UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549









Form 10-Q









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




For the
quarterly period ended March 31, 2010




 ̈
            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 registrant as specified in its charter)




Nevada
              98-0403396(State
      or other jurisdiction of
                incorporation
      or organization)
              (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
of principal executive offices)




Telephone:
86-451-86116757


(Issuer’s
telephone number)







Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934,
during the 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 x   No ̈




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





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





Large
      accelerated filer   ̈
                Accelerated
      filer x
                Non-accelerated
      filer  ̈Smaller
      reporting company ̈





Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).


Yes ̈ Nox





APPLICABLE
ONLY TO CORPORATE ISSUERS





State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of May 7, 2010: 31,067,471 shares of common stock, par value $0.00001 per
share.









TABLE
OF CONTENTS




PagePart
      I. Financial InformationItem
      1. Financial Statements
                
                
                3Consolidated
      Balance Sheets
                  As
      of March 31, 2010 (Unaudited) and December 31, 2009
                
                
                3Consolidated
      Statements of Income and Other Comprehensive Income
                  For
      the Three Months Ended March 31, 2010 and 2009 (Unaudited)
                
                
                4Consolidated
      Statements of Changes in Equity (Unaudited)
                
                
                5Consolidated
      Statements of Cash Flows
                  For
      the Three Months Ended March 31, 2010 and 2009 (Unaudited)
                
                
                6Notes
      to the Consolidated Financial Statements (Unaudited)
                
                
                7Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                
                
                31Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                
                
                38Item
      4. Controls and Procedures
                
                
                38Part
      II. Other InformationItem
      1. Legal Proceedings
                
                
                38Item
      1A. Risk Factors
                
                
                39Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
                
                
                43Item
      3. Defaults upon Senior Securities
                
                
                43Item
      4. Removed and Reserved
                
                
                43Item
      5. Other Information
                
                
                44Item
      6. Exhibits
                
                
                44Signatures
                
                
                45Index
      to Exhibits
                
                
                46


2




PART
I. FINANCIAL INFORMATION




Item
1. Financial Statements (Unaudited)




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


AS OF
MARCH 31, 2010 AND DECEMBER 31, 2009





March
      31,
                              
                              
                              December
      31,2010
                              
                              
                              2009(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                              
                              $
                              77,817,097
                              
                              
                              $
                              92,902,400Restricted
      cash
                              
                              
                              3,004,892
                              
                              
                              
                              3,522,009Notes
      receivable
                              
                              
                              1,290,371
                              
                              
                              
                              1,086,929Accounts
      receivable, net
                              
                              
                              104,919,312
                              
                              
                              
                              93,322,885Inventories
                              
                              
                              75,590,773
                              
                              
                              
                              74,913,877Other
      receivables & prepaid expenses
                              
                              
                              4,783,373
                              
                              
                              
                              5,828,453Advances
      on inventory purchases
                              
                              
                              11,003,248
                              
                              
                              
                              11,718,544Total
      current assets
                              
                              
                              278,409,066
                              
                              
                              
                              283,295,097PLANT
      AND EQUIPMENT, net
                              
                              
                              155,494,122
                              
                              
                              
                              156,364,548OTHER
      ASSETS:Debt
      issuance costs, net
                              
                              
                              218,287
                              
                              
                              
                              359,255Advance
      on non-current assets
                              
                              
                              13,659,178
                              
                              
                              
                              13,666,414Goodwill
                              
                              
                              54,073,754
                              
                              
                              
                              54,073,754Other
      intangible assets, net of accumulated amortization
                              
                              
                              21,174,757
                              
                              
                              
                              21,472,471Other
      assets
                              
                              
                              1,351,103
                              
                              
                              
                              1,722,693Total
      other assets
                              
                              
                              90,477,079
                              
                              
                              
                              91,294,587Total
      assets
                              
                              $
                              524,380,267
                              
                              
                              $
                              530,954,232LIABILITIES AND SHAREHOLDERS'
      EQUITYCURRENT
      LIABILITIES:Notes
      payable - short term
                              
                              $
                              3,499,033
                              
                              
                              $
                              4,533,268Accounts
      payable
                              
                              
                              48,963,748
                              
                              
                              
                              47,099,135Short
      term loans
                              
                              
                              45,648,772
                              
                              
                              
                              44,439,629Customer
      deposits
                              
                              
                              17,668,799
                              
                              
                              
                              18,455,842Accrued
      liabilities and other payables
                              
                              
                              10,661,137
                              
                              
                              
                              12,329,394Taxes
      payable
                              
                              
                              9,427,232
                              
                              
                              
                              8,233,862Amounts
      due to original shareholders
                              
                              
                              733,500
                              
                              
                              
                              28,681,976Current
      portion of notes payable, net
                              
                              
                              4,770,745
                              
                              
                              
                              7,660,210Current
      portion of long term bank loans
                              
                              
                              4,401,000
                              
                              
                              
                              -Total
      current liabilities
                              
                              
                              145,773,966
                              
                              
                              
                              171,433,316LONG
      TERM LIABILITIES:Long
      term bank loans
                              
                              
                              -
                              
                              
                              
                              4,401,000Warrant
      liability
                              
                              
                              4,857,636
                              
                              
                              
                              4,623,558Total
      liabilities
                              
                              
                              150,631,602
                              
                              
                              
                              180,457,874COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS'
      EQUITY:Common
      Stock, $0.00001 par value, 100,000,000 shares authorized, 31,067,471 and
      31,067,471 shares issued and outstanding as of March 31, 2010 and December
      31, 2009, respectively
                              
                              
                              310
                              
                              
                              
                              310Paid-in-capital
                              
                              
                              218,349,044
                              
                              
                              
                              218,094,374Retained
      earnings
                              
                              
                              87,844,800
                              
                              
                              
                              69,594,111Statutory
      reserves
                              
                              
                              25,172,422
                              
                              
                              
                              22,869,423Accumulated
      other comprehensive income
                              
                              
                              18,729,093
                              
                              
                              
                              18,638,299Total
      shareholders' equity
                              
                              
                              350,095,669
                              
                              
                              
                              329,196,517NONCONTROLLING
      INTERESTS
                              
                              
                              23,652,996
                              
                              
                              
                              21,299,841Total
      liabilities and shareholders' equity
                              
                              $
                              524,380,267
                              
                              
                              $
                              530,954,232





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


3




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


FOR THE
THREE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)




2010
                
                
                2009REVENUES
                
                $
                105,485,157
                
                
                $
                30,724,893COST
      OF SALES
                
                
                69,743,087
                
                
                
                19,801,115GROSS
      PROFIT
                
                
                35,742,070
                
                
                
                10,923,778RESEARCH
      AND DEVELOPMENT EXPENSE
                
                
                594,195
                
                
                
                393,282SELLING,
      GENERAL AND  ADMINISTRATIVE EXPENSES
                
                
                7,416,758
                
                
                
                2,504,904INCOME
      FROM OPERATIONS
                
                
                27,731,117
                
                
                
                8,025,592OTHER
      EXPENSE (INCOME), NETOther
      income, net
                
                
                (1,119,286
                )
                
                
                (539,379
                )Interest
      expense, net
                
                
                1,646,923
                
                
                
                1,441,384Change
      in fair value of warrants
                
                
                234,078
                
                
                
                (2,573,421
                )Total
      other expense (income), net
                
                
                761,715
                
                
                
                (1,671,416
                )INCOME
      BEFORE PROVISION FOR INCOME TAXES
                
                
                26,969,402
                
                
                
                9,697,008PROVISION
      FOR INCOME TAXES
                
                
                4,063,361
                
                
                
                1,042,674NET
      INCOME BEFORE NONCONTROLLING INTEREST
                
                
                22,906,041
                
                
                
                8,654,334LESS:
      NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTEREST
                
                
                2,352,353
                
                
                
                -NET
      INCOME ATTRIBUTABLE TO CONTROLLING INTEREST
                
                
                20,553,688
                
                
                
                8,654,334OTHER
      COMPREHENSIVE INCOME (LOSS)Foreign
      currency translation adjustment
                
                
                91,596
                
                
                
                (285,368
                )Foreign
      currency translation adjustment attributable to noncontrolling
      interest
                
                
                (802
                )
                
                
                -Change
      in fair value of derivative instrument
                
                
                -
                
                
                
                (2,529,076
                )COMPREHENSIVE
      INCOME
                
                $
                20,644,482
                
                
                $
                5,839,890EARNINGS
      PER SHAREBasicWeighted
      average number of shares
                
                
                31,067,471
                
                
                
                22,102,078Earnings
      per share before noncontrolling interest
                
                $
                0.74
                
                
                $
                0.39Earnings
      per share attributable to controlling interest
                
