**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**Form
      10-QSB**







o
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
                1934




For
      the
      period ended June 30, 2007




o
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
                ACT OF 1934




For
      the
      transition period from ________ to ________


Commission
      file number   000-51006





**HARBIN
      ELECTRIC, INC.**


(Exact
      name of small business issuer in its charter)




**Nevada**
              (State
                or other jurisdiction of
              incorporation
                or organization)
            
            **98-0403396**
              (I.R.S.
                Employer
              Identification
                Number)







**No.
      9 Ha Ping Xi Lu, Ha Ping Lu Ji Zhong Qu**


**Harbin
      Kai Fa Qu, Harbin, People’s Republic of China 150060**


(Address
      and telephone number of principal executive offices)




**Telephone:
      215-854-8104**


(Issuer’s
      telephone number)







Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or 15(d) of the Securities Exchange Act of 1934, during the past 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 o No
o




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




**APPLICABLE
      ONLY TO ISSUERS INVOLVED IN BANKRUPTCY**


**PROCEEDINGS
      DURING THE PRECEDING FIVE YEARS**




Check
      whether the registrant filed all documents and reports required to be filed
      by
      Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 after
      the distribution of securities under a plan confirmed by a court.
      Yes   o No
o




**APPLICABLE
      ONLY TO CORPORATE ISSUERS**




State
      the
      number of shares outstanding of each of the issuer’s classes of common equity,
      as of June 30, 2007: 16,600,451 shares of common stock, par value $0.00001
      per
      share.




Transitional
      Small Business Disclosure Format (Check one): Yes  o No o








**TABLE
      OF CONTENTS**




**Page****Part
                I. Financial Information**Item
                1. Financial Statements
            
            
            1Consolidated
                Balance Sheet (Unaudited) as of June 30, 2007
            
            
            1Consolidated
                Statements of Income and Other Comprehensive Income
                (Unaudited)
              For
                the Six months and Three months Ended June 30, 2007 and
                2006
            
            
            2Consolidated
                Statements of Stockholders’ Equity (Unaudited)
            
            
            4Consolidated
                Statements of Cash Flows (Unaudited)
            
            
            3Notes
                to the Consolidated Financial Statements (Unaudited)
            
            
            5Item
                1A. Risk Factors
            
            
            29Item
                2. Management’s Discussion and Analysis or Plan of
                Operation
            
            
            35Item
                3. Controls and Procedures
            
            
            46**Part
                II. Other Information**Item
                1. Legal Proceedings.
            
            
            46Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds.
            
            
            46Item
                3. Defaults upon Senior Securities.
            
            
            47Item
                4. Submission of Matters to a Vote of Securities Holders.
            
            
            47Item
                5. Other Information.
            
            
            47Item
                6. Exhibits.
            
            
            48Signatures
            
            
            51Index
                to Exhibits
            
            
            52










**PART
      I. FINANCIAL INFORMATION**


**Item
      1. Financial Statements (Unaudited)**





HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
  CONSOLIDATED
          BALANCE SHEETS
 AS
            OF
            JUNE 30, 2007 AND DECEMBER 31, 2006


JUNE
                  30,
              
              DECEMBER 31,2007
              
              2006UNAUDITEDASSETSCURRENT
                  ASSETS:Cash
              
              $
              62,700,593
              
              $
              67,313,919Accounts
                  receivable, net of allowance for doubtful accounts of
                  $45,699and
                  $44,552 as of June 30, 2007 and December 31, 2006,
                  respectively
              
              
              10,546,850
              
              
              8,827,799Inventories
              
              
              1,391,605
              
              
              583,287Other
                  receivables
              
              
              100,769
              
              
              27,991Other
                  receivables - related parties
              
              
              -
              
              
              44,998Advances
                  on inventory purchases
              
              
              2,527,626
              
              
              834,590Total
                  current assets
              
              
              77,267,443
              
              
              77,632,584PLANT
                  AND EQUIPMENT, net
              
              
              10,233,847
              
              
              9,219,534OTHER
                  ASSETS:Debt
                  issue costs, net of amortization
              
              
              2,510,937
              
              
              2,757,155Advances
                  on equipment purchases
              
              
              11,913,900
              
              
              -Advances
                  on intangible assets
              
              
              2,134,625
              
              
              2,585,977Intangible
                  assets, net of accumulated amortization
              
              
              825,433
              
              
              640,337Other
                  assets
              
              
              174,168
              
              
              123,234Investment
                  in derivative hedge
              
              
              1,004,401
              
              
              -Total
                  other assets
              
              
              18,563,464
              
              
              6,106,703Total
                  assets
              
              $
              106,064,754
              
              $
              92,958,821LIABILITIES
                  AND SHAREHOLDERS' EQUITYCURRENT
                  LIABILITIES:Accounts
                  payable
              
              $
              183,333
              
              $
              258,911Other
                  payables
              
              
              468,371
              
              
              406,520Other
                  payables - related party
              
              
              35,613
              
              
              -Accrued
                  liabilities
              
              
              165,950
              
              
              107,263Customer
                  deposits
              
              
              330,214
              
              
              319,261Taxes
                  payable
              
              
              499,981
              
              
              556,943Interest
                  payable
              
              
              1,122,000
              
              
              1,122,000Total
                  current liabilities
              
              
              2,805,462
              
              
              2,770,898NOTES
                  PAYABLE, net of debt discount $19,144,335 and $21,410,401 as ofJune
                  30, 2007 and December 31, 2006, respectively
              
              
              30,855,665
              
              
              28,589,599CROSS
                  CURRENCY HEDGE PAYABLE
              
              
              3,945,951
              
              
              -WARRANT
                  LIABILITIES
              
              
              -
              
              
              16,568,080Total
                  liabilities
              
              
              37,607,078
              
              
              47,928,577COMMITMENTS
                  AND CONTINGENCIES
              
              
              -
              
              
              -SHAREHOLDERS'
                  EQUITY:Common
                  Stock, $0.00001 par value, 100,000,000 shares authorized,16,602,951
                  shares issued and outstanding
              
              
              166
              
              
              166Paid-in-capital
              
              
              35,674,843
              
              
              12,252,064Retained
                  earnings
              
              
              27,829,594
              
              
              26,222,408Statutory
                  reserves
              
              
              4,523,715
              
              
              4,523,715Accumulated
                  other comprehensive income
              
              
              429,358
              
              
              2,031,891Total
                  shareholders' equity
              
              
              68,457,676
              
              
              45,030,244Total
                  liabilities and shareholders' equity
              
              $
              106,064,754
              
              $
              92,958,821


The
      accompanying notes are an integral part of these unaudited consolidated
      financial statements.




-
          1 -




HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
  CONSOLIDATED
        STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


(UNAUDITED)


FOR THE SIX MONTHS
                
                FOR THE THREE MONTHSENDED
                    JUNE 30,
                
                ENDED
                    JUNE 30,2007
                
                2006
                
                2007
                
                2006REVENUES
                
                $
                27,615,907
                
                $
                18,590,003
                
                $
                13,989,693
                
                $
                9,711,345COST
                    OF SALES
                
                
                13,537,609
                
                
                9,515,476
                
                
                6,769,323
                
                
                4,910,553GROSS
                    PROFIT
                
                
                14,078,298
                
                
                9,074,527
                
                
                7,220,370
                
                
                4,800,792RESEARCH
                    AND DEVELOPMENT EXPENSE
                
                
                453,359
                
                
                826,754
                
                
                235,519
                
                
                504,165SELLING,
                    GENERAL AND ADMINISTRATIVE EXPENSES
                
                
                2,960,321
                
                
                1,430,853
                
                
                1,445,858
                
                
                636,677INCOME
                    FROM OPERATIONS
                
                
                10,664,618
                
                
                6,816,920
                
                
                5,538,993
                
                
                3,659,950Other
                    (income) expense, net
                
                
                (9,310
                )
                
                (53,148
                )
                
                (6,854
                )
                
                914Non-operating
                    (income)
                
                
                (763,408
                )
                
                -
                
                
                (757,087
                )
                
                -Realized
                    (gain) on sale of marketable securities
                
                
                -
                
                
                (571,143
                )
                
                -
                
                
                -Amortization
                    expense of debt discount
                
                
                2,266,066
                
                
                -
                
                
                1,133,033
                
                
                -Gain
                    on cross currency hedge
                
                
                (297,637
                )
                
                -
                
                
                (297,637
                )
                
                -Interest
                    expense (income), net
                
                
                1,508,688
                
                
                (31,030
                )
                
                911,382
                
                
                (18,709
                )OTHER
                    EXPENSE (INCOME), NET
                
                
                2,704,399
                
                
                (655,321
                )
                
                982,837
                
                
                (17,795
                )INCOME
                    BEFORE PROVISION FOR INCOME TAXES
                
                
                7,960,219
                
                
                7,472,241
                
                
                4,556,156
                
                
                3,677,745PROVISION
                    FOR INCOME TAXES
                
                
                -
                
                
                -
                
                
                -
                
                
                -NET
                    INCOME
                
                
                7,960,219
                
                
                7,472,241
                
                
                4,556,156
                
                
                3,677,745OTHER
                    COMPREHENSIVE LOSS
                
                
                1,602,533
                
                
                264,816
                
                
                2,307,201
                
                
                1,093,730COMPREHENSIVE
                    INCOME
                
                $
                6,357,686
                
                $
                7,207,425
                
                $
                2,248,955
                
                $
                2,584,015BASIC
                    WEIGHTED AVERAGE NUMBER OF SHARES
                
                
                16,600,507
                
                
                16,600,451
                
                
                16,600,562
                
                
                16,600,451BASIC
                    EARNING PER SHARE
                
                $
                0.48
                
                $
                0.45
                
                $
                0.27
                
                $
                0.22DILUTED
                    WEIGHTED AVERAGE NUMBER OF SHARES
                
                
                18,739,186
                
                
                17,245,535
                
                
                18,740,981
                
                
                17,350,758DILUTED
                    EARNING PER SHARE
                
                $
                0.42
                
                $
                0.43
                
                $
                0.24
                
                $
                0.21
 The
        accompanying notes are an integral part of these unaudited consolidated
        financial statements.


-
          2 -




HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
  CONSOLIDATED
          STATEMENTS OF CASH FLOWS
 FOR
            THE
            SIX MONTHS ENDED JUNE 30, 2007 AND 2006
 (UNAUDITED)


2007
              
              2006CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  income
              
              $
              7,960,219
              
              $
              7,472,241Adjustments
                  to reconcile net income to cash provided
                  by (used in) operating activities:Depreciation
              
              
              209,399
              
              
              146,512Amortization
                  of intangible assets
              
              
              47,304
              
              
              -Amortization
                  of debt issuance cost
              
              
              246,218
              
              
              -Amortization
                  of debt discount
              
              
              2,266,066
              
              
              -Gain
                  on cross currency hedge
              
              
              (297,637
              )
              
              -Realized
                  gain on sale of marketable securities
              
              
              -
              
              
              (571,143
              )Stock
                  based compensation
              
              
              492,916
              
              
              330,000(Increase) decrease in assets:Accounts
                  receivable
              
              
              (1,473,337
              )
              
              (2,490,257
              )Inventories
              
              
              (782,505
              )
              
              444,295Other
                  receivables
              
              
              (108,294
              )
              
              -Other
                  receivables - related parties
              
              
              45,528
              
              
              -Advances
                  on inventory purchases
              
              
              (1,650,174
              )
              
              (1,826,602
              )Other
                  assets
              
              
              (9,914
              )
              
              (960
              )Increase (decrease) in liabilities:Accounts
                  payable
              
              
              (74,302
              )
              
              583,747Other
                  payables
              
              
              51,203
              
              
              -Accrued
                  liabilities
              
              
              37,431
              
              
              -Customer
                  deposits
              
              
              15,395
              
              
              670,950Taxes
                  payable
              
              
              (69,427
              )
              
              -Net
                  cash provided by operating activities
              
              
              6,906,089
              
              
              4,758,783CASH
                  FLOWS FROM INVESTING ACTIVITIES:Advances
                  on intangible assets
              
              
              505,709
              
              
              -Advances
                  on equipment purchases
              
              
              (11,741,760
              )
              
              -Additions
                  to intangible assets
              
              
              198,998
              
              
              -Additions
                  to plant and equipment
              
              
              (861,752
              )
              
              (175,582
              )Proceeds
                  from sale of marketable securities
              
              
              -
              
              
              1,093,165Net
                  cash (used in) provided by investing activities
              
              
              (11,898,805
              )
              
              917,583CASH
                  FLOWS FINANCING ACTIVITIES:Proceeds
                  received from conversion of warrants
              
              
              8,750
              
              
              -Deposit
                  to secure investment in cross currency hedge
              
              
              (1,000,000
              )
              
              -Proceeds
                  from cross currency hedge
              
              
              297,637
              
              
              -Net
                  cash used in financing activities
              
              
              (693,613
              )
              
              -EFFECTS
                  OF EXCHANGE RATE CHANGE IN CASH
              
              
              1,073,003
              
              
              79,412(DECREASE)
                  INCREASE IN CASH
              
              
              (4,613,326
              )
              
              5,755,778CASH,
                  beginning of period
              
              
              67,313,919
              
              
              5,739,019CASH,
                  end of period
              
              $
              62,700,593
              
              $
              11,494,797SUPPLEMENTAL
                  DISCLOSURE OF CASH FLOW INFORMATION:Cash
                  paid for interest expense
              
              $
              1,998,896
              
              $
              -Cash
                  paid for taxes
              
              $
              2,258,151
              
              $
              1,307,919


The
      accompanying notes are an integral part of these unaudited consolidated
      financial statements.





-
          3 -




HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES


CONSOLIDATED
                STATEMENTS OF SHAREHOLDERS' EQUITY
 Additional
                        
                        
                        Retained
                            earnings
                        
                        
                        Accumulated otherNumber
                        
                        
                        Common
                        
                        
                        paid-in
                        
                        
                        Statutory
                        
                        
                        Unrestricted
                        
                        
                        Comprehensiveof
                            shares
                        
                        
                        stock
                        
                        
                        capital
                        
                        
                        reserves
                        
                        
                        retained earnings
                        
                        
                        income
                        
                        
                        TotalsBALANCE,
                            January 1, 2006
                        
                        
                        16,600,451
                        
                        $
                        166
                        
                        $
                        11,297,676
                        
                        $
                        1,846,724
                        
                        $
                        10,460,887
                        
                        $
                        997,466
                        
                        $
                        24,602,919Stock
                            based compensation
                        
                        
                        
                        
                        
                        
                        
                        
                        330,000
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        330,000Adjustment
                            to statutory reserve
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,120,837
                        
                        
                        (1,120,837
                        )
                        
                        
                        
                        
                        -Net
                            income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,472,241
                        
                        
                        
                        
                        
                        7,472,241Unrealized
                            loss on investment
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (587,171
                        )
                        
                        (587,171
                        )Foreign
                            currency translation gain
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        322,355
                        
                        
                        322,355BALANCE,
                            June 30, 2006, unaudited
                        
                        
                        16,600,451
                        
                        $
                        166
                        
                        $
                        11,627,676
                        
                        $
                        2,967,561
                        
                        $
                        16,812,291
                        
                        $
                        732,650
                        
                        $
                        32,140,344Capital
                            contribution
                        
                        
                        
                        
                        
                        
                        
                        
                        36,300
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        36,300Stock
                            based compensation
                        
                        
                        
                        
                        
                        
                        
                        
                        588,088
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        588,088Adjustment
                            to statutory reserve
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,556,154
                        
                        
                        (1,556,154
                        )
                        
                        
                        
                        
                        -Net
                            income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        10,966,271
                        
                        
                        
                        
                        
                        10,966,271Foreign
                            currency translation gain
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,299,241
                        
                        
                        1,299,241BALANCE,
                            December 31, 2006
                        
                        
                        16,600,451
                        
                        $
                        166
                        
                        $
                        12,252,064
                        
                        $
                        4,523,715
                        
                        $
                        26,222,408
                        
                        $
                        2,031,891
                        
                        $
                        45,030,244Reclassification
                            of warrant liabilities to equity
                        
                        
                        
                        
                        
                        
                        
                        
                        22,921,113
                        
                        
                        
                        
                        
                        (6,353,033
                        )
                        
                        
                        
                        
                        16,568,080Exercise
                            of warrants
                        
                        
                        2,500
                        
                        
                        
                        
                        
                        8,750
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        8,750Stock
                            based compensation
                        
                        
                        
                        
                        
                        
                        
                        
                        492,916
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        492,916Net
                            income
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,960,219
                        
                        
                        
                        
                        
                        7,960,219Foreign
                            currency translation gain
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2,343,418
                        
                        
                        2,343,418Net
                            change related to cash flow hedges
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (3,945,951
                        )
                        
                        (3,945,951
                        )BALANCE,
                            June 30, 2007, unaudited
                        
                        
                        16,602,951
                        
                        $
                        166
                        
                        $
                        35,674,843
                        
                        $
                        4,523,715
                        
                        $
                        27,829,594
                        
                        $
                        429,358
                        
                        $
                        68,457,676
  The
                accompanying notes are an integral part of these unaudited consolidated
                financial statements.





-
          4 -




HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES




NOTES
      TO
      THE CONSOLIDATED FINANCIAL STATEMENTS


JUNE
      30,
      2007


(UNAUDITED)


**Note
        1** **–
        Organization and
        description of business**
 
 Harbin
        Electric, Inc, (the “Company”) is a Nevada corporation, incorporated on July 9,
        2003 under the name Torch Executive Services Ltd. The Company through its
        indirect wholly-owned subsidiary, Harbin Tech Full Electric Co., Ltd. (“HTFE”),
        develops, engineers, manufactures and sells a wide array of customized linear
        motors and other special motors.
 
 On
        April
        9, 2007, the Company entered into an Agreement with Shelton Technology, LLC
        (“Shelton”), Shaotang Chen (“Dr Chen”) and Xiaogang Luo (“Dr Luo”) whereby the
        Company and Shelton agreed to work together through the Company’s newly formed,
        wholly-owned subsidiary, Advanced Automation Group, LLC (“AAG”) to design,
        develop and manufacture custom industrial automation controllers. The Company
        is
        required to contribute $3,000,000 to AAG in 3 installments: $1.2 million
        was
        paid on April 16, 2007, $800,000 by May 1, 2008 and $1,000,000 by March 31,
        2009. Shelton contributed an exclusive worldwide royalty-free license for
        motorized automation technology. Shelton is entitled to receive 49% of any
        profits earned by AAG through the initial term of the Agreement. The initial
        term begins April 9, 2007 and terminates August 31, 2008.
 
 **Note
        2 – Accounting policies**
 
 Use
        of
        estimates
 
 The
        preparation of financial statements in conformity with generally accepted
        accounting principles requires management to make estimates and assumptions
        that
        affect the reported amounts of assets and liabilities and disclosure of
        contingent assets and liabilities at the date of the financial statements
        and
        the reported amounts of revenues and expenses during the reporting period.
        For
        example, the Company estimated the fair value of warrants using subjective
        assumptions including estimated length of time employees will retain their
        options before exercising them, forfeitures, and expected volatility of
        Company’s stock price over the expected term. Changes in these assumptions can
        materially affect the estimated fair value and the resulting expense. Actual
        results could differ from management’s estimates.
 
