ITEM 2. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management's discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements, as well as information relating to the plans of our current management. This report includes forward-looking statements. Generally, the words "believes," "anticipates," "may," "will," "should," "expect," "intend," "estimate," "continue," and similar expressions or the negative thereof or comparable terminology are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including the matters set forth in this report or other reports or documents we file with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those projected. Undue reliance should not be placed on these forward-looking statements which speak only as of the date hereof. We undertake no obligation to update these 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 Form 10-Q.

GENERAL OVERVIEW

We are a leader in all natural vertically integrated aquaculture and aquatic product processing, with processing facilities located in Hainan, People's Republic of China (" PRC"). We market our products in Asia, America and Europe. We have two processing plants in Hainan, one that processes aquatic products providing all natural tilapia and other aquatic products, and the other processing marine bio and healthcare products. We seek to expand our operations through providing additional processing facilities (e.g. the construction of our third facility in 2009, which will process extruded feed) in China and increasing our marketing efforts throughout North America and Europe. Our current sales activities are primarily directed to distributors within PRC, rather than within U.S.

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 report. 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 HQ Ocean Fishing Co. Ltd ("HQOF"), currently our principal operating subsidiary that processes our seafood products; in August 2004 we acquired the remaining ownership interest that we did not already own in HQOF. The fiscal year-end of Process Equipment 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 Hainan Jiahua Marine Bio-products Co. Ltd ("Jiahua Marine") which operates a marine bio and healthcare plant, including nutraceuticals, in Hainan Province, China.

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, that segment represented a significant contribution to our net income and currently provides higher profit margins than our aquaculture products segment. Our management expects, but cannot guarantee, 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 are completed in 2009, our management expects that the aquaculture product segment will begin to contribute a greater portion of net income in 2009 and beyond.

The following Management's Discussion and Analysis ("MD&A") is intended to provide the readers with an insight of HQS and subsidiaries ("Group"). MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes ("Notes").

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

Inventories

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

Income Taxes

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

Related Parties

Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operational decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Related parties may be individuals or corporate entities.

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 collectability is probable. The Company recognizes sales when the merchandise is shipped, title has passed to the customers and collectability is reasonably assured.

Concentration of Credit Risk

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

Recent developments

No significant development happened during the three months period ended September 30, 2009

Results of Operations - Three Months Ended September 30, 2009 as Compared to Three Months Ended September 30, 2008

Total sales for the three months period ended September 30, 2009 decreased by 1.4%, from $22,470,184 for the three months period ended September 30, 2008 to $22,156,867 for the three months period ended September 30, 2009. The gross profit for the three months period ended September 30, 2009 increased by 5.% to $10,008,841 when compared to the corresponding period of 2008. That increase in the gross profit in 2009 was the result of the combination of higher sales from the health and bio-product segment in the current quarter, added to better gross margins from the aquatic product segment when compared to the corresponding quarter of 2008. The overall gross profit ratio was 45.2% in the third quarter of 2009 compared to 42.4% in the same period of 2008, resulting from a better gross profit ratio from the aquatic product segment. Income from operations for the three months period ended September 30, 2009 decreased by $1,663,175 when compared to the same period of 2008; although the results showed an improved gross profit during the current three months period of 2009, the increase in doubtful accounts by approximately $1,606,000 and advertising expenses by approximately $979,000 mostly from the health and bio-product segment resulted in reducing the income from operations in the current period. Net income for the three months period ended September 30, 2009 was reduced by $1,567,248 mostly due to increased doubtful accounts and marketing and advertising expenses from the health and bio-product segment.

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By Segments

Manufacturing and Selling of aquatic products

HQ Ocean Fishing Co. Ltd ("HQOF") is engaged in the manufacturing and selling of aquatic products. The sales contributed by this segment decreased to $14,047,803 for the three months period ended September 30, 2009 compared to $15,112,565 for the corresponding period of 2008, a decrease of 7%. Although volume of fish sold in the period was higher in the current period of 2009, the decrease was related to lower sales price of tilapia and shrimps in 2009, compared to the same period of 2008. The related gross profit ratio of this segment was 27% and 24% for the three months period ended September 30, 2009 and 2008 respectively. The improvement in the gross profit margin in the third quarter of 2009 compared to the third quarter of 2008 is due to a reduction in raw material costs of our fish and a reduction in indirect manufacturing costs. This segment contributed $3,191,927 and $2,666,762 to net income for the three months period ended September 30, 2009 and 2008 respectively, an improvement of 19.6%.