                $
                0.66
                
                
                $
                0.39Earnings
      per share attributable to noncontrolling interest
                
                $
                0.08
                
                
                $
                -DilutedWeighted
      average number of shares
                
                
                31,353,863
                
                
                
                22,158,573Earnings
      per share before noncontrolling interest
                
                $
                0.73
                
                
                $
                0.39Earnings
      per share attributable to controlling interest
                
                $
                0.66
                
                
                $
                0.39Earnings
      per share attributable to noncontrolling interest
                
                $
                0.07
                
                
                $
                -





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


4




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY


(Unaudited)




Common stock
                          
                          
                          Additional
                          
                          
                          Retained earnings
                          
                          
                          Accumulated otherPar
                          
                          
                          paid-in
                          
                          
                          Unrestricted
                          
                          
                          Statutory
                          
                          
                          comprehensive
                          
                          
                          NoncontrollingShares
                          
                          
                          value
                          
                          
                          capital
                          
                          
                          earnings
                          
                          
                          reserves
                          
                          
                          income (loss)
                          
                          
                          interest
                          
                          
                          TotalBALANCE,
      January 1, 2009
                          
                          
                          22,102,078
                          
                          
                          $
                          220
                          
                          
                          $
                          95,029,290
                          
                          
                          $
                          52,100,479
                          
                          
                          $
                          14,573,994
                          
                          
                          $
                          12,945,352
                          
                          
                          
                          -
                          
                          
                          $
                          174,649,335Reclassification
      of warrant liabilities to equity
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (13,613,718
                          )
                          
                          
                          6,142,280
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (7,471,438
                          )Amortization
      of stock compensation
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          341,362
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          341,362Net
      income
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          8,654,334
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          8,654,334Adjustment
      to statutory reserve
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (1,249,558
                          )
                          
                          
                          1,249,558
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          -Foreign
      currency translation gain
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (285,368
                          )
                          
                          
                          
                          
                          
                          
                          (285,368
                          )Net
      change related to cash flow hedge
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (2,529,076
                          )
                          
                          
                          
                          
                          
                          
                          (2,529,076
                          )BALANCE,
      March 31, 2009 (Unaudited)
                          
                          
                          22,102,078
                          
                          
                          
                          220
                          
                          
                          
                          81,756,934
                          
                          
                          
                          65,647,535
                          
                          
                          
                          15,823,552
                          
                          
                          
                          10,130,908
                          
                          
                          
                          -
                          
                          
                          
                          173,359,149Exercise
      of stock warrants at $7.80
                          
                          
                          1,428,846
                          
                          
                          
                          14
                          
                          
                          
                          26,122,124
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          26,122,138Amortization
      of stock compensation
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          869,675
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          869,675Non
      cash exercise of warrant at $12.25
                          
                          
                          85,227
                          
                          
                          
                          1
                          
                          
                          
                          1,055,266
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          1,055,267Stock
      issuance for cash at $16
                          
                          
                          7,187,500
                          
                          
                          
                          72
                          
                          
                          
                          107,521,878
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          107,521,950Noncontrolling
      interest in acquiree
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          17,957,815
                          
                          
                          
                          17,957,815Net
      income
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          10,992,447
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          3,491,414
                          
                          
                          
                          14,483,861Exercise
      of stock options at $3.10
                          
                          
                          65,000
                          
                          
                          
                          1
                          
                          
                          
                          201,499
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          201,500Exercise
      of stock options at $8.10
                          
                          
                          70,000
                          
                          
                          
                          1
                          
                          
                          
                          566,999
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          567,000Cashless
      exercise of options
                          
                          
                          128,820
                          
                          
                          
                          1
                          
                          
                          
                          (1
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          -Adjustment
      to statutory reserve
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (7,045,871
                          )
                          
                          
                          7,045,871
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          -Dividend
      distribution
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (150,071
                          )
                          
                          
                          (150,071
                          )Foreign
      currency translation gain
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          215,357
                          
                          
                          
                          683
                          
                          
                          
                          216,040Net
      change related to cash flow hedge
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (707,966
                          )
                          
                          
                          
                          
                          
                          
                          (707,966
                          )Reclassification
      of change in cash flow hedge to earnings
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          9,000,000
                          
                          
                          
                          
                          
                          
                          
                          9,000,000BALANCE,
      December 31, 2009
                          
                          
                          31,067,471
                          
                          
                          
                          310
                          
                          
                          
                          218,094,374
                          
                          
                          
                          69,594,111
                          
                          
                          
                          22,869,423
                          
                          
                          
                          18,638,299
                          
                          
                          
                          21,299,841
                          
                          
                          
                          350,496,358Amortization
      of stock compensation
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          254,670
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          254,670Net
      income
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          20,553,688
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          2,352,353
                          
                          
                          
                          22,906,041Adjustment
      to statutory reserve
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (2,302,999
                          )
                          
                          
                          2,302,999
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          -Foreign
      currency translation gain
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          90,794
                          
                          
                          
                          802
                          
                          
                          
                          91,596BALANCE,
      March 31, 2010 (Unaudited)
                          
                          
                          31,067,471
                          
                          
                          $
                          310
                          
                          
                          $
                          218,349,044
                          
                          
                          $
                          87,844,800
                          
                          
                          $
                          25,172,422
                          
                          
                          $
                          18,729,093
                          
                          
                          
                          23,652,996
                          
                          
                          $
                          373,748,665




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


5




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR THE
THREE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)




2010
                      
                      
                      2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income attributable to noncontrolling interest
                      
                      $
                      2,352,353
                      
                      
                      $
                      -Net
      income attributable to controlling interest
                      
                      
                      20,553,688
                      
                      
                      
                      8,654,334Consolidated
      net income
                      
                      
                      22,906,041
                      
                      
                      
                      8,654,334Adjustments
      to reconcile net income to cash provided by (used in) operating
      activities:Depreciation
                      
                      
                      1,888,108
                      
                      
                      
                      667,780Amortization
      of intangible assets
                      
                      
                      365,848
                      
                      
                      
                      292,927Amortization
      of debt issuance costs
                      
                      
                      140,968
                      
                      
                      
                      135,610Amortization
      of debt discount
                      
                      
                      910,535
                      
                      
                      
                      1,122,614Provision
      for bad debt expense
                      
                      
                      45,384
                      
                      
                      
                      -Share-based
      compensation
                      
                      
                      254,669
                      
                      
                      
                      341,362Loss
      on derivative instrument
                      
                      
                      -
                      
                      
                      
                      219,188Loss
      on disposal of equipment
                      
                      
                      45,880
                      
                      
                      
                      -Change
      in fair value of warrants
                      
                      
                      234,078
                      
                      
                      
                      (2,573,421
                      )Change
      in operating assets and liabilitiesNotes
      receivable
                      
                      
                      (104,501
                      )
                      
                      
                      1,354,449Accounts
      receivable
                      
                      
                      (11,637,766
                      )
                      
                      
                      10,111,075Inventories
                      
                      
                      (665,548
                      )
                      
                      
                      3,250,970Other
      receivables & prepaid expenses
                      
                      
                      1,044,592
                      
                      
                      
                      (1,379,675
                      )Advances
      on inventory purchases
                      
                      
                      699,662
                      
                      
                      
                      98,070Other
      assets
                      
                      
                      371,477
                      
                      
                      
                      (37,918
                      )Accounts
      payable
                      
                      
                      2,039,115
                      
                      
                      
                      (298,129
                      )Accrued
      liabilities and other payables
                      
                      
                      (1,599,798
                      )
                      
                      
                      (1,613,002
                      )Customer
      deposits
                      
                      
                      (786,773
                      )
                      
                      
                      1,865,532Taxes
      payable
                      
                      
                      1,192,964
                      
                      
                      
                      670,942Net
      cash  provided by operating activities
                      
                      
                      17,344,935
                      
                      
                      
                      22,882,708CASH
      FLOWS FROM INVESTING ACTIVITIES:Payment
      for advances on intangible assets
                      
                      
                      -
                      
                      
                      
                      (1,233,614
                      )Payment
      for advances on equipment purchases
                      
                      
                      22,623
                      
                      
                      
                      -Purchase
      of intangible assets
                      
                      
                      (68,236
                      )
                      
                      
                      (30,555
                      )Purchase
      of plant and equipment
                      
                      
                      (1,466,942
                      )
                      
                      
                      (175,791
                      )Additions
      to construction-in-progress
                      
                      
                      121,648
                      
                      
                      
                      (3,360,011
                      )Proceeds
      from disposal of equipments
                      
                      
                      10,467
                      
                      
                      