 Basis
        of presentation
 
 The
        consolidated financial statements of Harbin Electric Inc. reflect the activities
        of the following subsidiaries:
  Percentage
                  ofOwnershipAdvanced
                  Electric Motors, Inc
              
              Delaware,
                  USA
              
              100%Harbin
                  Tech Full Electric, Co., Ltd
              
              Harbin,
                  China
              
              100%Advanced
                  Automation Group, LLC
              
              Delaware,
                  USA
              
              100%
  -
            5 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  T he
        accompanying financial statements have been prepared in accordance with
        accounting principles generally accepted in the United States of America.
        All
        material intercompany transactions and balances have been eliminated in the
        consolidation.
 
 Cash
        and concentration of risks
 
 The
        Company considers all highly liquid investments with original maturities
        of
        three months or less at the time of purchase to be cash equivalents, for
        cash
        flow statement purposes. Cash includes cash on hand and demand deposits in
        accounts maintained with state owned banks within the People’s Republic of China
        (“PRC”) and the United States.
  Certain
        f inancial
        instruments, which subject the Company to concentration of credit risk, consist
        of cash. The Company maintains balances at financial institutions which,
        from
        time to time, may exceed Federal Deposit Insurance Corporation insured limits
        for the banks located in the Unites States. Balances at financial institutions
        or state owned banks within the PRC are not covered by insurance. As of June
        30,
        2007 and December 31, 2006, the Company had deposits in excess of federally
        insured limits totaling $ 62,586,531 and $67,221,852 ,
        respectively. The Company has not experienced any losses in such accounts
        and
        believes it is not exposed to any significant risks on its cash in bank
        accounts.
 
 Accounts
        receivable
 
 The
        Company’s policy is to maintain reserves for potential credit losses on accounts
        receivable. Management reviews the composition of accounts receivable and
        analyzes historical bad debts, customer concentrations, customer credit
        worthiness, current economic trends and changes in customer payment patterns
        to
        evaluate the adequacy of these reserves. The Company had accounts receivable,
        net of allowance for doubtful accounts of $10,546,850 and $ 8,827,799 as
        of
        June 30, 2007 and December 31, 2006, respectively. The allowance for doubtful
        accounts amounted to $45,699  and
        $ 44,552 as
        of
        June 30, 2007 and December 31, 2006, respectively.
 
 Investment
        in marketable securities
 
 Securities
        available for sale are carried at fair value with unrealized gains and losses
        reported as accumulated other comprehensive income in the stockholders’ equity
        section of the balance sheet. Realized gains and losses on securities available
        for sale are included in other income (expense) and, when applicable, are
        reported as a reclassification adjustment in other comprehensive income.
        Gains
        and losses on the sale of available for sale securities are determined using
        the
        specific-identification method.
 
 The
        realized gain was $571,143 for the six months ended June 30, 2006. The Company
        determines cost on specific identification method. All marketable securities
        were sold during 2006 and the related unrealized gains totaling $587,171
        were
        released from other comprehensive income. As of June 30, 2007, the Company
        did
        not have any marketable securities.
 
 -
            6 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  Inventories
 
 Inventory
        is composed of raw material for manufacturing electrical motors, work in
        process, and finished goods. Inventory is valued at the lower of cost or
        market
        value using weighted average method. Management compares the cost of inventory
        with the market value and an allowance is made for writing down the inventory
        to
        its market value, if lower than cost.
 
 Plant
        and equipment
 
 Plant
        and
        equipment are stated at cost. Expenditures for maintenance and repairs are
        charged to earnings as incurred; additions, renewals and betterments are
        capitalized. When assets are retired or otherwise disposed of, the related
        cost
        and accumulated depreciation are removed from the respective accounts, and
        any
        gain or loss is included in operations. Depreciation of plant and equipment
        is
        provided using the straight-line method for substantially all assets with
        estimated lives as follows:
  EstimatedUseful
                  LifeBuildings
              
              
              20
                  yearsVehicle
              
              
              5
                  yearsOffice
                  equipment
              
              
              5
                  yearsProduction
                  equipment
              
              
              10
                  years
 
 Construction
        in progress represents the costs incurred in connection with the construction
        of
        buildings or new additions to the Company’s plant facilities. No depreciation is
        provided for construction in progress until such time as the assets are
        completed and placed into service.
 
 The
        Company periodically evaluates the carrying value of long-lived assets in
        accordance with SFAS 144. When estimated cash flows generated by those assets
        are less than the carrying amounts of the asset, the Company recognizes an
        impairment loss. Based on its review, the Company believes that, as of June
        30,
        2007, there were no impairments of its long-lived assets.
 
 Stock-based
        compensation
 
 The
        Company records stock based compensation expense pursuant to SFAS No 123R.
        The
        Company estimates the fair value of the award using the Black-Scholes Option
        Pricing Model. Under SFAS No. 1123R, the Company’s expected volatility
        assumption is based on the historical volatility of Company’s stock. The
        expected life assumption is primarily based on historical exercise patterns
        and
        employee post-vesting termination behavior. The risk-free interest rate for
        the
        expected term of the option is based on the U.S. Treasury yield curve in
        effect
        at the time of grant.
 
 -
            7 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  Stock
        compensation expense is recognized based on awards expected to vest, and
        there
        were no estimated forfeitures as the Company has a short history of issuing
        options. SFAS No. 123R requires forfeitures to be estimated at the time of
        grant and revised in subsequent periods, if necessary, if actual forfeitures
        differ from those estimates.
 
 Revenue
        recognition
 
 The
        Company's revenue recognition policies are in compliance with Staff Accounting
        Bulletin (“SAB”) 104. Sales revenue is recognized at the date of shipment to
        customers when a formal arrangement exists, the price is fixed or determinable,
        the delivery is completed, no other significant obligations of the Company
        exist
        and collectability is reasonably assured. Payments received before all of
        the
        relevant criteria for revenue recognition are recorded as customer deposits.
 
 In
        addition, our revenue recognition could be negatively impacted by returns.
        However, the Company makes custom products which are customer specific, and
        no
        returns are allowed. The Company warrants the product for repair only in
        the
        event of defects for two years from the date of shipment. Historically, the
        Company has not experienced significant defects, and replacements for defects
        have not been material. The Company charges such costs to cost of goods sold.
        For the six months ended June 30, 2007 and 2006 such returns and allowances
        were
        $0. Should returns increase in the future it would be necessary to adjust
        the
        estimates, in which case recognition of revenues could be delayed.
 
 Shipping
        and handling costs related to costs of goods sold are included in selling,
        general and administrative costs and totaled $218,175 and $129,860 for the
        six
        months ended June 30, 2007 and 2006 and totaled $122,357 and $60,496 for
        the
        three months ended June 30, 2007 and 2006.
 
 Income
        taxes
 
 The
        Company utilizes Statement of Financial Accounting Standards (SFAS) No. 109,
        "Accounting for Income Taxes," which requires the 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.
 
 Under
        this method, deferred income taxes are recognized for the tax consequences
        in
        future years of differences between the tax bases of assets and liabilities
        and
        their financial reporting amounts at each period end based on enacted tax
        laws
        and statutory tax rates applicable to the periods in which the differences
        are
        expected to affect taxable income. Valuation allowances are established,
        when
        necessary, to reduce deferred tax assets to the amount expected to be realized.
        There are no deferred tax amounts at June 30, 2007 and December 31, 2006,
        respectively.
 
 -
            8 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        charge for taxation is based on the results for the quarter as adjusted for
        items, which are non-assessable or disallowed. It is calculated using tax
        rates
        that have been enacted or substantively enacted by the balance sheet
        date.
 
 Under
        the
        Income Tax Laws of PRC, the Company is generally subject to income tax at
        an
        effective rate of 33% (30% state income taxes plus 3% local income taxes)
        on
        income reported in the statutory financial statements after appropriated
        tax
        adjustments, since the enterprise is located in a specially designated region
        where **** the
        Income Tax Laws of PRC allows foreign enterprises 50% income tax reduction
        and a
        two-year income tax exemption and an additional 50% income tax reduction
        for the
        following three years.
 
 According
        to the Provisional Regulations of the People's Republic of China on Income
        Tax,
        the Document of Reductions and Exemptions of Income Tax for the Company has
        been
        approved by the local tax bureau and the Management Regulation of Harbin
        Economic and Technological Development Zone for the reporting period. The
        Company is exempt from income tax from July 1, 2004 through December 31,
        2007.
        The Company has been approved to have its tax rate reduced by 50% from January
        1, 2008 to December 31, 2010.
 
 Beginning
        January 1, 2008, the new Chinese Enterprise Income Tax (“EIT”) law will replace
        the existing laws for Domestic Enterprises (“DES”) and Foreign Invested
        Enterprises (“FIEs”). The new standard EIT rate of 25% will replace the 33% rate
        currently applicable to both DES and FIEs.
 
 The
        following table reconciles the U.S. statutory rates to the Company’s effective
        tax rate for the six months ended June 30, 2007 and 2006:
 
 JUNE
                  30,2007
              
              2006U.S.
                  Statutory rates
              
              
              34
              %
              
              34
              %Foreign
                  income not recognized in USA
              
              
              (34
              )
              
              (34
              )China
                  income taxes
              
              
              33
              
              
              33Tax
                  exemption
              
              
              (33
              )
              
              (33
              )Total
                  provision for income taxes
              
              
              -
              %
              
              -
              %
  The
        estimated tax savings for the six months ended June 30, 2007 and 2006 amounted
        to $4,608,753 and $2,626,872. The net effect on earnings per share had the
        income tax been applied would decrease earnings per share from $ 0.43 to
        $ 0.18
        in 2007 and $ 0.45 to $ 0.30 in 2006.
 
 -
            9 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income
        Taxes” (“FIN 48”), as of January 1, 2007. A tax position is recognized as a
        benefit only if it is “more likely than not” that the tax position would be
        sustained in a tax examination, with a tax examination being presumed to
        occur.
        The amount recognized is the largest amount of tax benefit that is greater
        than
        50% likely of being realized on examination. For tax positions not meeting
        the
“more likely than not” test, no tax benefit is recorded. The adoption had no
        affect on the Company’s financial statements
 
 Harbin
        Electric, Inc. and Advanced Electric Motors, Inc. were incorporated in the
        United States and have incurred net operating losses for income tax purposes
        for
        the six months ended June 30, 2007. The net operating loss carry forwards
        for
        United States income taxes amounted to $5,710,151 which may be available
        to
        reduce future years’ taxable income. These carry forwards will expire, if not
        utilize, through 2027 and 2024. Management believes that the realization
        of the
        benefits from these losses appears uncertain due to the Company’s limited
        operating history and continuing losses for United States income tax purposes.
        Accordingly, the Company has provided a 100% valuation allowance on the deferred
        tax asset benefit to reduce the asset to zero. The net change in the valuation
        allowance for the six month period ended June 30, 2007 was increase of
        $1,940,000. Management will review this valuation allowance periodically
        and
        make adjustments as warranted.
 
 Value
        added tax
 
 Sales
        revenue represents the invoiced value of goods, net of a value-added tax
        (“VAT”). All of the Company’s products that are sold in the PRC are subject to a
        Chinese value-added tax at a rate of 17% of the gross sales price. This VAT
        may
        be offset by VAT paid by the Company on raw materials and other materials
        included in the cost of producing their finished product. The Company recorded
        VAT Payable and VAT receivable net of payments in the financial statements.
        The
        VAT tax return is filed offsetting the payables against the
        receivables.
 
 VAT
        on
        sales and VAT on purchases amounted to $4,176,354 and $2,246,373 for the
        six
        months ended June 30, 2007 and $3,142,793 and $1,491,763  for
        the
        six months ended June 30, 2006, respectively. Sales and purchases are recorded
        net of VAT collected and paid as the Company acts as an agent for the
        government. VAT taxes are not impacted by the income tax holiday.
 
 -
            10 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  Taxes
        payable consisted of the followings:
  June
                  30, 2007
              
              December 31, 2006VAT
                  tax payable
              
              $
              464,836
              
              $
              522,197Individual
                  income tax payable
              
              
              1,761
              
              
              335Business
                  tax payable
              
              
              -
              
              
              6,538Others
                  misc tax payable
              
              
              33,384
              
              
              27,873Total
              
              $
              499,981
              
              $
              556,943
 
 Advertising
        costs
 
 The
        Company expenses the cost of advertising as incurred in selling, general
        and
        administrative costs. Advertising costs were $0 and $146,578 for the three
        months ended June 30, 2007 and 2006, and $0 and $199,261 for the six months
        ended June 30, 2007 and 2006, respectively.
 
 Research
        and development costs
 
 Research
        and development costs are expensed as incurred. The costs of material and
        equipment that are acquired or constructed for research and development
        activities, and have alternative future uses; either in research and
        development, marketing, or sales are classified as plant and equipment and
        depreciated over their estimated useful lives. Research and development expense
        amounted to $453,359 and $826,754 for the six months ended June 30, 2007
        and
        2006, respectively. Research and development expense amounted to $235,519
        and
        $504,165 for the three months ended June 30, 2007 and 2006,
        respectively.
 
 Fair
        value of financial instruments
 
 Statement
        of financial accounting standard No. 107, “Disclosures about Fair Value of
        Financial Instruments,” requires that the Company disclose estimated fair values
        of financial instruments. The carrying amounts reported in the balance sheets
        for current assets and current liabilities qualifying as financial instruments
        are a reasonable estimate of fair value. The Company considers the carrying
        amount of cash, accounts receivable, other receivables, accounts payable,
        accrued liabilities and other payables to approximate their fair values because
        of the short period of time between the origination of such instruments and
        their expected realization and their current market rate of interest.
 
 Derivative
        Financial Instruments
 
 The
        Company uses a cross currency hedge, a derivative financial instrument, to
        hedge
        the risk of rising interest rates on their variable interest rate debt. This
        type of derivative financial instrument is known as a cash flow hedge. The
        Company accounts for this interest rate swap in accordance with FAS No. 133,
        “Accounting for Derivatives Instruments and Hedging Activity,” which requires
        the derivative to be carried on the balance sheet at fair value and to meet
        certain documentary and analytical requirements to qualify for hedge accounting
        treatment. The above derivative qualifies for hedge accounting under FAS
        133
        and, accordingly, changes in the fair value is reported in accumulated other
        comprehensive income, net of related income tax effects. Amounts included
        in
        accumulated other comprehensive income are reclassified into earnings when
        the
        hedged transaction effects earnings.
 
 -
            11 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  At
        the
        inception of the transaction, the Company documents the relationship between
        hedging instruments and hedged items, as well as its risk management objective
        and the strategy for undertaking various hedge transactions. This process
        includes linking all derivatives designated to specific firm commitments
        of
        forecast transactions. The Company also documents its assessment, both at
        inception and on an ongoing basis, of whether the derivative financial
        instruments that are used in hedging transactions are highly effective in
        offsetting changes in fair values or cash flows of hedged items.
 
 Foreign
        currency transactions and comprehensive income (loss)
 
 The
        reporting currency of the Company is the US dollar. The functional currency
        of
        HTFE is the Chinese Renminbi. The financial statements of HTFE are translated
        to
        United States dollars using quarter-end exchange rates as to assets and
        liabilities and average exchange rates as to revenues and expenses and cash
        flows. Capital accounts are translated at their historical exchange rates
        when
        the capital transaction occurred. Translation adjustments resulting from
        this
        process are included in accumulated other comprehensive income in the statement
        of shareholders’ equity. Transaction gains and losses that arise from exchange
        rate fluctuations on transactions denominated in a currency other than the
        functional currency are included in the results of operations as
        incurred.
 
 Translation
        adjustments resulting from this process amounted to $4,375,309 and $2,031,891
        as
        of June 30, 2007 and December 31, 2006, respectively. The balance sheet amounts
        with the exception of equity at June 30, 2007 were translated 7.60 RMB to
        $1.00
        USD as compared to 7.80 RMB at December 31, 2006. The equity accounts were
        stated at their historical rate. The average translation rates applied to
        income
        statement accounts for the periods ended June 30, 2007 and 2006 were 7.73
        RMB
        and 8.04 RMB to $1.00 USD, respectively.
 
 Changes
        in the fair values of derivative financial instruments accounted for as cash
        flow hedges, to the extent they qualify for hedge accounting, are recorded
        in
        accumulated other comprehensive income. On April 2, 2007, $5,387,485 was
        recorded as a loss on the derivative investment in other comprehensive
        income/loss upon entering into the hedge agreement. As of June 30, 2007,
        net
        changes in the fair value of the hedge totaled $1,441,534 and was recorded
        in
        other comprehensive income.
  Statement
        of cash
        flows
  In
        accordance with Statement of Financial Accounting Standards No. 95, "Statement
        of Cash Flows," cash flows from the Company's operations is calculated based
        upon the local currencies. As a result, amounts related to assets and
        liabilities reported on the statement of cash flows will not necessarily
        agree
        with changes in the corresponding balances on the balance sheet.
 
 -
            12 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  Change
        in accounting for registration rights penalties:
 
 On
        January 1, 2007, the Company adopted FASB Staff Position No. EITF 00-19-2,
        “Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”). FSP
        EITF 00-19-2 requires contingent obligations under a registration payment
        arrangement to be recognized and measured in accordance with SFAS No. 5,
“Accounting for Contingencies” (“FAS 5”). FAS 5 requires loss contingencies to
        be accrued and expensed if they are probable and reasonably
        estimable.
 
 In
        connection with the convertible debt and warrants issued in October 2006,
        the
        Company filed a registration statement with the Securities and Exchange
        Commission (SEC) to register for resale the common shares underlying the
        convertible debt and warrants. Initially, pursuant to EITF 00-19, “Accounting
        for Derivative Financial Instruments Indexed to, and Potentially Settle in,
        a
        Company’s Own Stock,” the existence of contingent cash penalties in the
        Registration Rights Agreement triggered derivative accounting treatment.
 
 As
        a
        result the Company recorded the warrants as a liability at their fair value
        on
        the date they were issued and then marked them to market each subsequent
        reporting period. Upon adoption of FSP EITF 00-19-2, any warrants originally
        classified as a liability under EITF 00-19 that would have been classified
        as
        equity without regard to the registration payment arrangement should be
        reclassified. The transition to the accounting treatment under FSP EITF 00-19-2
        is shown in the accompanying financial statements through 1) a cumulative-effect
        adjustment to the opening balance of retained earnings, as of January 1,
        2007
        and 2) reclassifying the warrants to equity at their fair value on the date
        of
        grant. The adjustment totaled $6,353,033 and was equal to the change in fair
        value of the warrants between October 6, 2006, the date the warrants were
        issued, and December 31, 2006, the last reporting period. Additionally, the
        warrants were reclassified as equity at $22,921,113, their fair value on
        October
        6, 2006. The adoption of FSP EITF 00-19-2 did not have an impact on prior
        year
        financial statements.
 
