400 and $36,248,437 for the years ended December 31, 2008 and 2007, respectively, an improvement of 25 percent. Our aquaculture sales in 2008 and in 2007 were realized from three sources: tilapia, shrimp and ocean caught fish. Of the total increase in sales during 2008 compared to 2007, 46% originated from tilapia, 32% originated from shrimp and 22% from ocean caught fish. The tilapia increase in sales in 2008 compared to 2007 was mostly the result of increased prices in the first half of 2008,

 

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because market conditions forced the prices up as a result of a supply shortage in the industry due to an especially harsh 2007-2008 freezing winter in China. Shrimp sales increased in 2008 compared to 2007 due to a combination of both increase in volume and price. Volume of shrimp sold increased by 18% while prices increased by approximately 17%. Sales of shrimp occurred mostly in the second half of the year. Finally, sales originating from ocean caught fish, which also occur mostly in the second half of the year, were the result of a combination of increased prices of 20% and increased volumes of approximately 35%. In 2008, the production capacity of our fish processing plant was increased by 50 percent, effective as of the third quarter of the year. The related gross profit ratio of this segment was 25 percent and 27 percent for the years ended December 31, 2008 and 2007, respectively. The second half of 2008 showed a recovery in the percentage of gross profit as compared to the first half of the year when gross profit margins were hurt significantly due to the international markets’ failure to recognize the difficult position of the tilapia industry during that period. This segment contributed $9,963,357 and $6,299,304 to net income for the years ended December 31, 2008 and 2007, respectively. The significant increase in sales and related gross profit of this segment in 2008, combined with bad debt recovery and no income taxes since January 2008, led to favorable improvement in the profitability in 2008 compared to 2007.

Manufacturing and selling of health and bio-products

Our other manufacturing subsidiary, Jiahua Marine, is engaged in the manufacturing and selling of marine bio and healthcare products. During the years ended December 31, 2008 and 2007, Jiahua Marine realized sales of $22,352,883 and $18,721,774, respectively, an increase of 19 percent. Approximately 88% of the increase in sales in 2008 compared to 2007 was the result of a combination of increase in volumes and sales prices originating from our shark processed related products. The gross profit ratio from this segment was 75 percent and 84 percent for the years ended December 31, 2008 and 2007, respectively. That reduction in gross profit experienced in 2008 was the result of a different sales mix, added to development costs incurred in relation to new products to be marketed in 2009, and finally to market penetration costs incurred from the second half of 2008. The major expense of this segment was advertising, representing 20 percent and 28 percent of revenue for the year ended December 31, 2008 and 2007, respectively. The net income contributed by this segment was $8,999,699 and $7,984,935 for the years ended December 31, 2008 and 2007, respectively, an increase of 13 percent in the year in 2008.

Operations

Sales. For the year ended December 31, 2008, sales increased by $12,753,072, or 23 percent, to $67,723,283 from $54,970,211. This significant increase in sales was the result of better performances of both segments in 2008. Sales from the aquaculture product segment increased by $9,121,963, or 25 percent, while sales from the health and bio product segment increased by $3,631,109, or 19 percent in 2008, compared to 2007. In 2008, the production capacity of our fish processing plant increased by 50 percent, effective as of the third quarter of the year.

Cost of Sales. Cost of sales increased by $10,099,015, or 34 percent, to $39,525,933 from $29,426,918 for the year ended December 31, 2008, as compared to the year ended December 31, 2007. The overall gross profit margin decreased from 46 percent for the year ended December 31, 2007 to 42 percent for the year ended December 31, 2008, mostly due to the margin decrease in the health and bio-product segment related to product mix, the development costs of new products to be marketed in 2009 and the market penetration costs incurred in 2008.

Selling and distribution expenses. Selling and distribution expenses increased by $709,597, or 84 percent, from $841,263 to $1,550,860 for the year ended December 31, 2008, as compared to 2007. The increase was the result of higher sales volumes realized in the current year from both our segments, including higher transportation costs.

Marketing and advertising expenses. Marketing and advertising expenses decreased by $735,921, or 14 percent, from $5,162,299 to $4,426,378 for the year ended December 31, 2008, as compared to 2007. The reduction in those expenses is mostly due to the winding down of publicity programs for those products that have successfully penetrated the targeted markets and that have raised consumer awareness about our products. In 2008, we continued to maintain a high level of advertising in order to sustain our market share in this highly competitive market as is consistent with industry practices.

General and administrative expenses. For the year ended December 31, 2008, general and administrative expenses increased by $1,405,632, or 29 percent, to $6,205,993, as compared to 2007. The major part of the increase was the result of additional costs related to Sarbanes Oxley’s documentation and audit requirements of section 404 (approximately $215,000), increased franchise tax from State of Delaware (approximately $263,000), branding-related expenses (approximately $105,000), traveling (approximately $173,000), investors’ relations (approximately $47,000) and other U.S. head office expenses.

Depreciation and amortization. Depreciation and amortization increased by $239,172 to $1,456,456 for the year ended December 31, 2008, mainly as a result of acquisition of fixed assets in 2008 triggering new depreciation charges.

 

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(Recovery of)/Provision for doubtful accounts. Recovery of doubtful accounts amounted to $491,223 for the year ended December 31, 2008 compared to a provision of $672,086 for the year ended 2007. The 2008 recovery originated from the aquaculture segment where the statistical estimate provided in 2007 reversed in 2008.

Income from operations. Income from operations increased to $15,048,886 in financial year 2008, compared to $12,850,000 in 2007, an improvement of 17 percent. That improvement in 2008 is mostly the result of increased sales and related gross profit from both our segments in 2008 as described above, added to bad debt recovery and offset by increased selling, marketing and general and administrative expenses.

Finance costs. Finance costs decreased to $2,662,734 from $5,857,117 for the year ended December 31, 2008 as compared to the previous year, a reduction of $3,194,383 or 55 percent. Included in the 2008 finance costs are the non-recurring costs of $699,000 recognized in relation to the final judgment on the Westminster Securities and John O’Shea claims against the Company and settled in the first half of 2008. In addition, by virtue of a Waiver and Amendment Agreement dated February 22, 2008 and relating to the promissory notes issued in November 2006, included also in the first half of 2008 are the non-recurring costs of penalties and interests amounting to approximately $1,621,000 regarding the late filing of the registration statement relating to the underlying shares of the convertible notes issued in November 2006. Finally, the carrying interests on the promissory notes issued in 2006 added to the continued combination of amortization of the future conversion of warrants (non–cash) attributed to investors on those notes of $10,225,000 issued in 2006, and to the amortization of the embedded conversion option (also non–cash) related to the same notes. Those non-cash financing costs were recognized in accordance with FAS 123R and EITF 00-27. Such amortization will be repeated, on a pro-rata basis, until maturity of the underlying notes. Finance costs will continue to decrease in 2009 as the maturity of the promissory notes will occur in November 2009.

Other income. Other income amounted to $567,876 in 2008 compared to $42,491 in 2007. The 2008 balance was mostly the result of a non-recurring gain on disposal of fixed assets of approximately $495,000 during the last quarter of 2008.

Income before income taxes. Income before income taxes increased by $5,918,654 to $12,954,028 for the year ended December 31, 2008, from $7,035,374 in 2007. That significant increase is the result of increased income from operations as described above coupled with a reduction in finance costs.

Current income tax. Current income taxes decreased by $453,836 to $2,094,976 from $2,548,812 for the year ended December 31, 2008 and December 31, 2007, respectively. Income taxes were lower in 2008 due to the application of the new PRC Enterprise Income Tax Law (EIT), which became effective on January 1, 2008. That new Law provides, amongst other issues, that income derived from processing of fishery products is now exempted from income tax while it stood at 15 percent in 2007. Furthermore, with regards to our nutraceutical unit, the income tax rate increased to 18 percent in 2008 from 15 percent in 2007; for that segment, the income tax rate will gradually increase to a maximum of 25 percent by 2012.

Deferred income tax. Deferred income taxes increased from NIL in 2007 to $818,364 for year ended December 31, 2008. The increase was the result of a non-recurring write-off of deferred taxation representing an expense of approximately $818,000 related to the sale of fixed assets. Otherwise, there was no deferred income tax recognized in both financial years as there were no other material timing differences to justify recognition of such deferred tax expenses.

Net income attributable to shareholders. Net income attributable to shareholders increased significantly from $4,486,562 for the year ended December 31, 2007, to $10,040,688 for the year ended December 31, 2008. That increase of 124 percent in net income was the result of increased sales and gross profit from both segments in 2008, added to a reduction in finance costs and income taxes as described above.

Results of Operations—Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Total sales for the year ended December 31, 2007 increased by $15,874,808 or 41% compared to the same period of 2006. While both of our segments contributed to that increase, the aquaculture segment contributed more significantly as higher demand for our products materialized during 2007. Income from operations for the year ended December 31, 2007 increased by 82% when compared to 2006; that major improvement was due mostly to the higher sales and gross profit of 2007 originating from our aquaculture product segment. A net income of $4,486,562 was generated in 2007, increasing from $873,964 in 2006; that increase in 2007 is mostly attributed to the aquaculture segment. Financing costs have increased by $673,550 or 13% to $5,857,117 as compared to $5,183,567 for 2006. In 2007, we incurred approximately $900,000 of penalties for late filing of the registration statement in regards to the November 2006 financing and $670,000 of penalties for late payment of interests on the same financing. Those penalties were recognized as financing costs in 2007 and they were paid in common shares issued by the Company in March 2008. Furthermore, the amount of the claim attributed to Westminster Securities Corp. by the American Arbitration Association (“AAA”) was accounted for, as determined by the AAA, in the financing costs. The warrants amortization costs (non–cash) related to the promissory notes and the amortization of the related embedded conversion option (non–cash), make-up the major part of the financial costs and are recognized as such in accordance with FAS 123R and EITF 00–27.

 

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Segments

Manufacturing and selling of health and bio-products

Jiahua Marine is engaged in the manufacturing and selling of marine bio and healthcare products. During the years ended December 31, 2007 and 2006, Jiahua Marine realized sales of $18,721,774 and $15,302,713 respectively, an increase of 22%. The gross profit ratio from this segment was 84% and 86% for the years ended December 31, 2007 and 2006 respectively. The major expense of this segment was advertising, representing 28% and 30% of revenue for the year ended December 31, 2007 and 2006 respectively. The net income contributed by this segment was $7,984,935 and $7,339,374 for the years ended December 31, 2007 and 2006 respectively, an increase of 9% in the year in 2007. A recovery of bad debt of $900,410 improved the 2006 net income as such recovery did not occur in 2007. Notwithstanding such 2006 debt recovery, the growth in net income would have shown more than 21% improvement in 2007 compared to 2006. The improvement in the net income was mostly contributed by the increase in sales in the current year compared to 2006.

Manufacturing and selling of aquatic products

Our other subsidiary, HQOF, is engaged in the processing and selling of aquaculture products. The revenue contributed by this segment was $36,248,437 and $23,792,690 for the year ended December 31, 2007 and 2006, respectively, an improvement of 52%. The related gross profit ratio of this segment was 27% and 17% for the year ended December 31, 2007 and 2006 respectively. Such improvement in the gross profit ratio was due to the combination of overall selling price increases of our tilapia products in 2007 combined to increased volumes which generated average costs reductions. This segment contributed $6,299,304 and $1,273,290 to net income for the year ended December 31, 2007 and 2006 respectively. The sharp increase in sales of this segment in 2007, together with the increase in gross profit margin led to such favorable improvement in the profitability in 2007 compared to 2006.

Operations

Sales. For the year ended December 31, 2007, sales increased by $15,874,808 or 41% to $54,970,211 from $39,095,403. That significant increase in sales was the result of better performances of both segments in 2007. The sales from the marine bio and healthcare product segment increased by $3,419,061, or 22% in 2007 compared to 2006, while the sales from the aquaculture segment improved by $12,455,747 or 52% in the same comparative period.

Cost of Sales. Cost of sales increased by $7,509,573 or 34% to $29,426,918 from $21,917,345 for the year ended December 31, 2007, as compared to the year ended December 31, 2006. The overall gross profit margin increased from 44% for the year ended December 31, 2006 to 46% for the year ended 2007, mostly originating from increased selling prices and sales volumes in the aquaculture segment during 2007.

Selling and distribution expenses. Selling and distribution expenses increased by $249,887 or 42% from $591,376 to $841,263 for the year ended December 31, 2007, as compared to 2006. The increase was the result of higher sales volumes realized in the current year from our two segments, leading to higher transportation costs in 2007, as compared to those of 2006.

Marketing and advertising expenses. Marketing and advertising expenses increased by $614,684 from $4,547,615 to $5,162,299 for the year ended December 31, 2007, as compared to 2006. The primary factor responsible for that increase in 2007 was that the health and bio-products segment maintained a proportionate level of advertising in order to sustain its market share in its highly competitive and developed market. Furthermore, heavy advertising expenditures for the promotion of our bio–products to achieve better customer recognition are consistent with industry practices.

General and administrative expenses. For the year ended December 31, 2007, general and administrative expenses increased by $126,682 or 3% to $4,800,361, as compared to the corresponding period of 2006. Most of the increase was the result of additional branding-related expenses and traveling.

Depreciation and amortization. Depreciation and amortization increased by $187,612 to $1,217,284 for the year ended December 31, 2007, mainly as a result of the amortization of intangible assets related to the purchase of a U.S. distribution network in the third quarter of 2006. Furthermore, acquisition of fixed assets in 2007 triggered additional depreciation.

Provision for/(Recovery of) doubtful accounts. Doubtful accounts amounted to $672,086 for the year ended December 31, 2007 compared to a recovery of $706,514 for the year ended 2006. The 2006 recovery originated from the health and bio-product segment while the 2007 provision originated from the aquaculture segment. The 2007 provision is the result of an estimate of unfavorable settlements that might occur with clients being late in their payments.

Income from operations. Income from operations increased to $12,850,000 in financial year 2007, compared to $7,042,230 in 2006, an 82% improvement. That improvement in the current year is the result of increased sales and related gross profit from both our segments in 2007, mostly the aquaculture segment, offset by increased bad debt estimated during the current year.