Manufacturing and Selling of Marine Bio and Healthcare products

Our other wholly-owned subsidiary, Jiahua Marine, is engaged in the manufacturing and selling of Marine Bio and Healthcare products. During the three months period ended September 30, 2009 and 2008, Jiahua Marine recorded sales of $8,109,064 and $7,357,619 respectively, an increase of 10%. The gross profit ratio from this segment was 76% and 80% for the three months ended September 30, 2009 and 2008 respectively. The decrease in the gross profit margin in 2009 was mostly the result of higher cost of raw materials. Furthermore, the major expense of this segment continues to be marketing and advertising, corresponding to 21% and 10% of revenues for the three months ended September 30, 2009 and 2008, respectively. The increase in marketing and advertising expenses was related to the launching of new products in the last few months. In 2008, advertising and marketing reduction was due to winding down of publicity programs for those product that had been marketed for years. The net income contributed by this segment was $2,129,780 for the three months period ended September 30, 2009, a reduction of 52.6% when compared to the net income of $4,498,668 for the three months period ended September 30, 2008. The reduction in net income in 2009 was mostly due to higher provision for doubtful accounts of approximately $1,800,000 recognized in the current period of 2009 combined with higher marketing and advertising expenses of approximately $979,000, when compared to the corresponding period of 2008.

By Operations

Sales. For the three months period ended September 30, 2009, sales decreased by $313,317 to $22,156,867 or 1.4% when compared to the same period of 2008. This reduction in sales resulted from lower sales of $1,064,762 (or 7%) in the aquatic segment offset by increased sales of $751,445 (or 10.2%) from the health and bio-product segment, when compared to the corresponding period of 2008. The increased sales from the bio-product segment were mostly due to new products having been put on the market during the current period. The reduced sales in the aquatic product segment is mostly related to lower average selling prices of our products in the current period of 2009, since the volumes were better in 2009.

Cost of sales. Cost of sales decreased by $788,064 or 6.1% to $12,148,026 from $12,936,090 for the three months period ended September 30, 2009, when compared to the corresponding period of the prior year. The overall gross profit ratio improved by 2.8% to 45.2% for the three months period ended September 30, 2009 compared with 42.4% for the corresponding period of 2008. The improvement in the gross profit margin in 2009 was the result of a mix of increased gross profit margin from the aquaculture segment due to lower raw material and manufacturing costs, offset by reduced profit margin from the health and bio-product segment due to higher raw material costs.

Selling and distribution expenses. Selling and distribution expenses decreased by $140,687 to $417,076 for the three months period ended September 30, 2009, as compared to the corresponding period of the previous year. As a percentage of sales, the selling and distribution expenses remained relatively stable at approximately 2% of sales in the current quarter of 2009, as compared to the corresponding quarter of 2008.

Marketing and advertising expenses. Marketing and advertising expenses increased by $979,153 or 135% from $724,511 to $1,703,664 as compared to the corresponding period of the previous year. As a percentage of sales, this expense continues to be the most important expense of the health and bio-product segment, corresponding to 21% of sales in 2009 compared to 10% in the same period of 2008. The increase in these expenses in 2009 were related to new products that had been launched in recent months and are consistent with industry practices.

General and administrative expenses. General and administrative expenses decreased by $33,305, or 2%, to $1,432,869 in the current three months period ended September 30, 2009, from $1,466,174 in the corresponding period of 2008. Overall, those expenses remained stable as a percentage of sales in the three months period ended September 30, 2009 as compared to the corresponding 2008 period.

Depreciation and amortization. Depreciation and amortization decreased by $273,697 to $281,044 in the current quarter when compared to the same quarter of 2008. In the three months period ended September 30, 2009, depreciation of newly acquired fixed assets in the second portion of 2008 and the first nine months of 2009 was offset by the effect of fully depreciated and amortized fixed assets.

(Recovery of)/Doubtful accounts. Doubtful accounts in the current three months period of 2009 amounted to $1,309,803, compared to a recovery of $296,655 in the corresponding period of 2008. The increase in 2009, which originated mostly from the health and bio-product segment, was the result of providing for potential losses in our receivables which did not materialize to date, in accordance with our accounting policy. The delay in perception of receivables increased in the current quarter of 2009 as we are providing longer credit facilities to our clients on the new bio- products launched in 2009.

Income from operations. Income from operations decreased to $4,864,385 in the current quarter of 2009 from $6,527,560 in the corresponding quarter of the previous year. Although we realized better gross profit in 2009, the substantial decrease in income from operations was mainly the result of increased doubtful accounts and marketing and advertising expenses in 2009, as explained above.