                      -Payment
      to original shareholders for acquisition
                      
                      
                      (27,938,951
                      )
                      
                      
                      -Net
      cash used in investing activities
                      
                      
                      (29,319,391
                      )
                      
                      
                      (4,799,971
                      )CASH
      FLOWS FROM FINANCING ACTIVITIES:Decrease
      in restricted cash
                      
                      
                      516,941
                      
                      
                      
                      512,785Payment
      on cross currency hedge
                      
                      
                      -
                      
                      
                      
                      (332,027
                      )Payment
      on notes payable
                      
                      
                      (3,800,000
                      )
                      
                      
                      (2,000,000
                      )Increase
      of notes payable-short term
                      
                      
                      1,019,218
                      
                      
                      
                      -Payment
      on notes payable-short term
                      
                      
                      (2,053,100
                      )
                      
                      
                      (1,025,570
                      )Proceeds
      from short term loan-bank
                      
                      
                      3,372,950
                      
                      
                      
                      -Repayment
      of short term loan-bank
                      
                      
                      (2,199,750
                      )
                      
                      
                      -Proceeds
      from short term loan-other
                      
                      
                      35,531
                      
                      
                      
                      -Net
      cash used in financing activities
                      
                      
                      (3,108,210
                      )
                      
                      
                      (2,844,812
                      )EFFECTS
      OF EXCHANGE RATE CHANGE ON CASH
                      
                      
                      (2,637
                      )
                      
                      
                      (79,407
                      )(DECREASE)
      INCREASE IN CASH
                      
                      
                      (15,085,303
                      )
                      
                      
                      15,158,518Cash
      and cash equivalents, beginning of period
                      
                      
                      92,902,400
                      
                      
                      
                      48,412,263Cash
      and cash equivalents, end of period
                      
                      $
                      77,817,097
                      
                      
                      $
                      63,570,781





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


6




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Note
1 - Nature of Business





Harbin
Electric, Inc. (the “Company” or “Harbin Electric”) is a Nevada Corporation,
incorporated on July 9, 2003. Through its subsidiaries, the Company designs,
develops, engineers, manufactures, sells and services a wide array of electric
motors including linear motors, specialty micro-motors, and industrial rotary
motors, with focus on innovation, creativity, and value-added
products.  Products are sold in China and to certain international
markets.





Recent
development





In
October 2009, Harbin Electric acquired Xi’an Tech Full Simo Motor Co., Ltd.
(“Simo Motor”). Simo Motor formerly known as Xi’an Simo Motor Incorporation
(Group), was initially established in 1955 as a State-Owned Enterprise and one
of the major backbone companies of China’s electric motor industry. In January
2004, Simo Motor was privatized as a shareholding company from the former Xi’an
Electric Motor Works under the corporate laws of the People’s Republic of
China (“PRC”). Simo Motor develops and manufactures various industrial motors.
Simo Motor sells its products primarily in China and also in certain
international markets. Simo Motor has developed to a large enterprise group
which consists of 15 wholly-owned and 8 majority owned subsidiaries mainly
engaged in manufacturing and selling of electric motors. As a result, the
Company’s ownership to Simo Motor and all subsidiaries averages to 87.2%. The
remaining 12.8% is owned by noncontrolling shareholders. See Note 16 for further
discussion.





Note
2 - Summary of Significant Accounting Policies





Basis of
presentation





The
consolidated financial statements of Harbin Electric Inc. reflect the activities
of the following subsidiaries.  All material intercompany transactions
have been eliminated.


Placeincorporated
                  
                  Ownership
                    percentageAdvanced
      Electric Motors, Inc. (“AEM”)
                  
                  Delaware,
      USA
                  
                  
                  100
                  %Harbin
      Tech Full Electric Co., Ltd. (“HTFE”)
                  
                  Harbin,
      China
                  
                  
                  100
                  %Advanced
      Automation Group, LLC (“AAG”)
                  
                  Delaware,
      USA
                  
                  
                  100
                  %Advanced
      Automation Group Shanghai Co., Ltd. (“SAAG”)
                  
                  Shanghai,
      China
                  
                  
                  100
                  %Shanghai
      Tech Full Electric Co., Ltd. (“STFE”)
                  
                  Shanghai,
      China
                  
                  
                  100
                  %Weihai
      Tech Full Simo Motor Co., Ltd. (“Weihai”)
                  
                  Weihai,
      China
                  
                  
                  100
                  %Xi’an
      Tech Full Simo Motor Co., Ltd. (“Simo Motor”)
                  
                  Xi’an,
      China
                  
                  
                  87.2
                  %





The
accompanying consolidated financial statements include the accounts of all
directly and indirectly owned subsidiaries listed above.





The
interim unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States,
or GAAP, for interim financial information and with the instructions to
Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC
Regulation S-X and consistent with the accounting policies stated in the
Company’s 2009 Annual Report on Form 10-K. Certain information and note
disclosures normally included in financial statements prepared in accordance
with GAAP have been condensed or omitted pursuant to such rules and regulations.
Therefore, these financial statements should be read in conjunction with our
audited consolidated financial statements and notes thereto for the year ended
December 31, 2009, included in our Annual Report on Form 10-K filed with the
SEC.





7





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





The
interim consolidated financial statements included herein are unaudited;
however, they contain all normal recurring accruals and adjustments that, in the
opinion of management, are necessary to present fairly our consolidated
financial position as of March 31, 2010, and our consolidated results of
operations and cash flows for the three months ended March 31, 2010 and 2009.
The results of operations for the three ended March 31, 2010 are not necessarily
indicative of the results to be expected for future quarters or the full
year.





Use of
estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions about future events. These estimates and the
underlying assumptions affect the reported amounts of assets, liabilities,
revenue and expenses, and disclosures about contingent assets and liabilities.
Such estimates and assumptions by management affect accrued expenses, the
valuation of accounts receivable, inventories, and long-lived assets, legal
contingencies, lives of plant and equipment, lives of intangible assets,
business combinations, goodwill, calculation of warranty accruals, taxes,
share-based compensation and others.





Although
the Company regularly assesses these estimates, actual results could materially
differ. The Company bases its estimates on historical experience and various
other assumptions that it believes to be reasonable under the
circumstances.





Foreign currency
transactions





Our
reporting currency is the US dollar.  The functional currency of PRC
subsidiaries is the Chinese Renminbi (“RMB”). Our results of operations and
financial position of the PRC subsidiaries are translated to United States
dollars using the end of period exchange rates as to assets and liabilities and
weighted average exchange rates as to revenues, expenses and cash flows. Capital
accounts are translated at their historical exchange rates when the capital
transaction occurred. The resulting currency translation adjustments are
recorded as a component of accumulated other comprehensive income (loss) within
stockholders’ equity.  As a result, translation adjustments amount
related to assets and liabilities reported on the consolidated statement of cash
flows will not necessarily agree with changes in the corresponding consolidated
balances on the balance sheet. 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 a gain of $91,596, and a
loss of $285,368 for the three months ended March 31, 2010 and 2009,
respectively.  The balance sheet amounts with the exception of equity
at March 31, 2010 and December 31, 2009 were translated at 6.836 RMB to $1.00
and 6.837 RMB to $1.00, respectively.  The equity accounts were stated
at their historical exchange rate.  The average translation rates
applied to the revenues, expenses and cash flows statement amounts for the three
months ended March 31, 2010 and 2009 were 6.836 RMB and 6.847 RMB to $1.00,
respectively.




Transaction
loss of $2,682 and $292,309 were recognized during the three months ended March
31, 2010 and 2009, respectively.





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 PRC and with
banks in the United States. 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 insured.
As of March 31, 2010 and December 31, 2009, the Company had deposits in excess
of federally insured limits totaling $76,170,844 and $92,701,730, 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.





8





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





No
customer accounted for more than 10% of the net revenue for the three months
ended March 31, 2010.  Three major customers accounted for
approximately 38% of the net revenue for the three months ended March 31, 2009,
with each customer individually accounting for 15%, 12%, and 11%,
respectively.   At March 31, 2009, the total receivable balance
due from these customers was $8,876,293, representing 44% of total accounts
receivable.





No vendor
accounted for more than 10% of the raw material purchases for the three months
ended March 31, 2010. Two major vendors provided 25% of the Company’s purchase
of raw materials for the three months ended March 31, 2009, with each vendor
individually accounting for 17% and 8%, respectively. The Company’s accounts
payable to these vendors was $0 at March 31, 2009.





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 environment 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.