 

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Finance costs. Finance costs increased to $5,857,117 from $5,183,567 for the year ended December 31, 2007 as compared to the previous year, an increase of $673,550 or 13%. Included in the 2007 finance costs are the carrying interests on the promissory notes issued in 2006 added to the continued combination of amortization of the future conversion of warrants (non–cash) attributed to investors on those notes of $10,225,000 issued in 2006, and to the amortization of the embedded conversion option (non–cash) related to the same notes. Those non-cash financing costs were recognized in accordance with FAS 123R and EITF 00-27. Such amortization will be repeated, on a pro-rata basis, until maturity of the underlying notes. Furthermore, in 2007, we incurred approximately $900,000 of penalties for late filing of the registration statement in regards to the November 2006 financing and $670,000 of penalties for late payment of interests on the same financing. Those penalties were recognized as financing costs in 2007 and they were paid in common shares issued by the Company in March 2008. Finally, the effect of the decision rendered in January 2008 (but appealed) in the arbitration proceeding in regards to claims of an investment banker were included as finance costs for the amount attributed to the claimant.

Other (income)/ expenses. For 2007, $42,491 was reported as other income while other expenses of $16,731 was recorded for 2006.

Income before income taxes. Income before income taxes increased by $5,193,442 to $7,035,374 for the year ended December 31, 2007, from $1,841,932 in 2006. That significant increase was mostly the result of increased volume and gross profits from both segments experienced during 2007, offset mostly by the penalties and arbitration decision described above in the finance costs and also to the provision for bad debts.

Current income tax. Current income taxes increased by $1,723,394 to $2,548,812 from $825,418 for the year ended December 31, 2007. The increase was mainly due to higher taxable income experienced in 2007 from both segments, as described above, and to the termination of the tax rate holiday period in the health and bio-product segment as of December 31, 2006. The actual tax rate for both segments was 15% in 2007. On March 17, 2007, a new PRC Enterprise Income Tax Law (EIT) was promulgated and introduced a new uniform tax regime in the PRC. The EIT became effective on January 1, 2008. That new Law provides, amongst other issues, that income derived from processing of fishery products and processing of agricultural products will be exempt from the EIT tax rate. Starting in 2008, our existing fish processing unit and our new feed mill plant which is under construction will both benefit from a “0”% tax rate. As we forecast commencement of the construction of a new processing plant in 2008 to be in operation in 2009, that new plant will also benefit from a “0” tax rate in 2009. With regards to our neutraceutical unit, the income tax rate will increase progressively by 2% yearly under the new law until it reaches a maximum of 25% in 2012.

Deferred income tax. The change in deferred income tax decreased from $142,550 to nil for the year ended December 31, 2007. There were no material timing differences during the period to justify recognition of deferred tax expenses.

Net income attributable to shareholders. Net income attributable to shareholders increased from $873,964 for the year ended December 31, 2006, to $4,486,562 for the year ended December 31, 2007. Higher sales and gross profit from both segments in 2007, mainly the aquaculture segment, offset by the penalties in financing costs and increased bad debts are the main components of increased profitability experienced in 2007.

Quarterly Results

The following table contains unaudited quarterly results for the years ended December 31, 2008 and 2007:

 

     Quarters Ended
     31-Mar     30-Jun     30-Sep    31-Dec

Year Ended December 31, 2008

         

REVENUES

   $ 9,210,490      $ 14,531,487      $ 22,470,184    $ 21,511,122

GROSS PROFIT

   $ 3,899,788      $ 4,958,877      $ 9,534,094    $ 9,804,591

NET INCOME/(LOSS)

   $ (1,029,443   $ (993,438   $ 5,614,682    $ 6,448,887

Basic net income/(loss) per common share

   $ (0.089   $ (0.083   $ 0.4658    $ 0.5492

Diluted net income/(loss) per common share

   $ (0.089   $ (0.083   $ 0.4268    $ 0.5302

Year Ended December 31, 2007

         

REVENUES

   $ 7,849,730      $ 13,660,698      $ 15,779,385    $ 17,680,398

GROSS PROFIT

   $ 2,590,446      $ 6,525,333      $ 7,739,924    $ 8,687,590

NET INCOME/(LOSS)

   $ (1,566,495   $ 832,081      $ 3,453,806    $ 1,767,170

Basic net income/(loss) per common share

   $ (0.235   $ 0.110      $ 0.4360    $ 0.2315

Diluted net income/(loss) per common share

   $ (0.235   $ 0.102      $ 0.3784    $ 0.1966

 

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     Quarters Ended
     31-Mar     30-Jun    30-Sep    31-Dec

Year Ended December 31, 2006

          

REVENUES

   $ 6,885,340      $ 9,574,081    $ 10,528,996    $ 12,106,986

GROSS PROFIT

   $ 2,531,885      $ 4,644,447    $ 4,618,512    $ 5,383,214

NET INCOME/(LOSS)

   $ (1,243,303   $ 641,368    $ 592,356    $ 883,543

Basic net income/(loss) per common share

   $ (0.212   $ 0.109    $ 0.098    $ 0.147

Diluted net income/(loss) per common share

   $ (0.212   $ 0.109    $ 0.098    $ 0.146

Liquidity and Capital Resources

Our cash and cash equivalents increased by $7,960,640 during the financial year of 2008, to $54,920,548. As at December 31, 2008, working capital was $72,203,260 compared to $61,550,488 at December 31, 2007. The funds generated by the operating activities during 2008 were used mainly to support the increase in our receivable and inventory levels, to decrease our payables and increase in our investment in the new feed plant under construction.

Total assets increased by $15,859,407 to $100,186,273 at December 31, 2008, from $84,326,866 as of December 31, 2007. Stockholders’ equity increased by $19,497,365, or 28 percent, to $88,273,028 as at December 31, 2008, from $68,775,663 as of December 31, 2007.

To date, we have financed our operations through the combination of our operating revenues, equity and debt financing (in connection with which we have at times incurred significant costs), short–term bank loans, and the use of shares of our common stock issued as payment for services rendered to us by third parties. In the past, we issued shares of our common stock and warrants in private placement transactions to help finance our operations, and to pay for professional services (such as financial consulting, market development, legal services and public relations services). We recognized these services on our books as operating or deferred expenses and amortized over their estimated useful life. The number of shares we issued for these purposes were determined as of the dates of invoices relating to such services, and the shares were valued at their market prices on those respective dates. In addition, as required by PRC laws, we establish yearly reserves shown in the stockholders’ equity section of our balance sheet. Those reserves, which are created by a transfer from the retained earnings account, limit our capacity to pay dividends to stockholders until the retained earnings become positive. The laws and regulations of the PRC restrict any form of distribution of statutory surplus reserve outside of the PRC, whether by cash dividends or for use in the US operations. As of December 31, 2008, the remaining statutory surplus reserve required is approximately $3.25 million (2007: $4.25 million). As we are in an expansion phase, we do not intend to pay dividends to stockholders in the foreseeable future. To date, we have not paid any dividends.

We also completed a financing in January 2006, in which we issued to a group of twenty one investors, in a private placement, (1) convertible secured promissory notes bearing interest at 8 percent per year which matured on January 25, 2008, in the aggregate principal amount of $5,225,000; (2) Class A warrants, with each warrant giving the right to the holder to purchase one share of our common stock at the exercise price of $6.00 until January 2009; and (3) Class B warrants, with each warrant giving the right to the holder to purchase one share of our common stock at the exercise price of $6.00 until January 2011. The net proceeds of this financing to us were $4,702,500, after deducting commissions and other costs of this transaction equal to $522,500. At December 31, 2008, that financing was totally reimbursed.

In addition, we also completed a financing in November 2006, in which we issued to two investors, in a private placement, (1) convertible promissory notes bearing interest at 6.5 percent and maturing in November 1, 2009, in the principal aggregate amount of $5,000,000 with the conversion price of $5.00 per share and (2) warrants registered in the name of each investor to purchase an aggregate of up to 200,000 of our common stock, with each warrant giving the right to the holder to purchase one share of our common stock at the exercise price of $5.00 until the fifth anniversary of the effective date of the reverse stock split effectuated in January 2007. At December 31, 2008, 170,000 such warrants were exercised, leaving a balance of 30,000 unexercised warrants. The net proceeds of this financing to us were $4,932,500, after deducting commissions and other costs of this transaction equal to $67,500. The notes are due on November 1, 2009.

In December 2007, we completed a follow-on offering by issuing 3,450,000 new shares of common stock to two underwriters (including the over-allotment of 450,000 shares) for a total gross consideration of $26,910,000 (corresponding to a net proceed of approximately $23,800,000). The Company intends to use this financing for the purpose of completing its new feed plant expected to be in operation in the first half of 2009, to build a new processing plant expected to be in operation in 2010 and to use the balance for general working capital purpose.

We are currently in the process of examining various financing opportunities to obtain additional liquidities to help finance our operations, as well as support our additional cash requirements related to volume increases that we anticipate might occur in the future, specifically in the inventory and receivables build–up. No assurances can be given that additional debt or equity financing we may require will be available to us or, even if available, that such financing will be on terms favorable to us.

 

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At present, about 38 percent of our consolidated sales are derived from our five largest clients, and our results of operations therefore depend on a small number of clients (39 percent in 2007). As part of our short and medium–term business plan, including our recent efforts to raise funds to support the anticipated expansion of our operations, we intend to invest in our infrastructure to construct a new processing plant and our own feed mill. We expect that this will allow us to meet forecasted incremental demand for our products in the United States and Europe. As a result, we plan to develop and serve new clients, which should reduce our dependence on individual clients to more acceptable levels.

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

The ratio of current assets to current liabilities increased to 7.06 times ($84,116,505/$11,913,245) at December 31, 2008, from 6.2 times ($73,448,339/$11,897,851) at December 31, 2007.

Contractual Obligations

We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. Other items, such as purchase commitments, are not recognized as liabilities in our consolidated financial statements but are required to be disclosed. For example, we are contractually committed to make certain minimum lease payments for the use of property and equipment under operating lease agreements and arrangements we classify as capital leases.

The following table summarizes (in millions) our significant contractual obligations and commercial commitments at December 31, 2008 and the future periods in which such obligations and commitments are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding borrowings. This table does not reflect regular recurring trade payables incurred in the normal course of business and generally due within 30 days of service. Additional details regarding these obligations are provided in notes to the consolidated financial statements also included herein, as referenced in the table:

 

     Less than 1 year    1-3 years    3-5 years    More than 5 years    Total

Notes payable & other borrowings

   $ 5,000,000             $ 5,000,000

Operating leases

   $ 124,432    $ 165,464    $ 82,064    $ 430,832    $ 802,792

Purchase and other commitments

   $ 3,195,890             $ 3,195,890

Total

   $ 8,320,322    $ 165,464    $ 82,064    $ 430,832    $ 8,998,682

Off-Balance Sheet Transactions

We have no off-balance sheet arrangements or transactions with unconsolidated, special purpose entities.

 

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ITEM 8. CONSOLIDATED FINANCIAL STATEMENT AND SUPPLEMENTARY DATA

The financial statements presented below are identical to the financial statements that appeared in the Original Annual Report, except the Company’s income statement, statement of stockholders’ equity and statement of cash flows for the year ended December 31, 2006 have been incorporated, the notes to the financial statements have been updated to reflect this change and the audit reports have been updated to reflect this change. The management report on internal control over financial reporting and report of independent registered public accounting firm on internal control over financial reporting included in the Original Annual Report are reproduced below.

 

     Page

Management’s Report on Internal Control Over Financial Reporting

   11

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

   12

Report of Independent Registered Public Accounting Firm - Schwartz Levitsky Feldman LLP

   13

Report of Independent Registered Public Accounting Firm - Rotenberg & Co., LLP

   14

Consolidated Balance Sheets as of December 31, 2008 and 2007

   15

Consolidated Statements of Income and Comprehensive Income for the years ended December  31, 2008, 2007 and 2006

   17

Consolidated Statements of Stockholders’ Equity for the years ended December  31, 2008, 2007 and 2006

   18

Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006

   20

Notes to Consolidated Financial Statements

   21

 

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MANAGEMENT REPORT

Management is responsible for the preparation and integrity of the Consolidated Financial Statements appearing in this Annual Report. The Consolidated Financial Statements were prepared in conformity with accounting principles generally accepted in the United States and include amounts based on management’s estimates and judgments.

Management is also responsible for establishing and maintaining an adequate system of internal control over financial reporting as defined in Rules 13a-15(f) and 15d-l5(f) promulgated under the Securities Exchange Act of 1934. We maintain a system of internal controls that is designed to provide reasonable assurance as to the fair and reliable preparation and presentation of the Consolidated Financial Statements in accordance with generally accepted accounting principles, as well as to safeguard assets from unauthorized use or disposition.

Our control environment is the foundation for our system of internal control over financial reporting and is embodied in our Code of Conduct. Our internal control over financial reporting includes written policies and procedures that:

 

   

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company;

 

   

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles;

 

   

provide reasonable assurance that receipts and expenditures of the Company are made in accordance with the appropriate authorization of management and the directors of the Company; and

 

   

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements. Internal control over financial reporting includes the controls themselves, monitoring and internal auditing practices and remedial actions to correct deficiencies as they are identified.

Management evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. Management based such assessment upon the criteria set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Although there are inherent limitations in the effectiveness of any system of internal controls over financial reporting, based on our evaluation, we have concluded that our internal controls over financial reporting were effective as of December 31, 2008.

Schwartz Levitsky Feldman LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Report and, as part of their audit, has issued their report, included herein in Item 8, on the effectiveness of our internal control over financial reporting.

 

Norbert Sporns   Jean- Pierre Dallaire
President and Chief Executive Officer   Chief Financial Officer

 

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Schwartz Levitsky Feldman LLP

CHARTERED ACCOUNTANTS

LICENSED PUBLIC ACCOUNTANTS

TORONTO • MONTREAL

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON INTERNAL CONTROL OVER FINANCIAL REPORTING

To the Shareholders of

HQ Sustainable Maritime Industries, Inc.

We have audited HQ Sustainable Maritime Industries, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as at December 31, 2008 and the related consolidated statement of income and comprehensive income, cash flows and changes in shareholders’ equity for the year ended December 31, 2008 and our report dated March 2, 2009 expressed an unqualified opinion thereon.

 

/s/ Schwartz Levitsky Feldman LLP  
Toronto, Ontario, Canada   Chartered Accountants
March 2, 2009   Licensed Public Accountants

 

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Schwartz Levitsky Feldman LLP

CHARTERED ACCOUNTANTS

LICENSED PUBLIC ACCOUNTANTS

TORONTO • MONTREAL

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of

HQ Sustainable Maritime Industries, Inc.

We have audited the accompanying consolidated balance sheet of HQ Sustainable Maritime Industries, Inc. (the “Company”) as at December 31, 2008 and the related consolidated statements of income and comprehensive income, cash flows and changes in shareholders’ equity for the year ended December 31, 2008. These consolidated financial statements are the responsibility of the management of HQ Sustainable Maritime Industries, Inc. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (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 audit provides a reasonable basis for our opinion.