 Recently
        issued accounting pronouncements
 
 In
        July
        2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty
        in
        Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN 48"). The
        Company adopted Interpretation No. 48 on January 1, 2007. (See Note
        2)
 
 -
            13 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  In
        September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
        defines fair value, establishes a framework for measuring fair value in
        generally accepted accounting principles (GAAP), and expands disclosures
        about
        fair value measurements. This Statement applies under other accounting
        pronouncements that require or permit fair value measurements, the Board
        having
        previously concluded in those accounting pronouncements that fair value is
        the
        relevant measurement attribute. Accordingly, this Statement does not require
        any
        new fair value measurements. However, for some entities, the application
        of this
        Statement will change current practice. This Statement is effective for
        financial statements issued for fiscal years beginning after November 15,
        2007,
        and interim periods within those fiscal years. Management is currently
        evaluating the effect of this pronouncement on financial
        statements.
 
 In
        December 2006, the FASB issued FASB Staff Position No. EITF 00-19-2 “Accounting
        for Registration Payment Arrangements” (“FSP EITF 00-19-2”), which addresses an
        issuer’s accounting and disclosures relating to registration payment
        arrangements. In connection with issuance of Units in the private placement
        in
        February 2007, the Company has agreed to register the shares underlying the
        Units.
 
 In
        accordance with FSP EITF 00-19-2, the registration payment arrangements are
        accounted for as an instrument separate and apart from the related securities
        and will be accounted for in accordance with Statement of Financial Accounting
        Standards No. 5 “Accounting for Contingencies,” accruing a liability if payment
        is probable and the amount can be reasonably estimated.
 
 This
        FSP
        also requires certain disclosures regarding registration payment arrangements
        and liabilities recorded for such purposes. This FSP is immediately effective
        for registration payment arrangements entered into or modified after December
        21, 2006. The guidance of this FSP is effective for fiscal years beginning
        after
        December 15, 2006, and interim periods within those fiscal years for
        registration payment arrangements entered into prior to December 21, 2006.
        This
        FSP requires adoption by reporting a change in accounting principle through
        a
        cumulative-effect adjustment to the opening balance of retained earnings
        as of
        the first interim period of the year in which this FSP is initially applied.
        The
        Company recorded an adjustment to retained earnings totaling $6,353,033 which
        equaled the gain recognized for the change in fair value of the warrants
        between
        the date the warrants were issued and December 31, 2006.
 
 In
        February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
        Assets and Financial Liabilities—Including an amendment of FASB Statement No.
        115 (“SFAS 159”). SFAS 159 permits companies to choose to measure many financial
        instruments and certain other items at fair value that  are
        not
        currently required to be measured at fair value. The objective of SFAS 159
        is to
        provide opportunities to mitigate volatility in reported earnings caused
        by  measuring
        related assets and liabilities differently without having to apply hedge
        accounting provisions. SFAS 159 also establishes presentation and
        disclosure  requirements
        designed to facilitate comparisons between companies that choose different
        measurement attributes for similar types of assets and liabilities.
        SFAS  159
        will
        be effective in the first quarter of fiscal 2009. The Company is evaluating
        the
        impact that this statement will have on its consolidated financial  statements.
 
 -
            14 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  In
        June
        2007, the
        FASB
        issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance
        Payments for Goods or Services Received for use in Future Research and
        Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable
        advance payments for goods or services that used or rendered for research
        and
        development activities should be expensed when the advance payment is made
        or
        when the research and development activity has been performed. Management
        is
        currently evaluating the effect of this pronouncement on financial
        statements.
 
 Reclassifications **
 
 Certain
        prior period  amounts have been reclassified to conform to the current
        period presentation. These reclassifications have no effect on net income
        or
        cash flows.
 
 **Note
        3 – Earnings per share**
 
 The
        Company reports earnings per share in accordance with the provisions of SFAS
        No.
        128, “Earnings Per Share.” SFAS No. 128 requires presentation of basic and
        diluted earnings per share in conjunction with the disclosure of the methodology
        used in computing such earnings per share. Basic earnings per share excludes
        dilution and is computed by dividing
        income available to common stockholders by the weighted average common shares
        outstanding during the period. Diluted earnings per share takes into account
        the
        potential dilution that could occur if securities or other contracts to issue
        common stock were exercised and converted into common stock.
 
 -
            15 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        following is a reconciliation of the basic and diluted earnings per share
        computations for the periods ended June 30, 2007 and 2006:
 2007
                
                2006For
                    the six months ended June 30, 2007 and 2006Net
                    income for basic and diluted earnings per share
                
                $
                7,960,219
                
                $
                7,472,241Weighted
                    average shares used in basic computation
                
                
                16,600,507
                
                
                16,600,451Diluted
                    effect of stock options and warrants
                
                
                2,138,679
                
                
                645,084Weighted
                    average shares used in diluted computation
                
                
                18,739,186
                
                
                17,245,535Earnings
                    per share:Basic
                
                $
                0.48
                
                $
                0.45Diluted
                
                $
                0.42
                
                $
                0.43For
                    the three months ended June 30, 2007 and 2006Net
                    income for basic and diluted earnings per share
                
                $
                4,556,156
                
                $
                3,677,745Weighted
                    average shares used in basic computation
                
                
                16,600,562
                
                
                16,600,451Diluted
                    effect of stock options and warrants
                
                
                2,140,419
                
                
                750,307Weighted
                    average shares used in diluted computation
                
                
                18,740,981
                
                
                17,350,758Earnings
                    per share:Basic
                
                $
                0.27
                
                $
                0.22Diluted
                
                $
                0.24
                
                $
                0.21
  At
        June
        30, 2007 and 2006, 25,000 options (whose exercise price is $12.40 and vest
        through 2010) and 500,000 options (whose exercise price is $8.10 and vest
        through 2010), respectively, were excluded from the calculation because of
        their
        antidilutive nature.
 
 **Note
        4 – Inventories**
 
 Inventories
        consist of the following at June 30, 2007 and December 31, 2006:
  2007
              
              2006Raw
                  and packing materials
              
              $
              498,768
              
              $
              432,998Work
                  in process
              
              
              489,295
              
              
              120,367Finished
                  goods
              
              
              403,542
              
              
              29,922Total
              
              $
              1,391,605
              
              $
              583,287
  -
            16 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  **Note
        5 – Plant and equipment**
 
 Plant
        and
        equipment consist of the following at June 30, 2007 and December 31,
        2006:
 2007
                
                
                2006Buildings
                
                $
                5
                    ,480,263
                
                $
                5,396,163Office
                    equipment
                
                
                280,264
                
                
                203,188Production
                    equipment
                
                
                1
                    ,014,477
                
                
                803,854Vehicles
                
                
                268,605
                
                
                129,938Construction
                    in progress
                
                
                4
                    ,323,902
                
                
                3,477,322Total:
                
                
                11,367,511
                
                
                10,010,465Less:
                    accumulated depreciation
                
                
                (
                    1,133,664
                )
                
                (790,931
                )Property
                    and equipment, net
                
                $
                10,233,847
                
                $
                9
                    ,219,534
  Depreciation
        expense for the six months ended June 30, 2007 and 2006 amounted to $209,399
        and
        $146,512, respectively. Depreciation expense for the three months ended June
        30,
        2007 and 2006 amounted to $105,669 and $77,658, respectively.
 
 **Note
        6 – Major customers and vendors**
 
 Five
        major customers accounted for approximately 86% of the net revenue for the
        period ended June 30, 2007, with each customer individually accounting for
        27%,
        23%, 19%, 12%, and 5%, respectively.  At
        June
        30, 2007, the total receivable balance due from these customers was $10,502,362.
        Four major customers accounted for 81% of the net revenue for the six months
        period ended June 30, 2006. One major customer accounted for 31% of the net
        revenue for the six months period ended June 30, 2006. At June 30, 2006,
        the
        total receivable balance due from these customers was $7,519,460.
 
 Five
        major vendors provided approximately 82% of the Company’s purchases of raw
        materials for the period ended June 30, 2007, with each vendor individually
        accounting for 31%, 20%, 16%, 11% and 5%, respectively. The Company’s accounts
        payable to these vendors was $0 at June 30, 2007. Four vendors provided 86%
        of
        the Company’s purchase of raw materials for the six month period ended June 30,
        2006. The Company’s accounts payable to these vendors was $0 at June 30,
        2006.
 
 **Note
        7– Intangible assets**
 
 Intangible
        assets consist of land use rights and patents. All land in the People’s Republic
        of China is government owned and cannot be sold to any individual or company.
        However, the government grants the user a “land use right” (the Right) to use
        the land. The Company acquired land use rights during 2005 for the amount
        of
        $344,804. The Company has the right to use the land for 50 years and amortizes
        the Right on a straight line basis of the 50 years.
 
 The
        Company amortizes its patents over a 6 year period.
 
 -
            17 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        Company evaluates intangible assets for impairment, at least on an annual
        basis
        and whenever events or changes in circumstances indicate that the carrying
        value
        may not be recoverable from its estimated future cash flows. Recoverability
        of
        intangible assets, other long-lived assets, and goodwill is measured by
        comparing their net book value to the related projected undiscounted cash
        flows
        from these assets, considering a number of factors including past operating
        results, budgets, economic projections, market trends and product development
        cycles. If the net book value of the asset exceeds the related undiscounted
        cash
        flows, the asset is considered impaired, and a second test is performed to
        measure the amount of impairment loss. As of June 30, 2007, no impairment
        of
        intangible assets has been identified or recorded.
 
 Net
        intangible assets at June 30, 2007 and December 31, 2006 were as
        follows:
  2007
              
              2006Land
                  use rights
              
              $
              365,659
              
              $
              356,484Patents
              
              
              668,101
              
              
              444,216Less:
                  accumulated amortization
              
              
              (208,317
              )
              
              (160,363
              )Intangible
                  assets, net
              
              $
              825,443
              
              $
              640,337
 
 Amortization
        expense for the six months ended June 30, 2007 and 2006 amounted to $47,304
        and
        $0, respectively. Amortization expense for the three months ended June 30,
        2007
        and 2006, amounted to $24,358 and $0 for the three months ended June 30,
        2007
        and 2006, respectively.
 
 **Note
        8 –** **Advances
        to suppliers**
 
 The
        Company makes advances to certain vendors’ inventory purchases, construction
        projects and research and development expenses. The advances on inventory
        purchases were $ 2,527,626 and $ 834,590 as
        of
        June 30, 2007 and December 31, 2006, respectively. Additionally, the Company
        made advances on equipment purchases totaling $11,913,900 as of June 30,
        2007
        and $0 as of December 31, 2006, respectively.
 
 **Note
        9 – Advance for intangible assets**
 
 The
        advances for intangible assets as of June 30, 2007 and December 31, 2006
        consist
        of the following:
 
 2007
              
              2006Patent
                  prepayment
              
              $
              -
              
              $
              192,300Land
                  use right prepayment
              
              
              1,328,150
              
              
              1,294,820Research
                  and development prepayment
              
              
              806,475
              
              
              1,098,857Advances
                  on intangible assets
              
              $
              2,134,625
              
              $
              2,585,977
  -
            18 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  On
        September 8, 2006, HTFE entered into an agreement ("Land Use Agreement")
        with
        Shanghai Lingang Investment and Development Company Limited ("Shanghai Lingang")
        with respect to HTFE’s use of 40,800 square meters of State-owned land in the
        Shanghai Zhuqiao Airport Industrial Zone (the "Site").
 
 The
        term
        of the land use agreement is 50 years and the aggregate amount that HTFE
        shall
        pay to Shanghai Lingang is approximately $2.54 million ("Fee"), 55% ($1,294,820)
        of which has been paid and 45% of which is payable upon Shanghai Lingang's
        completion of certain regulatory applications on behalf of HTFE. The balance
        of
        the Fee is payable within seven days of receipt of a regulatory permit for
        work
        commencement. The Site will be used for industrial purposes. The Land Use
        Agreement provides that HTFE shall invest approximately $15 million in the
        Site
        over the next year. This investment amount includes fees, improvement costs,
        constructing a factory building and installing necessary equipment. HTFE
        shall
        register a Sino-foreign joint venture company at the location of Shanghai
        Lingang, with taxes payable at the same location. HTFE has agreed to compensate
        Shanghai Lingang for certain local taxes due to the local tax authority in
        connection with applicable tax generation requirements. As of June 30, 2007,
        the
        application of the land use lease is still in process .
 
 On
        August
        21, 2006, HTFE entered into a joint research and development agreement (the
        “R&D Agreement”) with the Institute of Electrical Engineering of the Chinese
        Academy of Sciences (“IEECAS”) to produce a train system to be tested at the
        Beijing Airport railway line in the People’s Republic of China (“PRC”) by the
        end of 2008. The Agreement provides that the term of the project shall commence
        on August 2006 and terminate in early 2009.
 
 The
        R&D Agreement provides for a budget of approximately $3.13 million (RMB 25
        million), consisting of $1.88 million (RMB 15 million) to be invested by
        HTFE
        and the remainder to be invested by IEECAS.  Of this amount, approximately
        $1,282,000 (RMB 10 million) has been invested to date by HTFE. The balance
        of
        approximately $0.625 million (RMB 5 million) will be invested prior to
        termination of the agreement at the end of 2008 as testing and evaluation
        occurs. The Company has started to amortize the R&D prepayment based on the
        progress of the projects. A total of $475,525 has been amortized and netted
        with
        R&D prepayment to the amount of $806,475.
 
 **Note
        10 - Financing**
 
 On
        August
        29, 2006, the Company, Citadel Equity Fund Ltd. (“Citadel”) and Merrill Lynch
        International (“Merrill Lynch” and, together with Citadel, the “Investors”)
        entered into an indicative financing term sheet dated as of August 2, 2006
        (the
“Term Sheet”). The Term Sheet relates to the proposed issuance of Senior Secured
        Notes in a purchase agreement (the “Purchase Agreement”) relating to the
        purchase and sale of (a) $50 million aggregate principal amount of the Company's
        Guaranteed Senior Secured Floating Rate Notes (collectively, the “Notes”) and
        (b) fully detachable warrants (the “Warrants”) to purchase an aggregate of
        3,487,368 shares of our common stock. The transaction closed on August 30,
        2006.
 
 -
            19 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        Notes
        are governed by an indenture, dated August 30, 2006, entered into among the
        Company, as guarantor, and The Bank of New York, as trustee for the Notes
        (the
“Indenture”). Of the $50 million aggregate principal amount of the Notes,
        Citadel subscribed to $38 million of the principal amount of the Notes, which
        mature on September 1, 2012 (the “2012 Notes”), and Merrill Lynch subscribed to
        $12 million of the principal amount of the Notes, which mature on September
        1,
        2010 (the “2010 Notes”). Pursuant to the indenture, our subsidiary AEM has
        agreed, and all of the Company’s other existing and future subsidiaries (other
        than subsidiaries domiciled in the People's Republic of China) are obligated,
        to
        guarantee, on a senior secured basis, to the Investors and to the trustee
        the
        payment and performance of our obligations.
 
 The
        2010
        Notes bear interest, payable semi-annually in arrears commencing March 1,
        2007,
        at a rate equal to LIBOR (approximately 5.3% at June 30, 2007), plus 4.75%.
        The
        2010 Notes bear an additional 4% interest on any overdue principal and premium,
        if any, including interest on overdue interest, to the extent permitted by
        law.
 
 The
        2010
        Notes are redeemable at the option of the Company, in whole but not in part,
        at
        any time after September 1, 2007, initially at 106% of the principal amount
        thereof and declining to 100% of the principal amount on September 1, 2009.
        The
        2010 Notes are subject to mandatory redemption semi-annually commencing March
        1,
        2008 in the principal amount $2,000,000 at price equal to 100% of such principal
        amount.
 
 The
        2012
        Notes bear interest, payable semi-annually in arrears commencing March 1,
        2007,
        at a rate equal to LIBOR plus 3.35%. See below for discussion of swap agreement
        changing the variable interest to 7.2% fixed. The 2012 Notes bear an additional
        4% interest on any overdue principal and premium, if any, including interest
        on
        overdue interest, to the extent permitted by law. The 2012 Notes are redeemable
        at the option of the Company, in whole but not in part, at any time after
        September 1, 2007, initially at 106% of the principal amount thereof and
        declining to 100% of the principal amount on September 1, 2011. The 2012
        Notes
        are subject to mandatory redemption semi-annually commencing September 1,
        2008
        in the principal amount $2,400,000 on September 1, 2009, $3,800,000 on March
        1,
        2010, $9,900,000 on September 1, 2010 and March 1, 2011, and $4,000,000 on
        September 1, 2011 and March 1, 2012, in each instance at price equal to 100%
        of
        such principal amount. Holders of the 2012 Notes may require the Company
        to
        repurchase such Notes at 100% of the principal amount thereof at any time
        after
        September 1, 2011.
 
 Upon
        a
        Change of Control (as defined in the indenture), holders of the Notes may
        require the Company to repurchase any or all such Notes at a price equal
        to
        102.5% of the principal amount thereof. The Company is required to offer
        to
        purchase Notes at a price equal to 100% of the principal amount thereof with
        the
        proceeds of certain asset sales.
 
 -
            20 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        Indenture contains numerous affirmative and negative covenants. The Indenture
        requires the payment of liquidated damages in the amount of (i) $750,000
        if the
        Company’s common stock shall not have been approved for listing on the NASDAQ
        Global Market or the NASDAQ Capital Market by April 1, 2007 and if such listing
        is not being maintained as of such date, (ii) $1,500,000 if the Company’s common
        stock shall not have been approved for listing on the NASDAQ Global Market
        or
        the NASDAQ Capital Market by July 1, 2007 and if such listing is not being
        maintained as of such date, (iii) $2,500,000 if the Company shall not have
        engaged a permitted independent accounting firm by January 1 of each year
        and
        such engagement is in effect as of March 1 of such year, commencing with
        2007;
        and (iv) $1,200,000 if a full time senior financial officer knowledgeable
        with
        respect to the capital markets in the United States and proficient in the
        English language shall not have been appointed within 120 days after August
        30,
        2006, with the same aggregate amount for each 120 day period thereafter during
        which such senior financial officer shall not have been appointed.
 
 On
        December 21, 2006, the Company obtained a waiver from Citadel to waive any
        and
        all claims to liquidated damages that may otherwise have accrued prior to
        February 28, 2007 due to the Company’s failure to appoint a senior financial
        officer.
 
 As
        security for the Notes, the Company and The Bank of New York, as collateral
        agent, entered into a share pledge agreement, dated August 30, 2006, to secure
        the Notes with all of the shares of AEM common stock held by the Company
        as
        collateral.
 
 The
        Warrants are governed by a warrant agreement, dated August 30, 2006, between
        AEM
        and The Bank of New York, as warrant agent. The Warrants consist of (i) six-year
        warrants to purchase an aggregate of 2,192,308 shares of our common stock,
        at an
        exercise price of $7.80 per share (the “First Tranche 2012 Warrants”), (ii)
        six-year warrants to purchase an aggregate of 525,830 shares of our common
        stock
        at an exercise price of $10.84 per share (the “Second Tranche 2012 Warrants”)
        and (iii) three-year warrants to purchase an aggregate of 769,230 shares
        of our
        common stock at an exercise price of $7.80 per share (the “2009 Warrants”).
 
 The
        First
        Tranche 2012 Warrants and the Second Tranche 2012 Warrants were issued to
        Citadel, and the 2009 Warrants were issued to Merrill. Each Warrant is
        exercisable at the option of the Warrants holder at any time through the
        maturity date of such Warrant.
 