Restricted
cash





Restricted
cash represent amounts set aside by the Company in accordance with the Company’s
debt agreements with certain financial institutions.  These cash
amounts are designated for the purpose of paying down the principal amounts owed
to the financial institutions, and these amounts are held at the same financial
institutions with which the Company has debt agreements in the
PRC.  Due to the short-term nature of the Company’s debt obligations
to these banks, the corresponding restricted cash balances have been classified
as current in the consolidated balance sheets.





Notes
receivable





Notes
receivable arose from sale of goods and represented commercial drafts issued by
customers to the Company that are guaranteed by banks of the
customers.  Notes receivables are interest-free with maturity dates of
three or six months from date of issuance.





Accounts
receivable





Accounts
receivable are presented net of an allowance for bad debts account. The Company
maintains 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 estimated loss rate is based on our historical
loss experience and also contemplates current market conditions. Delinquent
account balances are written-off after management has determined that the
likelihood of collection is not probable, and known bad debts are written off
against allowance for doubtful accounts when identified.





Inventories





Inventories
are valued at the lower of cost or market value, as determined on a first-in,
first-out basis, using the weighted average method. Management compares the cost
of inventories with the market value and an allowance is made for writing down
the inventory to its market value, if lower than cost. 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. When inventories are written-down to
the lower of cost or market, it is not marked up subsequently based on changes
in underlying facts and circumstances.  Inventories are composed
of raw material for manufacturing electrical motors, work in process and
finished goods within the Company’s warehouse premise or consigned at a customer
site.





9


HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31,
2010
 (UNAUDITED)


Plant and
equipment





Plant and
equipment are stated at cost, net of depreciation. 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:





Estimated Useful LifeBuildings
                        20
      -40  yearsVehicle
                        5-10  yearsOffice
      equipment
                        5-6  yearsProduction
      equipment
                        10-12  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. Maintenance, repairs and minor
renewals are charged directly to expense as incurred. Major additions and
betterment to buildings and equipment are capitalized. Interest incurred during
construction is capitalized into construction in progress. All other interest is
expensed as incurred.





The
Company recognizes an impairment loss when estimated cash flows generated by
those assets are less than the carrying amounts of the asset. Based on
management review, the Company believes that there were no impairments as of
March 31, 2010.





Goodwill and other
intangible assets





Goodwill
– the excess of the cost of an acquired entity over the net of the amounts
assigned to assets acquired and liabilities assumed shall be recognized as
goodwill.  Goodwill is tested for impairment at the reporting unit
level (operating segment or one level below an operating segment) on an annual
basis in the fourth quarter or more frequently if there are indicators of
impairment exist. For purposes of our goodwill impairment test, a two-step test
is used to identify the potential impairment and to measure the amount of
goodwill impairment, if any. The first step is to compare the fair value of the
reporting unit with its carrying amount, including goodwill. If the fair value
of the reporting unit exceeds its carrying amount, goodwill is considered not
impaired. If the carrying amount of a reporting unit exceeds its fair value, the
second step of the goodwill impairment test is performed to measure the
amount of impairment loss, if any. Under step two, the impairment loss is
measured by comparing the implied fair value of the reporting unit goodwill with
the carrying amount of that goodwill. If the carrying amount of the reporting
unit goodwill exceeds the implied fair value of that goodwill, an impairment
loss is recognized in an amount equal to that excess.





Land use
rights - all land in the PRC is government owned.  As a result, the
government grants land use rights (the “Right”).  The Company has the
right to use the land for 50 years and amortizes the Right on a straight line
basis over 50 years.





Patents –
capitalized patent costs represent legal costs incurred to establish patents and
the portion of the acquisition price paid attributed to patents upon the assets
acquisition on July 16, 2007. Capitalized patent costs are amortized on a
straight line method over the related patent terms generally from 6 to 10
years.





10


HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 MARCH 31,
2010
 (UNAUDITED)


The
Company evaluates intangible assets for impairment, at least annually and
whenever events or changes in circumstances indicate that the assets might be
impaired.  We perform our annual impairment test in the fourth
quarter.





Our
impairment test consists of a comparison of the fair value of the intangible
asset with its carrying amount. If the carrying amount of an intangible asset
exceeds its fair value, an impairment loss is recognized in an amount equal to
the excess.  As of March 31, 2010, management believes there was no
impairment.





Accounting for long-lived
assets





Long-lived
assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable. We assess
the recoverability of the assets based on the undiscounted future cash flow the
assets are expected to generate and recognize an impairment loss when estimated
undiscounted future cash flow expected to result from the use of the asset plus
net proceeds expected from disposition of the asset, if any, are less than the
carrying value of the asset. When we identify an impairment, we reduce the
carrying amount of the asset to its estimated fair value based on a discounted
cash flow approach or, when available and appropriate, to comparable market
values.  As of March 31, 2010, management believes there was no
impairment.





Stock-based
compensation





We record
share-based compensation expense based upon the grant date fair value of
share-based awards. The value of the award is principally recognized as expense
ratably over the requisite service periods. We use the Black-Scholes Merton
(“BSM”) option-pricing model, which incorporates various assumptions including
volatility, expected life and interest rates to determine fair value. The
Company’s expected volatility assumption is based on the historical volatility
of Company’s stock. The expected life assumption is primarily based on the
simplified method of the terms of the options. 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.





The
Company is required to measure the cost of the equity instruments issued in
exchange for the receipt of goods or services from other than employees at the
estimated fair market value of the consideration received or the estimated fair
value of the equity instruments issued, whichever is more reliably determinable.
The value of equity instruments issued for consideration other than employee
services is determined on the earlier of a performance commitment or completion
of performance by the provider of goods or services.





Stock
compensation expense is recognized based on awards expected to
vest.  GAAP requires forfeitures to be estimated at the time of grant
and revised in subsequent periods, if necessary, when actual forfeitures differ
from those estimates.  There were no estimated forfeitures as the
Company has a short history of issuing options.





Revenue
recognition





The
Company recognizes sales 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. For products that are required to be
examined by customers, sales revenue is recognized after the customer
examination is passed. Payments received before all of the relevant
criteria for revenue recognition are recorded as customer deposits.




In
addition, revenue recognition could be negatively impacted by returns. For our
linear motor and specialty micro-motor businesses, our products are 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.  We charge such costs to cost of goods sold. For our
industrial rotary motor business, our products are standardized products and
returns are allowed within three days upon receipt of products by customers. We
provide product warranty for repair one year from the date of shipment.
Historically, the returns and defects have not been material. Should returns
increase in the future it would be necessary to adjust the estimates, in which
case recognition of revenues could be delayed.





11





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Shipping
and handling costs are included in selling, general and administrative costs and
totaled $832,415 and $464,363 for the three months ended March 31, 2010 and
2009, respectively.





Income
taxes





The
Company utilizes the asset and liability method of accounting for income taxes,
under which deferred taxes are determined based on the temporary differences
between the financial statement and tax basis of assets and liabilities using
tax rates expected to be in effect during the years in which the basis
differences reverse. A valuation allowance is recorded when it is more likely
than not that some of the deferred tax assets will not be
realized.  GAAP also 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. As of January 1, 2007,
income tax positions must meet a more-likely-than-not recognition threshold to
be recognized.  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.





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.  No material deferred tax amounts were recorded at March 31,
2010 and December 31, 2009, respectively. Penalties
and interest incurred related to underpayment of income tax are classified as
income tax expense in the year incurred.  No significant penalties or
interest relating to income taxes have been incurred during the three months
ended March 31, 2010 and 2009.  GAAP also provides guidance on
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosures and transition.




The
charge for taxation is based on the results for the reporting period 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.





The
Company’s operating subsidiaries located in PRC are subject to PRC income tax.
The new Chinese Enterprise Income Tax (“EIT”) law was effective on January 1,
2008. Under the new Income Tax Laws of PRC, a company is generally subject to
income tax at an effective rate of 25% on income reported in the statutory
financial statements after appropriated tax adjustments. HTFE is located in a
specially designated region where HTFE is subject to a 10% EIT rate from January
1, 2008 to December 31, 2010. Weihai is currently at the standard 25%
income tax rate.  Our operations under STFE was  income tax
exempt in 2009 and is subject to preferential income tax rate of 11% in
2010 since its located in an economic development zone.  Simo Motor is
located in the Province of Shaanxi which is in the mid-west region of China, a
specially designated region where the government grants special income tax rates
to qualified entities.  Simo Motor qualifies for the “Go-west” special
income tax rate of 15% promulgated by the government and therefore is subject to
a 15% EIT rate from year 2007 to 2010.