In our opinion, these consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and the results of its income and comprehensive income and its cash flows for the year ended December 31, 2008 in conformity with generally accepted accounting principles in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 2, 2009, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

The consolidated financial statements of HQ Sustainable Maritime Industries, Inc. and Subsidiaries as of December 31, 2007 and December 31, 2006 were audited by other auditors whose report dated March 27, 2008 expressed an opinion without qualification on those consolidated financial statements.

 

/s/ Schwartz Levitsky Feldman LLP  
Toronto, Ontario, Canada   Chartered Accountants
March 2, 2009   Licensed Public Accountants

 

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LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

HQ Sustainable Maritime Industries, Inc. and Subsidiaries

Delaware

We have audited the accompanying consolidated balance sheets of HQ Sustainable Maritime Industries, Inc. and Subsidiaries as of December 31, 2007, and the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for the years ended December 31, 2007 and 2006. HQ Sustainable Maritime Industries, Inc. and Subsidiaries’ management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated 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 HQ Sustainable Maritime Industries, Inc. and Subsidiaries as of December 31, 2007, and the results of its operations and its cash flows for the years ended December 31, 2007 and 2006, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Rotenberg & Co., LLP

Rotenberg & Co., LLP

Rochester, New York

March 27, 2008

 

 

New York • Penn Yan • Rochester

 

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE

WITH LIMITED LIABILITY)

CONSOLIDATED BALANCE SHEETS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

 

     2008    2007

ASSETS

     

CURRENT ASSETS:

     

Cash and cash equivalents

   $ 54,920,548    $ 46,959,908

Trade receivables, net of provisions

     27,689,410      25,234,502

Inventories

     1,041,628      877,716

Prepayments

     464,919      350,116

Future income taxes

     —        26,097
             

TOTAL CURRENT ASSETS

     84,116,505      73,448,339
             

PROPERTY, PLANT AND EQUIPMENT, NET

     8,315,593      7,716,615

CONSTRUCTION IN PROGRESS

     6,622,501      949,728

INTANGIBLE ASSETS

     1,112,904      1,254,002
             
     16,050,998      9,920,345

OTHER ASSETS

     

Deferred taxes

     —        873,865

Deferred expenses

     18,770      84,317
             
     18,770      958,182
             

TOTAL ASSETS

   $ 100,186,273    $ 84,326,866
             

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

 

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE

WITH LIMITED LIABILITY)

CONSOLIDATED BALANCE SHEETS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

 

     2008    2007

LIABILITIES AND STOCKHOLDERS’ EQUITY

     

CURRENT LIABILITIES:

     

Accounts payable and accrued liabilities

   $ 5,787,514    $ 8,935,928

Taxes payable

     823,382      956,289

Due to directors

     698,429      1,544,350

Current portion of promissory notes

     4,603,920      461,284
             

TOTAL CURRENT LIABILITIES

     11,913,245      11,897,851

OTHER LIABILITIES

     

Convertible promissory notes, net of discount

     —        3,653,352
             

TOTAL LIABILITIES

     11,913,245      15,551,203

SHAREHOLDERS’ EQUITY

     

Preferred stock, $0.001 par value, 10,000,000 shares authorized, 100,000 shares issued and outstanding

     100      100

Common stock, $0.001 par value, 200,000,000 shares authorized, 12,085,846 and 11,511,317 shares issued and outstanding as of December 31, 2008 and December 31, 2007 respectively

     12,086      11,511

Additional paid-in capital

     61,572,410      57,142,204

Accumulated other comprehensive income

     9,615,956      4,590,060

Retained earnings

     10,510,961      2,373,825

Appropriation of retained earnings (reserves)

     6,561,515      4,657,963
             

TOTAL SHAREHOLDERS’ EQUITY

     88,273,028      68,775,663
             

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 100,186,273    $ 84,326,866
             

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

 

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE

WITH LIMITED LIABILITY)

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

     2008     2007     2006  

Sales

   $ 67,723,283      $ 54,970,211      $ 39,095,403   

Cost of sales

     39,525,933        29,426,918        21,917,345   
                        

Gross profit

     28,197,350        25,543,293        17,178,058   

Selling and distribution expenses

     1,550,860        841,263        591,376   

Marketing and advertising

     4,426,378        5,162,299        4,547,615   

General and administrative expenses

     6,205,993        4,800,361        4,673,679   

Depreciation and amortization

     1,456,456        1,217,284        1,029,672   

(Recovery of)/doubtful accounts

     (491,223     672,086        (706,514
                        

Income from operations

     15,048,886        12,850,000        7,042,230   

Finance costs

     2,662,734        5,857,117        5,183,567   

Other income

     (567,876     (42,491     16,731   
                        

Income before income taxes

     12,954,028        7,035,374        1,841,932   

Income taxes

      

Current

     2,094,976        2,548,812        825,418   

Deferred

     818,364        —          142,550   
                        

Net income attributable to shareholders

     10,040,688        4,486,562        873,964   

OTHER COMPREHENSIVE INCOME

      

Foreign currency translation income

     5,025,896        2,977,694        1,113,115   
                        

COMPREHENSIVE INCOME

   $ 15,066,584      $ 7,464,256      $ 1,987,079   
                        

NET INCOME PER SHARE

      

Basic

   $ 0.843      $ 0.587      $ 0.145   
                        

Diluted

   $ 0.785      $ 0.543      $ 0.145   
                        

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING

      

Basic

     11,905,739        7,635,124        6,028,935   
                        

Diluted

     13,198,438        8,989,469        6,037,325   
                        

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

 

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Table of Contents

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

(INCORPORATED IN THE STATE OF DELAWARE

WITH LIMITED LIABILITY)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

     Common Stock
(after reverse split)
    Preferred Stock    Additional
paid in
Capital
     Share
(after reverse split)
    Par Value     Share    Par Value   

Balance at January 1, 2006

   116,105,225      $ 116,105      100,000    $ 100    $ 15,574,742
                                

Adjustment for reverse split

   (110,299,964     (110,300           110,300

Issuance of common stock and warrants

   611,595        612      —        —        9,756,574

Net income for the year

   —          —        —        —        —  

Transfer to reserve

   —          —        —        —        —  
                                

Balance at December 31, 2006

   6,416,856      $ 6,417      100,000    $ 100    $ 25,441,626
                                

Issuance of common stock and warrants

   5,094,461        5,094      —        —        31,700,578

Net income for the year

   —          —        —        —        —  

Transfer to reserve

   —          —        —        —        —  
                                

Balance at December 31, 2007

   11,511,317      $ 11,511      100,000    $ 100    $ 57,142,204
                                

 

     Appropriation of
retained earnings
(reserves)
   Accumulated
other
comprehensive

income
   Retained
earnings
(deficit)
    Total

Balance at January 1, 2006

   $ 1,985,845    $ 499,251    $ (314,583   $ 17,861,470
                            

Issuance of common stock and warrants

     —        —        —          9,757,186

Net income for the year

     —        —        873,964        873,964

Transfer to reserve

     1,243,227      —        (1,243,227     —  

Foreign currency translation adjustment

     —        1,113,115      —          1,113,115
                            

Balance at December 31, 2006

   $ 3,229,072    $ 1,612,366    $ (683,846   $ 29,605,735
                            

Issuance of common stock and warrants

     —        —        —          31,705,672

Net income for the year

     —        —        4,486,562        4,486,562

Transfer to reserve

     1,428,891      —        (1,428,891     —  

Foreign currency translation adjustment

     —        2,977,694      —          2,977,694
                            

Balance at December 31, 2007

   $ 4,657,963    $ 4,590,060    $ 2,373,825      $ 68,775,663
                            

 

     Common Stock    Preferred Stock    Additional
paid in
Capital
     Share    Par Value    Share    Par Value   

Balance at January 1, 2007

   6,416,856    $ 6,417    100,000    $ 100    $ 25,441,626
                              

Issuance of common stock and warrants

   5,094,461      5,094    —        —        31,700,578

Net income for the year

   —        —      —        —        —  

Transfer to reserve

   —        —      —        —        —  

Transfer to reserve

   —        —      —        —        —  
                              

Balance at December 31, 2007

   11,511,317    $ 11,511    100,000    $ 100    $ 57,142,204
                              

Issuance of common stock and warrants

   574,529      575    —        —        4,430,206

Net income for the year

   —        —      —        —        —  

Transfer to reserve

   —        —      —        —        —  
                              

Balance at December 31, 2008

   12,085,846    $ 12,086    100,000    $ 100    $ 61,572,410
                              

 

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Table of Contents
     Appropriation of
retained earnings
(reserves)
   Accumulated
other
comprehensive
income
   Retained
earnings
(deficit)
    Total

Balance at January 1, 2007

   $ 3,229,072    $ 1,612,366    $ (683,846   $ 29,605,735
                            

Issuance of common stock and warrants

     —        —        —          31,705,672

Net income for the year

     —        —        4,486,562        4,486,562

Transfer to reserve

     1,428,891      —        (1,428,891     —  

Foreign currency translation adjustment

     —        2,977,694      —          2,977,694
                            

Balance at December 31, 2007

   $ 4,657,963    $ 4,590,060    $ 2,373,825      $ 68,775,663
                            

Issuance of common stock and warrants

     —        —        —          4,430,781

Net income for the year

     —        —        10,040,688        10,040,688

Transfer to reserve

     1,903,552      —        (1,903,552     —  

Foreign currency translation adjustment

     —        5,025,896      —          5,025,896
                            

Balance at December 31, 2008

   $ 6,561,515    $ 9,615,956    $ 10,510,961      $ 88,273,028
                            

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

 

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Table of Contents

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, 2008, 2007 AND 2006

 

     2008     2007     2006  

OPERATING ACTIVITIES

      

Net income

   $ 10,040,688      $ 4,486,562      $ 873,964   

Non-cash items:

      

Depreciation and amortization

     1,456,456        1,217,284        1,029,672   

(Gain)/loss on disposal of fixed assets

     (491,253     53,603     

Write off of fixed assets

     —          41,637        —     

Financial and other non cash services

     3,032,822        5,164,795        5,919,549   

Deferred income taxes

     818,362        —          109,046   

Change in non-cash working capital items:

      

Inventories

     (76,042     (168,858     (151,394

Trade receivables, net of provisions

     (656,094     (7,276,981     (9,407,163

Prepayments

     (44,576     34,577        (252,829

Tax recoverable

         185,429   

Accounts payable and accrued expenses

     (1,329,388     5,113,418        1,205,064   

Taxes payable

     (166,708     624,860        —     
                        

Cash flow generated from operating activities

     12,584,269        9,290,897        (488,662 )
                        

INVESTING ACTIVITIES

      

Acquisition of property, plant and equipment-net

     (1,310,683     (745,546     (65,337

Sale proceeds of disposal of fixed assets

     495,449        —          —     

Construction in progress

     (5,398,904     (634,905     (1,196,453

Acquisition of intangible assets

     —          —          (550,000

Acquisition of deferred expenses

     —          —          (983,060

Cash flow used in investing activities

     (6,214,138     (1,380,451     (2,794,850
                        

FINANCING ACTIVITIES

      

Cash proceeds from issuance of common stock

     137,536        28,570,475        —     

Convertible promissory notes issued, net of cash repayments

         9,112,554   

Due (to)/from directors

     (845,921     (153,915     347,726   

Repayment to related parties

     —          (198,553     (62,968

Bank loan payments

     —          (1,255,203     (471,061
                        

Cash flow (used in)/generated from financing activities

     (708,385     26,962,804        8,926,251   
                        

NET CHANGE IN CASH AND CASH EQUIVALENTS

     5,661,746        34,873,250        5,642,739   
                        

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

     2,298,894        697,283        606,477   

Cash and cash equivalents, beginning of year

     46,959,908        11,389,375        5,140,159   
                        

Cash and cash equivalents, end of year

     54,920,548        46,959,908        11,389,375   
                        

SUPPLEMENTARY CASH FLOWS DISCLOSURES

      

Interest paid

     —          —          17,478   
                        

Taxes paid

     2,263,701        1,155,429        430,643   
                        

SUPPLEMENTARY DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES

      

Common shares issued for services

     4,425,432        173,000        195,000   
                        

Reclassification of Construction in Progress to Land Use Rights

     —          964,002        —     
                        

 

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Table of Contents

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

NOTE 1 – ORGANIZATION AND PRINCIPAL ACTIVITIES

Our company was initially incorporated on September 21, 1989 under the laws of the State of Nevada. 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 with us. Pursuant to that agreement, Process Equipment, Inc., through PEAC, acquired Jade, and 84.42 percent 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, HQS. The name change, change of domicile and merger became effective on May 19, 2004, with HQS 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 this current report.

Further, as previously disclosed in the above current report, effective August 17, 2004, HQS caused Jade Profit Investment Limited, its wholly-owned subsidiary, to acquire the minority equity interest equal to 15.58 percent that Jade did not already own in Hainan Quebec Ocean Fishing Company Limited, HQS’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 cooperative 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, which are exported, directly and indirectly, to the United States, Canada, Japan and European countries. The major market is for export.

The Group is 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 percent held subsidiary of Sealink) are Shark Cartilage Capsule, Shark Liver Oil and Shark Liver (Soft gel). The major market is domestic in the PRC.

NOTE 2 – BASIS OF PRESENTATION

The consolidated financial statements include the accounts of HQS 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.

NOTE 3 – 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.

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.

 

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Table of Contents

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

C. Construction in progress

Construction in progress represents buildings under construction and plant and equipment pending installation as of December 31, 2008 and 2007, and is stated at cost. Cost includes construction of buildings, acquisitions and installation of equipment, and interest charges arising from borrowings used to finance assets during the period of construction or installation and testing. No provision for depreciation is made on assets under construction until such time as the relevant assets are completed and ready for their intended commercial use.

D. Long-live Assets

The Company has adopted the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets”. Property, plant and equipment and intangible assets are reviewed periodically for impairment losses whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If required, an impairment loss is recognized as the difference between the carrying value and the fair value of the assets.

In January 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets”, impairment of long-lived assets is monitored on a continuing basis, and is assessed based on the undiscounted cash flows generated by the underlying assets. In the event that the carrying amount of long-lived assets exceeds the undiscounted future cash flows, then the carrying amount of such assets is adjusted to their fair value.

E. 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

   10 – 40 years

Plant and machinery

   5 – 10 years

Motor vehicles

   5 – years

Office equipment and furnishings

   5 – years

F. 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, 2008 and 2007 due to the relatively short-term nature of these instruments.