 In
        addition, Mr. Tianfu Yang and Citadel entered into a voting agreement, dated
        August 30, 2006, pursuant to which Mr. Yang agreed to vote his shares of
        the
        capital stock of the Company to elect up to two members of the Company’s board
        of directors designated by Citadel. On
        March
        19, 2007, Citadel exercised its right to terminate that certain Voting Agreement
        dated August 30, 2006. The Company incurred no termination expenses or penalties
        in connection with the termination of the Voting Agreement .
 
 -
            21 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        Investors and Mr. Tianfu Yang also entered into a non-competition covenant
        and
        agreement, dated August 30, 2006, relating to Mr. Yang's employment as our
        Chief
        Executive Officer and his ability to engage in a business that is competitive
        with our business for so long as any of the Notes remain
        outstanding.
 
 In
        connection with the issuance of the Notes, the Company agreed to file a shelf
        registration statement by March 30, 2007 covering the resale of the common
        stock
        underlying the Warrants. The registration statement was effective on February
        9,
        2007.
 
 On
        January 1, 2007, the Company adopted FASB Staff Position No. EITF 00-19-2,
        “Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”). FSP
        EITF 00-19-2 requires contingent obligations under a registration payment
        arrangement to be recognized and measured in accordance with SFAS No. 5,
“Accounting for Contingencies” (“FAS 5”). FAS 5 requires loss contingencies to
        be accrued and expensed if they are probable and reasonably estimable.
 
 In
        connection with the convertible debt and warrants issued in August
        2006, the Company filed registration statement with the Securities and Exchange
        Commission (SEC) to register for resale the common shares underlying the
        convertible debt and warrants.
 
 Initially,
        pursuant to EITF 00-19, “Accounting for Derivative Financial Instruments Indexed
        to, and Potentially Settle in, a Company’s Own Stock,” the existence of
        contingent cash penalties in the Registration Rights Agreement triggered
        derivative accounting treatment. As a result the Company recorded the warrants
        as a liability at their fair value on the date they were issued and then
        marked
        them to market each subsequent reporting period. Upon adoption of FSP EITF
        00-19-2, any warrants originally classified as a liability under EITF 00-19
        that
        would have been classified as equity, without regard to the registration
        payment
        arrangement, should be reclassified.
 
 The
        transition to the accounting treatment under FSP EITF 00-19-2 is shown in
        the
        accompanying financial statements through 1) a cumulative-effect adjustment
        to
        the opening balance of retained earnings, as of January 1, 2007 and 2)
        reclassifying the warrants to equity at their fair value on the date of grant.
        The adjustment totaled $6,353,033 was equal to the change in fair value of
        the
        warrants between October 6, 2006, the date the warrants were issued, and
        December 31, 2006, the last reporting period. Additionally, the warrants
        were
        reclassified as equity at $22,921,113, their fair value on October 6, 2006.
        The
        adoption of FSP EITF 00-19-2 did not have an impact on prior year financial
        statements.
 
 -
            22 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        fair
        value of the warrants upon issuance totaled $22,921,112, was initially treated
        as a discount to the carrying value of the debt, and would have been amortized
        over the life of the loan using the effective interest method. $2,266,066
        and
        $1,510,711 was amortized to interest expense for the six months ended June
        30,
        2007 and for the year ended December 31, 2006, respectively. As of June 30,
        2007, the unamortized debt discount totaled $19,144,335.
 
 LONG-TERM
                  DEBT
              
              2007
              
              2006Principal
                  amount
              
              $
              50,000,000
              
              $
              50,000,000Less
                  unamortized discount
              
              
              (19,144,335
              )
              
              (21,410,401
              )Long-term
                  debt, net of unamortized discount
              
              $
              30,855,665
              
              $
              28,589,599
 
 Debt
        issuance costs totaled $2,954,625, are carried in other assets and are amortized
        over the life of the loan using the effective interest method. $246,218 was
        amortized to interest expense during the first six months of 2007. As of
        June
        30, 2007, the unamortized debt issuance costs totaled $2,510,937.
 
 Net,
        interest expense for six months ended June 30, 2007 and 2006 was comprised
        of
        the following:
  2007
              
              2006Interest
                  expense on debt issuance costs
              
              $
              246,218
              
              $
              -Interest
                  expense
              
              
              1,575,119
              
              
              -Interest
                  income earned on cash deposits
              
              
              (312,649
              )
              
              31,030Interest
                  expense, net
              
              $
              1,508,688
              
              $
              31,030
 
 **Note
        11 – Derivative financial instruments**
 
 Cross
        currency hedge
 
 The
        Company's operations are exposed to a variety of global market risks, including
        the effect of changing interest rates. This exposure is managed, in part,
        with
        the use of financial derivatives. The Company uses financial derivatives
        only to
        hedge exposures in the ordinary course of business and dose not invest in
        derivative instruments for speculative purposes.
 
 Effective
        April 17, 2007, the Company entered into a cross currency swap agreement
        with
        Merrill Lynch exchanging the LIBOR plus 4.75% variable rate interest payable
        on
        the $38 million Merrill Lynch debt for 7.2% (3.6% semi-annually) fixed rate
        interest. The agreement requires semi-annual payments on March 1 and September
        1
        through the maturity of the agreement on September 1, 2012. Merrill Lynch
        required the Company to deposit $1,000,000 with them to secure the agreement.
        The deposit may be increased to $2,500,000 if the exchange rate for Renminbi
        to
        USD falls below 6.5, and to $4,000,000 if the exchange rate falls below 5.5.
        This swap is designated and qualified as a cash flow hedge.
  -
            23 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  The
        fair
        value of this swap agreement at April 02, 2007 (inception date) was a payable
        of
        $5,387,487, and at June 30, 2007 was a payable of $3,945,951. For
        the
        six months ended June 30, 2007, changes in fair value of the swap resulted
        in a
        decrease in the liability and a gain to other comprehensive income of
        $1,441,536, net of taxes. During the six months ended June 30, 2007, the
        Company
        received $297,637, which was recorded as a gain from derivative
        transactions. For six
        months ended June 30, 2007, there were no amounts recorded in the consolidated
        statement of income in relation to this interest rate swap related to
        ineffectiveness.
 
 **Note
        12 – Accumulated other comprehensive income**
 
 The
        components of accumulated other comprehensive income as follows:
 
 Accumulated
                  other comprehensive income:Balance
                  at December 31, 2005
              
              $
              997,466Foreign
                  currency translation gain
              
              
              322,355Unrealized
                  loss on investment
              
              
              (587,171
              )Balance
                  at June 30, 2006
              
              
              732,650Foreign
                  currency translation gain
              
              
              1,299,241Balance
                  at December 31, 2006
              
              
              2,031,891Foreign
                  currency translation gain
              
              
              2,343,418Fair
                  value of cross currency hedge at inception, April 2, 2007
              
              
              (5,387,485
              )Net
                  change during the period related to cross currency hedge
              
              
              1,441,534Balance
                  at June 30, 2007
              
              $
              429,358
 
 **Note
        13 – Commitments and contingencies**
 
 The
        Company enters into non-cancelable purchase commitments with its vendors.
        As of
        June 30, 2007 and December 31, 2006, the Company was obligated under the
        non
        cancelable commitments to purchase materials amounting to $663,182 and
        $1,130,000, respectively. These commitments are short-term and expire within
        one
        year. The Company has experienced no losses on these purchase commitments
        over
        the years.
 
 As
        discussed in more detail in Note 1, the Company entered into an agreement
        with
        Shelton Technology, LLC on April 9, 2007. Under the terms of the agreement,
        the
        Company is required to contribute $3,000,000 to AAG in 3 installments: $1.2
        million was paid on April 16, 2007. The Company will contribute $800,000
        by May
        1, 2008 and $1,000,000 by March 31, 2009.
 
 As
        discussed in Note 11, the Company entered into a swap agreement that required
        a
        $1,000,000 deposit to secure the transaction. If the exchange rate for Renminbi
        to US Dollars drops below certain levels, the Company will be required to
        deposit up to $4,000,000.
 
 -
            24 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  **Note
        14 – Shareholders’ equity**
 
 Warrants
 
 Following
        is a summary of the warrant activity:
  Outstanding
                  as of December 31, 2006
              
              
              3,967,368Granted
              
              
              -Forfeited
              
              
              -Exercised
              
              
              (2,500
              )Outstanding
                  as of June 30, 2007
              
              
              3,964,868
 
 Following
        is a summary of the status of warrants outstanding at June 30, 2007:
 Outstanding
                    Warrants
                  
                  Exercisable
                    WarrantsExercise
                      Price
                  
                  Number
                  
                  Average
                      Remaining Contractual Life
                  
                  Average
                      Exercise Price
                  
                  Number
                  
                  Average
                      Exercise Price$
                  3.50
                  
                  
                  477,500
                  
                  
                  3.67
                  
                  $
                  3.50
                  
                  
                  477,500
                  
                  $
                  3.50$
                  10.84
                  
                  
                  525,830
                  
                  
                  5.42
                  
                  $
                  10.84
                  
                  
                  525,830
                  
                  $
                  10.84$
                  7.80
                  
                  
                  2,192,308
                  
                  
                  5.42
                  
                  $
                  7.80
                  
                  
                  2,192,308
                  
                  $
                  7.80$
                  7.80
                  
                  
                  769,230
                  
                  
                  2.42
                  
                  $
                  7.80
                  
                  
                  769,230
                  
                  $
                  7.80
  **Note
        15 – Options**
 
 In
        May
        2005 the Board of Directors of the Company adopted and approved the 2005
        Stock Option Plan (the “Plan”) which authorized the issuance of up
        to 1,500,000 shares under the Plan.
 
 Following
        is a summary of the stock option activity:
 
 OptionsOutstanding
              
              WeightedAverageExercisePrice
              
              AggregateIntrinsicValueOutstanding
                  as of December 31, 2006
              
              
              900,000
              
              $
              6.11
              
              $
              3,052,500Granted
              
              
              25,000
              
              
              12.40
              
              
              -Forfeited
              
              
              -
              
              
              -
              
              
              -Exercised
              
              
              -
              
              
              -
              
              
              -Outstanding
                  as of June 30, 2007
              
              
              925,000
              
              $
              6.28
              
              $
              3,052,500
  -
            25 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  Following
        is a summary of the status of options outstanding at June 30, 2007:
  Outstanding
                    Option
                
                Exercisable
                    OptionsExercise
                    Price
                
                Number
                
                Average
                    Remaining Contractual Life
                
                Average
                    Exercise Price
                
                Number
                
                Average
                    Exercise Price$
                3.10
                
                
                150,000
                
                
                3.09
                
                $
                3.10
                
                
                150,000
                
                $
                3.10$
                3.93
                
                
                250,000
                
                
                1.74
                
                $
                3.93
                
                
                150,000
                
                $
                3.93$
                8.10
                
                
                500,000
                
                
                4.10
                
                $
                8.10
                
                
                152,778
                
                $
                8.10$
                12.40
                
                
                25,000
                
                
                2.67
                
                $
                12.40
                
                
                2,087
                
                $
                12.40
 
 Significant
        assumptions used to estimate fair value
 
 Under
        SFAS No 123R, the Company’s expected volatility assumption is based on the
        historical volatility of Company’s stock. The expected life assumption is
        primarily based on historical exercise patterns and employee post-vesting
        termination behavior. The risk-free interest rate for the expected term of
        the
        option is based on the U.S. Treasury yield curve in effect at the time of
        grant.
 
 Stock
        compensation expense recognized in 2006 is based on awards expected to vest,
        and
        there were no estimated forfeitures as the Company has a short history of
        issuing options. SFAS No. 123R requires forfeitures to be estimated at the
        time of grant and revised in subsequent periods, if necessary, if actual
        forfeitures differ from those estimates.
 
 **Notes
        16 – Supplemental disclosure of cash flows**
 
 The
        Company prepares its statements of cash flows using the indirect method as
        defined under the Financial Accounting Standard No. 95. A
        total
        of $194,250 has been reclassified from advance on intangible assets as of
        December 31, 2006 to intangible assets as of June 30, 2007 and has no effect
        on
        cash flow.
 
 **Note
        17** **–** **Employee
        pension**
 
 The
        employee pension in Harbin generally includes two parts: the first part to
        be
        paid by the Company is 20% of the employees’ actual salary in the prior year. If
        the average salary falls below $1,165 for each individual, $1,165 will be
        used
        as the basis. The other part, paid by the employees, is 8% of actual salary
        with
        the same minimum requirement. The Company made $ 24,107 contributions of
        employment benefits, including pension in the period ended June 30, 2007.
        The
        Company made $ 10,244 in
        contributions of employment benefits, including pension in the period ended
        June
        30, 2006.
  -
            26 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
 
 **Note
        18 – Current vulnerability due to certain concentrations**
 
 The
        Company's operations are carried out in the PRC. Accordingly, the Company's
        business, financial condition and results of operations may be influenced
        by the
        political, economic and legal environments in the PRC, and by the general
        state
        of the PRC's economy.
 
 The
        Company's operations in the PRC are subject to specific considerations and
        significant risks not typically associated with companies in the North America
        and Western Europe. These include risks associated with, among others, the
        political, economic and legal environments and foreign currency exchange.
        The
        Company's results may be adversely affected 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
        19 – Legal proceedings**
 
 From
        time
        to time, the Company becomes involved in various lawsuits and legal proceedings
        which arise in the ordinary course of business.
  Following
        is the summary of the current litigation as of June 30, 2007.
  Leong
        Sing Lye v. Harbin Electric, Inc. United States District Court, District
        of
        Nevada, Case No. 2:06-CV-00796
 
 In
        June
        2006, an action was filed against the Company by Leong Sing Lye in the United
        States District Court for the District of Nevada, seeking specific performance
        of the Company's alleged obligation to issue 228,000 shares of Common Stock
        and
        warrants to purchase 38,400 shares of common stock, or , in the alternative,
        the
        value of securities alleged to be owed to Mr. Lye under, or, monetary damages
        allegedly arising from, a so-called Appointment Agreement pursuant to which
        Mr.
        Lye alleges to have been appointed the Company's Consultant of Corporate
        Strategy, as well as court costs and reasonable attorneys' fees. The Company
        has
        filed an answer to Mr. Lye's complaint denying the material allegations thereof
        and a counterclaim against Mr. Lye for fraud and related claims. The Company
        intends to vigorously defend against Mr.Lye's claim, if not withdrawn, and
        pursue its counterclaim. The parties are in the discovery process. The Company
        has filed a motion for summary judgment to eliminate portions of Mr. Lye's
        case
        and Mr. Lye has filed a cross-motion. The parties await the Court's ruling
        on
        these matters. The Company does not believe that the ultimate outcome of
        this
        matter will have a material adverse effect on the Company.
 
 -
            27 -
  HARBIN
          ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
          TO
          THE CONSOLIDATED FINANCIAL STATEMENTS
 JUNE
          30,
          2007
 (UNAUDITED)
  **Note
        20 – Subsequent event**
 
 On
        July
        19, 2007, Harbin Tech Full Electric Co., Ltd. acquired Harbin Taifu Auto
        Electric Co., Ltd., a company that was owned 98% by the Company’s Chairman and
        Chief Executive Officer and 2% by other Company management. The aggregate
        purchase totaled $10,944,000 consisting of $4,000,000 in cash and $6,944,103
        is
        newly issued Company common stock or 473,354 shares, based on the closing
        price
        of the Company’s common stock on Friday, June 15, 2007 of $14.67.


-
            28 -




**Item
      1A. Risk Factors**




You
      should carefully consider these risk factors as each of these risks could
      adversely affect our business, operating results and financial condition.
      Additional risks and uncertainties not presently foreseeable to us may also
      impair our business operations. If any of the following risks actually occurs,
      our business, financial condition or operating results could be materially
      and
      adversely affected. In such case, the trading price of our common stock could
      decline, and you may lose all or part of your investment.




**GENERAL
      RISKS RELATING TO OUR BUSINESS**




**We
      need to manage growth in operations to maximize our potential growth and achieve
      our expected revenues.**




In
      order
      to maximize potential growth in our current and potential markets, we believe
      that we must expand our manufacturing and marketing operations. We experienced
      growth in our revenues of over seventy one percent (71%) during the last fiscal
      year; however, there can be no assurance that we will be able to maintain such
      growth or any growth of our business. An expansion of our operations will place
      a significant strain on our management and our operational, accounting, and
      information systems. We expect that we will need to continue to improve our
      financial controls, operating procedures, and management information systems.
      We
      will also need to effectively train, motivate, and manage our employees. Our
      failure to manage our growth could disrupt our operations and ultimately prevent
      us from generating the revenues we expect.




**We
      may require additional financing in the future and a failure to obtain such
      required financing will inhibit our ability to grow.**




The
      continued growth of our business may require additional funding from time to
      time. Funding would be used for general corporate purposes. General corporate
      purposes may include acquisitions, investments, repayment of debt, capital
      expenditures, repurchase of our capital stock and any other purposes that we
      may
      specify in any prospectus supplement. Obtaining additional funding would be
      subject to a number of factors including market conditions, operational
      performance and investor sentiment, many of which are outside of our control.
      These factors may make the timing, amount, terms and conditions of additional
      funding unattractive, or unavailable, to us.





**The
      terms of any future financing may adversely affect your interest as
      stockholders.**




If
      we
      require additional financing in the future, we may be required to incur
      indebtedness or issue equity securities, the terms of which may adversely affect
      your interests in the Company. For example, the issuance of additional
      indebtedness may be senior in right of payment to your shares upon liquidation
      of the Company. In addition, indebtedness may be under terms that make the
      operation of our business more difficult because the lender’s consent will be
      required before we take certain actions. Similarly the terms of any equity
      securities we issue may be senior in right of payment of dividends to your
      common stock and may contain superior rights and other rights as compared to
      your common stock. Further, any such issuance of equity securities may dilute
      your interest in the Company.




**Covenants
      in our debt instruments restrict or prohibit our ability to engage in or enter
      into a variety of transactions.**




The
      indenture governing our Notes contains various covenants that may limit our
      discretion in operating our business. In particular, we are limited in our
      ability to merge, consolidate or transfer substantially all of our assets,
      issue
      preferred stock of subsidiaries and create liens on our assets to secure debt.
      In addition, if there is default, and we do not maintain certain financial
      covenants or we do not maintain borrowing availability in excess of certain
      pre-determined levels, we may be unable to incur additional indebtedness, make
      restricted payments (including paying cash dividends on our capital stock)
      or
      redeem or repurchase our capital stock.




The
      indenture governing our Notes requires us to maintain certain financial ratios
      and limits our ability to make capital expenditures. These covenants and ratios
      could have an adverse effect on our business by limiting our ability to take
      advantage of financing, merger and acquisition or other corporate opportunities
      and to fund our operations. Any future debt could also contain financial and
      other covenants more restrictive than those imposed under the indenture
      governing our Notes.