The
Company’s subsidiaries were paying the following tax rate for the three months
ended March 31:





2010
                                
                                
                                2009Subsidiaries
                                
                                Income
                                  Tax
                                  Exemption
                                
                                
                                Effective
                                  Income
                                  TaxRate
                                
                                
                                Income
                                  Tax
                                  Exemption
                                
                                
                                Effective
                                  Income
                                  TaxRateHTFE
                                
                                
                                15
                                %
                                
                                
                                10
                                %
                                
                                
                                15
                                %
                                
                                
                                10
                                %Weihai
                                
                                
                                0
                                %
                                
                                
                                25
                                %
                                
                                
                                0
                                %
                                
                                
                                25
                                %STFE
                                
                                
                                14
                                %
                                
                                
                                11
                                %
                                
                                
                                25
                                %
                                
                                
                                0
                                %Simo
      Motor (a)
                                
                                
                                10
                                %
                                
                                
                                15
                                %
                                
                                
                                n/a
                                
                                
                                
                                n/a




(a) Simo
Motor was acquired in October 2009 and the tax rate only applied to its results
of operations included in the consolidated financial statements, which is the
three months ended March 31, 2010.





12





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the three months ended March 31:




2010
                          
                          
                          2009U.S.
      statutory reserve rates
                          
                          
                          34.0
                          %
                          
                          
                          34.0
                          %Foreign
      income not recognized in U.S.
                          
                          
                          -34.0
                          %
                          
                          
                          -34.0
                          %China
      income taxes
                          
                          
                          25.0
                          %
                          
                          
                          25.0
                          %Tax
      exemption
                          
                          
                          -16.4
                          %
                          
                          
                          -14.1
                          %Other
      items (b)
                          
                          
                          6.5
                          %
                          
                          
                          -0.1
                          %Effective
      income taxes
                          
                          
                          15.1
                          %
                          
                          
                          10.8
                          %


(b)  The
6.5 % represents the $1,765,674 of expenses incurred by the Company and its US
subsidiaries AEM and AAG that are not subject to PRC income tax for the three
months ended March 31, 2010. The (0.1)% represents the $131,072 of
income generated by the Company and its US subsidiaries AEM and AAG that
are not subject to PRC income tax for the three months ended March 31,
2009.





The
estimated tax savings for the three months ended March 31, 2010 and 2009
amounted to $3,120,440 and $1,305,422, respectively. The net effect on earnings
per share attributable to controlling interest had the income tax been applied
would decrease earnings per share from $0.66 to $0.57 for the three months ended
March 31, 2010, and $0.39 to $0.33 for the three months ended March 31,
2009.





Harbin
Electric, AEM and AAG were organized in the United States and have incurred net
operating losses for income tax purposes for the three months ended March 31,
2010.  The net operating loss carry forwards for United States income
taxes amounted to $29,756,230 which may be available to reduce future years’
taxable income.  These carry forwards will expire, if not utilized,
starting from 2027 through 2030.  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 three months
ended March 31, 2010 was an increase of approximately $163,232. Management will
review this valuation allowance periodically and make adjustments
accordingly.





The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $148,954,972 as of March 31, 2010, which is included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations.  Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if we concluded that such earnings will be remitted in the
future.





13





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





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 $17,983,171 and $11,313,713 for the three
months ended March 31, 2010, respectively.  VAT on sales and VAT on
purchases amounted to $5,986,746 and $3,669,570 for the three months ended
March 31, 2009, respectively.  Sales and purchases are recorded net of VAT
collected and paid as the Company acts as an agent for the
government.





Advertising
costs





The
Company expenses the cost of advertising as incurred in selling, general and
administrative costs. The Company incurred $32,449 and $3,616 for the three
months ended March 31, 2010 and 2009, 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 are classified as plant and
equipment and depreciated over their estimated useful lives.





Fair value of financial
instruments





On
January 1, 2008, the Company began recording financial assets and liabilities
subject to recurring fair value measurement at the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. On January 1, 2009, the Company began recording
non-recurring financial as well as all non-financial assets and liabilities
subject to fair value measurement under the same principles. These fair value
principles prioritize valuation inputs across three broad levels. The three
levels are defined as follows:





-
            Level
      1 inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets or liabilities in active
  markets.





-
            Level
      2 inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs that are observable
      for the assets or liability, either directly or indirectly, for
      substantially the full term of the financial
  instruments.





-
            Level
      3 inputs to the valuation methodology are unobservable and significant to
      the fair value.





As of
March 31, 2010, the outstanding principal on the Company’s 2012 Notes Payable,
evaluated under these accounting standards, amounted to $4,770,745, net of
discount.  Management concluded the carrying values are a reasonable
estimate of fair value because of the short period of time between the
origination of such instruments and their expected realization and if
applicable, their stated interest rate approximates current
rates available.





Effective
January 1, 2009, a total of 2,030,158 warrants previously treated as equity
pursuant to the derivative treatment exemption is no longer afforded equity
treatment because the strike price of the warrants is denominated in US dollar,
a currency other than the Company’s functional currency, the Chinese
RMB.  As a result, the warrants are not considered indexed to the
Company’s own stock, and as such, all future changes in the fair value of these
warrants will be recognized currently in earnings until such time as the
warrants are exercised or expired. The Company reclassified the fair value of
these warrants from equity to liability, as if these warrants were treated as a
derivative liability since their issuance in August 2006. On January 1,
2009, the Company reclassified from additional paid-in capital, as a cumulative
effect adjustment, $6.1 million to beginning retained earnings and $7.4
million to warrant liabilities to recognize the fair value of such warrants. As
of March 31, 2010, the Company has 366,697 warrants outstanding. The fair value
of the outstanding warrants was $4.9 million.  The Company
recognized a total of $0.2 million loss from the change in fair value of
the warrants for the three months ended March 31, 2010.





14





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





These
common stock purchase warrants do not trade in an active securities market, and
as such, we estimate the fair value of these warrants using the Black-Scholes
Option Pricing Model using the following assumptions:





March31,2010
                
                
                January1,2009(Unaudited)
                
                
                (Unaudited)Annual
      dividend yield
                
                
                -
                
                
                
                -Expected
      life (years)
                
                
                2.42
                
                
                
                3.67Risk-free
      interest rate
                
                
                1.27
                %
                
                
                1.20
                %Expected
      volatility
                
                
                68
                %
                
                
                66
                %





Expected
volatility is based primarily on historical volatility. Historical volatility
was computed using daily pricing observations for recent periods that correspond
to the term of the warrants. We believe this method produces an estimate that is
representative of our expectations of future volatility over the expected term
of these warrants. We have no reason to believe future volatility over the
expected remaining life of these warrants likely to differ materially from
historical volatility. The expected life is based on the remaining term of the
warrants. The risk-free interest rate is based on U.S. Treasury securities
according to the remaining term of the warrants.





CarryingValue
                            asof
                            March31,
                            2010
                          
                          FairValueMeasurementsatMarch31,2010Using
                            FairValueHierarchy(Unaudited)
                          
                          Level1
                          
                          Level2
                          
                          Level3Fair
      value of warrant liabilities
                          
                          $
                          4,857,636
                          
                          
                          
                          $
                          4,857,636





Other
than the warranty liabilities, the Company did not identify any assets and
liabilities that are required to be presented on the balance sheet at fair
value.





Recent Accounting
Pronouncements





In
January 2010, FASB issued ASU No. 2010-01– Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and
Earnings Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The adoption of this ASU did not have impact on the
Company’s consolidated financial statements.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity. The amendments in this update are effective
beginning in the period that an entity adopts SFAS No. 160, “Non-controlling
Interests in Consolidated Financial Statements – An Amendment of ARB No. 51.” If
an entity has previously adopted SFAS No. 160 as of the date the amendments in
this update are included in the Accounting Standards Codification, the
amendments in this update are effective beginning in the first interim or annual
reporting period ending on or after December 15, 2009. The amendments in this
update should be applied retrospectively to the first period that an entity
adopted SFAS No. 160. The adoption of this ASU did not have a material impact on
the Company’s consolidated financial statements.





15





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and 2. A
reporting entity should disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers. 2) Activity in Level 3 fair value measurements. In
the reconciliation for fair value measurements using significant unobservable
inputs (Level 3), a reporting entity should present separately information about
purchases, sales, issuances, and settlements (that is, on a gross basis rather
than as one net number). This update provides amendments to Subtopic 820-10 that
clarifies existing disclosures as follows: 1) Level of disaggregation. A
reporting entity should provide fair value measurement disclosures for each
class of assets and liabilities. A class is often a subset of assets or
liabilities within a line item in the statement of financial position. A
reporting entity needs to use judgment in determining the appropriate classes of
assets and liabilities. 2) Disclosures about inputs and valuation techniques. A
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements that
fall in either Level 2 or Level 3. The new disclosures and clarifications of
existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. These disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company is currently evaluating the impact of this ASU, however, the
Company does not expect the adoption of this ASU to have a material impact on
its consolidated financial statements.