Finance costs. Finance costs increased from $60,240 in 2008 to $146,791 in 2009. That increase was the result of overall reduction of interest rates on our deposits in the third quarter of 2009 when compared to the third quarter of 2008. In 2008 as in 2009, financing costs also included recognition of the carrying interests on the promissory notes issued in November 2006 ("November 2006 Notes") added to the continued combination of amortization of the future conversion of warrants (non-cash) attributed to investors on those November 2006 Notes of $5,000,000, added to the amortization of the embedded conversion option (non-cash) related to the same notes. Such amortization will be repeated, on a pro-rata basis, until maturity of the underlying notes in November 2009.

Fair value change in derivative financial instruments. Effective January 01, 2009, in recognition of new accounting standards related to the fair value of our outstanding warrants and embedded conversion feature of our promissory notes in accordance with FASB ASC 815-40 and FAS No.133, we recognized in our income statement the change in value ("mark-to-market") from January 1, 2009 to September 30, 2009 of those two items included in our current liabilities. In the third quarter of 2009, we recognized an income of $154,200 corresponding to the decrease in the fair value of those two financial instruments between July 1, 2009 and September 30, 2009. This fair value change will continue to be evaluated quarterly until expiration of the warrants and the promissory notes, and the corresponding change will be charged or credited to our income in the corresponding period.

Income before income taxes.Income before income taxes showed a reduction of $1,595,526 in the current three months of 2009, when compared to the same period of 2008. The reduction of income was the result of lower income from operations recognized in the current three months of 2009 as indicated above, mostly offset by the decrease in fair value of our derivative financial instruments recognized in the same period of 2009.

Current income taxes. In the current three months period ended September 30, 2009, current income taxes decreased by $28,278 to $824,360 from $852,638 in the corresponding period of 2008. The decrease was mostly due to the reduced taxable income in 2009. Since the new tax legislation was promulgated in 2008, the health and bio product segment income tax rate is to be increased yearly until it reaches 25% in year 2012.

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

Net income attributable to shareholders. In the current three months period of 2009, we realized a net income of $4,047,433 compared to a net income of $5,614,682 in the corresponding period of 2008. The overall increase in gross profit during the three months period ended September 30, 2009 was offset by an increase in doubtful accounts and marketing and advertising expenses from the health and bio-product segment in the current 2009 period, compared to the corresponding period of 2008.

Results of Operations - Nine Months Ended September 30, 2009 as Compared to Nine Months Ended September 30, 2008

Total sales for the nine months period ended September 30, 2009 increased by 6%, from $46,212,161 in 2008 to $49,007,445 in 2009. Approximately 22% of the increase in sales originates from the aquaculture product segment and 78% from the health and bio-product segment. Gross profit for the nine months period ended September 30, 2009 increased by 17.3% to $21,574,090 when compared to the same period of 2008. The gross profit ratio for the nine months period ended September 30 increased from 39.8% in 2008 to 44.0% in 2009. That improvement in the gross profit ratio in the first nine months of 2009 compared to the corresponding 2008 period originates mostly from the aquatic product segment which saw a substantial increase the gross profit ratio (26% in 2009 compared to 22% in 2008). Income from operations for the current nine months period of 2009 increased from $7,400,477 in September 2008 to $8,703,404 in September 2009. That improvement in income from operations experienced in 2009 was mostly the result of increased sales and related gross profit from both segments in 2009, offset by increased bad debts and marketing and

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advertising expenses. Net income increased from $3,591,801 in the nine months period ended September 30, 2008 to $6,247,524 in the corresponding period of 2009. The increased net income of 2009 was the result of increased income from operations as described above, coupled with a substantial reduction of finance costs in the same period. In the first nine months of 2008, finance costs were affected by penalties for late filing of the registration statement of the underlying shares related to those convertible notes issued in November 2006 (approximately $1,621,000), added to the result of a final settlement amounting to approximately $699,000 from the American Arbitration Association in relation with financial fees payable to one of our financial service suppliers.