-
          29 -




**Our
      debt may have significant consequences, and cash flows and capital resources
      may
      be insufficient to make required payments on our substantial indebtedness and
      future indebtedness.**





We
      have a
      substantial amount of debt. As of June 30, 2007, we had approximately $2.8
      million of total current liabilities, in addition to $50 million outstanding
      under our indenture relating to the Notes issued in August 2006. Our substantial
      debt could have important consequences to you. For example, it
      could:




operations
                to payments on our indebtedness, which could reduce the availability
                of
                our cash flow to fund future working capital, capital expenditures,
                acquisitions and other general corporate
                purposes;




limit
                our ability to obtain additional financing for working capital, capital
                expenditures, and other general corporate
                requirements;




expose
                us to interest rate fluctuations because the interest rate is
                variable;




increase
                our vulnerability to general adverse economic and industry
                conditions;




require
                us to sell assets to reduce indebtedness or influence our decisions
                about
                whether to do so;




restrict
                us from making strategic acquisitions or pursuing business
                opportunities;




limit
                our flexibility in planning for, or reacting to, changes in our business
                and the industry in which we
                operate;




limit,
                along with the financial and other restrictive covenants in our
                indebtedness, among other things, our ability to borrow additional
                funds;
                and




place
                us at a competitive disadvantage compared to competitors that may
                have
                proportionately less debt.




In
      addition, our ability to make scheduled payments or refinance our obligations
      depends on our successful financial and operating performance, cash flows,
      and
      capital resources, which in turn depend upon prevailing economic conditions
      and
      certain financial, business, and other factors, many of which are beyond our
      control. If our cash flows and capital resources are insufficient to fund our
      debt obligations, we may be forced to reduce or delay capital expenditures,
      sell
      material assets or operations, obtain additional capital, restructure our debt,
      or declare bankruptcy. In the event that we are required to dispose of material
      assets or operations to meet our debt service and other obligations, the value
      realized on such assets or operations will depend on market conditions and
      the
      availability of buyers. Accordingly, we may be forced to sell at an unfavorable
      price. Furthermore, our obligations under various debt instruments are secured
      by our equity interests in Advanced Electric Motors, Inc. These security
      interests may limit our ability to dispose of material assets or operations.
      We
      also may not be able to restructure our debt on favorable economic terms, if at
      all.




**We
      do not anticipate paying cash dividends on our common
      stock.**




We
      have
      never paid cash dividends on our common stock and do not anticipate paying
      cash
      dividends in the foreseeable future. We intend to follow a policy of retaining
      all of our earnings, if any, to finance development and expansion of our
      business.





**We
      may not be able to adequately protect and maintain our intellectual property.**




Our
      success will depend on our ability to continue to develop and market linear
      motors and other motor products. While we have been granted three patents in
      China relating to linear motor applications, we currently have not applied
      for
      patents for our technical processes and designs, as we believe an application
      for such patents would result in public knowledge of our proprietary technology
      and designs.




**Because
      of our dependence on a few key customers, the loss of any key customer could
      cause a significant decline in our revenues.**




-
          30 -




Five
      major customers accounted for 86% of the net revenue for the three months ended
      June 30, 2007. The loss of any of our major customers, or a significant
      reduction in sales to any such customers, would adversely affect our
      revenues.




**We
      depend on the supply of raw materials, and any adverse changes in such supply
      or
      the costs of raw materials may adversely affect our
      operations.**




Five
      major vendors provided approximately 82% of the Company’s purchases of raw
      materials for the three months ended June 30, 2007. We currently obtain most
      of
      our raw materials from Acheng Relay Company Limited, Zhejiang Hongbo Wire and
      Cable Co., Jiangyin Chuangyi Special Insulation Material Co.. Any material
      change in the spot and forward rates could have a material adverse effect on
      the
      cost of our raw materials and on our operations. In addition, if we need
      alternative sources for key component parts for any reason, these component
      parts may not be immediately available to us. If alternative suppliers are
      not
      immediately available, we will have to identify and qualify alternative
      suppliers, and production of these components may be delayed. We may not be
      able
      to find an adequate alternative supplier in a reasonable time period, or on
      commercially acceptable terms, if at all. Shipments of affected products have
      been limited or delayed as a result of such problems in the past, and similar
      problems could occur in the future. Our inability to obtain our key source
      supplies for the manufacture of our products may require us to delay shipments
      of products, harm customer relationships or force us to curtail or cease
      operations.





**Our
      success depends on our management team and other key personnel, the loss of
      any
      of whom could disrupt our business operations.**




Our
      future success will depend in substantial part on the continued service of
      our
      senior management, including Mr. Tianfu Yang, our Chairman and Chief Executive
      Officer, Mr. Xu Suofei, our Vice President and Board Member, Mr. Tianli Yang,
      our Vice President, and Mr. Zedong Xu, our Chief Financial Officer. The loss
      of
      the services of one or more of our key personnel could impede implementation
      of
      our business plan and result in reduced profitability. We do not carry key
      person life insurance on any of our officers or employees. Our future success
      will also depend on the continued ability to attract, retain and motivate highly
      qualified technical sales and marketing customer support.




Because
      of the rapid growth of the economy in China, competition for qualified personnel
      is intense. We cannot assure you that we will be able to retain our key
      personnel or that we will be able to attract, assimilate or retain qualified
      personnel in the future.





**Our
      directors and officers control a majority of our common stock and, as a result,
      they may exercise voting control and be able to take actions that may be adverse
      to your interests.**





Our
      directors and executive officers, directly or through entities that they
      control, currently beneficially own, as a group, approximately 70% of our issued
      and outstanding common stock as of June 30, 2007. This significant concentration
      of share ownership may adversely affect the trading price of our common stock
      because investors often perceive a disadvantage in owning shares in a company
      with just one or several controlling stockholders. Furthermore, our directors
      and officers, as a group, have the ability to significantly influence or control
      the outcome of all matters requiring stockholder approval, including the
      election of directors and approval of significant corporate transactions, such
      as mergers, consolidations or the sale of substantially all of our assets.
      This
      concentration of ownership may have the effect of delaying or preventing a
      change of control, including a merger, consolidation or other business
      combination involving us, or discouraging a potential acquirer from making
      a
      tender offer or otherwise attempting to obtain control.




**RISKS
      RELATING TO DOING BUSINESS IN THE PEOPLE’S REPUBLIC OF
      CHINA**




**China’s
      economic policies could adversely affect our business.**





Substantially
      all of our assets are located in China and substantially all of our revenue
      is
      derived from our operations in China. Accordingly, our results of operations
      and
      prospects are subject, to a significant extent, to the economic, political
      and
      legal developments in China.





While
      China’s economy has experienced a significant growth in the past twenty years,
      growth has been uneven, both geographically and among various sectors of the
      economy. The Chinese government has implemented various measures to encourage
      economic growth and guide the allocation of resources. Some of these measures
      benefit the overall economy of China, but may also have a negative effect on
      us.
      For example, our operating results and financial condition may be adversely
      affected by the government control over capital investments or changes in tax
      regulations.





-
          31 -




The
      economy of China has been transitioning from a planned economy to a more
      market-oriented economy. In recent years the Chinese government has implemented
      measures emphasizing the utilization of market forces for economic reform and
      the reduction of state ownership of productive assets and the establishment
      of
      corporate governance in business enterprises; however, a substantial portion
      of
      productive assets in China are still owned by the Chinese government. In
      addition, the Chinese government continues to play a significant role in
      regulating industry development by imposing industrial policies. It also
      exercises significant control over China’s economic growth through the
      allocation of resources, controlling payment of foreign currency-denominated
      obligations, setting monetary policy and providing preferential treatment to
      particular industries or companies.





**Capital
      outflow policies in the People’s Republic of China may hamper our ability to
      remit income to the United States.**





The
      PRC
      has adopted currency and capital transfer regulations. These regulations may
      require that we comply with complex regulations for the movement of capital.
      Although we believe that we are currently in compliance with these regulations,
      should these regulations or the interpretation of them by courts or regulatory
      agencies change we may not be able to remit all income earned and proceeds
      received in connection with our operations or from the sale of our operating
      subsidiary to the United States or to our stockholders. Please see “Description
      of Business - PRC Regulations.”




**If
      preferential tax concessions granted by the PRC government are changed or
      expire, our financial results and results of operations would be materially
      and
      adversely affected.**




Our
      results of operation may be adversely affected by changes to or expiration
      of
      preferential tax concessions that our subsidiary in the PRC currently enjoys.
      The statutory tax rate generally applicable to domestic Chinese companies is
      33%. A reduced income tax rate of 15% may be possible for productive foreign
      investment enterprises in the Economic and Technological Development Zones
      and
      for enterprises engaged in production or business operations in the Special
      Economic Zones. As a result of preferential tax rate incentives, our operations
      have been subject to relatively low tax liabilities. The estimated tax savings
      for the year ended December 31, 2006 and 2005 without preferential tax treatment
      amounted to approximately $2.8 million and $1.5 million,
      respectively.





Tax
      laws
      in China are subject to interpretations by relevant tax authorities. The
      preferential tax treatment may not remain in effect or may change, in which
      case
      we may be required to pay the higher income tax rate generally applicable to
      Chinese companies, or such other rate as is required by the laws of
      China.





Beginning
      January 1, 2008, the new Chinese Enterprise Income Tax (“EIT”) law will replace
      the existing laws for Domestic Enterprises (“DES”) and Foreign Invested
      Enterprises (“FIEs”). The new standard EIT rate of 25% will replace the 33% rate
      currently applicable to both DES and FIEs.




**The
      legal authorities in China are in the process of evaluating heretofore tax
      and
      fee benefits provided to foreign investors and companies to encourage
      development within the country such that these benefits may be lessened or
      removed with the consequence that expenses may rise impacting margins and net
      income.**




The
      legal
      authorities are evaluating tax and fee benefits that have been available to
      foreign investors and companies operating in China and tax holidays for new
      enterprises. It is anticipated, in the near term, there are going to be changes
      that substantially reduce or eliminate many, if not all, the tax and other
      governmental fee advantages that heretofore have been available to foreign
      entities and newly created entities whether or not such new entities are
      foreign. The goal is to institute greater equalization of tax and government
      fee
      treatment of all corporate and similar entities in China. China is being
      encouraged to create this more equal treatment because of its WTO obligations
      and public opinion within China. There may be phase-ins of various taxes and
      fees for entities that currently benefit from either no or lower tax rates
      and
      fees compared to wholly Chinese companies and entities, but there can be no
      assurance of this. Even if there are phase-in periods, the length of such
      periods is not known. Overall, it is expected that the cost of operating in
      China will increase for those companies and entities that have had various
      tax
      and fee advantages in the past.





**Fluctuations
      in the value of the RMB could materially affect our financial condition and
      results of operations.**





-
          32 -




The
      value
      of the RMB against the U.S. dollar and other currencies may fluctuate and is
      affected by, among other things, changes in the PRC’s political and economic
      conditions. As the majority of our net revenue is denominated in RMB, any
      significant revaluation of the RMB may materially and adversely affect our
      cash
      flows, revenues and financial condition. For example, to the extent that we
      need
      to convert U.S. dollars we receive from an offering of our securities into
      RMB
      for our operations, appreciation of the RMB against the U.S. dollar could have
      a
      material adverse effect on our business, financial condition and results of
      operations. Conversely, if we decide to convert our RMB into U.S. dollars for
      the purpose of making payments for business purposes and the U.S. dollar
      appreciates against the RMB, the U.S. dollar equivalent of the RMB we convert
      would be reduced. In addition, the depreciation of significant U.S. dollar
      denominated assets could result in a charge to our income statement and a
      reduction in the value of these assets.





On
      July
      21, 2005, the PRC government changed its policy of tying the value of the RMB
      to
      the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within
      a narrow and managed band against a basket of certain foreign currencies. This
      change in policy has resulted in an approximately 3.0% appreciation of the
      RMB
      against the U.S. dollar. While the international reaction to the RMB revaluation
      generally has been positive, there remains significant international pressure
      on
      the PRC government to adopt an even more flexible currency policy, which could
      result in a further and more significant appreciation of the RMB against the
      U.S. dollar.





**We
      may experience currency fluctuation and longer exchange rate payment
      cycles.**





The
      local
      currencies in the countries in which we sell our products may fluctuate in
      value
      in relation to other currencies. Such fluctuations may affect the costs of
      our
      products sold and the value of our local currency profits. While we are not
      conducting any meaningful operations in countries other than China at the
      present time, we may expand to other countries and may then have an increased
      risk of exposure of our business to currency fluctuation.




**We
      may face obstacles from the Communist system in the PRC.**





Foreign
      companies conducting operations in the PRC face significant political, economic
      and legal risks. The Communist regime in the PRC, including a stifling
      bureaucracy, may hinder Western investment.




**We
      may have difficulty establishing adequate management, legal and financial
      controls in the PRC.**





The
      PRC
      historically has been deficient in Western style management and financial
      reporting concepts and practices, as well as in modern banking, computer and
      other control systems. We may have difficulty in hiring and retaining a
      sufficient number of qualified employees to work in the PRC. As a result of
      these factors, we may experience difficulty in establishing management, legal
      and financial controls, collecting financial data and preparing financial
      statements, books of account and corporate records and instituting business
      practices that meet Western standards.





**It
      will be extremely difficult to acquire jurisdiction and enforce liabilities
      against our officers, directors and assets based in the
      PRC.**





Because
      our executive officers and several of our directors, including our chairman
      of
      the Board of Directors, are Chinese citizens, it may be difficult, if not
      impossible, to acquire jurisdiction over these persons in the event a lawsuit
      is
      initiated against us and/or our officers and directors by a stockholder or
      group
      of stockholders in the United States. Also, because the majority of our assets
      are located in the PRC, it would also be extremely difficult to access those
      assets to satisfy an award entered against us in U.S. court.




**The
      legal system in China has inherent uncertainties that may limit the legal
      protections available in the event of any claims or disputes with third
      parties.**





The
      legal
      system in China is based on written statutes. Prior court decisions may be
      cited
      for reference but have limited precedential value. Since 1979, the central
      government has promulgated laws and regulations dealing with economic matters
      such as foreign investment, corporate organization and governance, commerce,
      taxation and trade. As China’s foreign investment laws and regulations are
      relatively new and the legal system is still evolving, the interpretation of
      many laws, regulations and rules is not always uniform and enforcement of these
      laws, regulations and rules involve uncertainties, which may limit the remedies
      available in the event of any claims or disputes with third parties. In
      addition, any litigation in China may be protracted and result in substantial
      costs and diversion of resources and management attention.




-
          33 -




**We
      may face political and/or judicial corruption in the PRC.**




Another
      obstacle to foreign investment is corruption. There is no assurance that we
      will
      be able to obtain recourse, if desired, through the PRC’s poorly developed and
      often corrupt judicial systems.




Most
      of
      our assets are located in China, any dividends of proceeds from liquidation
      is
      subject to the approval of the relevant Chinese government
      agencies.


-
          34 -





**Item
      2.****Management’s
      Discussion and Analysis or Plan of Operation**




**INFORMATION
      REGARDING FORWARD LOOKING STATEMENTS**




The
      following discussion should be read in conjunction with the unaudited condensed
      consolidated financial statements and notes thereto set forth in Item 1 of
      this
      Quarterly Report. In addition to historical information, this discussion and
      analysis contains forward-looking statements that relate to future events and
      expectations and, as such, constitute forward-looking statements.
      Forward-looking statements include those containing such words as” anticipates,”
“believes,” “estimates,” “expects,” “hopes,” “targets,” “should,” will,” “will
      likely result,” “forecast,” “outlook,” “projects” or similar expressions. Such
      forward-looking statements involve known and unknown risks, uncertainties and
      other factors that may cause actual results, performance or achievements of
      the
      Company to be materially different from those expressed or implied in the
      forward-looking statements




**OVERVIEW**




We
      were
      incorporated under the laws of the state of Nevada and, along with our
      wholly-owned subsidiaries, are headquartered in Harbin, China. We manufacture,
      design, supply and service linear motors and special motors for domestic China
      and other international markets. Our products are purchased by a broad range
      of
      customers, including those involved in oil services, factory automation,
      packaging and mass transportation systems.




Our
      expenses have consisted primarily of those incurred with sales and marketing
      of
      our products, general and administrative costs associated with our operations
      and costs of maintaining our facilities, salaries and research and development.
      To date, we have funded our operations primarily through the sale of equity
      securities and retained earnings.




We
      are
      subject to risks common to companies operating in China, including risks
      inherent in our distribution and commercialization efforts, uncertainty of
      foreign regulatory and marketing approvals and laws, reliance on key customers,
      enforcement of patent and proprietary rights, the need for future capital and
      retention of key employees. We cannot provide assurance that we will generate
      revenues or achieve and sustain profitability in the future.




**ACCOUNTING
      POLICIES AND ESTIMATES**




We
      believe that the application of the following accounting policies, which are
      important to our financial position and results of operations, requires
      significant judgments and estimates on the part of management. For a summary
      of
      our significant accounting policies, see Note 2 of the consolidated
      financial statements appearing elsewhere in this Quarterly Report.




***Accounts
      Receivable***




We
      maintain reserves for potential credit losses on accounts receivable. Management
      reviews the composition of accounts receivable and analyze historical bad debts,
      customer concentrations, customer credit worthiness, current economic trends
      and
      changes in customer payment patterns to evaluate the adequacy of these
      reserves.




We
      use
      estimates in determining our allowance for bad debts that are based on our
      historical collection experience, current trends, credit policy and a percentage
      of our accounts receivable by aging category. In determining these percentages,
      we review historical write-offs in our receivables. In determining the
      appropriate reserve percentages, we also review current trends in the credit
      quality of our customers, as well as changes in our internal credit policies.
      We
      maintain reserves for potential credit losses on accounts receivable. Management
      reviews the composition of accounts receivable and analyzes historical bad
      debts, customer concentrations, customer credit worthiness, current economic
      trends and changes in customer payment patterns to evaluate the adequacy of
      these reserves. Reserves are recorded primarily on a specific identification
      basis. Additional allowances for doubtful accounts may be required if there
      is
      deterioration in past due balances, if economic conditions are less favorable
      than anticipated, or for customer-specific circumstances, such as financial
      difficulty.




Reserves
      are recorded primarily on a specific identification basis. Reserve for potential
      credit losses was $44,552 as of December 31, 2006 and $45, 699 as of June 30,
      2007. No amounts were written off during the periods indicated. If our estimate
      of our allowance is understated in future periods, operating income would be
      reduced.




-
          35 -




***Inventories***




Inventory
      levels are based on projections of future demand and market conditions.
      Inventories are stated at cost, which is not in excess of market using the
      weighted average cost method. Any sudden decline in demand and/or rapid product
      improvements and technological changes can result in excess and/or obsolete
      inventories. Because most of our products are customized and unique to a
      particular customer, there is a risk that we will forecast inventory needs
      incorrectly and purchase or produce excess inventory. As a result, actual demand
      may differ from forecasts, and such differences, if not managed, may have a
      material adverse effect on future results of operations due to required
      write-offs of excess or obsolete inventory. To mitigate against such exposure,
      we require a binding purchase order or a signed agreement by our customer
      agreeing to pay for and take possession of finished goods inventory parts for
      the duration of the agreement.