In
February 2010, FASB issued ASU No. 2010-9 –Amendments to Certain Recognition and
Disclosure Requirements. This update addresses certain implementation issues
related to an entity’s requirement to perform and disclose subsequent-events
procedures, removes the requirement that public companies disclose the date of
their financial statements in both issued and revised financial statements.
According to the FASB, the revised statements include those that have been
changed to correct an error or conform to a retrospective application of U.S.
GAAP. The amendment is effective for interim and annual reporting periods in
fiscal year ending after June 15, 2010. The Company does not expect the adoption
of this ASU to have a material impact on the Company’s consolidated financial
statements.





In March
2010, FASB issued ASU No. 2010-10 –Amendments for Certain Investment Funds. This
update defers the effective date of the amendments to the consolidation
requirements made by FASB Statement 167 to a reporting entity’s interest in
certain types of entities. The deferral will mainly impact the evaluation of
reporting enterprises’ interests in mutual funds, private equity funds, hedge
funds, real estate investment entities that measure their investment at fair
value, real estate investment trusts, and venture capital funds. The ASU also
clarifies guidance in Statement 167 that addresses whether fee arrangements
represent a variable interest for all service providers and decision makers. The
ASU is effective for interim and annual reporting periods in fiscal year
beginning after November 15, 2009. The adoption of this ASU did not have a
material impact on the Company’s consolidated financial statements.





16





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





In March
2010, FASB issued ASU No. 2010-11 –Scope Exception Related to Embedded Credit
Derivatives. Embedded credit-derivative features related only to the transfer of
credit risk in the form of subordination of one financial instrument to another
are not subject to potential bifurcation and separate accounting as clarified by
recently issued FASB guidance. Other embedded credit-derivative features are
required to be analyzed to determine whether they must be accounted for
separately. This update provides guidance on whether embedded credit-derivative
features in financial instruments issued by structures such as collateralized
debt obligations (CDOs) and synthetic CDOs are subject to bifurcation and
separate accounting. The guidance is effective at the beginning of a company’s
first fiscal quarter beginning after June 15, 2010. The Company does not expect
the adoption of this ASU to have a material impact on the Company’s consolidated
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 – Supplemental disclosure of cash flows





The
Company prepares its statements of cash flows using the indirect method as
defined under the ASC Topic 230. The following information relates to non-cash
investing and financing activities for the three months ended March 31, 2010 and
2009.





Total
interest paid amounted to $872,884 and $1,963,110 for the three months ended
March 31, 2010 and 2009, respectively.





Total
income tax paid amounted to $3,078,707 and $1,042,674 for three months ended
March 31, 2010 and 2009, respectively.





For the
three months ended March 31, 2010, notes receivable in the amount of $98,871 was
transferred as payment for purchase of equipment.  Equipment in the
amount of $243,100 was transferred as payment to accounts payable for $170,866
and as payment to other payables for the amount of $72,234.





Note
4 – Accounts receivable





Accounts
receivable consisted of the following:





March 31,
                  
                  
                  December 31,2010
                  
                  
                  2009(Unaudited)Accounts
      receivable
                  
                  $
                  108,943,858
                  
                  
                  $
                  97,302,153Less:
      allowance for bad debts
                  
                  
                  (4,024,546
                  )
                  
                  
                  (3,979,268
                  )Accounts
      receivable, net
                  
                  $
                  104,919,312
                  
                  
                  $
                  93,322,885





The
following table consists of allowance for bad debts:





Allowance
      for bad debts at January 1, 2009
                                      
                                      $
                                      153,155Provision
      for bad debts
                                      
                                      
                                      -Accounts
      receivable write off
                                      
                                      
                                      -Effect
      of foreign currency translation
                                      
                                      
                                      (209)Allowance
      for bad debts at March 31, 2009 (Unaudited)
                                      
                                      
                                      152,946Provision
      for bad debts
                                      
                                      
                                      -Accounts
      receivable write off
                                      
                                      
                                      (437,191)Increase
      in allowance from acquisition of Simo Motor
                                      
                                      
                                      4,263,411Effect
      of foreign currency translation
                                      
                                      
                                      102Allowance
      for bad debts at December 31, 2009
                                      
                                      
                                      3,979,268Provision
      for bad debts
                                      
                                      
                                      45,384Accounts
      receivable write off
                                      
                                      
                                      -Effect
      of foreign currency translation
                                      
                                      
                                      (106
                                      )Allowance
      for bad debts at March 31, 2010 (Unaudited)
                                      
                                      $
                                      4,024,546





17


HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
  NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 MARCH
31, 2010
 (UNAUDITED)


Note
5 – Inventories





The
following is a summary of inventories by major category:





March 31,
                  
                  
                  December 31,2010
                  
                  
                  2009(Unaudited)Raw
      and packing materials
                  
                  $
                  9,585,384
                  
                  
                  $
                  11,826,804Work
      in process
                  
                  
                  27,907,954
                  
                  
                  
                  28,434,522Finished
      goods
                  
                  
                  28,011,285
                  
                  
                  
                  25,471,544Finished
      goods - consignment
                  
                  
                  17,629,927
                  
                  
                  
                  18,077,870Inventory
      valuation allowance
                  
                  
                  (7,543,777
                  )
                  
                  
                  (8,896,863
                  )Total
      inventories, net
                  
                  $
                  75,590,773
                  
                  
                  $
                  74,913,877





As of
March 31, 2010 and December 31, 2009, total inventory valuation allowance
amounted to $7,543,777 and $8,896,863.  All inventory valuation
allowance is from the subsidiary Simo Motor acquired on October 2,
2009.





Allowance
      for inventory valuation at January 1, 2009
                  
                  $
                  -Additional
      reserves
                  
                  
                  -Recovery
      of reserves
                  
                  
                  -Effect
      of foreign currency translation
                  
                  
                  -Allowance
      for inventory valuation at March 31, 2009 (Unaudited)
                  
                  
                  -Additional
      reserves
                  
                  
                  710,466Recovery
      of reserves
                  
                  
                  -Increase
      in allowance from acquisition of Simo Motor
                  
                  
                  8,186,252Effect
      of foreign currency translation
                  
                  
                  145Allowance
      for inventory valuation at December 31, 2009
                  
                  
                  8,896,863Additional
      reserves
                  
                  
                  -Recovery
      of reserves
                  
                  
                  (1,352,625
                  )Effect
      of foreign currency translation
                  
                  
                  (461
                  )Allowance
      for inventory valuation at March 31, 2010 (Unaudited)
                  
                  $
                  7,543,777





Note
6 – Advances on inventory purchases





The
Company makes advances to certain vendors for inventory
purchases.  The advances on inventory purchases were $11,003,248 and
$11,718,544 as of March 31, 2010 and December 31, 2009,
respectively.





18




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Note
7 – Plant and equipment





The
following table presents details of our property and equipment:





March 31,
                  
                  
                  December 31,2010
                  
                  
                  2009(Unaudited)Buildings
                  
                  $
                  87,854,945
                  
                  
                  $
                  88,081,895Office
      equipment
                  
                  
                  2,658,296
                  
                  
                  
                  1,437,761Production
      equipment
                  
                  
                  29,148,114
                  
                  
                  
                  28,801,414Vehicles
                  
                  
                  3,157,303
                  
                  
                  
                  3,633,367Construction
      in progress
                  
                  
                  40,453,610
                  
                  
                  
                  40,504,272Total
                  
                  
                  163,272,268
                  
                  
                  
                  162,458,709Less:
      accumulated depreciation
                  
                  
                  (7,778,146
                  )
                  
                  
                  (6,094,161
                  )Property
      and equipment, net
                  
                  $
                  155,494,122
                  
                  
                  $
                  156,364,548





Construction
in progress represents labor costs, material, capitalized interest incurred in
connection with the construction of the new plant facility in Shanghai and the
construction and installation of manufacturing equipment in HTFE, Weihai and
Simo Motor.  The Company expects to complete the construction of
Shanghai plant on or before the end of year 2010.




Depreciation
expense for the three months ended March 31, 2010 and 2009 amounted to
$1,888,108, and $667,780, respectively.





For the
three months ended March 31, 2010 and 2009, a total of $78,328 and
$1,201,944 of interest were capitalized into construction in progress,
respectively.





Note
8 – Advances on non-current assets





Advance for intangible
assets





The
advances for intangible assets consisted of land use right prepayment. As of
March 31, 2010 and December 31, 2009, advances for intangible assets amounted to
$3,133,512 and $3,133,512, respectively.