G. 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.

H. 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.

I. 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.

 

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

J. FOREIGN CURRENCY TRANSLATION

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

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

 

     2008    2007

Year-end RMB : US$ exchange rate

   6.8240    7.3046

Average RMB : US$ exchange rate

   7.0643    7.5603

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

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

K. 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.

L. REVENUE RECOGNITION

The Company recognizes revenue when the significant risks and rewards of ownership have been transferred to the customer, including factors such as when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is probable. The Company recognizes sales when the merchandise is shipped, title has passed to the customers and collectibility is reasonably assured.

M. 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.

 

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Table of Contents

HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

N. SEGMENTS

No geographical segment analysis is provided for the years ended December 31, 2008, 2007 and 2006 as less than 10 percent of consolidated revenues and less than 10 percent of consolidated income from operations is attributable to the segment other than the Mainland China.

Business Segment for the year ended December 31, 2008

 

     Aquaculture
Product
    Health and
Bio-product
    Unallocated
Items
    Consolidation  

Sales to external customers

   $ 45,370,400      $ 22,352,883      $ —        $ 67,723,283   
                                

Selling and distribution expenses

     872,589        678,271        —          1,550,860   

Marketing and advertising

     —          4,426,378        —          4,426,378   

General and administrative expenses

     855,546        562,794        4,787,653        6,205,993   

Depreciation and amortization

     761,923        437,045        257,488        1,456,456   

(Recovery of)/doubtful accounts

     (498,681     7,458        —          (491,223

Finance costs

     (40,667     (152,747     2,856,148        2,662,734   

Income/(loss) before income taxes

     10,320,298        10,785,850        (8,152,120     12,954,028   

Income taxes

     864,279        2,049,061        —          2,913,340   

Net Income/(loss) for the year

   $ 9,456,019      $ 8,736,789      $ (8,152,120   $ 10,040,688   
                                

Segment assets

   $ 49,054,644      $ 36,026,012      $ 15,105,617      $ 100,186,273   
                                

Segment liabilities

   $ 2,541,594      $ 2,271,766      $ 7,099,885      $ 11,913,245   
                                

Business Segment for the year ended December 31, 2007

 

     Aquaculture
Product
   Health and
Bio-product
   Unallocated
Items
    Consolidation

Sales to external customers

   $ 36,248,437    $ 18,721,774    $ —        $ 54,970,211
                            

Selling and distribution expenses

     371,939      469,324      —          841,263

Marketing and advertising

     —        5,162,299      —          5,162,299

General and administrative expenses

     856,068      237,655      3,706,638        4,800,361

Depreciation and amortization

     645,152      355,667      216,465        1,217,284

Doubtful accounts

     664,873      5,644      1,569        672,086

Finance costs

     1,717      112,937      5,742,463        5,857,117

Income/(loss) before income taxes

     7,478,613      9,380,535      (9,823,774     7,035,374

Income taxes

     1,179,309      1,395,600      (26,097     2,548,812

Net Income/(loss) for the year

   $ 6,299,304    $ 7,984,935    $ (9,797,677   $ 4,486,562
                            

Segment assets

   $ 34,238,892    $ 25,076,495    $ 25,011,479      $ 84,326,866
                            

Segment liabilities

   $ 4,208,988    $ 1,965,657    $ 9,376,558      $ 15,551,203
                            

Business Segment for the year ended December 31, 2006

 

     Aquaculture
Product
    Health and
Bio-product
    Unallocated
Items
    Consolidation  

Sales to external customers

   $ 23,792,690      $ 15,302,713      $ —        $ 39,095,403   
                                

General and administrative expenses

     1,264,378        883,197        2,526,104        4,673,679   

Depreciation and amortization

     632,525        301,191        95,956        1,029,672   

Selling and distribution expenses

     233,641        357,735        —          591,376   

Marketing and advertising

     —          4,547,615        —          4,547,615   

Finance costs

     (10,201     73,153        5,120,615        5,183,567   

Provision for/(Recovery of) doubtful accounts

     193,896        (900,410     —          (706,514

Income/(loss) before taxation

     1,733,928        7,846,704        (7,738,700     1,841,932   

Income taxes

     460,638        507,330        —          967,968   

Net Income/(loss) for the year

   $ 1,273,290      $ 7,339,374      $ (7,738,700   $ 873,964   
                                

Segment assets

   $ 24,019,621      $ 16,270,332      $ 1,562,527      $ 41,852,480   
                                

Segment liabilities

   $ 1,810,912      $ 2,388,875      $ 8,046,958      $ 12,246,745   

 

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

O. COMPREHENSIVE INCOME

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 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.

P. 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 collectability of outstanding accounts receivable.

Q. SHIPPING AND HANDLING COSTS

Shipping and handling costs are classified as cost of sales and are expensed as incurred.

R. ADVERTISING COSTS

Advertising costs are expensed as incurred.

S. 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.

T. DEFERRED EXPENSES

Deferred expenses represent the unamortized portion of finders’ fees related to the convertible promissory notes issued in November 2006.

U. INTANGIBLE ASSETS

Intangible assets are recognized if it is probable that the future economic benefits attributable to the assets will flow to the Company, and if the cost of the assets can be measured reliably. After initial recognition, intangible assets are measured at cost less any impairment losses. Intangible assets with definite useful lives are amortized on a straight-line basis over their useful lives.

V. RECENT PRONOUNCEMENTS

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115”. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. This Statement applies to all entities, including not-for-profit organizations. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. As such, the Company has currently chosen not to elect the fair value option as permitted by SFAS No. 159, which provides entities the option to measure many financial instruments and certain other items at fair value.

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (“SFAS”) No. 141(R), “Business Combinations”. SFAS 141(R) establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, an any non controlling interest in the

 

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NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

acquiree, recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. As such, the Company is required to adopt these provisions at the beginning of the fiscal year ended December 31, 2009. The Company is currently evaluating the impact of SFAS 141(R) on its consolidated financial statements but does not expect it to have a material effect.

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

In March, 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (“FAS 161”). FAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhances disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The guidance in FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company is currently assessing the impact of FAS 161.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S.GAAP for non-governmental entities. SFAS 162 is effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board auditing amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted accounting Principles. “The Company does not expect SFAS 162 to have a material effect on its consolidated financial statements.

In May, 2008, the FASB issued Statement of Financial Accounting Standards No. 163 (“SFAS 163”), “Accounting for Financial Guarantee Insurance Contracts-an interpretation of FASB Statement No. 60”. SFAS 163 prescribes accounting for insures of financial obligations, bringing consistency to recognizing and recording premiums and to loss recognition. SFAS 163 also requires expanded disclosures about financial guarantee insurance contracts. Except for some disclosures, SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The adoption of SFAS 163 will not have an impact on the results of operations or financial position of the Company.

The Company believes that the above standards would not have a material impact on its financial position, results of operations or cash flows.

NOTE 4 – TRADE RECEIVABLES

The Group’s trade receivables at December 31, 2008 and 2007 are summarized as follows:

 

     2008    2007

Trade receivables

   $ 27,175,264    $ 25,383,330

Other receivables

     813,271      523,730
             
     27,988,535      25,907,060

Less: Provision for doubtful accounts

     299,125      672,558
             

Balance at end of year

   $ 27,689,410    $ 25,234,502
             

The activity in the Group’s provision for doubtful accounts during the year ended December 31, 2008 and 2007 is summarized as follows:

 

     2008     2007  

Balance at beginning of year

   $ 672,558      $ 59,866   

Add/(less): Provision / (recovery) during the year

     (491,223     672,086   

Exchange difference transfer to exchange reserve

     117,790        (59,394
                

Balance at end of year

   $ 299,125      $ 672,558   
                

 

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HQ SUSTAINABLE MARITIME INDUSTRIES, INC. AND SUBSIDIARIES

NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

NOTE 5 – PROPERTY, PLANT AND EQUIPMENT, NET

 

     2008    2007

Cost:

     

Buildings and leasehold improvement

   $ 3,705,261    $ 3,465,219

Plant and machinery

     11,451,662      9,583,421

Motor vehicles

     217,901      130,212

Office equipment and furnishings

     308,691      254,120
             
     15,683,515      13,432,972

Less: Accumulated depreciation:

     

Buildings and leasehold improvement

     691,039      560,107

Plant and machinery

     6,455,502      4,968,053

Motor vehicles

     53,403      55,914

Office equipment and furnishings

     167,978      132,283
             
     7,367,922      5,716,357
             

Property, plant and equipment, net

   $ 8,315,593    $ 7,716,615
             

Depreciation expenses relating to property, plant and equipment was $1,248,342 and $1,034,084 for the year ended December 31, 2008 and 2007, respectively.

NOTE 6 – INVENTORIES

The inventories at December 31, 2008 and December 31, 2007 are summarized as follows:

 

     2008    2007

Raw materials

   $ 183,232    $ 288,656

Work-in-progress

     156,416      106,756

Finished goods

     701,980      482,304
             
   $ 1,041,628    $ 877,716
             

NOTE 7 – PREPAYMENTS

The Group’s prepayment at December 31, 2008 and 2007 are summarized as follows:

 

     2008    2007

Advances to suppliers

   $ 322,392    $ 301,180

Prepaid expenses

     142,527      48,936
             
   $ 464,919    $ 350,116
             

NOTE 8 – INTANGIBLE ASSETS

At December 31, 2008 and 2007, the Group’s intangible assets are comprised of the following:

 

     2008    2007

Land use rights, at cost

   $ 1,031,895    $ 964,002

Sales network, at cost

     550,000      550,000
             

Intangible assets, at cost

     1,581,895      1,514,002

Less: Accumulated amortization, land use rights

     25,791      —  

Less: Accumulated amortization, sales network

     443,200      260,000
             

Intangible assets, net

   $ 1,112,904    $ 1,254,002
             

 

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NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

LAND USE RIGHTS:

According to the Law in China, the government owns all the land in China. Companies or individuals are authorized to possess and use the land only through land use rights granted by the Chinese government. Land use rights are being amortized using the straight-line method over the lease term of 48 years. Since the related building will be completed in 2009 and operations will start in 2009, amortization will commence only in that year. The estimated amortization for each of the next five years will be approximately $25,800.

SALES NETWORK:

In 2006, the Company entered into an agreement with an unrelated third party by which it was agreed to purchase a sales network in order for us to develop the American market for our branded seafood products. The cost of the network, established at $550,000, is amortized on a 36 months period, starting in August 2006. The amortization of 2006 amounted to $76,800. The amortization of 2007 and 2008 amounted to $183,200. The amortization for 2009 will amount to $106,800.

NOTE 9 – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities at December 31, 2008 and 2007 are summarized as follows:

 

     2008    2007

Accounts payables

   $ 1,005,921    $ 1,226,797

Other payables

     2,735,484      4,275,774

Accrued liabilities

     2,046,109      3,433,357
             
   $ 5,787,514    $ 8,935,928
             

NOTE 10 – RELATED PARTY TRANSACTIONS

The net amounts due to related parties at December 31, 2008 and December 31, 2007 are non-interest bearing and are without terms of maturity. They consist mainly of net advances from shareholders of the Company and are shown in the current liabilities as management expects those advances to be repaid during the next year. The amounts due to directors of $698,429 was repaid subsequent to year-end.

NOTE 11 – CONVERTIBLE PROMISSORY NOTES AND WARRANTS

Effective January 25, 2006, the Company closed on a financing transaction with a group of private investors for an amount of $5,225,000. After deducting commissions and other costs of the offering of $522,500, the Company received net proceeds of $4,702,500. The Notes matured January 25, 2008. The Notes were convertible into shares of the Company’s Common Stock at a per share conversion price at the rate of $6.00 per share of Common Stock. The Company followed EITF 00–27, the issue 98–5 model in recording the convertible notes and warrants in its financial statements. The Notes were accruing interest on the principal amount at a rate per annum of eight percent (8 percent) from January 25, 2006 payable in arrears, subject to the terms and conditions of the Notes, together with principal amount payments, up to January 25, 2008.

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

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

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

 

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NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

Furthermore, effective November 8, 2006, the Company completed another financing transaction with a group of private investors for an amount of $5,000,000, bearing interest at 6.5 percent per annum. The financing consisted of two components: (a) promissory notes of the Company, in the principal aggregate amount of $5,000,000 due November 1, 2009 and (b) warrants registered in the name of each Investor to purchase an aggregate of up to 200,000 shares of our Common Stock. The Notes are convertible into shares of the Company’s $0.001 par value Common Stock at a conversion price of $5.00 per share. The Warrants expire on the fifth (5th ) anniversary of the effective date of the reverse stock split. In 2008, 170,000 such warrants were exercised leaving a balance of 30,000 unexercised at December 31, 2008. The exercise price to acquire a share of Common Stock is equal to the Conversion Price under the Notes, currently at the rate of $5.00 per share of Common Stock.

NOTE 12 – INCOME TAXES

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. 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. On March 17, 2007, a new PRC Enterprise Income Tax Law (EIT) was promulgated and introduced a new uniform tax regime in the PRC. The EIT became effective on January 1, 2008. That new Law provides, amongst other issues, that income derived from processing of fishery products and processing of agricultural products will be exempt from the EIT tax rate. Starting in 2008, HQOF benefits from a “0” percent tax rate. Jiahua Marine was subject to a tax rate under the new law, which increased by 3 percent in 2008 and will increase gradually until it reaches a maximum of 25 percent in 2012.

The reconciliation of the effective income tax rate of the Company to the statutory income tax rate in the PRC for 2008 is as follows:

 

     HQOF    Jiahua Marine

Statutory tax rate

   0 percent    18 percent

Tax holidays and concessions

   —      —  
         

Effective tax rate

   0 percent    18 percent
         

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

NOTE 13 – DEFERRED TAX

Deferred tax assets as at December 31, 2008 and 2007 comprise the following:

 

     2008     2007

Balance at January 1

   $ 873,865      $ 817,577

Deferred tax written off for the year

     (935,409     —  

Exchange difference transfer to exchange reserve

     61,544        56,288
              

Balance at December 31

   $ —        $ 873,865
              

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.

NOTE 14 – APPROPRIATION OF RETAINED EARNINGS (RESERVES)

The reserves are comprised of the following:

 

     2008    2007

Statutory surplus reserve

   $ 5,460,527    $ 3,556,975

Public welfare reserve

     1,064,042      1,064,042

Capital reserve

     36,946      36,946
             
   $ 6,561,515    $ 4,657,963
             

 

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NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

The reserves are disclosed separately in the statement of changes in equity as appropriation of retained earnings. Pursuant to the relevant laws and regulations of Wholly Owned Foreign Enterprises, the profits of the companies, 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 reserves, 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 reserves, consisting of the statutory surplus reserve and public welfare reserve. 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 net income, as determined in accordance with the PRC accounting standards applicable to the companies, to the statutory surplus reserve until such reserve reaches 50 percent of the registered capital of the companies.