On
      an
      ongoing basis, inventories are reviewed for potential write down for estimated
      obsolescence or unmarketable inventories equal to the difference between the
      costs of inventories and the estimated net realizable value based upon forecasts
      for future demand and market conditions. We have experienced no inventory write
      downs since our inception. Accordingly, we have not created any reserve for
      obsolete inventory consistent with our historical experience. To the extent
      we
      increase our reserves for future periods, operating income will be
      reduced.




***Revenue
      Recognition***




Our
      revenue recognition policies are structured to comply with Staff Accounting
      Bulletin (SAB) 104 and SFAS 48. SAB 104 requires that revenue can only be
      recognized when it is realized or realizable and earned. Revenue generally
      is
      realized or realizable and earned when all four of the following criteria have
      been met: (1) persuasive evidence of an arrangement exists; (2) delivery has
      occurred or services rendered; (3) the price is fixed and determinable; and
      (4)
      collectability is reasonably assured.




Determination
      of criterion (4) is based on our judgments regarding the collectability of
      those
      amounts. Historically, we have not encountered any significant problems with
      collectability and thus have determined that it is not necessary to defer
      revenue recognition on that basis. Should changes in conditions cause us to
      determine this criterion is not met for certain future transactions, revenues
      for any reporting period could be adversely affected by delaying recognition
      of
      such revenues.




In
      addition, our revenue recognition could be negatively impacted by returns.
      However, we make custom products which are customer specific, and no returns
      are
      allowed. We warrant our product for repair only in the event of defects for
      two
      years from the date of shipment. Historically, we have not experienced
      significant defects, and replacements for defects have not been material. We
      charge such costs to cost of goods sold. For the year ended December 31, 2006
      and for the six months ended June 30, 2007, such returns and allowances were
      $0
      for each of the periods. Should returns increase in the future it would be
      necessary to adjust our estimates, in which case recognition of revenues could
      be delayed.




***Stock-Based
      Compensation***




The
      Company accounts for stock-based compensation in accordance with the fair value
      recognition provisions of SFAS 123R. The Company uses the Black-Scholes-Merton
      option-pricing model which requires the input of highly subjective assumptions.
      These assumptions include estimating the length of time employees will retain
      their stock options before exercising them (“expected term”), the estimated
      volatility of the Company’s common stock price over the expected term and the
      number of options that will ultimately not complete their vesting requirements
      (“forfeitures”). Changes in the subjective assumptions can materially affect the
      estimate of fair value of stock-based compensation and consequently, the related
      amount recognized on the consolidated statements of earnings.





***Derivative
      Financial Instruments***





The
      Company uses derivative financial instrument such as cross-currency swap.
      Derivative financial instrument is initially recognized in the balance sheet
      at
      cost and subsequently remeasured at the fair value. Changes in the fair values
      of derivative financial instruments accounted for as cash flow hedges, to the
      extent they qualify for hedge accounting, are recorded in accumulated other
      comprehensive income, net of deferred taxes, changes in fair values of
      derivative financial instruments not qualifying as hedges are reported in
      income.





-
          36 -




At
      the
      inception of the transaction, the Company documents the relationship between
      hedging instruments and hedged items, as well as its risk management objective
      and the strategy for undertaking various hedge transactions. This process
      includes linking all derivatives designated to specific firm commitments of
      forecast transactions. The Company also documents its assessment, both at
      inception and on an ongoing basis, of whether the derivative financial
      instruments that are used in hedging transactions are highly effective in
      offsetting changes in fair values or cash flows of hedged items.





***Change
      in Accounting Principle***





On
      January 1, 2007, the Company adopted FASB Staff Position No. EITF 00-19-2,
      “Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”). FSP
      EITF 00-19-2 requires contingent obligations under a registration payment
      arrangement to be recognized and measured in accordance with SFAS No. 5,
“Accounting for Contingencies” (“FAS 5”). FAS 5 requires loss contingencies to
      be accrued and expensed if they are probable and reasonably
      estimable.





Upon
      ado ption
      of
      FSP EITF 00-19-2, any warrants originally classified as a liability under EITF
      00-19 that would have been classified as equity without regard to the
      registration payment arrangement should be reclassified. The transition to
      the
      accounting treatment under FSP EITF 00-19-2 is shown in the accompanying
      financial statements through 1) a cumulative-effect adjustment to the opening
      balance of retained earnings, as of January 1, 2007 and 2) reclassifying the
      warrants to equity at their fair value on the date of grant.





The
      adjustment totaled $6,353,033 and was equal to the change in fair value of
      the
      warrants between October 6, 2006, the date the warrants were issued, and
      December 31, 2006, the last reporting period. Additionally, the warrants were
      reclassified as equity at $22,921,113, their fair value on October 6, 2006.
      The
      adoption of FSP EITF 00-19-2 did not have an impact on prior year financial
      statements.




**RESULTS
      OF OPERATIONS**





SIX
      MONTHS ENDED JUNE 30, 2007 COMPARED TO SIX MONTHS ENDED JUEN 30,
      2006





***Revenue***





For
      the
      six- month period ended June 30, 2007, we generated net revenues of $27,615,907
      compared to $18,590,003 during the six-month period ended June 30, 2006. Sales
      of linear motor and special motor products drove the growth in the period.
      Industrial electric linear motors and special motors continued to comprise
      significantly all of our total product sales in both comparable periods. The
      increase was due to increased sales to our existing customers.





***Gross
      Profit***





The
      Company achieved a gross profit of $14,078,298 for the six months ended June
      30,
      2007 compared to $9,074,527 for the six months ended June 30, 2006. The increase
      is directly related to our increases in sales levels and improved mix of product
      sales. Gross margin, as a percentage of revenues, was 50.98% for the six months
      ended June 30, 2007 compared to 48.81% for the six months ended June 30, 2006.
      The gross margin percentage remains within a normal range and the change
      reflects a more favorable mix of products shipped in the first & second
      quarters of 2007 versus the corresponding period in 2006.





***Operating
      Expenses***





Our
      total
      operating expenses consist of costs associated with sales and marketing,
      research and development expenditures, general administrative costs, and amounts
      to account for stock based compensation. The Company incurred total operating
      expenses of $3,413,680, or 12.4% of sales, for the six months ended June 30,
      2007. This represents an increase of $1,156,073 compared to $2,257,607, or
      12.1%
      of sales for the six months ended June 30, 2006. Aggregated selling general
      and
      administrative (SG&A) expenses of $2,960,321, or 10.7% of sales, compared to
      $1,430,853 or 7.7% for the six months ended June 30, 2006. SG&A accounts for
      expenses associated with sales, marketing of the Company’s products, costs of
      maintaining the Company’s facilities, salaries, as well as amounts allocated to
      stock based compensation through options grants. The increase this period is
      due
      to our efforts to support an increased revenues level and related sales activity
      and stock based compensation expense.





-
          37 -




***Amortization
      expense of debt discount***





Amortization
      expense of debt discount increased to $2,266,066 during the six months ended
      June 30, 2007 compared to $0 for the six months ended June 30, 2006. The
      increase for the period was attributable to amortization of debt discount for
      the $50 million notes issued on August 30, 2006. As of June 30, 2007, the
      unamortized debt discount totaled $19,144,335.





***Interest
      expense***





Net
      interest expense and income for the six months ended June 30, 2007 and 2006,
      were $1,508,688 and $31,030, respectively. Net interest expense for six months
      ended June 30, 2007 was comprised of the amortization of debt issuance costs,
      accrued interest expense for the semiannual interest due in August on our $50
      million debt, and offset by interest income earned on cash deposits and interest
      rate swap agreement with Merrill Lynch signed April 2, 2007. We accrued $
      1,575,119 of interest expense during the six months ended June 30, 2007,
      $246,218 was amortized to interest expense during the same period, and net
      interest income earned on cash deposits was $312,649.





As
      of
      June 30, 2007, the Company received $297,637 from Merrill Lynch on behalf of
      the
      cross currency hedge, which was recorded as a gain from derivative
      transactions.





The
      Company paid $1,998,896 for interest and $2,258,151 for income tax for the
      six
      months ended June 30, 2007 and $0 for interest and $1,037,919 for income tax
      for
      the six months ended June 30, 2006.





***Non-operating
      income***





The
      Chinese government grants to all new technology and innovated manufacturers
      financial grant income. The income received from the government was recorded
      as
      additional paid in capital. The Company has received a total of $763,408 and
      $0
      for the six months ended June 30, 2007 and 2006, respectively. The grant income
      can be continuous and under the Chinese government restriction, the Company
      cannot forecast or control the amount to be received.





***Net
      Income***





The
      Company's net income was $ 7,960,219 or 28.8% of sales for the six month period
      ended June 30, 2007, compared to $7,472,241 or 40.2% of sales for the six month
      period ended June 30, 2006. Increased income was due to the increase of the
      Company's main operation sales, which has caused the Company's gross profit
      increase by $5 million or 55.1%. Increase in the company's cash in bank and
      also
      the cross currency swap agreement has increased the company's interest income
      and the gain on cross currency hedge.





THREE
      MONTHS ENDED JUNE 30, 2007 COMPARED TO THREE MONTHS ENDED JUNE 30,
      2006





***Revenue***





For
      the
      three months ended June 30, 2007, we generated net revenues of $13,989,693
      compared to $9,711,345 for the three months ended June 30, 2006. Sales of linear
      motor and special motor products drove the growth in the period. Industrial
      electric linear motors and special motors continued to comprise significantly
      all of our total product sales in both comparable periods.





-
          38 -




***Gross
      Profit***





The
      Company achieved a gross profit of $7,220,370 for the three months ended June
      30, 2007 compared to $4,800,792 for the three months ended June 30, 2006. The
      increase is directly related to our increases in sales levels and improved
      mix
      of product sales. Gross margin, as a percentage of revenues, was 51.6% for
      the
      three months ended June 30, 2007 compared to 49.4% for the three months ended
      June 30, 2006. The gross margin percentage remains within a normal range and
      the
      change reflects a more favorable mix of products shipped in the second quarters
      of 2007 versus the corresponding period in 2006.





***Operating
      Expenses***





Our
      total
      operating expenses consist of costs associated with sales and marketing,
      research and development expenditures, general administrative costs, and amounts
      to account for stock based compensation. The Company incurred total operating
      expenses of $1,681,377, or 12.0% of sales, for the three months ended June
      30,
      2007. This represents an increase of $540,535 compared to $1,140,842, or 11.7%
      of sales for the three months ended June 30, 2006. Aggregated selling general
      and administrative (SG&A) expenses of $1,445,858, or 10.3% of sales,
      compared to $636,677 or 6.6% for the three months ended June 30, 2006. SG&A
      accounts for expenses associated with sales, marketing of the Company’s
      products, costs of maintaining the Company’s facilities, salaries, as well as
      amounts allocated to stock based compensation through options grants.





***Net
      Income***





The
      Company's net income was $ 4,556,156 or 32.6% of sales for the three months
      ended June 30, 2007, an increase of $878,411 or 23.9% compared to $3,677,745
      or
      37.9% of sales for the three month period ended June 30, 2006. Increase in
      income was due to the increase of the company's main operation sales, increase
      in government grants, and also the interest income due to the cash deposit
      in
      bank and the cross currency swap interest income.




***Debt
      Financing***





On
      August
      29, 2006, we, AEM, and the Investors entered into a purchase agreement (the
      “Purchase Agreement”) relating to the purchase and sale of $50 million aggregate
      principal amount of the Notes and Warrants to purchase an aggregate of 3,487,368
      shares of our common stock in an offshore transaction pursuant to Regulation
      S
      under the Securities Act of 1933. The transaction closed on August 30,
      2006.





***Indenture***





The
      Notes
      are governed by an indenture, dated August 30, 2006, entered into among us,
      AEM,
      as guarantor, and The Bank of New York, as trustee for the Notes. Of the $50.0
      million aggregate principal amount of the Notes, Citadel subscribed to $38.0
      million of the principal amount of the Notes, which mature on September 1,
      2012
      (the “2012 Notes”), and Merrill Lynch subscribed to $12.0 million of the
      principal amount of the Notes, which mature on September 1, 2010 (the “2010
      Notes”). Pursuant to the indenture, AEM has agreed, and all of our other
      existing and future subsidiaries (other than subsidiaries domiciled in the
      People's Republic of China) are obligated, to guarantee, on a senior secured
      basis, to the Investors and to the trustee the payment and performance of our
      obligations.





Under
      the
      indenture, we are prohibited, and we are obligated to preclude our subsidiaries,
      from incurring additional debt unless such debt has been designated as
      permissible debt under the terms of the indenture. The indenture imposes further
      limitations on our ability to (i) make investments in other companies, (ii)
      create liens, (iii) sell our assets if the fair market value of such sales
      exceeds, in the aggregate, $4.5 million per year, (iv) make distributions from
      our subsidiaries and (v) engage in transactions with our affiliates. We must
      also maintain a consolidated tangible net worth of not less than $25.0 million
      from the issuance date of the Notes until the first annual anniversary thereof,
      which amount increases at each annual anniversary of such issuance date by
      $10.0
      million. We will also be required to pay an additional interest of 2.0% per
      annum on the Notes if we have not obtained a listing of our common stock on
      either the Nasdaq Capital Market or the Nasdaq Global Market on or before July
      1, 2007 and if we are not at that time currently maintaining such listing.
      Pursuant to the indenture, AEM has agreed, and all of our other existing and
      future subsidiaries (other than subsidiaries domiciled in the People's Republic
      of China), are obligated, to guarantee, on a senior secured basis, to the
      purchasers of the Notes and to the trustee the payment and performance of our
      obligations. If we are required to pay any of these penalties, which could
      be
      substantial in aggregate amount, such payments could have a material and adverse
      effect on our financial results and results of operations.




-
          39 -




In
      addition, we are obligated to pay liquidated damages upon failure to complete
      certain events. They include:




(i)
      an
      aggregate amount of $750,000 due and payable by us to the noteholders on a
      pro
      rata basis (proportionate to their holding of the Notes that are at that time
      outstanding) on or before April 9, 2007 if we have not obtained a listing of
      our
      common stock on either the Nasdaq Capital Market or the Nasdaq Global Market
      on
      or before April 1, 2007 and if we are not at that time currently maintaining
      such listing. On January 26, 2007, our Common Stock began trading on the Nasdaq
      Global Market.




(ii)
      an
      aggregate amount of $1,500,000 due and payable by us to the noteholders on
      a pro
      rata basis (proportionate to their holding of the Notes that are at that time
      outstanding) on or before July 9, 2007 if we have not obtained a listing of
      our
      common stock on either the Nasdaq Capital Market or the Nasdaq Global Market
      on
      or before July 1, 2007 and if we are not at that time currently maintaining
      such
      listing.




(iii)
      an
      aggregate amount of $2,500,000 due and payable by us to the noteholders on
      a pro
      rata basis (proportionate to their holding of the Notes that are at that time
      outstanding) on or before March 1 of each year, beginning March 1, 2007, if
      we
      have not appointed a new independent accounting firm from a list of pre-approved
      candidates by the January 1 immediately preceding each such March 1, and if
      an
      independent accounting firm identified as a pre-approved candidate in the
      indenture is not at each such March 1 engaged by us. On December 14, 2006,
      we
      appointed Moore Stephens Wurth Frazer and Torbet, LLP as our new independent
      certified public accountants.




(iv)
      an
      aggregate amount of $1,200,000 due and payable by us to the noteholders on
      a pro
      rata basis (proportionate to their holding of the Notes that are at that time
      outstanding) on or before the 125th day following the issuance date of the
      Notes, if we have not appointed a senior financial officer knowledgeable about
      the U.S. capital markets and proficient in English by the 120th day following
      the issuance date of the Notes, and the same aggregate amount for each
      subsequent 120-day period in which we fail to so comply. On December 21, 2006,
      the noteholders approved an extension of the time period (until February 28,
      2007) by which we were obligated to have appointed a senior financial officer.
      On February 28, 2007, we appointed Ms. Joann Hu as our senior financial
      officer.




***Notes
      and Guarantee***





The
      Notes:




o
            are
                general senior secured obligations of the Company;o
            are
                secured on a first priority basis by all of the shares of AEM held by
                the Company;o
            rank
                equally in right of payment with all existing and future pari passu
                indebtedness of the Company; ando
            will
                rank senior in right of payment to all existing and future subordinated
                indebtedness of the Company.




The
      Notes
      are unconditionally guaranteed on a senior secured basis by AEM (the
“Guarantor”) and will be guaranteed on a senior secured basis by all of our
      other existing and future subsidiaries (other than subsidiaries domiciled in
      the
      People's Republic of China).





The
      Notes
      bear interest on the principal amount at the rate per annum, reset
      semi-annually, equal to (a) LIBOR plus 4.750% for the 2010 Notes and (b) LIBOR
      plus 3.350% for the 2012 Notes. The interest rate on the Notes is subject to
      increase pursuant to the provisions of the Indenture. The Company shall pay
      interest semi-annually in arrears on March 1 and September 1 of each year.
      Interest shall accrue from the most recent date to which interest has been
      paid
      on the Notes or, if no interest has been paid, from the date of issuance. If
      there is no existing default in the payment of interest, and if the Note is
      authenticated between a record date and the next succeeding interest payment
      date, interest shall accrue from such next succeeding interest payment date.
      [The first interest payment date shall be March 1, 2007]. The Company shall
      pay
      interest on overdue principal and premium, if any, from time to time at a rate
      that is 4% per annum in excess of the interest rate then in effect under the
      Indenture and the Notes. Interest shall be computed on the basis of a 360-day
      year of twelve 30-day months for the actual number of days elapsed. The interest
      rate on the Notes will in no event be higher than the maximum rate permitted
      by
      New York law as such rate may be modified by United States law of general
      application.





-
          40 -




The
      2010
      Notes shall not be redeemable at the option of the Company prior to September
      1,
      2007. Starting on that date, the Company may redeem all (but not less than
      all)
      of the 2010 Notes, after giving notice. The 2012 Notes shall not be redeemable
      at the option of the Company prior to September 1, 2007. Starting on that date,
      the Company may redeem all (but not less than all) of the 2012 Notes, after
      giving notice.




Upon
      a
      change of control of the Company, each noteholder may require the Company to
      repurchase all or any part (equal to $1,000 or an integral multiple of $1,000)
      of such holder’s Notes at a purchase price in cash equal to 102.5% of the
      aggregate principal amount of the Notes repurchased, plus accrued and unpaid
      interest on the Notes repurchased to the purchase date (subject to the right
      of
      holders of record on the relevant record date to receive interest).




If
      the
      Company or any of its subsidiaries consummates an asset sale, they shall not
      be
      required to apply any net available cash in accordance with the Indenture until
      the aggregate net available cash from all asset sales following the date the
      Notes are first issued exceeds $2.0 million. Thereafter, the Company shall,
      after applying the additional aggregate $2.0 million of net available cash,
      commence an offer for Notes pursuant to the Indenture by applying the net
      available cash to purchase the maximum principal amount of Notes that may be
      purchased out of the net available cash at an offer price in cash equal to
      100%
      of the principal amount plus accrued and unpaid interest to the date fixed
      for
      the closing of such offer in accordance with the procedures set forth in the
      Indenture. To the extent that the aggregate amount of Notes tendered pursuant
      to
      an asset sale offer is less than the net available cash, the Company may use
      such deficiency for any purpose not prohibited by the Indenture. If the
      aggregate principal amount of Notes surrendered by Holders thereof exceeds
      the
      amount of net available cash, the Trustee shall select the Notes to be purchased
      on a pro rata basis. Holders of Notes that are the subject of an offer to
      purchase will receive an asset sale offer from the Company prior to any related
      purchase date and may elect to have such Notes purchased by completing the
      required form.