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 size of
the land used by HTFE was later revised to a total of approximately 53,000
square meters. The term of the land use agreement is 50 years and the aggregate
amount HTFE shall pay to Shanghai Lingang is approximately $6.28 million
(RMB 42,840,000) ("Fee"), approximately 93% or $5.85 million (RMB
39,880,000) has been paid, as of March 31, 2010. 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.




Advance to
suppliers





The
Company makes advances to certain vendors for construction
projects.  The advances on equipment and construction amounted to
$10,525,666 and $10,532,902 as of March 31, 2010 and December 31, 2009,
respectively.





19





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Note
9 – Goodwill and other intangible assets





Net
intangible assets consist of the following at:





March31,
                  2010
                
                
                December31,
                  2009(Unaudited)Goodwill
      on 2008 Acquisition of Weihai
                
                $
                12,273,778
                
                
                $
                12,273,778Goodwill
      on 2009 Acquisition of Simo Motor
                
                
                41,799,976
                
                
                
                41,799,976Total
      goodwill
                
                
                54,073,754
                
                
                
                54,073,754Land
      use rights
                
                
                18,090,830
                
                
                
                17,481,972Patents
                
                
                6,706,353
                
                
                
                6,702,983Software
                
                
                221,099
                
                
                
                95,110Total
      goodwill and other intangible assets
                
                
                79,092,036
                
                
                
                78,353,819Less:
      accumulated amortization
                
                
                (3,843,525
                )
                
                
                (2,807,594
                )Intangible
      assets, net
                
                $
                75,248,511
                
                
                $
                75,546,225





Amortization
expense for the three months ended March 31, 2010 and 2009 amounted to $365,848
and $292,927, respectively.





The
Company uses the purchase method of accounting for business combinations. Annual
testing for impairment of goodwill is performed during the fourth quarter of
each year unless events or circumstances indicate earlier impairment testing is
required. No impairment loss was recognized for the three months ended March 31,
2010 and 2009.





Note
10 – Taxes payable





Taxes
payable consisted of the following:


March31,
                  2010
                
                
                December31,
                  2009(Unaudited)VAT
      tax payable
                
                $
                3,548,584
                
                
                $
                3,473,092Individual
      income tax withholding payable
                
                
                86,194
                
                
                
                71,563Corporation
      income tax payable
                
                
                3,672,402
                
                
                
                2,825,545Others
      miscellaneous tax payable
                
                
                2,120,052
                
                
                
                1,863,662Total
                
                $
                9,427,232
                
                
                $
                8,233,862





Note
11 – 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 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.





On June
1, 2009, the Company and Citadel entered into a Letter Agreement (the “Citadel
Agreement”). Pursuant to the Citadel Agreement, the Company was granted the
option to repurchase, all (but not part), of the $26.5 million 2012 Notes held
by Citadel before August 31, 2009 (“the Proposed 2012 Notes
Repurchase”).  On August 4, 2009, the Company notified Citadel that
pursuant to the Citadel Agreement (i) the Company was exercising its option to
consummate the Proposed 2012 Notes Repurchase and (ii) the Proposed 2012 Notes
Repurchase shall be consummated on August 11, 2009 (the “Citadel Repurchase
Date”) at an aggregate Citadel Repurchase Price of $23,131,997 to be paid in
cash, which Repurchase Price shall be comprised of $22,525,000 representing 85%
of the $26,500,000 aggregate principal amount of the 2012 Notes held by Citadel
(the “Citadel Notes”) plus $606,997 representing accrued and unpaid
interest on the Citadel Notes to but excluding the Repurchase Date. On August
11, 2009, the Company made cash payment in accordance with terms of the Citadel
Agreement and recorded a gain of $3,975,000 from the repurchase transaction.
 After principal payment of $2,400,000 made in September 2009 and
$3,800,000 made in March 2010, the 2012 Notes balance as of March 31, 2010
amounted to $4,770,745 (net of debt discount of $529,255), or a total of
$5,300,000 which will be fully paid off in September 2010.





20





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





On July
14, 2009, the Company entered into a Letter Agreement with Merrill Lynch
International and ABN AMRO Bank N.V., London Branch (the “Merrill Agreement”).
Pursuant to the Merrill Agreement, the Company was granted the option to
repurchase, all (but not part),  of the remaining $6 million 2010
Notes held by Merrill Lynch International ($3 million) and ABN AMRO Bank N.V.,
London Branch  ($3 million) before July 31, 2009.  On July
31, 2009, the Company paid a total of $5,983,844 to repurchase the 2010
Notes, which amount was comprised of $5,820,000 representing 97% of the
$6,000,000 aggregate principal amount of the 2010 Notes held by the Holders plus
$163,844 representing accrued and unpaid interest on the 2010 Notes to but
excluding the Repurchase Date. As of August 5, 2009, the repurchase have been
completed and the 2010 Notes were cancelled and the Company recorded a gain of
$180,000 from the repurchase transaction.





The
following table disclosed the combined aggregate amounts of maturities for all
the notes payable discussed above for each of the five years following
March 31, 2010:





Contractual Obligations
                  
                  2012Notes
                  
                  
                  Total2010
                  
                  $
                  5,300,000
                  
                  
                  $
                  5,300,000Thereafter
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  $
                  5,300,000
                  
                  
                  $
                  5,300,000





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 Warrant holder at any time through the maturity
date of such Warrant. The warrant agreements contain a cashless exercise
provision.  During the three months ended March 31, 2010, no warrants
were exercised.





The fair
value of the warrants upon issuance totaled $22,921,113, was treated as a
discount on the carrying value of the debt, and is being amortized over the life
of the loan using the effective interest method. $910,535 and $1,122,614 were
amortized to interest expense for the three months ended March 31, 2010, and
2009, respectively.  As of March 31, 2010 and December 31, 2009, the
unamortized discounts totaled $529,255 and $1,439,790,
respectively.




Debt
issuance costs, initially $2,954,625, are carried in other assets and are
amortized over the life of the loan using the effective interest
method.  A total of $140,968 and $135,610 was amortized to interest
expense for the three months ended March 31, 2010, and 2009, respectively. As of
March 31, 2010 and December 31, 2009, unamortized debt issuance costs totaled
$218,287, and $359,255, respectively.





21





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Note
12 -Short term loans





The
Company’s short term loans are comprised of the following:





March31,2010
                
                
                December31,2009(Unaudited)Short
      term loan – bank
                
                $
                39,465,234
                
                
                $
                38,291,634Short
      term loan – non controlling shareholders
                
                
                548,658
                
                
                
                918,342Short
      term loan – others
                
                
                5,634,880
                
                
                
                5,229,653Total
      short term loans
                
                $
                45,648,772
                
                
                $
                44,439,629





Short
term loans – bank


March31,
                        2010
                      
                      
                      December31,
                        2009(Unaudited)Loan
      from Citic Bank in city of Wendeng, due June 2010. Monthly interest-only
      payments at 5.310% per annum, secured by assets
                      
                      $
                      3,080,700
                      
                      
                      $
                      3,080,700Loan
      from Commercial Bank in city of Wendeng, due from various dates from
      August to September 2010. Monthly interest-only payments at 5.841% per
      annum, guaranteed loan
                      
                      
                      1,173,600
                      
                      
                      
                      -Loan
      from Xi'an City Commercial Bank, due September 2010. Monthly interest-only
      payment at 5.31% per annum, guaranteed loan
                      
                      
                      1,173,600
                      
                      
                      
                      1,173,600Loan
      From Huaxia Bank, due various dates from April to October 2010. Monthly
      interest-only payment at 6.480% per annum, secured by
    assets
                      
                      
                      8,802,000
                      
                      
                      
                      8,802,000Loan
      From Industrial Commercial Bank of China, due various dates from July to
      December 2010. Monthly interest-only payment at 6.372% per annum,
      guaranteed loan
                      
                      
                      2,995,614
                      
                      
                      
                      2,995,614Loan
      From Weihai City Commercial Bank, due various dates from August to
      September 2010. Monthly interest-only payment at 5.841% per annum, secured
      by assets
                      
                      
                      -
                      
                      
                      
                      1,173,600Loan
      from Citic Bank, due in January 2010 through January 2011. Average
      interest from 5.310% to 5.832% per annum, secured by
assets
                      
                      
                      7,335,000
                      
                      
                      
                      6,161,400Loan
      from China Merchant Bank, due various dates from May to December 2010.
      Monthly interest-only payments from 5.310% to 5.841% per annum, secured by
      assets
                      
                      
                      8,215,200
                      
                      
                      
                      8,215,200Loan
      from China Construction Bank, due in October 2010. Monthly interest-only
      payment at 10% per annum, guaranteed loan
                      
                      
                      1,467,000
                      
                      
                      
                      1,467,000Loan
      from China Zheshang Bank, due in various dates from June to July 2010.
      Monthly interest-only payment at 5.841% per annum, guaranteed
      loan.
                      