Net income as reported in the US GAAP financial statements differs from that reported in the PRC statutory financial statements. In accordance with the relevant laws and regulations in the PRC, 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.

NOTE 15 – EMPLOYEE STOCK OPTION PLAN

In 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. The following number of share options and related values are shown after giving effect to the reverse stock split that occurred in January 2007. 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 $5.60. Specifically, Norbert Sporns, our Chief Executive Officer, President and director, received 25,000 stock options; Lillian Wang, the Chairman of our board of directors, received 25,000 stock options; Harry Wang, our Chief Operating Officer, director and brother of Ms. Wang, received 25,000 stock options; and Fusheng Wang, director (who resigned in 2006) and Honorary Chairman and father of Ms. Wang, received 50,000 stock options. Together, Norbert Sporns, Harry Wang and Lillian Wang also indirectly control the majority of capital stock of HQS. 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 10,000 stock options. Mr. Dallaire’s options were vested in 2004 as to 50 percent of the grant, with the remaining 50 percent 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 HQS. These stock options were vested then as to 50 percent of each individual grant, with the remaining 50 percent 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 250,000 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 Fred Bild, an independent director, and Daniel Too, also an independent director of HQS.

 

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NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

Information concerning the plan incentive and non-qualified stock options is as follows:

 

     Options    Exercise Price Per Share

December 31, 2006 (Vested)

   198,334    $ 5.60

Options vested in 2007

   16,666    $ 5.60

Options cancelled/forfeited

   —     

Options exercised in 2007

   151,250    $ 5.60

December 31, 2007 (Vested)

   63,750    $ 5.60

Options vested in 2008

   —      $ 5.60

Options canceled/forfeited in 2008

   —     

Options exercised in 2008

   10,000    $ 5.60

December 31, 2008 (Vested)

   53,750    $ 5.60

The table below summarizes information with respect to stock options outstanding as of December 31, 2008:

 

Exercise Price

   Options Outstanding    Remaining
Contractual Life
   Options
Exercisable
   Exercise Price of
Exercisable Options
$ 5.60    53,750    Up to June 2014    53,750    $ 5.60

The aggregate intrinsic value of the options outstanding as at December 31, 2008 is $119,862. Since no options were granted in 2007 and 2008, the weighted average fair value of options granted under the plan during fiscal years 2007 and 2008 was $NIL and $NIL, respectively.

The Company has ceased 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.

NOTE 16 – SIGNIFICANT CONCENTRATION

The Group grants credit to its customers, generally on an open account basis. The Group’s five largest customers accounted for 38.6 percent of the consolidated sales for the year ended December 31, 2008 and they are all related to the aquaculture product segment. At December 31, 2008, approximately 46.3 percent of trade receivables were from trade transactions with the aforementioned five largest customers.

For the year ended December 31, 2007, the Group’s five largest customers accounted for 38.6 percent of the consolidated sales for the year. At December 31, 2007, approximately 35.4 percent of trade receivables were from trade transactions with the aforementioned five largest customers.

NOTE 17 – WARRANTIES

The Group did not incur any warranty costs for both years ended December 31, 2008 and 2007.

NOTE 18 – COMMITMENTS AND CONTINGENCIES

A. CAPITAL COMMITMENTS

As of December 31, 2008, there were capital commitments amounting to $3,195,890, which were mainly related to the construction work of the feed mill.

B. LEASE COMMITMENTS

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

 

2009

   $ 124,432

2010

     124,432

2011

     41,032

2012

     41,032

2013

     41,032

Thereafter

     430,832
      

Total

   $ 802,792

 

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NOTES FOR THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

 

C. 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.

NOTE 19 – CAPITAL STRUCTURE

Common stock consists of authorized shares of 200,000,000 with a par value of $0.001 per share. Common stock issued and outstanding as of December 31, 2008 and 2007 was 12,085,846 and 11,511,317, 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, 2008 and 2007, the Company issued 574,529 and 5,094,461 common shares for net proceeds of $6,658,567 and $32,866,506, respectively. The amounts recorded in the accompanying financial statements are net of costs incurred in raising capital.

NOTE 20 – EARNINGS PER SHARE

Basic earnings per share are computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share is computed by adjusting the weighted average common shares outstanding assuming conversion of all potentially dilutive convertible securities.

The following is a reconciliation of the numerators and the denominators of the basic and diluted earnings per share (EPS) computation at December 31, 2008.

 

     2008
     Income
(Numerator)
   Shares
(Denominator)
   Per Share
Amount

Basic EPS

        

Net income available to common shareholders

   10,040,688    11,905,739    0.843

Effect of dilutive securities stock options issued to employees and investors

   325,000    1,292,689    —  
              

Diluted EPS

        

Net income available to common stockholders plus assumed conversions

   10,365,688    13,198,438    0.785
              

NOTE 21 – 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.

NOTE 22 – SUBSEQUENT EVENT

On February 2, 2009, the Board of Directors approved the 2009 Stock Option Plan which will attribute 971,000 shares to employees of the Company. There was consequently a similar amount of shares reserved for issuance under that 2009 stock option plan. No grants are attributed yet and consequently no financial impact was recognized in the financial statements for the year ended December 31, 2008.

 

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PART III

 

ITEM 11. EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

Executive Compensation Philosophy

Our compensation program is designed to attract, retain and motivate highly qualified executives and drive sustainable growth. We compensate our executives named in the “Summary Compensation Table,” which we refer to as “named executive officers” or “NEOs,” through a combination of base salary, incentive, and cash bonuses. Cash bonuses are designed to reward current performance and are based on the Company’s performance, the executive’s performance and the executive’s adherence to our core values.

Our Compensation Committee

The responsibilities of the Compensation Committee are to:

 

   

oversee development and administration of the Company’s executive compensation plans; set the compensation of the Chief Executive Officer and other executive officers; review and consider the performance of the Chief Executive Officer and other officers;

 

   

oversee the evaluation of the Chief Executive Officer and other members of management; and review and approve employment, severance, change-in-control, termination and retirement arrangements for all officers.

The Compensation Committee has not delegated its authority for officer compensation, but has delegated all of its authority under the Company’s equity plan to the Chief Executive Officer to grant equity awards to employees below the officer level.

Officer compensation decisions are made by the Compensation Committee after discussing recommendations with the Chief Executive Officer. He may attend Compensation Committee meetings to discuss the financial performance of the Company and the performance of individual executives.

The members of the Compensation Committee are Fred Bild and Daniel Too. The Board has determined that all of the members of the Compensation Committee are independent under the Company’s Corporate Governance Guidelines and the AMEX Corporate Governance Rules. No member of the Compensation Committee was or is an officer or employee of the Company or any of its subsidiaries.

Overview of Our Executive Compensation

Our compensation objectives are to:

 

   

attract first-class executive talent

 

   

retain key leaders

 

   

reward past performance

 

   

motivate future performance

 

   

foster the identification and development of leadership potential in key talent

The compensation framework for our named executive officers consists of the following three key elements:

 

   

Base salary;

 

   

Annual cash bonuses; and

 

   

Long-term incentives (including the grant of stock options)

In addition to these key elements of compensation, our compensation framework includes limited fringe benefits, perquisites, severance and other benefits.

Our executive compensation program is designed to develop and motivate the collective and individual abilities of our management team. In establishing the type and size of executive compensation awards, the Compensation Committee considers the factors listed below under “Performance Criteria.”

Base Salaries

Our named executive officers receive a majority of their overall cash compensation as base salary. Generally, base salaries have not been based upon specific measures of corporate performance, but are determined upon the recommendations of the Chief Executive Officer, based upon his determination of each employee’s individual performance, position and responsibilities, and contributions to both our financial performance and ethical culture, and approved by the Compensation Committee. We kept the original terms of the employment agreements including the amount of salaries for the named executive officers over the years.

 

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Annual Bonuses

Pursuant to employment agreements, the named executive officers are entitled to an annual cash bonus in an amount no less than $100,000 for Mr. Harry Wang, $100,000 for Ms. Lillian Wang, $50,000 for Mr. Norbert Sporns and $25,000 Mr. Jean-Pierre Dallaire. The Compensation Committee determines whether to pay any annual cash bonus to the named executive officers in excess of these thresholds and the amount of such excess. The Compensation Committee makes this determination at the end of each fiscal year, based on the factors described below under “Performance Criteria.”

For each of the last four fiscal years, the Compensation Committee increased the cash bonus for each of the named executive officers by 10%. Although the Compensation Committee does not directly link the amounts of annual cash bonuses to the Company’s financial performance when determining the amount of these bonuses, the Compensation Committee considered the fact that the Company’s income from operations increased substantially over 10% in each of the past four years. The amount of the cash bonus for each named executive officer for each of the last three years is set forth below under “Summary Compensation Table.”

Long-Term Incentives

The Compensation Committee believes that the grant of non-cash, long-term compensation, primarily in the form of long-term incentive awards, to our named executive officers is appropriate to attract, motivate and retain such individuals, and enhance stockholder value through the use of non-cash, equity incentive compensation opportunities. The Compensation Committee believes that our best interests will be advanced by enabling our named executive officers, who are responsible for our management, growth and success, to receive compensation in the form of long-term incentive awards. Since long-term awards will increase in value in conjunction with an increase in the value of our common stock, the awards are designed to provide our named executive officers with an incentive to remain with us.

Perquisites

Our compensation framework includes limited fringe benefits, perquisites and other benefits. Based on the employment agreements entered into between the Company and the named executives, the named executives are eligible to participate in incentive, savings, retirement (401(k)), and welfare benefit plans, including without limitation, health medical, dental, vision, life (including accidental death and dismemberment) and disability insurance plans. Since our main operation is in China and the named executive officers maintain personal residences in China and other places than Seattle, our headquarters office, the company also supports the rent for the named executive officers during their stay in Seattle.

The Company periodically reviews the perquisites that named executive officers receive. These perquisites are relatively few in number, and the Compensation Committee believes that its policies regarding perquisites are conservative compared to other companies.

The total costs to the Company for providing perquisites and personal benefits to the named executive officers during fiscal 2008 are shown in the “Summary Compensation Table.”

Our Executive Compensation Principles

The following core principles reflect the compensation philosophy of the Company with respect to the named executive officers, as established and refined from time to time by the Compensation Committee:

 

1. Compensation should reinforce the Company’s business objectives and values.

 

2. Compensation should be performance-related.

 

3. There should be flexibility in allocating the various compensation elements.

 

4. Incentive compensation should balance short-term and long-term performance.

 

5. Named executive officers should have financial risk and reward tied to their business decisions.

These principles are intended to motivate the named executive officers to improve the Company’s financial performance; to be personally accountable for the performance of the business units, divisions, or functions for which they are responsible; and to collectively make decisions about the Company’s business that will deliver stockholder value. Below is a description of how these principles are implemented.

 

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1. Compensation should reinforce the Company’s business objectives and values.

Our executive compensation program includes the incentives necessary to reward the contributions and leadership that serve to increase profits, revenue, and operating cash flow; enhance confidence in our financial stewardship; create and maintain the high morale and commitment of our employees; and enhance our reputation as a responsible corporate citizen.

2. Compensation should be performance-related.

We consider both business performance and the competitive marketplace when we design, deliver and fund our compensation programs. We pay for performance by rewarding superior performers with premium compensation. We reward named executive officers when the Company performs well. Likewise, we award lower compensation if the Company does not perform well. The Compensation Committee believes that a significant portion of a named executive officer’s total compensation should be at risk and tied to how well the Company, the individual, and the individual’s business unit, division, or function performs.

3. There should be flexibility in allocating the various compensation elements.

The Compensation Committee does not target any specific mix of elements of compensation in cash versus equity, in short-term compensation versus long-term compensation, or in fixed pay versus variable pay. Instead, the Compensation Committee has the flexibility to establish compensation consistent with the principle that the majority of pay should be at risk through short-term and long-term incentives.

4. Incentive compensation should balance short-term and long-term performance.

While the Compensation Committee seeks to structure a balance between achieving strong annual results and ensuring the Company’s long-term viability and success, it does not target a specific mix of short-term and long-term incentives. Named executive officers are regularly provided incentive opportunities based on both short-term and long-term achievements. Participation in the Company’s short-term and long-term incentive programs increases with positions at higher levels of responsibility such as those held by named executive officers who have the greatest influence over time on the Company’s strategic direction and results.

5. Named executive officers should have financial risk and reward tied to their business decisions.

The Compensation Committee believes that named executive officers should have a financial interest in the Company’s long-term results. Consequently, we require our named executive officers to be stockholders of the Company and provide them various ways to do so. In addition, the majority of our named executives’ compensation is designed to be at risk through short-term and long-term incentives.

Prohibition Against Speculative Transactions

Our Code of Business Conduct and Ethics, which applies to all of our employees and directors, prohibits speculative transactions in our stock such as short sales, puts, calls or other similar options to buy or sell our stock.

Guidelines For Trades By Insiders

We maintain policies that govern trading in our stock by officers and directors required to report under Section 16 of the Securities Exchange Act of 1934 (the “Exchange Act”), as well as certain other employees who regularly have access to material non-public information about us. These policies include pre-approval requirements for all trades and periodic trading “black-out” periods designed with reference to our quarterly financial reporting schedule. We also require pre-approval of all trading plans adopted pursuant to Rule 10b5-1 promulgated under the Exchange Act. To mitigate the potential for abuse, no trades are allowed under a plan within 30 days after adoption. We discourage termination or amendment of plans by prohibiting trades under new or amended plans within 90 days following a plan termination or amendment.

Performance Criteria

The Compensation Committee considers the following criteria when it establishes the type and size of executive compensation awards:

 

   

financial performance (e.g., growing revenue and improving profitability and cash flow);

 

   

leadership effectiveness (e.g., communicating and implementing the Company’s strategic direction, implementing and executing strategic succession plans, setting the appropriate moral and ethical tone, strengthening the Company’s leadership as a model corporate citizen, executing short-term and long-term business plans);

 

   

improving the product line and the marketing of our products;

 

   

continuing to explore opportunities to extend market reach; and

 

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employee satisfaction (e.g., retaining key talent, creating a positive employee environment, and providing employee development opportunities).

The Compensation Committee expects a high level of collaborative and individual performance and contributions, consistent with our named executive officer level of responsibility. The Compensation Committee discusses and evaluates the quality of the overall performance of the CEO after considering the CEO’s self-assessment and Company performance. The CEO in turn uses a similar process when reviewing performance of the other executives and makes recommendations to the Compensation Committee.