The
      Guarantee of the Notes:





o
            is
                a senior secured obligation of the Guarantor;o
            will
                be secured, on a first priority basis, by security interests in any
                other
                collateral owned by the Guarantor;o
            is
                senior in right of payment to all existing and future subordinated
                indebtedness of the Guarantor; ando
            ranks
                equally in right of payment with all existing and future pari passu
                indebtedness of the Guarantor.





***Share
      Pledge Agreement***




As
      security for the Notes, we and The Bank of New York, as collateral agent,
      entered into a share pledge agreement, dated August 30, 2006, pursuant to which
      the Notes were secured with all of the shares of AEM common stock held
      by us.




***Warrant
      Agreement and Warrants***




The
      Warrants are governed by a warrant agreement, dated August 30, 2006, between
      us
      and The Bank of New York, as warrant agent. The Warrants consist of (i) six-year
      warrants to purchase an aggregate of 2,192,308 shares of our common stock,
      at an
      exercise price of $7.80 per share (the “First Tranche 2012 Warrants”), (ii)
      six-year warrants to purchase an aggregate of 525,830 shares of our common
      stock
      at an exercise price of $10.84 per share (the “Second Tranche 2012 Warrants”)
      and (iii) three-year warrants to purchase an aggregate of 769,230 shares of
      our
      common stock at an exercise price of $7.80 per share (the “2009 Warrants”). The
      First Tranche 2012 Warrants and the Second Tranche 2012 Warrants were issued
      to
      Citadel, and the 2009 Warrants were issued to Merrill. Each Warrant is
      exercisable at the option of the Warrant holder beginning on the date of
      issuance through the maturity date of such Warrant.




-
          41 -




The
      Warrant Agreement provides that upon the occurrence of certain events the
      exercise price of the Warrants may, subject to certain conditions, be adjusted.
      If the exercise price is adjusted, the Warrant Agreement provides that the
      number of shares of common stock issuable upon the exercise of each warrant
      shall be adjusted. No fractions of a share of common stock will be issued upon
      the exercise of any Warrant, but the Company will pay the cash value of the
      fractional share, determined as provided in the Warrant Agreement.




The
      applicable exercise price and the number of shares issuable upon the exercise
      of
      each Warrant are subject to adjustment from time to time upon the occurrence
      of
      certain events, including:




o
            if
                the Company makes a dividend payment or distribution on its common
                stock
                payable in shares of its common stock, subdivides, combines or
                reclassifies its share capital or makes a distribution on its common
                stock
                in shares of its capital stock other than common
                stock;






o
            if
                the Company distributes any rights, options or warrants to all holders
                of
                its common stock entitling them to subscribe for shares of common
                stock or
                securities convertible into, or exchangeable or exercisable for,
                shares of
                common stock, in either case, at a price per share less than the
                fair
                value per share;




o
            if
                the Company distributes to all holders of its common stock any of
                its
                assets (including cash), debt securities, preferred stock or any
                rights or
                warrants to purchase assets (including cash), debt securities, preferred
                stock or other securities of the
                Company;




o
            if
                the Company issues shares of common stock for a consideration per
                share
                less than the fair value per share on the date the Company fixes
                the
                offering price of such additional shares;
                or




o
            if
                the Company issues any securities convertible into or exchangeable
                or
                exercisable for common stock for a consideration per share of common
                stock
                initially deliverable upon conversion, exchange or exercise of such
                securities less than the fair value per share on the date of issuance
                of
                such securities or on the date the Company fixes the offering price
                of
                such securities.




The
      exercise price, however, shall not be less than $0.01 per share. In addition
      to
      the adjustments described above, the Company may, at any time, reduce the
      exercise price to any amount greater than or equal to $0.01 per share for any
      period of time.




The
      Warrant Agreement further provides that (i) each holder of 2012 Warrants shall
      have the right until August 30, 2012 and (ii) each holder of 2009 Warrants
      shall
      have the right until August 30, 2009 to receive from the Company the number
      of
      shares underlying such Warrants which the holder may at the time be entitled
      to
      receive on exercise of such Warrants and payment of the applicable exercise
      price.





***Equity
      Registration Rights Agreement***




Pursuant
      to a Registration Rights agreement, we registered the shares underlying the
      warrants. The SEC declared the registration statement effective on February
      9,
      2007.





We
      agreed
      to indemnify each warrantholder against any losses, claims, damages or
      liabilities arising out of or are based upon any untrue statement or alleged
      untrue statement of a material fact contained in, or a failure to state a
      material fact required to be stated in, the registration statement or related
      prospectus, and to provide reimbursement for any legal or other expenses
      reasonably incurred in connection with investigating or defending any such
      loss,
      claim, damage, liability or action. The Company, however, shall not be liable
      to
      the extent that such loss, claim, damage or liability arises out of or is based
      upon any untrue statement or omission made in the registration statement or
      related prospectus in reliance upon and in conformity with written information
      pertaining to such warrantholder and furnished to the Company by or on behalf
      of
      such warrantholder. In addition, a warrantholder shall not be indemnified to
      the
      extent that the prospectus was required to be delivered by such warrantholder
      and any such loss, claim, damage or liability of such warrantholder results
      from
      the fact that there was not sent or given to such person, at or prior to the
      written confirmation of the sale of such registrable securities to such person,
      a copy of the final prospectus if the Company had previously furnished copies
      to
      such warrantholder.





-
          42 -




***Voting
      Agreement***




In
      addition, we, Mr. Tianfu Yang and Citadel entered into a voting agreement,
      dated
      August 30, 2006, (the “Voting Agreement”) pursuant to which Mr. Yang
      agreed to vote his shares of the capital stock of the Company in whatever
      manner as shall have been necessary (i) to ensure the election of up to two
      nominees of Citadel to the Company’s board of directors (ii) to ensure
      that the size of the Company’s board of directors is sufficient to permit the
      appointment and/or election of the Citadel nominees and (iii) to ensure that
      the
      total size of the Company’s board of directors does not exceed ten (10) members
      at any time. As of March 19, 2007, both of the Citadel nominees had resigned
      from the Company’s board of directors. The decision by the Citadel nominees to
      resign was not the result of any disagreement with the Company on any matters
      relating to its operations, policies or practices. The Voting Agreement was
      terminated by Citadel on March 19, 2007. The Company incurred no termination
      expenses or penalties in connection with the termination of the Voting
      Agreement.





***Noncompetition
      Covenant and Agreement***




The
      Investors and Mr. Tianfu Yang also entered into a noncompetition covenant and
      agreement, dated August 30, 2006, relating to Mr. Yang's employment as our
      Chief
      Executive Officer and his ability to engage in a business that is competitive
      with our business for so long as any of the Notes remain
      outstanding.




**Land
      Use Lease**





On
      September 8, 2006, HTFE entered into an agreement (“Land Use Agreement”) with
      Shanghai Lingang Investment and Development Company Limited (“Shanghai Lingang”)
      with respect to HTFE’s use of 40,800 square meters of State-owned land in the
      Shanghai Zhuqiao Airport Industrial Zone (the “Site”). The term of the land use
      agreement is 50 years and the aggregate amount that HTFE shall pay to Shanghai
      Lingang is approximately $2.54 million (“Fee”), 55%,($ 1,294,820) of which has
      been paid and 45% of which is payable upon Shanghai Lingang’s completion of
      certain regulatory applications on behalf of HTFE. The balance of the Fee is
      payable within seven days of receipt of a regulatory permit for work
      commencement. The Site will be used for industrial purposes. The Land Use
      Agreement provides that HTFE shall invest approximately $15 million in the
      Site
      over the next year. This investment amount includes fees, improvement costs,
      constructing a factory building and installing necessary equipment. HTFE shall
      register a Sino-foreign joint venture company at the location of Shanghai
      Lingang, with taxes payable at the same location. HTFE has agreed to compensate
      Shanghai Lingang for certain local taxes due to the local tax authority in
      connection with applicable tax generation requirements. As of June 30, 2007,
      the
      application of the land use lease is still in process.





**Agreements
      with Shelton Technology LLC**





On
      April
      9, 2007, we entered into a Letter Agreement (the “Letter Agreement”) with
      Shelton Technology, LLC (“Shelton”), Shaotang Chen (“Dr Chen”) and Xiaogang Luo
      (“Dr Luo”) whereby we and Shelton agreed to work together through our newly
      formed, indirect wholly-owned subsidiary, Advanced Automation Group, LLC (“AAG”)
      to design, develop and manufacture custom industrial automation controllers.
      The
      initial term of this arrangement shall run from April 9, 2007 until August
      30,
      2008. Pursuant to the terms of the Letter Agreement, during the initial term
      of
      this arrangement, Shelton shall be entitled to receive 49% of the profits earned
      by AAG. The joint cooperation between us and Shelton in this business line
      may
      be extended, at our option, beyond the expiration of the initial term of the
      arrangement on the terms and subject to the conditions described in the Letter
      Agreement.




Pursuant
      to the terms of the Letter Agreement, we have agreed to contribute to AAG up
      to
      $3,000,000 in separate installments ($1,200,000 by April 19, 2007, $800.000
      by
      May 1, 2008 and $1,000,000 by March 31, 2009). Pursuant to the terms of the
      Letter Agreement, Shelton has assigned to AAG, all of its existing customer
      accounts. In addition, concurrently with its execution and delivery of the
      Letter Agreement, Shelton granted to AAG an exclusive, royalty-free worldwide
      license to its technology and intellectual property related to precision servo
      motor controllers for industrial automation, including research and development,
      design, manufacturing and testing. This license was granted to AAG pursuant
      to a
      License Agreement dated as of April 9, 2007 by and among Shelton, AAG, Dr Chen
      and Dr Luo.




In
      connection with the execution and delivery of the Letter Agreement, AAG entered
      into separate Employment Agreements with Dr Chen and Dr Luo. Pursuant to the
      terms of Dr Chen’s Employment Agreement, Dr Chen has agreed to serve as Research
      and Development Director of AAG. Pursuant to the terms of Dr Luo’s Employment
      Agreement, Dr Luo has agreed to serve as Chief Engineer of AAG





-
          43 -




**Liquidity
      and Capital Resources**




As
      of
      June 30, 2007, the Company had $62,700,593 cash and cash equivalents. The
      Company had net cash flows provided by operations of $6,906,089 for the six
      month period ended June 30, 2007, as compared to net cash provided by operations
      of $4,758,783 in the corresponding period last year. The change in net cash
      flows from operations in the current period as compared to the corresponding
      period last year was mainly from the working capital. Cash flows used in
      investing activities was $11,898,805 for the six month period ended June 30,
      2007 compared with a net cash provided by investing activities for the amount
      of
      $917,583 for the same period ended June 30, 2006. The increase investing
      activity was due to prepayments related to new equipment purchases and
      investments in fixed assets. The Company had a net decrease in cash and cash
      equivalent of $4,613,326 in the current period as compared to a net increase
      of
      $ 5,755,778 in the corresponding period last year. Our net decrease in cash
      & cash equivalents during the six month period ended June 30, 2007 was
      mainly due to prepayments made for equipment purchases and also the payment
      for
      investment on derivative hedge.





On
      August
      29, 2006, the Company, AEM, Citadel and Merrill Lynch entered into the Purchase
      Agreement relating to the purchase and sale of (a) $50.0 million aggregate
      principal amount of the Company's Notes and (b) fully detachable Warrants to
      purchase an aggregate of 3,487,368 shares of our common stock. The transaction
      closed on August 30, 2006.





The
      Notes
      are governed by an indenture, dated August 30, 2006 (the “Indenture”), entered
      into among the Company, AEM, as guarantor, and The Bank of New York, as trustee
      for the Notes. Of the $50 million aggregate principal amount of the Notes,
      Citadel subscribed to $38 million of the principal amount of the 2012 Notes,
      which mature on September 1, 2012, and Merrill Lynch subscribed to $12 million
      of the principal amount of the 2010 Notes, which mature on September 1, 2010.
      Pursuant to the indenture, AEM has agreed, and all of our other existing and
      future subsidiaries (other than subsidiaries domiciled in the People's Republic
      of China) are obligated, to guarantee, on a senior secured basis, to the
      Investors and to the trustee the payment and performance of our
      obligations.





As
      security for the Notes, we and The Bank of New York, as collateral agent,
      entered into a share pledge agreement, dated August 30, 2006, to secure the
      Notes with all of the shares of AEM common stock held by us.





The
      Warrants are governed by a warrant agreement, dated August 30, 2006, between
      us
      and The Bank of New York, as warrant agent. The Warrants consist of (i) the
      First Tranche 2012 Warrants which permit the purchase of an aggregate of
      2,192,308 shares of our common stock, at an exercise price of $7.80 per share,
      (ii) the Second Tranche 2012 Warrants which permit the purchase of an aggregate
      of 525,830 shares of our common stock at an exercise price of $10.84 per share
      and (iii) the 2009 Warrants which permit the purchase of an aggregate of 769,230
      shares of our common stock at an exercise price of $7.80 per share. The First
      Tranche 2012 Warrants and the Second Tranche 2012 Warrants were issued to
      Citadel, and the 2009 Warrants were issued to Merrill. Each Warrant is
      exercisable at the option of the Warrant holder at any time through the maturity
      date of such Warrant. All of the Warrants contain a cashless exercise feature.
      To the extent Warrants are exercised for cash, however, the Company would
      receive the payment of the exercise price.




On
      August
      25, 2006 the Company’s subsidiary HTFE signed an R&D Agreement with IEECAS.
      Under the R&D Agreement with IEECAS, HTFE is obligated to invest
      approximately $1.88 million (of which approximately $1.25 million previously
      has
      been paid) during the period ending in early 2009. On September 8, 2006 the
      Company’s subsidiary HTFE signed a Land Use Agreement for a plot of land in
      Shanghai. HTFE is obligated to make an additional Fee payment of approximately
      $1.27 million (the timing of which is dependent upon completion of certain
      regulatory applications and receipt of a regulatory permit for work
      commencement) as well as to invest approximately $15 million in Site
      investments. It is anticipated that, as permitted by the Indenture, the Company
      will use a portion of the proceeds from placement of the Notes to Merrill Lynch
      and Citadel for such purposes. In addition, interest on the Notes is payable
      semi-annually in arrears, commencing March 1, 2007. The Company anticipates
      that
      existing cash reserves and cash flow from future operations will be used for
      such purposes.





*Cross
      currency hedge*





The
      Company's operations are exposed to a variety of global market risks, including
      the effect of changes in foreign currency exchange rates and interest rates.
      These exposures are managed, in part, with the use of financial derivatives.
      The
      Company uses financial derivatives only to hedge exposures in the ordinary
      course of business and dose not invest in derivative instruments for speculative
      purposes.





-
          44 -





Effective April 17, 2007, the Company entered into a cross currency swap
      agreement with Merrill Lynch exchanging the LIBOR plus 4.75% variable rate
      interest payable on the $38 million Merrill Lynch debt for 7.2% (3.6%
      semi-annually) fixed rate interest. The agreement requires semi-annual payments
      on March 1 and September 1 through the maturity of the agreement on September
      1,
      2012. Merrill Lynch required the Company to deposit $1,000,000 with them to
      secure the agreement. The deposit may be increased to $2,500,000 if the exchange
      rate for Renminbi to USD falls below 6.5, and to $4,000,000 if the exchange
      rate
      falls below 5.5. This swap is designated and qualified as a cash flow hedge.





The
      fair
      value of this swap agreement at April 02, 2007 (inception date) was a payable
      of
      $5,387,487, and at June 30, 2007 was a payable of $3,945,951. For the six months
      ended June 30, 2007, changes in fair value of the swap resulted in an increase
      to equity and a gain to other comprehensive income of $1,441,536, net of taxes.
      During the six months period ended June 30, 2007, the Company received $297,637,
      which was recorded as a gain from derivative transactions. For six months ended
      June 30, 2007, there were no amounts recorded in the consolidated statement
      of
      income in relation to this interest rate swap related to
      ineffectiveness.





The
      Company accounts for this interest rate swap in accordance with FAS No. 133,
      “Accounting for Derivatives Instruments and Hedging Activity,” which requires
      all derivatives to be carried on the balance sheet at fair value and to meet
      certain documentary and analytical requirements to qualify for hedge accounting
      treatment. The above derivative qualifies for hedge accounting under FAS 133
      and, accordingly, changes in the fair value is reported in accumulated other
      comprehensive income, net of related income tax effects.





On
      April
      9, 2007, we entered into a Letter Agreement with Shelton, Dr Chen and Dr Luo
      whereby we and Shelton agreed to work together through our newly formed,
      indirect wholly-owned subsidiary, AAG to design, develop and manufacture custom
      industrial automation controllers. The initial term of this arrangement shall
      run from April 9, 2007 until August 30, 2008. Pursuant to the terms of the
      Letter Agreement, during the initial term of this arrangement, Shelton shall
      be
      entitled to receive 49% of the profits earned by AAG. The joint cooperation
      between us and Shelton in this business line may be extended, at our option,
      beyond the expiration of the initial term of the arrangement on the terms and
      subject to the conditions described in the Letter Agreement.




Pursuant
      to the terms of the Letter Agreement with Shelton, we have agreed to contribute
      to AAG up to $3,000,000 in separate installments ($1,200,000 by April 19, 2007,
      $800,000 by May 1, 2008 and $1,000,000 by March 31, 2009).





On
      June
      16,2007, we entered into an Asset Purchase Agreement with Harbin Tech Full
      Electric Co., Ltd., a People’s Republic of China limited liability company and a
      wholly owned subsidiary of the Company, Harbin
      Taifu Auto Electric Co., Ltd. ,
      a
      limited liability company organized and existing under the laws of the People’s
      Republic of China Harbin Tech Full Industry Co., Ltd., a shareholder of the
      Seller (“HTFI”), Tianfu Yang, Suofei Xu and Zedong Xu, shareholders of HTFI, and
      Tianli Yang, a shareholder of both Seller and HTFI. A copy of the Agreement
      is
      filed on the Form 8-K





Pursuant
      to the terms of the Asset Purchase Agreement with Harbin Taifu Auto Electric
      Co., Ltd., Taifu Auto has agreed to sell substantially all of its non-cash
      assets to Harbin Tech Full Electric Co., Ltd. In consideration for the sale
      of
      Taifu Auto’s assets, Taifu Auto received an aggregate purchase price consisting
      of (x) a cash payment in the amount of four million dollars ($4,000,000), and
      (y) 473,354 newly issued shares of the Company’s common stock. Based on the
      closing price of the Company’s common stock on Friday, June 15, 2007 of $14.67,
      the transaction would be valued at approximately $10,944,000, which is within
      the limitations established by the Company’s indenture relating to its senior
      secured floating rate notes. The transaction closed on
      July
      12, 2007.