Segments

Manufacturing and Selling of aquatic products

HQ Ocean Fishing Co. Ltd ("HQOF") is engaged in the manufacturing and selling of aquatic products. The revenue contributed by this segment increased by $616,425 or 2% to $31,858,522 for the nine months period ended September 30, 2009 compared to $31,242,097 for the corresponding period of 2008. Although volumes of fish sold increased by approximately 10% in 2009, sales prices went down in the same corresponding period of 2009. The related gross profit ratio of this segment went from 22% for the nine months period ending in September 2008 compared to 26% in the corresponding period of 2009. The increase in the gross profit ratio in 2009 originates mostly from lower manufacturing costs (mostly raw materials) experienced in the second and third quarters of 2009, compared to the second and third quarters of 2008. This segment contributed $6,791,498 to our net income in the first nine months of 2009, as compared to net income of $4,579,139 for the corresponding period of 2008, an improvement of 48.3%. That improvement is mostly due to the 4% increase in the gross profit ratio experienced in the first nine months period of 2009, compared to the corresponding period of 2008.

Manufacturing and Selling of Marine Bio and Healthcare products

Our other manufacturing subsidiary, Jihua Marine, is engaged in the manufacturing and selling of Marine Bio and Health-care products. During the nine months period ended September 30, 2009 and 2008, Jiahua Marine realized sales of $17,148,923 and $14,970,064 respectively, an increase of $2,178,859 or 14.6%. That increase in sales in 2009 was related mostly do increased prices of the already existing products, added to the new products marketed in that period. The gross profit ratio from this segment was stable to approximately 77% for first nine months period ended September 2009 and 2008. The major expense of this segment continues to be marketing and advertising, corresponding to 26% and 21% of revenues for the nine months ended September 30, 2009 and 2008 respectively. The net income contributed by this segment was $4,738,155 and $5,797,069 for the nine months period ended September 30, 2009 and 2008 respectively, a reduction of 18.3%. The decrease in net income was mostly due to the combination of higher bad debts and marketing and advertising expenses incurred in 2009, when compared to 2008.

Operations

Sales. For the nine months period ended September 30, 2009, sales increased by $2,795,284 or 6% to $49,007,445. This improvement in sales resulted from increased activities of both segments in 2009, mostly the bio-product segment which experienced an increase of $2,178,859 or 14.6%, mostly related to an increase in sales prices for the products already on the market, added to the marketing of new products in 2009. The sales from the aquaculture segment increased by $616,425 or 2% in the first nine months period of 2009, mostly related to a volume increase as the sales prices went down in 2009, compared to the corresponding period of 2008.

Cost of sales. Cost of sales decreased by $386,047 or 1.4% to $27,433,355 from $27,819,402 for the nine months period ended September 30, 2009, as compared to the corresponding period of the prior year. The gross profit ratio increased from 39.8% for the nine months period ended September 30, 2008 to 44% for the same period of 2009. The overall gross profit ratio improvement in the current nine months period of 2009 mostly originates from decreased cost of raw materials from aquaculture product segment.

Selling and distribution expenses. Selling and distribution expenses decreased by $150,493 or 13.5% from $1,111,871 to $961,378 for the nine months period ended September 30, 2009, as compared to the corresponding period of the prior year. As a percentage of sales, the selling and distribution expenses remained relatively stable at approximately 2% of sales in the current nine months period of 2009, as compared to the corresponding period of 2008.

Marketing and advertising expenses. Marketing and advertising expenses increased by $1,293,588 or 40.7% from $3,175,561 to $4,469,149 as compared to the corresponding period of prior year. Those expenses correspond to approximately 26% of our bio-products sales of 2009 and 21% in 2008. The increase in 2009 is related to new products launched in the bio-product segment in recent months. Those advertising expenditures for the promotion of our health and bio-products to achieve customer recognition are consistent with industry practices.

General and administrative expenses. General and administrative expenses increased by $200,185 or 4.1% to $5,062,834 from $4,862,649 as compared to the corresponding period of the previous year. As a percentage of total sales, those expenses remained stable at 10.2% in the nine months period ended September 30, 2009 compared to 11% in the corresponding period of 2008 and 11% in 2008.

Depreciation and amortization. Depreciation and amortization decreased by $208,669 or 16.6% to $1,048,335 as compared to the corresponding period of prior year, mainly originating from the effect of fully depreciated and amortized fixed assets in 2009 compared to the same period of 2008.

Doubtful accounts. Doubtful accounts expense amounted to $1,328,990 for the nine months period ended September 30, 2009 compared to $585,197 for the corresponding period of 2008. The increase in 2009, originating mostly from the health and bio-product segment, was the result of providing for potential losses in our receivables which did not materialize to date, in accordance with our accounting policy. The delay in perception of receivables increased in the nine months period ended on September 30, 2009 as a result of providing longer credit . . .