The Compensation Committee does not assign any particular weightings to the performance criteria listed above. Nonetheless, the Compensation Committee carefully reviews the Company’s financial performance, including income from operations, when determining the size of compensation awards. While the Compensation Committee carefully considers the Company’s actual financial performance, compensation is not directly tied to that measure.

Tax Implications of Executive Compensation

Section 162(m) of the Internal Revenue Code limits to $1 million per year the federal income tax deduction to public corporations for compensation paid for any fiscal year to the corporation’s Chief Executive Officer and certain other named executive officers (excluding the CFO) included in the “Summary Compensation Table.” This limitation does not apply to qualifying “performance-based compensation.”

The Company can deduct annual short-term incentives paid to named executive officers who are subject to Section 162(m) as performance-based compensation. The Compensation Committee defined Performance Profit as income from continuing operations before income taxes, equity income, discontinued operations, extraordinary items, and cumulative effect of change in accounting principles, but excluding restructuring charges as identified in the audited financial statements.

It is the Company’s goal to have compensation paid to its top officers qualify as tax deductible for federal tax purposes under Section 162(m) of the Internal Revenue Code. However, the Compensation Committee also believes it is appropriate to provide competitive compensation opportunities even though all compensation paid may not be fully tax deductible in any given year.

The non-performance-based compensation paid in cash to our executive officers for the 2008 fiscal year did not exceed the $1 million limit per officer, and the Compensation Committee does not anticipate that the non-performance-based compensation to be paid in cash to our executive officers for fiscal year 2009 will exceed that limit. In addition, the Compensation Committee does not anticipate that non-performance-based compensation to be paid in equity incentives to our executive officers for fiscal 2009 will exceed the $1 million limit per officer. However, the occurrence of certain events, including a change of control or a significant increase in the value of our common stock, could cause certain compensation to exceed the limit.

Accounting Implications of Executive Compensation

Base salaries and the short-term incentives are expensed over the period in which they are earned.

The long-term incentives used to reward named executive officers are primarily comprised of equity awards, including stock options. These equity awards are recorded according to Statement of Financial Accounting Standards (FAS) No. 123(R), “Share-Based Payments,” which states that the equity awards should be measured at fair value on the date of grant and expensed during the requisite service period for those equity awards that are expected to vest.

Conclusion

The foregoing discussion describes the compensation objectives and policies which were utilized with respect to our named executive officers during 2008. In the future, as the Compensation Committee continues to review each element of the executive compensation program with respect to our named executive officers, the objectives of our executive compensation program, as well as the methods which the Compensation Committee utilizes to determine both the types and amounts of compensation to award to our named executive officers, may change.

Report of the Compensation Committee of the Board of Directors

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with the management of the Company. Based upon its review and discussions, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be incorporated by reference in the Company’s Amendment No. 2 to Annual Report on Form 10-K/A for the year ended December 31, 2008.

Fred Bild

Daniel Too

 

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Executive Compensation

The following table sets forth information concerning the annual compensation earned by our named executive officers. Each of the named executive officers has an employment agreement that influences or defines certain of the elements of compensation shown below.

SUMMARY COMPENSATION TABLE

 

Name and Principal Position

   Year    (A)Salary ($)    (B)Bonus ($)    Stock
Awards
($)
   Option
Awards
($)
   Non-Equity
Incentive

Plan
Compensation
($)
   Change in
Pension

Value and
Nonqualified
Deferred
Compensation
Earnings

($)
   (C)All Other
Compensation
($)
   Total
($)

Norbert Sporns
Chief Executive Officer

   2008    219,615    73,205                33,210    326,030
   2007    199,650    66,550                31,800    298,000
   2006    181,500    60,500                26,340    268,340

Lillian Wang Li
Chairman of the Board

   2008    219,615    146,410                33,210    399,235
   2007    199,650    133,100                31,800    364,550
   2006    181,500    121,000                26,340    328,840

Harry Wang Hua
Chief Operating Officer

   2008    146,410    146,410                —      292,820
   2007    133,100    133,100                —      266,200
   2006    121,000    121,000                —      242,000

Jean-Pierre Dallaire
Chief Financial Officer

   2008    146,410    36,492                47,330    230,232
   2007    133,100    33,275                35,760    202,565
   2006    121,100    30,250                27,315    178,565

 

 

(A) The 2008 base salaries for all named executive officers as determined by their employment agreements. On April 1, 2004, the Company entered into a five-year employment agreement with each of Mr. Harry Wang, Ms. Lillian Wang, and Mr. Norbert Sporns (collectively, the “Executives”). Subsequently on April 11, 2005, the Company entered into Amendment No.1 to Employment Agreement with each of the Executives. The agreements automatically renewed for five (5) years. The agreements provide an annual base salary of US$100,000.00 for Mr. Wang, US$150,000.00 for Ms. Wang, and US$150,000.00 for Mr. Sporns, less all applicable taxes and other appropriate deductions. The base salary is increased annually in an amount no less than ten percent (10%) of the respective base salary. The Company’s Board of Directors (the “Board”) has the sole discretion to decide whether an Executive’s base salary may be increased by more than ten percent (10%).

On September 1, 2004, the Company entered into a five-year employment agreement with Mr. Jean Pierre Dallaire to serve as the Chief Financial Officer of the Company. This agreement automatically renews for an additional five (5) years unless either party provides written notice at least six (6) months prior to August 31, 2009. This agreement provides an annual base salary of US$100,000.00 for Mr. Dallaire. The base salary is increased annually in an amount no less than ten percent (10%). The Board has the sole discretion to decide whether Mr. Dallaire’s base salary may be increased by more than ten percent (10%). Mr. Dallaire’s employment agreement contains non-competition, non-solicitation, confidentiality, and related provisions that are relatively standard for executive employment agreements.

 

(B) The bonus for all named executive officers as determined by their employment agreements and the Board. The Executives are entitled to an annual bonus of no less than $100,000.00 for Mr. Wang, $100,000.00 for Ms. Wang, $50,000.00 for Mr. Sporns and $25,000.00 for Mr. Dallaire for each calendar year. The decision to pay any annual bonus to the Executive in excess of these threshold amounts, and the amount of any annual bonus increment in excess of these threshold amounts, will be within the Board’s sole discretion based on its review of the operating performance of the Company during the preceding fiscal year.

The Executives are eligible for non-qualified stock options under the stock option plan of the Company (the “Stock Option Plan”), subject to certain terms and conditions. Pursuant to the Stock Option Plan, the Company shall grant to each of the Executives an option to purchase an aggregate of twenty percent (20%) of the then fully diluted shares of the Company’s common voting stock that are available under the Stock Option Plan. In addition, at the beginning of each quarter during the term of the employment agreement, the Company shall grant to each of the Executives an option to purchase five percent (5%) of the then fully diluted shares of the Company’s common voting stock. Fifty percent (50%) of the options granted on the Grant Date (as defined in the agreements) is vested and exercisable from and after the Grant Date and the remaining fifty percent (50%) of the options vest and become exercisable on the first anniversary of the Grant Date. Subsequent grants of stock options vest and are exercisable pursuant to the terms and conditions of the Stock Option Plan. None of the options have been awarded to the Executives pursuant to the Stock Option Plan since 2004.

 

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The Executives are eligible to participate in incentive, savings, retirement (401(k)), and welfare benefit plans, including without limitation, health medical, dental, vision, life (including accidental death and dismemberment) and disability insurance plans. The Company will purchase directors and officers liability insurance for the Executives.

Mr. Dallaire is eligible for non-qualified stock options under the Stock Option Plan, subject to certain terms and conditions. The Company shall grant Mr. Dallaire an option to purchase an aggregate of ten percent (10%) of the then fully diluted shares of the Company’s common voting stock available under the Stock Option Plan. In addition, at the beginning of each quarter during the term of this agreement, the Company shall grant to Mr. Dallaire an option to purchase two and one half percent (2.5%) of the then fully diluted shares of the Company’s common voting stock. Fifty percent (50%) of the options granted on the Grant Date shall be vested and exercisable from and after the Grant Date and the remaining fifty percent (50%) of the options granted on the Grant Date shall be vested and become exercisable on the first anniversary of the Grant Date. Subsequent grants of stock options shall be vested and be exercisable pursuant to the terms and conditions of the Stock Option Plan.

Mr. Dallaire is eligible to participate in incentive, savings, retirement (401(k)), and welfare benefit plans, including without limitation, health medical, dental, vision, life (including accidental death and dismemberment) and disability insurance plans. The Company shall purchase directors and officers liability insurance for Mr. Dallaire.

 

(C) This column represents the payment of perquisites and personal benefits, including rental payment the Company supports for the named executive officers during their stay in Seattle and the insurance issued to Jean-Pierre Dallaire, our CFO, whereby he is reimbursed his premiums for health insurance, medication and disability according to the employment agreement he entered into with the Company. No such insurance has been issued to other named executive officers.

The following table sets forth information concerning outstanding equity awards held by our named executive officers as of December 31, 2008.

OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2008

 

     Option Awards (A)    Stock Awards
     Number of
Securities
Underlying
Unexercised
Options

(#)
   Number of
Securities
Underlying
Unexercised
Options

(#)
   Equity
Incentive
Plan Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options

(#)
   Option
Exercise
Price
($)
   Option
Expiration
Date
   Number of
Shares or
Units of
Stock That
Have Not
Vested

(#)
   Market
Value of
Shares or
Units of
Stock That
Have Not
Vested

($)
   Equity
Incentive
Plan
Awards:
Number of
Unearned
Shares,
Units
or Other
Rights That
Have Not
Vested

(#)
   Equity
Incentive
Plan Awards:
Market or
Payout Value
of Unearned
Shares, Units
or Other
Rights That
Have Not
Vested

($)

Name

   Exercisable    Unexercisable                                   

Norbert Sporns
Chief Executive Officer

   —      —      —      —      —      —      —      —      —  

Lillian Wang Li
Chairman of the Board of Directors

   —      —      —      —      —      —      —      —      —  

Harry Wang Hua
Chief Operating Officer

   —      —      —      —      —      —      —      —      —  

Jean-Pierre Dallaire
Chief Financial Officer

   —      —      —      —      —      —      —      —      —  

 

(A) All stock options are 100% vested and exercisable. There have been no stock options granted by the Company since June 2004. At December 31, 2008, all options were exercised.

 

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The following table sets forth information concerning options that were exercised by our named executive officers during 2008 and stock awards held by our named executive officers that vested during 2008.

2008 OPTION EXERCISES AND STOCK VESTED TABLE

 

     Option Awards    Stock Awards

Name

   Number of
Shares
Acquired on Exercise
(#)
   Value
Realized
on Exercise
($)
   Number of
Shares
Acquired on Vesting
(#)
   Value
Realized
on Vesting
($)

Norbert Sporns
Chief Executive Officer

      NIL    —      —  

Lillian Wang Li
Chairman of the Board of Directors

      NIL    —      —  

Harry Wang Hua
Chief Operating Officer

         —      —  

Jean-Pierre Dallaire
Chief Financial Officer

   (A)10,000    6,918    —      —  

 

(A) In February 2008, Jean-Pierre Dallaire exercised options to purchase 10,000 shares of our common stock at an exercise price of $9.75.

The following table sets forth information concerning nonqualified deferred compensation of our named executive officers.

2008 NONQUALIFIED DEFERRED COMPENSATION TABLE

 

Name

   Executive Contributions
in Last Fiscal Year

($)
   Registrant
Contributions in
Last

Fiscal Year
($)
   (A)Aggregate Earnings
in Last Fiscal

Year
($)
   (B)
Aggregate
Withdrawals /
Distributions
($)
   (C)
Aggregate Balance
at Last Fiscal
Year-End

($)

Norbert Sporns
Chief Executive Officer

   —      —      292,820    822,270    NIL

Lillian Wang Li
Chairman of the Board of Directors

   —      —      366,025    1,113,774    NIL

Harry Wang Hua
Chief Operating Officer

   —      —      292,820    NIL    1,133,540

Jean-Pierre Dallaire
Chief Financial Officer

   —      —      182,902    265,328    16,468

 

(A) These amounts were reported as the amount of salary and bonus earned by the named executive officer in the last completed fiscal year in the above Summary Compensation Table.
(B) Aggregate withdrawals/distributions is the aggregate dollar amount of all withdrawals by the named executive officer during the last fiscal year. This amount includes compensation that was earned in 2008 and in prior years.
(C) Aggregate balance is the total amount of salary and bonus earned by the named executive officer in the last completed fiscal year and in prior years that has been deferred as of December 31, 2008. Each named executive officer may defer his or her compensation by his or her own choice.

 

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The following table sets forth information concerning the compensation of our non-management directors for the year ended December 31, 2008.

2008 DIRECTOR COMPENSATION TABLE

 

Name

   (A)Fees Earned
or

Paid in Cash
($)
   (A)Stock Awards
($)
   Option Awards
($)
   Non-Equity
Incentive

Plan
Compensation
($)
   Change
in Pension
Value and
Nonqualified
Deferred
Compensation
Earnings

($)
   (B)All Other
Compensation
($)
   Total
($)

Norbert Sporns

   —      —      —      —      —      33,210    33,210

Lillian Wang Li

   —      —      —      —      —      33,210    33,210

Harry Wang Hua

   —      —      —      —      —      —      —  

Fred Bild

   28,280    15,000    —      —      —      —      43,280

Daniel Too

   28,280    15,000    —      —      —      —      43,280

Andrew Intrater

   45,000    20,000    —      —      —      —      65,000

Joseph I Emas

   30,000    20,000    —      —      —      —      50,000

 

(A) The annual remuneration of our independent non-executive directors Fred Bild, and Daniel Too was $28,280 (indexed by 10% yearly) plus an annual bonus to them of not less than $15,000 payable in shares of our common stock. Andrew Intrater is remunerated on the basis of $30,000 in cash per year. Mr. Intrater was paid an additional $15,000 in 2008 for services provided in the previous year. Joseph Emas was paid $10,000 for services provided in 2007 in addition to his $20,000 cash per year for 2008.
(B) For rental payments.

The following table quantifies the payments and benefits that each named executive officer would receive assuming his respective employment were terminated, or upon a change of control, on the last day of our most recent fiscal year, December 31, 2008, for the reason set forth in each of the columns.