Taifu
      Auto, is 98% owned by HTFI which is wholly owned by the Shareholders and is
      controlled by the Company’s Chairman and Chief Executive Officer, Mr. Tianfu
      Yang. The remaining 2% of Taifu Auto is owned by Tianli Yang, a Vice President
      of the Company. The Shareholders are comprised of Tianfu Yang, Chief Executive
      Officer and director of the Company, Tianli Yang, a Vice President of the
      Company, Suofei Xu, a Vice President and director of the Company, and Zedong
      Xu,
      Chief Financial Officer of the Company.





-
          45 -


On
      June
      13, 2007, a special committee of the Board of Directors of the Company composed
      solely of independent directors unanimously approved the Agreement and
      transactions contemplated thereby and determined that the transactions
      contemplated by the Agreement are in the best interests of the shareholders
      of
      the Company.





On
      June
      13, 2007, the full Board of Directors of the Company unanimously (with Mr.
      Tianfu Yang and Mr. Suofei Xu not participating) took action to indicate its
      concurrence with the Special Committee’s approval of the Agreement.




The
      majority of the Company's revenues and expenses were denominated primarily
      in
      Renminbi (“RMB”), the currency of the People's Republic of China. There is no
      assurance that exchange rates between the RMB and the U.S. dollar will remain
      stable. A revaluation of the RMB relative to the U.S. dollar could adversely
      affect our business, financial condition and results of operations. We do not
      engage in currency hedging, therefore inflation has not had a material impact
      on
      our business.




**Item
      3. Controls and Procedures**




(a) **Evaluation
      of Disclosure Controls and Procedures.**




The
      Company’s Chief Executive Officer and Chief Financial Officer conducted an
      evaluation of the effectiveness of the design and operation of the Company’s
      disclosure controls and procedures as defined in Securities Exchange Act of
      1934
      Rule 13a-15(e), as of the end of the period covered by this report. Based on
      that evaluation, the Chief Executive Officer and Chief Financial Officer
      concluded that the Company’s disclosure controls and procedures were effective
      as of the end of the period covered by this report.




**(b)**  **Changes
      in Internal Control over Financial Reporting.**





There
      were no changes in internal controls over financial reporting that occurred
      during the second quarter of 2007 that have materially affected, or are
      reasonably likely to materially affect, the Company’s internal control over
      financial reporting.





**PART
      II. OTHER INFORMATION**




**Item
      1.**  **Legal
      Proceedings**




From
      time
      to time, the Company becomes involved in various lawsuits and legal proceedings
      which arise in the ordinary course of business.




Following
      is the summary of the current litigation as of June 30, 2007.




Leong
      Sing Lye v. Harbin Electric, Inc. United States District Court, District of
      Nevada, Case No. 2:06-CV-00796





In
      June
      2006, an action was filed against the Company by Leong Sing Lye in the United
      States District Court for the District of Nevada, seeking specific performance
      of the Company's alleged obligation to issue 228,000 shares of Common Stock
      and
      warrants to purchase 38,400 shares of common stock, or , in the alternative,
      the
      value of securities alleged to be owed to Mr. Lye under, or, monetary damages
      allegedly arising from, a so-called Appointment Agreement pursuant to which
      Mr.
      Lye alleges to have been appointed the Company's Consultant of Corporate
      Strategy, as well as court costs and reasonable attorneys' fees. The Company
      has
      filed an answer to Mr. Lye's complaint denying the material allegations thereof
      and a counterclaim against Mr. Lye for fraud and related claims. The Company
      intends to vigorously defend against Mr. Lye's claim, if not withdrawn, and
      pursue its counterclaim. The parties are in the discovery process. The Company
      has filed a motion for summary judgment to eliminate portions of Mr. Lye's
      case
      and Mr. Lye has filed a cross-motion. The parties await the Court's ruling
      on
      these matters. The Company does not believe that the ultimate outcome of this
      matter will have a material adverse effect on the Company.





**Item
      2.**  **Unregistered
      Sales of Equity Securities and Use of Proceeds**




None.





-
          46 -




**Item
      3.**  **Defaults
      upon Senior Securities**




None.





**Item
      4.**  **Submission
      of Matters to a Vote of Securities Holders**




None.





**Item
      5.**  **Other
      Information**





None.




-
          47 -


**Item
      6.**  **Exhibits.**





**Exhibit
                Number**
            
            **Description**
            
            **Method
                of Filing**3.1
            
            Articles
                of Incorporation of the Company
            
            Filed
                as Exhibit 3.1 to the registration statement on Form SB-2 filed with
                the
                Commission on October 10, 2003 and incorporated herein by
                reference.3.2
            
            Amended
                and Restated Bylaws of the Company
            
            Filed
                as Exhibit 10.1 to the current report on Form 8-K filed with the
                Commission on July 6, 2005 and incorporated herein by
                reference.3.3
            
            Amendment
                to the Bylaws of the Company
            
            Filed
                as Exhibit 4.1 to the current report on Form 8-K filed with the
                Commission on December 20, 2006 and incorporated herein by
                reference.10.1
            
            Registration
                Rights Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.1 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.10.2
            
            Common
                Stock Purchase Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.2 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.10.3
            
            Option
                Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.3 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.10.4
            
            Employment
                Agreement, dated October 12, 2005, between the Company and Mr. Barry
                Raeburn
            
            Filed
                as Exhibit 10.1 to the current report on Form 8-K filed with the
                Commission on October 17, 2005 and incorporated herein by
                reference.10.5
            
            Term
                Sheet dated August 2, 2006
            
            Filed
                as Exhibit 10.5 to the current report on Form 8-K filed with the
                Commission on August 2, 2006 and incorporated herein by
                reference.10.6
            
            Agreement
                on Cooperation between Harbin Tech Full Electric Co., Ltd. and Institute
                of Electrical Engineering of the Chinese Academy of
                Sciences
            
            Filed
                as Exhibit 10.6 to the current report on Form 8-K filed with the
                Commission on August 25, 2006 and incorporated herein by
                reference.10.7
            
            Purchase
                Agreement among the Company, Advanced Electric Motors, Inc., Citadel
                Equity Fund Ltd. and Merrill Lynch International, dated August 29,
                2006
            
            Filed
                as Exhibit 4.1 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.8
            
            Indenture
                among the Company, Advanced Electric Motors, Inc. and The Bank of
                New
                York, as trustee, dated August 30, 2006
            
            Filed
                as Exhibit 4.2 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.9(a)
            
            2010
                Global Note
            
            Filed
                as Exhibit 4.3(a) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.10.9(b)
            
            2012
                Global Note
            
            Filed
                as Exhibit 4.3(b) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.




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          48 -




10.10
            
            Registration
                Rights Agreement between the Company and the Investors, dated August
                30,
                2006
            
            Filed
                as Exhibit 4.4 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.11
            
            Share
                Pledge Agreement between the Company and The Bank of New York, as
                collateral agent, dated August 30, 2006
            
            Filed
                as Exhibit 4.5 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.12
            
            Warrant
                Agreement between the Company and The Bank of New York, as warrant
                agent,
                dated August 30, 2006
            
            Filed
                as Exhibit 4.6 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.13(a)
            
            Global
                First Tranche 2012 Warrants
            
            Filed
                as Exhibit 4.7(a) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.10.13(b)
            
            Global
                Second Tranche 2012 Warrants
            
            Filed
                as Exhibit 4.7(b) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.10.13(c)
            
            Global
                2009 Warrants
            
            Filed
                as Exhibit 4.7(c) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.




10.14
            
            Voting
                Agreement among the Company, Tianfu Yang and Citadel Equity Fund
                Ltd.,
                dated August 30, 2006
            
            Filed
                as Exhibit 4.8 to the current report on Form 8-K filed with the Commission
                on September 1, 2001 and incorporated herein by
                reference.10.15
            
            Noncompetition
                Covenant and Agreement among Citadel Equity Fund Ltd., Merrill Lynch
                International and Tianfu Yang, dated August 30, 2006
            
            Filed
                as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                the
                Commission on October 4, 2006 and incorporated herein by
                reference.10.16
            
            Agreement
                between Harbin Tech Full Electric Co., Ltd. and Shanghai Lingang
                Investment and Development Company Limited, dated September 8,
                2006
            
            Filed
                as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                the
                Commission on October 4, 2006 and incorporated herein by
                reference.10.17
            
            Letter
                Agreement dated April 9, 2007 by and among Harbin Electric, Inc,
                Shelton
                Technology LLC, Shaotang Chen and Xioagang Luo
            
            Filed
                as Exhibit 10.1 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.10.18
            
            License
                Agreement dated as of April 9, 2007 by and among Advanced Automation
                Group. LLC, Shelton Technology, LLC, Shaotang Chen and Xiaogang
                Luo
            
            Filed
                as Exhibit 10.2 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.10.19
            
            Employment
                Agreement dated April 9, 2007 by and between Advanced Automation
                Group,
                LLC and Shaotang Chen
            
            Filed
                as Exhibit 10.3 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.10.20
            
            Employment
                Agreement dated April 9, 2007 by and between Advanced Automation
                Group,
                LLC and Xiaogang Luo.
            
            Filed
                as Exhibit 10.4 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.




-
          49 -




14.1
            
            Code
                of Ethics and Business Conduct
            
            Previously
                filed.21.1
            
            List
                of subsidiaries
            
            Filed
                as Exhibit 21.1 to the quarterly report on Form 10-QSB filed with
                the
                Commission on May 15, 2006 and incorporated herein by
                reference.31.1
            
            Certification
                by the Chief Executive Officer pursuant to Rule 13a-14(a) or
                15d-14(a)
            
            Filed
                herewith as Exhibit 31.1.31.2
            
            Certification
                by the Chief Financial Officer pursuant to Rule 13a-14(a) or
                15d-14(a)
            
            Filed
                herewith as Exhibit 31.2.32.1
            
            Certification
                of the Chief Executive Officer and the Chief Financial Officer pursuant
                18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002
            
            Filed
                herewith as Exhibit 32.1.99.1
            
            Press
                Release Announcing Financial Results for the Second quarter
                Ended June 30, 2007
            
            Filed
                herewith as Exhibit 99.1.




(b)
            Reports
                on Form 8-K during the second quarter ended June 30,
                2007:(i)
            Form
                8-K/A filed on January 4, 2007 disclosing the changes in the Company’s
                independent certified public accountants;
                and





(ii)
            Form
                8-K filed on January 26, 2007 disclosing the Company issued a press
                release announcing that its common stock has been approved for listing
                on
                the NASDAQ Stock Market; and




(iii)
            Form
                8-K filed on February 28, 2007 disclosing the Company’s entry into an
                employment agreement with Ms. Joann Hu pursuant to which she was
                appointed
                senior financial officer of the Company;
                and




(iv)
            Form
                8-K filed on March 20, 2007 disclosing the Company’s termination of a
                certain Voting Agreement dated August 30, 2006, by and among Citadel,
                Harbin Electric, Inc. and Mr. Tianfu Yang and resignation of Oliver
                Weisberg as a director of the Company
                and;




(v)
            Form
                8-K filed on April 13, 2007 disclosing the Company’s entry into a Letter
                Agreement with Shelton Technology, LLC (“Shelton”), Shaotang Chen and
                Xiaogang Luo whereby the Company and Shelton agreed to work together
                through the Company’s newly formed, indirect wholly-owned subsidiary,
                Advanced Automation Group, LLC to design, develop and manufacture
                custom
                industrial automation controllers.




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**SIGNATURES**




Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      caused this report to be signed on its behalf by the undersigned, thereunto
      duly
      authorized.




**Harbin
                Electric, Inc.**Date:
                August 13, 2007
            By:
            /s/ Tianfu
              YangTianfu
                YangChief
                Executive Officer, Director and Chairman of the Board
              (Principal
                Executive Officer)





Date:
                August 13, 2007
            By:
            /s/ Zedong
              XuZedong
                XuChief
                Financial Officer
              (Principal
                Accounting Officer)




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          51 -




**EXHIBIT
      INDEX**





Exhibits:





**Exhibit
                Number**
            
            **Description**
            
            **Method
                of Filing**3.1
            
            Articles
                of Incorporation of the Company
            
            Filed
                as Exhibit 3.1 to the registration statement on Form SB-2 filed with
                the
                Commission on October 10, 2003 and incorporated herein by
                reference.3.2
            
            Amended
                and Restated Bylaws of the Company
            
            Filed
                as Exhibit 10.1 to the current report on Form 8-K filed with the
                Commission on July 6, 2005 and incorporated herein by
                reference.3.3
            
            Amendment
                to the Bylaws of the Company
            
            Filed
                as Exhibit 4.1 to the current report on Form 8-K filed with the
                Commission on December 20, 2006 and incorporated herein by
                reference.10.1
            
            Registration
                Rights Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.1 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.10.2
            
            Common
                Stock Purchase Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.2 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.10.3
            
            Option
                Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.3 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.10.4
            
            Employment
                Agreement, dated October 12, 2005, between the Company and Mr. Barry
                Raeburn
            
            Filed
                as Exhibit 10.1 to the current report on Form 8-K filed with the
                Commission on October 17, 2005 and incorporated herein by
                reference.10.5
            
            Term
                Sheet dated August 2, 2006
            
            Filed
                as Exhibit 10.5 to the current report on Form 8-K filed with the
                Commission on August 2, 2006 and incorporated herein by
                reference.10.6
            
            Agreement
                on Cooperation between Harbin Tech Full Electric Co., Ltd. and Institute
                of Electrical Engineering of the Chinese Academy of
                Sciences
            
            Filed
                as Exhibit 10.6 to the current report on Form 8-K filed with the
                Commission on August 25, 2006 and incorporated herein by
                reference.10.7
            
            Purchase
                Agreement among the Company, Advanced Electric Motors, Inc., Citadel
                Equity Fund Ltd. and Merrill Lynch International, dated August 29,
                2006
            
            Filed
                as Exhibit 4.1 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.8
            
            Indenture
                among the Company, Advanced Electric Motors, Inc. and The Bank of
                New
                York, as trustee, dated August 30, 2006
            
            Filed
                as Exhibit 4.2 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.9(a)
            
            2010
                Global Note
            
            Filed
                as Exhibit 4.3(a) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.




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          52 -




10.9(b)
            
            2012
                Global Note
            
            Filed
                as Exhibit 4.3(b) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.10.10
            
            Registration
                Rights Agreement between the Company and the Investors, dated August
                30,
                2006
            
            Filed
                as Exhibit 4.4 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.11
            
            Share
                Pledge Agreement between the Company and The Bank of New York, as
                collateral agent, dated August 30, 2006
            
            Filed
                as Exhibit 4.5 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.12
            
            Warrant
                Agreement between the Company and The Bank of New York, as warrant
                agent,
                dated August 30, 2006
            
            Filed
                as Exhibit 4.6 to the current report on Form 8-K filed with the Commission
                on September 1, 2006 and incorporated herein by
                reference.10.13(a)
            
            Global
                First Tranche 2012 Warrants
            
            Filed
                as Exhibit 4.7(a) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.10.13(b)
            
            Global
                Second Tranche 2012 Warrants
            
            Filed
                as Exhibit 4.7(b) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.10.13(c)
            
            Global
                2009 Warrants
            
            Filed
                as Exhibit 4.7(c) to the current report on Form 8-K filed with the
                Commission on September 1, 2006 and incorporated herein by
                reference.10.14
            
            Voting
                Agreement among the Company, Tianfu Yang and Citadel Equity Fund
                Ltd.,
                dated August 30, 2006
            
            Filed
                as Exhibit 4.8 to the current report on Form 8-K filed with the Commission
                on September 1, 2001 and incorporated herein by
                reference.10.15
            
            Noncompetition
                Covenant and Agreement among Citadel Equity Fund Ltd., Merrill Lynch
                International and Tianfu Yang, dated August 30, 2006
            
            Filed
                as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                the
                Commission on October 4, 2006 and incorporated herein by
                reference.10.16
            
            Agreement
                between Harbin Tech Full Electric Co., Ltd. and Shanghai Lingang
                Investment and Development Company Limited, dated September 8,
                2006
            
            Filed
                as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                the
                Commission on October 4, 2006 and incorporated herein by
                reference.10.17
            
            Letter
                Agreement dated April 9, 2007 by and among Harbin Electric, Inc,
                Shelton
                Technology LLC, Shaotang Chen and Xioagang Luo
            
            Filed
                as Exhibit 10.1 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.10.18
            
            License
                Agreement dated as of April 9, 2007 by and among Advanced Automation
                Group. LLC, Shelton Technology, LLC, Shaotang Chen and Xiaogang
                Luo
            
            Filed
                as Exhibit 10.2 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.10.19
            
            Employment
                Agreement dated April 9, 2007 by and between Advanced Automation
                Group,
                LLC and Shaotang Chen
            
            Filed
                as Exhibit 10.3 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.




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          53 -




10.20
            
            Employment
                Agreement dated April 9, 2007 by and between Advanced Automation
                Group,
                LLC and Xiaogang Luo.
            
            Filed
                as Exhibit 10.4 to the current report on Form 8-K filed with the
                Commission on April 13, 2007 and incorporated herein by
                reference.14.1
            
            Code
                of Ethics and Business Conduct
            
            Previously
                filed.21.1
            
            List
                of subsidiaries
            
            Filed
                as Exhibit 21.1 to the quarterly report on Form 10-QSB filed with
                the
                Commission on May 15, 2006 and incorporated herein by
                reference.31.1
            
            Certification
                by the Chief Executive Officer pursuant to Rule 13a-14(a) or
                15d-14(a)
            
            Filed
                herewith as Exhibit 31.1.31.2
            
            Certification
                by the Chief Financial Officer pursuant to Rule 13a-14(a) or
                15d-14(a)
            
            Filed
                herewith as Exhibit 31.2.32.1
            
            Certification
                of the Chief Executive Officer and the Chief Financial Officer pursuant
                18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002
            
            Filed
                herewith as Exhibit 32.1.99.1
            
            Press
                Release Announcing Financial Results for the Second quarter
                Ended June 30, 2007
            
            Filed
                herewith as Exhibit 99.1.





(b)
            Reports
                on Form 8-K during the second quarter ended June 30,
                2007:(i)
            Form
                8-K/A filed on January 4, 2007 disclosing the changes in the Company’s
                independent certified public accountants;
                and


(ii)
            Form
                8-K filed on January 26, 2007 disclosing the Company issued a press
                release announcing that its common stock has been approved for listing
                on
                the NASDAQ Stock Market; and




(iii)
            Form
                8-K filed on February 28, 2007 disclosing the Company’s entry into an
                employment agreement with Ms. Joann Hu pursuant to which she was
                appointed
                senior financial officer of the Company;
                and




(iv)
            Form
                8-K filed on March 20, 2007 disclosing the Company’s termination of a
                certain Voting Agreement dated August 30, 2006, by and among Citadel,
                Harbin Electric, Inc. and Mr. Tianfu Yang and resignation of Oliver
                Weisberg as a director of the Company
                and;




(v)
            Form
                8-K filed on April 13, 2007 disclosing the Company’s entry into a Letter
                Agreement with Shelton Technology, LLC (“Shelton”), Shaotang Chen and
                Xiaogang Luo whereby the Company and Shelton agreed to work together
                through the Company’s newly formed, indirect wholly-owned subsidiary,
                Advanced Automation Group, LLC to design, develop and manufacture
                custom
                industrial automation controllers.




-
            54 -