2008 POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL TABLE

 

Name

   (A)Benefit    Before
Change in
Control
Termination
w/o Cause or
for
Good Reason
   After Change
in

Control
Termination
w/o Cause or
for Good
Reason
   Voluntary
Termination
   Death    Disability    (B)Change in
Control

Norbert Sporns
Chief Executive Officer

   Basic salary
Bonus
   219,615

73,205

               1,572,112
524,035

Lillian Wang Li
Chairman of the Board

   Basic salary
Bonus
   219,615
146,410
               1,572,112
1,048,070

Harry Wang Hua
Chief Operating Officer

   Basic salary
Bonus
   146,410
146,410
               1,048,070
1,048,070

Jean-Pierre Dallaire
Chief Financial Officer

   Basic salary
Bonus
   146,410

36,492

               107,367
26,761

 

(A) The basic salary and bonus provisions are described herein under the description of each named executive officers’ employment agreement.
(B)

“Good Reason” shall mean the occurrence, without the Executive’s consent, of any of the following events: (a) the assignment to the Executive of duties that are significantly different from, and that result in a substantial diminution of, the duties that he assumed on the Inception Date; (b) the assignment to the Executive of a title that is different from and subordinate to the title

 

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specified in paragraph 2 hereinabove, or (c) a Change of Control “Change of Control” means the Company’s Board votes to approve: (a) any consolidation or merger of the Company pursuant to which fifty percent (50%) or less of the outstanding voting securities of the surviving or resulting company are not owned collectively by the common share and warrant holders of Sino-Sult Canada (S.S.C.) Limited and Red Coral Group Limited, Inc. as of September 1, 2004 (the “Current Control Group”); (b) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company other than any sale, lease, exchange or other transfer to any company where the Company owns, directly or indirectly, 100 percent of the outstanding voting securities of such company after any such transfer; (c) any person or persons (as such term is used in Section 13(d) of the Exchange Act of 1934, as amended), other than the Current Control Group, shall acquire or become the beneficial owner (within the meaning of Rule 13d-3 under the Exchange Act) whether directly, indirectly, beneficially or of record, of 50 percent or more of outstanding voting securities of the Company; or (d) commencement by any entity, person, or group (including any affiliate thereof, other than the Company) of a tender offer or exchange offer where the offeree acquires more than 50 percent of the then outstanding voting securities of the Company.

Director Compensation

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 amount 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. The annual remuneration of our independent non-executive directors Fred Bild, and Daniel Too was $15,000 plus an annual bonus to them of not less than $15,000 payable in shares of our common stock. Andrew Intrater is remunerated on the basis of $30,000 per year in cash plus an annual bonus of $20,000 payable in shares of our common stock while Joseph Emas is remunerated on the basis of $20,000 in cash per year plus an annual bonus of $20,000 payable in shares of our common stock.

Audit Committee Financial Expert

As stated above, we appointed four independent non-executive directors to our Board of Directors. We consider one of our independent directors, Mr. Andrew Intrater to be an audit committee financial expert within the meaning of the applicable Securities and Exchange Commission rules and regulations.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee consists of Messrs. Bild and Too. None of the members of the Compensation Committee is a current or former officer or employee of the Company or any of our subsidiaries. There are no compensation committee interlocks or insider participation in compensation decisions that are required to be disclosed in this Annual Report on Form 10-K.

Employment Agreements

The following information summarizes the employment agreements we entered into with Lillian Wang Li, our Chairman and Secretary, Harry Wang Hua, our Chief Operating Officer, Norbert Sporns, our Chief Executive Officer and President, Jean-Pierre Dallaire, our Chief Financial Officer and Financial Controller, and Trond Ringstad, our Executive Vice-President Sales and Distribution.

Lillian Wang Li. Under Ms. Wang’s employment agreement, she has agreed to serve as the Chairman of our board of directors and Secretary. Her term of service under this agreement commenced on April 1, 2004 and continues for a term of five (5) years. The agreement provides for a base salary of $150,000 for the first year of the term and an annual increase of at least 10 percent thereafter. 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 a grant of options to purchase shares of our common stock. The options include an option to purchase an aggregate of twenty percent (20 percent) of the then fully diluted shares of our common voting stock made available under our 2004 Stock Incentive Plan, and, at the beginning of each calendar quarter, an option to purchase an aggregate of five percent (5 percent) of the then fully diluted shares of our common voting stock made available under our 2004 Stock Incentive Plan. No shares of common stock were made available for option grants since the initial grants in 2004, and therefore no option grants were made to Ms. Wang. We and Ms. Wang have an understanding that she would waive any right she might have to receive any options during year 2005 and through the present date under our 2004 Stock Incentive Plan. Each option grant must be evidenced by an option agreement substantially identical to the form included in the employment agreement. 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 days’ 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.

 

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Harry Wang Hua. Under Mr. Wang’s employment agreement, he has agreed to serve as our Chief Operating Officer. His term of service under this agreement commenced on April 1, 2004 and continues for a term of five (5) years. The agreement also provides for a base salary of $100,000 for the first year of the term and an annual increase of at least 10 percent thereafter. 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 percent) of the then fully diluted shares of our common voting stock made available under our 2004 Stock Incentive Plan, and, at the beginning of each calendar quarter, an option to purchase an aggregate of five percent (5 percent) of the then fully diluted shares of our company’s common voting stock made available under the 2004 Stock Incentive Plan. No shares of common stock were made available for option grants since the initial grants in 2004, and therefore no option grants were made to Mr. Wang. We and Mr. Wang have an understanding that he would waive any right he might have to receive any options during year 2005 and through the present date under our 2004 Stock Incentive Plan. Each option grant must be evidenced by an option agreement substantially identical to the form included in the employment agreement. 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. Wang’s employment with cause, or without cause upon at least ninety days’ 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. Under Mr. Sporns’ employment agreement, he has agreed to serve as our Chief Executive Officer and President. His term of service under this agreement commenced on April 1, 2004 and continues for a term of five (5) years. The agreement also provides for a base salary of $150,000 for the first year of the term and an annual increase of at least 10 percent thereafter. 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 percent) of the then fully diluted shares of our common voting stock made available under our 2004 Stock Incentive Plan, and, at the beginning of each calendar quarter, an option to purchase an aggregate of five percent (5 percent) of the then fully diluted shares of our company’s common voting stock made available under our 2004 Stock Incentive Plan. No shares of common stock were made available for option grants since the initial grants in 2004, and therefore no option grants were made to Mr. Sporns. We and Mr. Sporns have an understanding that he would waive any right she might have to receive any options during year 2005 and through the present date under our 2004 Stock Incentive Plan. Each option grant must be evidenced by an option agreement substantially identical to the form included in the employment agreement. 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 days’ 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.

Jean-Pierre Dallaire. Under Mr. Dallaire’s employment agreement, he has agreed to serve as our Chief Financial Officer and Financial Controller. His term of service under this agreement commenced on September 1, 2004 and continues for a term of five (5) years. The agreement provides for a base salary of $100,000 for the first year of the term and an annual increase of at least 10 percent thereafter. 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 ten percent (10 percent) of the then fully diluted shares of our common voting stock made available under our 2004 Stock Incentive Plan, and, at the beginning of each calendar quarter, an option to purchase an aggregate of two and one-half percent (2.5 percent) of the then fully diluted shares of our company’s common voting stock made available under our 2004 Stock Incentive Plan. No shares of common stock were made available for option grants since the initial grants in 2004, and therefore no option grants were made to Mr. Dallaire. Each option grant must be evidenced by an option agreement substantially identical to the form included in the employment agreement. 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 without cause upon at least ninety days’ 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.

 

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Trond Ringstad. Under Mr. Ringstad’s employment agreement, he has agreed to serve as our Executive Vice-President Sales and Distribution. His term of service under this agreement commenced on June 28, 2006 and continues for a term of three (3) years. The agreement provides for a base salary of $150,000 for the first year of the term and an annual adjustment, whereby Mr. Ringstad’s base salary will increase by no more than 150 percent and no less than 50 percent of his base salary if the volume of sales generated by our Seattle sales office for the year immediately following his employment exceeds $15,000,000. An adjustment in Mr. Ringstad’s base salary will be paid in 50 percent cash and 50 percent restricted shares of our common stock. The agreement also provides Mr. Ringstad with an annual bonus at the discretion of our board of directors. We can terminate Mr. Ringstad’s employment with cause, or without cause upon at least a thirty day written notice. In the event that Mr. Ringstad’s employment is terminated without cause, he will be eligible to receive (1) any earned but unpaid base salary through his last date of employment; (2) the value of any earned, but unused vacation days; (3) continued coverage under our company’s benefits plan; and (4) an amount equal to six months of his annual base salary in effect immediately prior to his last date of employment.

Stock Incentive Plan

The purpose of our 2004 Stock Incentive Plan is to encourage and enable employees, directors and other persons upon whose judgment, initiative and efforts we largely depend upon, to acquire a proprietary interest in our company. Under the Stock Incentive Plan, our board of directors, or a stock option committee appointed by the board of directors, may grant stock options to purchase up to 250,000 shares of our common stock (subject to adjustment due to certain recapitalizations, reorganizations or other corporate events) to our key employees (including officers), directors and consultants. To date, all of the options available under the 2004 Stock Incentive Plan have been granted, and our ability to grant additional options will be subject to first obtaining board and Shareholder approvals. The per share exercise price of options granted under our 2004 Stock Incentive Plan will be not less than 100 percent of the fair market value per share of common stock on the date the options are granted. Our board of directors or a committee thereof administering the 2004 Stock Incentive Plan has discretion to determine what portions of any awards shall be granted as incentive stock options or ISO’s, stock appreciation rights, or SAR’s, and non-statutory options, and is generally empowered to interpret the 2004 Stock Incentive 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. If any option expires, terminates or is cancelled without having been exercised, the shares subject to the option will again be available for issuance under the Stock Incentive Plan.

Our board of directors did not approve, and therefore, we did not make, any options/SAR grants during the fiscal year ended December 31, 2008.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Family Relationships and Related Transactions

In the last three fiscal years, none of our present directors, officers or principal shareholders, nor any family member of the foregoing, nor, to the best of our information and belief, any of our former directors, senior officers or principal shareholders, nor any family member of such former directors, officers or principal shareholders, has or had any material interest, direct or indirect, in any transaction, or in any proposed transaction which has materially affected or will materially affect us, except as follows:

Lillian Wang Li and Harry Wang Hua are brother and sister and Lillian Wang Li is married to Norbert Sporns.

The net amounts due to related parties at December 31, 2008 and December 31, 2007 are non-interest bearing and are without terms of maturity. They consist solely of net advances in the amount of $698,429 as of December 31, 2008 from Mr. Harry Wang, the COO of our company, who is also a director/founder of our company and owns indirectly approximately 13.4% of the issued and outstanding common shares of our Company as of December 31, 2008. The amount due to Mr. Wang is the result of unpaid remuneration since 2004, amount of which is determined by contractual agreement. That amount was paid to Harry Wang during the first quarter of 2009.

Due to the very limited related-party transaction the Company has had which is described above, the Company currently does not have policies and procedures for the review, approval, or ratification of the related-party transaction.

Director Independence

Our board of directors has adopted independence standards consistent with the current listing standards of American Stock Exchange to assist the board of directors in determining which of its members is independent. Our board of directors has determined that each of Fred Bild, Daniel Too, Joseph I. Emas, and Andrew Intrater satisfies our independence standards and further determined that each of them is independent within the meaning of American Stock Exchange’s listing standards. Our audit committee consists of

 

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Messrs. Andrew Intrater, Fred Bild and Daniel Too, and the compensation committee consists of Messrs. Fred Bild and Daniel Too. Our board of directors has determined that each of these directors is “independent” within the meaning of the applicable rules and regulations of the SEC and the American Stock Exchange.

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

The following documents are filed as part of this report:

1. Financial Statements

 

     Page

Management’s Report on Internal Control Over Financial Reporting

   11

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

   12

Report of Independent Registered Public Accounting Firm - Schwartz Levitsky Feldman LLP

   13

Report of Independent Registered Public Accounting Firm - Rotenberg & Co., LLP

   14

Consolidated Balance Sheets as of December 31, 2008 and 2007

   15

Consolidated Statements of Income and Comprehensive Income for the years ended December  31, 2008, 2007 and 2006

   17

Consolidated Statements of Stockholders’ Equity for the years ended December  31, 2008, 2007 and 2006

   18

Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006

   20

Notes to Consolidated Financial Statements

   21

2. Financial Statement Schedules

None.

3. Exhibits

 

Exhibit

No.

 

Description

  3.1(a)   Certificate of Incorporation of HQ Sustainable Maritime Industries, Inc., as amended (incorporated by reference to Exhibit 2 to the Schedule 14C of Process Equipment, Inc. (SEC file No. 0-18980), filed with the SEC on April 28, 2004).
  3.1(b)   Certificate of Amendment of Certificate of Incorporation, dated December 28, 2006, of HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on April 20, 2007).
  3.2   By-laws of HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 3 to the Schedule 14C of Process Equipment, Inc. (SEC file No. 0-18980), filed with the SEC on April 28, 2004).
  4.1   Form of Rights and Preferences of Preferred Stock (incorporated by reference to Form 14C (SEC File Number 0-18980), filed with the SEC on October 3, 2005).
  4.2   Form of Subscription Agreement between HQ Sustainable Maritime Industries, Inc. and Certain Investors, exhibits attached (incorporated by reference to Exhibit 4.1 to Form 8-K (SEC File Number 0-18980), filed with the SEC on January 26, 2006).
  4.3   Form of Stock Purchase Agreement by and among Process Equipment, Inc. and certain Investors, dated April 21, 2004 (incorporated by reference to Exhibit 10.19 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).
  4.4   Form of Registration Rights Agreement by and among Process Equipment, Inc. and certain Investors, dated April 21, 2004 (incorporated by reference to Exhibit 10.20 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).

 

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Exhibit

No.

  

Description

  4.5    Form of Class C Warrant (incorporated by reference to Exhibit 10.21 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).
  4.6    Form of Class D Warrant (incorporated by reference to Exhibit 10.22 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).
10.1    Employment Agreement, effective as of April 1, 2004, between HQ Sustainable Maritime Industries, Inc. and Harry Wang (incorporated by reference to Exhibit 10.1 to Form 10-QSB (SEC File Number 0-18980), filed with the SEC on August 13, 2004).
10.2    Amendment No. 1 to Employment Agreement, dated July, 2005, between HQ Sustainable Maritime Industries, Inc. and Harry Wang (incorporated by reference to Exhibit 10.16 to Form 10-KSB (SEC File Number 18980), filed with the SEC on April 11, 2005).
10.3    Employment Agreement, effective as of April 1, 2004, between HQ Sustainable Maritime Industries, Inc. and Lillian Wang Li (incorporated by reference to Exhibit 10.2 to Form 10-QSB (SEC File Number 0-18980), filed with the SEC on August 13, 2004).
10.4    Amendment No. 1 to Employment Agreement, dated July, 2005, between HQ Sustainable Maritime Industries, Inc. and Lillian Wang Li (incorporated by reference to Exhibit 10.15 to Form 10-KSB (SEC File Number 18980), filed with the SEC on April 11, 2005).
10.5    Employment Agreement, effective as of April 1, 2004, between HQ Sustainable Maritime Industries, Inc. and Norbert Sporns (incorporated by reference to Exhibit 10.3 to Form 10-QSB (SEC File Number 0-18980), filed with the SEC on August 13, 2004).
10.6    Amendment No. 1 to Employment Agreement, dated July, 2005, between HQ Sustainable Maritime Industries, Inc. and Norbert Sporns (incorporated by reference to Exhibit 10.14 to Form 10-KSB (SEC File Number 18980), filed with the SEC on April 11, 2005).
10.7    Employment Agreement, dated as of September 1, 2004, between HQ Sustainable Maritime Industries Inc. and Jean-Pierre Dallaire (incorporated by reference to Exhibit 10.3 to Form 10-QSB (Commission file No. 0-18980), filed with the Commission on November 15, 2004).
10.8    Employment Agreement, dated as of June 28, 2006, between HQ Sustainable Maritime Industries Inc. and Trond Ringstad (incorporated by reference to Exhibit 10.13 Form SB-2 (Commission file No. 333-139454), filed with the Commission on December 18, 2006).
10.9    Independent Non-Executive Director Agreement, dated as of June 15, 2004, between HQ Sustainable Maritime Industries Inc. and Fred Bild (incorporated by reference to Exhibit 10.4 to Form 10-QSB (SEC file No. 0-18980), filed with the SEC on August 13, 2004).
10.10    Independent Non-Executive Director Agreement, dated as of June 15, 2004, between HQ Sustainable Maritime Industries Inc. and Jacques Vallée (incorporated by reference to the Report on Form 10-QSB (SEC file No. 0-18980), filed with the SEC on August 13, 2004).
10.11    Independent Non-Executive Director Agreement, dated as of September 2, 2004, between HQ Sustainable Maritime Industries Inc. and Daniel Too (incorporated by reference to Exhibit 10.2 to Form 10-QSB (SEC file No. 0-18980), filed with the SEC on November 15, 2004).
10.12    Form of Stock Option Grant Notice (incorporated by reference to Exhibit 10.1 to Form 8-K (SEC File Number 0-18980), filed with the SEC on December 3, 2004).
10.13    Form of Option Agreement (incorporated by reference to Exhibit 10.2 to Form 8-K (SEC File Number 0-18980), filed with the SEC on December 3, 2004).
10.14    Form of Exercise Agreement (incorporated by reference to Exhibit 10.3 to Form 8-K (SEC File Number 0-18980), filed with the SEC on December 3, 2004).
10.15    Agreement, dated as of November 4, 2004, between HQ Sustainable Maritime Industries, Inc. and Sino-Sult Canada (S.S.C.) Limited (incorporated by reference to Exhibit 10.1 to Form 10-QSB (SEC file No. 0-18980), filed with the SEC on November 15, 2004).
10.16    Form of Purchase Agreement between HQ Sustainable Maritime Industries, Inc. and Certain Investors dated November 8, 2006 (incorporated by reference to Exhibit 4.1 to Form 8-K (SEC File Number 18980), filed with the SEC on November 13, 2006).

 

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Exhibit

No.

  

Description

10.17    Form of Underwriters’ Purchase Option between HQ Sustainable Maritime Industries, Inc. and Several Underwriters (incorporated by reference to Exhibit 10.24 to Amendment No. 2 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on May 24, 2007).
10.18    Melbourne Tower Lease, dated November 22, 2005, between Doncaster Investments NV, Inc. and HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 10.18 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).
10.19    Waiver and Amendment Agreement between HQ Sustainable Maritime Industries, Inc. and Certain Investors, dated February 22, 2008 (incorporated by reference to Exhibit 10.24 to Amendment No. 5 to Form S-3 (SEC File Number 333-143453), filed with the SEC on May 8, 2008).
10.20    Contract for Land Use Rights Transfer between Hainan Hengtian Industry Co., Ltd. and Hainan Yu Bao Feedstuff Co., Ltd. dated October 18, 2006 (incorporated by reference to Exhibit 10.25 to Amendment No. 2 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on May 24, 2007).
10.21    Contract for Land Attachment Transfer between Hainan Hengtian Industry Co., Ltd. and Hainan Yu Bao Feedstuff Co., Ltd. dated December 20, 2006 (incorporated by reference to Exhibit 10.26 to Amendment No. 2 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on May 24, 2007).
10.22    2009 Stock Option Plan (incorporated by reference to Exhibit 10.22 to Annual Report on Form 10-K (SEC File Number 001-33473), filed with the SEC on March 12, 2009).
21.1    Subsidiaries of HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 21.1 to Annual Report on Form 10-K (SEC File Number 001-33473), filed with the SEC on March 12, 2009).
23.1    Consent of Schwartz Levitsky Feldman LLP*
23.2    Consent of Rotenberg & Co., LLP*
31.1    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a).*
31.2    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a).*
32.1    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.*
32.2    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.*

 

* Filed herewith.

 

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SIGNATURES

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

 

By:  

/S/    NORBERT SPORNS        

Name:   Norbert Sporns
Title:   Chief Executive Officer and President
October 16, 2009
By:  

/S/    JEAN–PIERRE DALLAIRE        

Name:   Jean–Pierre Dallaire
Title:   Chief Financial Officer
October 16, 2009

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

SIGNATURE

  

TITLE

 

DATE

/S/    NORBERT SPORNS        

   Chief Executive Officer, President and Director   October 16, 2009
Norbert Sporns        (Principal Executive Officer)  

/S/    LILLIAN WANG        

   Secretary, Chairman of the Board of Directors and     Director   October 16, 2009
Lillian Wang     

/S/    HARRY WANG        

   Chief Operating Officer and Director   October 16, 2009
Harry Wang     

/S/    ANDREW INTRATER        

   Independent Non-Executive Director   October 16, 2009
Andrew Intrater     

/S/    FRED BILD        

   Independent Non-Executive Director   October 16, 2009
Fred Bild     

/S/    DANIEL TOO        

   Independent Non-Executive Director   October 16, 2009
Daniel Too     

/S/    JEAN-PIERRE DALLAIRE        

   Chief Financial Officer and Financial Controller   October 16, 2009
Jean-Pierre Dallaire        (Principal Financial & Accounting Officer)  

/S/    JOSEPH I. EMAS        

   Independent Non-Executive Director   October 16, 2009
Joseph I. Emas     

 

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EXHIBIT INDEX

 

Exhibit

No.

  

Description

  3.1(a)

   Certificate of Incorporation of HQ Sustainable Maritime Industries, Inc., as amended (incorporated by reference to Exhibit 2 to the Schedule 14C of Process Equipment, Inc. (SEC file No. 0-18980), filed with the SEC on April 28, 2004).

  3.1(b)

   Certificate of Amendment of Certificate of Incorporation, dated December 28, 2006, of HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 3.1 to Amendment No. 1 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on April 20, 2007).

  3.2

   By-laws of HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 3 to the Schedule 14C of Process Equipment, Inc. (SEC file No. 0-18980), filed with the SEC on April 28, 2004).

  4.1

   Form of Rights and Preferences of Preferred Stock (incorporated by reference to Form 14C (SEC File Number 0-18980), filed with the SEC on October 3, 2005).

  4.2

   Form of Subscription Agreement between HQ Sustainable Maritime Industries, Inc. and Certain Investors, exhibits attached (incorporated by reference to Exhibit 4.1 to Form 8-K (SEC File Number 0-18980), filed with the SEC on January 26, 2006).

  4.3

   Form of Stock Purchase Agreement by and among Process Equipment, Inc. and certain Investors, dated April 21, 2004 (incorporated by reference to Exhibit 10.19 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).

  4.4

   Form of Registration Rights Agreement by and among Process Equipment, Inc. and certain Investors, dated April 21, 2004 (incorporated by reference to Exhibit 10.20 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).

  4.5

   Form of Class C Warrant (incorporated by reference to Exhibit 10.21 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).

  4.6

   Form of Class D Warrant (incorporated by reference to Exhibit 10.22 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).

10.1

   Employment Agreement, effective as of April 1, 2004, between HQ Sustainable Maritime Industries, Inc. and Harry Wang (incorporated by reference to Exhibit 10.1 to Form 10-QSB (SEC File Number 0-18980), filed with the SEC on August 13, 2004).

10.2

   Amendment No. 1 to Employment Agreement, dated July, 2005, between HQ Sustainable Maritime Industries, Inc. and Harry Wang (incorporated by reference to Exhibit 10.16 to Form 10-KSB (SEC File Number 18980), filed with the SEC on April 11, 2005).

10.3

   Employment Agreement, effective as of April 1, 2004, between HQ Sustainable Maritime Industries, Inc. and Lillian Wang Li (incorporated by reference to Exhibit 10.2 to Form 10-QSB (SEC File Number 0-18980), filed with the SEC on August 13, 2004).

10.4

   Amendment No. 1 to Employment Agreement, dated July, 2005, between HQ Sustainable Maritime Industries, Inc. and Lillian Wang Li (incorporated by reference to Exhibit 10.15 to Form 10-KSB (SEC File Number 18980), filed with the SEC on April 11, 2005).

10.5

   Employment Agreement, effective as of April 1, 2004, between HQ Sustainable Maritime Industries, Inc. and Norbert Sporns (incorporated by reference to Exhibit 10.3 to Form 10-QSB (SEC File Number 0-18980), filed with the SEC on August 13, 2004).

10.6

   Amendment No. 1 to Employment Agreement, dated July, 2005, between HQ Sustainable Maritime Industries, Inc. and Norbert Sporns (incorporated by reference to Exhibit 10.14 to Form 10-KSB (SEC File Number 18980), filed with the SEC on April 11, 2005).

10.7

   Employment Agreement, dated as of September 1, 2004, between HQ Sustainable Maritime Industries Inc. and Jean-Pierre Dallaire (incorporated by reference to Exhibit 10.3 to Form 10-QSB (Commission file No. 0-18980), filed with the Commission on November 15, 2004).

10.8

   Employment Agreement, dated as of June 28, 2006, between HQ Sustainable Maritime Industries Inc. and Trond Ringstad (incorporated by reference to Exhibit 10.13 Form SB-2 (Commission file No. 333-139454), filed with the Commission on December 18, 2006).

 


Table of Contents

Exhibit

No.

  

Description

10.9

   Independent Non-Executive Director Agreement, dated as of June 15, 2004, between HQ Sustainable Maritime Industries Inc. and Fred Bild (incorporated by reference to Exhibit 10.4 to Form 10-QSB (SEC file No. 0-18980), filed with the SEC on August 13, 2004).

10.10

   Independent Non-Executive Director Agreement, dated as of June 15, 2004, between HQ Sustainable Maritime Industries Inc. and Jacques Vallée (incorporated by reference to the Report on Form 10-QSB (SEC file No. 0-18980), filed with the SEC on August 13, 2004).

10.11

   Independent Non-Executive Director Agreement, dated as of September 2, 2004, between HQ Sustainable Maritime Industries Inc. and Daniel Too (incorporated by reference to Exhibit 10.2 to Form 10-QSB (SEC file No. 0-18980), filed with the SEC on November 15, 2004).

10.12

   Form of Stock Option Grant Notice (incorporated by reference to Exhibit 10.1 to Form 8-K (SEC File Number 0-18980), filed with the SEC on December 3, 2004).

10.13

   Form of Option Agreement (incorporated by reference to Exhibit 10.2 to Form 8-K (SEC File Number 0-18980), filed with the SEC on December 3, 2004).

10.14

   Form of Exercise Agreement (incorporated by reference to Exhibit 10.3 to Form 8-K (SEC File Number 0-18980), filed with the SEC on December 3, 2004).

10.15

   Agreement, dated as of November 4, 2004, between HQ Sustainable Maritime Industries, Inc. and Sino-Sult Canada (S.S.C.) Limited (incorporated by reference to Exhibit 10.1 to Form 10-QSB (SEC file No. 0-18980), filed with the SEC on November 15, 2004).

10.16

   Form of Purchase Agreement between HQ Sustainable Maritime Industries, Inc. and Certain Investors dated November 8, 2006 (incorporated by reference to Exhibit 4.1 to Form 8-K (SEC File Number 18980), filed with the SEC on November 13, 2006).

10.17

   Form of Underwriters’ Purchase Option between HQ Sustainable Maritime Industries, Inc. and Several Underwriters (incorporated by reference to Exhibit 10.24 to Amendment No. 2 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on May 24, 2007).

10.18

   Melbourne Tower Lease, dated November 22, 2005, between Doncaster Investments NV, Inc. and HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 10.18 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on December 18, 2006).

10.19

   Waiver and Amendment Agreement between HQ Sustainable Maritime Industries, Inc. and Certain Investors, dated February 22, 2008 (incorporated by reference to Exhibit 10.24 to Amendment No. 5 to Form S-3 (SEC File Number 333-143453), filed with the SEC on May 8, 2008).

10.20

   Contract for Land Use Rights Transfer between Hainan Hengtian Industry Co., Ltd. and Hainan Yu Bao Feedstuff Co., Ltd. dated October 18, 2006 (incorporated by reference to Exhibit 10.25 to Amendment No. 2 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on May 24, 2007).

10.21

   Contract for Land Attachment Transfer between Hainan Hengtian Industry Co., Ltd. and Hainan Yu Bao Feedstuff Co., Ltd. dated December 20, 2006 (incorporated by reference to Exhibit 10.26 to Amendment No. 2 to Form SB-2 (SEC File Number 333-139454), filed with the SEC on May 24, 2007).

10.22

   2009 Stock Option Plan (incorporated by reference to Exhibit 10.22 to Annual Report on Form 10-K (SEC File Number 001-33473), filed with the SEC on March 12, 2009).

21.1

   Subsidiaries of HQ Sustainable Maritime Industries, Inc. (incorporated by reference to Exhibit 21.1 to Annual Report on Form 10-K (SEC File Number 001-33473), filed with the SEC on March 12, 2009).

23.1

   Consent of Schwartz Levitsky Feldman LLP*

23.2

   Consent of Rotenberg & Co., LLP*

31.1

   Certification of Chief Executive Officer Pursuant to Rule 13a-14(a).*

31.2

   Certification of Chief Financial Officer Pursuant to Rule 13a-14(a).*

32.1

   Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.*

32.2

   Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.*

 

* Filed herewith.