                      
                      4,401,000
                      
                      
                      
                      4,401,000Loan
      from Bank of China. Monthly interest-only payment at 4% per
      annum
                      
                      
                      821,520
                      
                      
                      
                      821,520Short
      term loan - bank
                      
                      $
                      39,465,234
                      
                      
                      $
                      38,291,634





22





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Short
term loan – non controlling shareholders represent borrowing from its minority
shareholders and amounted to $548,658 and $918,342 as of March 31, 2010 and
December 31, 2009, respectively. All amounts are due within one year,
uncollaterized and the amount will be paid in the form of cash.





The
Company has short term loans from sources other than banks amounted to
$5,634,880 and $5,229,653 as of March 31, 2010 and December 31,
2009.





The
Company’s long term bank loan as of March 31, 2010 and December 31, 2009 are as
follows:




March31,
                  2010
                
                
                December31,
                  2009(Unaudited)Loan
      from Huaxia Bank in city of Xi’an, due various dates from February 2011 to
      March 2011. Interest-only payments at 6.48% per annum, secured by
      assets.Current
      portion
                
                $
                4,401,000
                
                
                $
                -Noncurrent
      portion
                
                
                -
                
                
                
                4,401,000$
                4,401,000
                
                
                $
                4,401,000




The above
loans are secured by the Company's plants, buildings, land use rights and
inventories located within PRC, with carrying net value as follows:




March31,
                  2010
                
                
                December31,
                  2009(Unaudited)Plant
      in Xi’an, Shaanxi, China
                
                $
                18,305,124
                
                
                $
                18,424,465Buildings
      in Xi’an and Weihai, China
                
                
                5,974,048
                
                
                
                6,037,376Land
      use rights in Xi’an and Weihai, China
                
                
                4,775,438
                
                
                
                4,742,161Inventories
      in Xi’an, Shaanxi, China
                
                
                8,802,000
                
                
                
                8,802,000Total
      assets pledged as collateral for bank loans
                
                $
                37,856,610
                
                
                $
                38,006,002




Net
interest expense for the three months ended March 31, 2010 and 2009 was
comprised of the following (Unaudited):





2010
                  
                  
                  2009Amortization
      of debt discount
                  
                  $
                  910,535
                  
                  
                  $
                  1,122,614Amortization
      of debt issuance costs
                  
                  
                  140,968
                  
                  
                  
                  135,610Interest
      expense
                  
                  
                  795,217
                  
                  
                  
                  89,698Interest
      earned on cash deposits
                  
                  
                  (202,479
                  )
                  
                  
                  (198,847
                  )Foreign
      currency transaction loss
                  
                  
                  2,682
                  
                  
                  
                  292,309Interest
      expense, net
                  
                  $
                  1,646,923
                  
                  
                  $
                  1,441,384





23





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Note
13 – Due to original shareholders





Due to
original shareholders represent the amount that was unpaid for the acquisition
of Simo Motor and Wehai, which consisted of the following:


March31,
                  2010
                
                
                December31,
                  2009(Unaudited)Amount
      due to Simo Motor original shareholders
                
                $
                -
                
                
                $
                27,948,476Amount
      due to Weihai original shareholders
                
                
                733,500
                
                
                
                733,500$
                733,500
                
                
                $
                28,681,976





The
amount due to Simo Motor original shareholders was paid in January 2010 in full.
Amount due to Weihai original shareholders is due in July 2010, which is two
years from the acquisition date of July 2008.




Note
14 – Derivative instrument





The
Company's operations are exposed to a variety of global market risks, including
the effect of changing currency exchange rates and interest rates. The Company
has used a financial derivative to manage these exposures in the past.
The Company uses financial derivatives only to hedge exposures in the ordinary
course of business and does not invest in derivative instruments for speculative
purposes.





Effective
April 17, 2007, the Company entered into a cross currency interest rate swap
agreement with Merrill Lynch exchanging the LIBOR plus 3.35% variable rate
interest payable on the $38 million principle amount or 2012 Notes for a 7.2%
(3.6% semi-annually) RMB fixed rate interest.  The agreement required
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 RMB to USD falls below 6.5,
and to $4,000,000 if the exchange rate falls below 5.5. This swap was 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 on
September 16, 2009 (the termination date), was a payable of $9,003,322,
respectively. Changes in the fair values of derivative instruments accounted for
as cash flow hedges, to the extent they qualify for hedge accounting, are
recorded in accumulated other comprehensive income.   For the three
months ended March 31, 2009, the Company recorded $2,529,076 as loss on
the derivative instrument, respectively, in other comprehensive income
(loss).





Effective
September 1, 2009, the whole original swap, with outstanding USD notional of
35,600,000 and outstanding CNY notional of 281,240,000 was unwound with a
$9,000,000 premium payment made to Merrill Lynch.  As a result,
$9,000,000 was transferred from the accumulated other comprehensive loss into
earnings as a loss from termination of the swap.  There were no
amounts recorded in the consolidated statements of income in relation to
ineffectiveness of this interest swap prior to unwind.





During
the three months ended March 31, 2009, the Company paid $110,676 as hedging
payment and the Company recognized $178,149 of loss from derivative
transactions.





24




Changes
of cross currency hedge are as follows:





Cross
      currency hedge payable balance at January 1,
    2009
                          
                          $
                          175,986Proceeds
      from cross currency hedge
                          
                          
                          -Loss
      from derivative transactions
                          
                          
                          110,676Payments
      for cross currency hedge
                          
                          
                          (178,149
                          )Cross
      currency hedge payable balance at March 31, 2009
    (Unaudited)
                          
                          
                          108,513Proceeds
      from cross currency hedge
                          
                          
                          -Loss
      from derivative transactions
                          
                          
                          1,013,102Payments
      for cross currency hedge
                          
                          
                          (1,121,615
                          )Cross
      currency hedge payable balance at December 31,
      2009
                          
                          
                          -Proceeds
      from cross currency hedge
                          
                          
                          -Loss
      from derivative transactions
                          
                          
                          -Payments
      for cross currency hedge
                          
                          
                          -Cross
      currency hedge payable balance at March 31, 2010
    (Unaudited)
                          
                          $
                          -





Note
15 – Additional product sales information





The
Company has a single operating segment. The majority of the Company’s revenue
was generated from local sales. Summarized financial information concerning the
Company’s revenues based on geographic areas for the three months ended March
31, 2010 and 2009 are as follows (Unaudited):




2010
                  
                  
                  2009China
                  
                  $
                  98,421,710
                  
                  
                  $
                  27,463,006International
                  
                  
                  7,063,447
                  
                  
                  
                  3,261,887Total
      sales
                  
                  
                  105,485,157
                  
                  
                  
                  30,724,893Cost
      of sales - China
                  
                  
                  65,280,189
                  
                  
                  
                  18,001,310Cost
      of sales - International
                  
                  
                  4,462,898
                  
                  
                  
                  1,799,805Total
      cost of sales
                  
                  
                  69,743,087
                  
                  
                  
                  19,801,115Gross
      profit
                  
                  $
                  35,742,070
                  
                  
                  $
                  10,923,778





Note
16 – Business combinations





Acquisition of
Xi’an Tech Full Simo Motor
Co. Ltd.




On
October 2, 2009, HTFE entered into an Equity Acquisition Agreement (the
“Agreement”) with Xi’an Simo Electric Co. Ltd. (“Xi’an Simo”) and Shaanxi
Electric Machinery Association (“Shaanxi Electric” and collectively with Xi’an
Simo, the “Selling Shareholders”) whereby HTFE agreed to acquire (i) 100% of the
outstanding shares of Simo Motor, which is 99.94% owned by Xi’an Simo and 0.06%
owned by Shaanxi Electric, and (ii) all corresponding assets of Simo Motor,
including but not limited to, all of the manufacturing equipment, real-estate,
land use rights, stocks, raw materials, automobiles, intellectual property,
receivables, other receivables, payables, business contracts and external
investments owned by Simo Motor for an aggregate price of approximately $111.6
million (RMB 763.2 million), payable in cash.  The acquisition
also included 15 wholly-owned and 8 majority-owned subsidiaries by Simo Motor.
As a result, the Company’s ownership to Simo Motor and all subsidiaries averages
to 87.2%. The remaining 12.8% is owned by noncontrolling shareholders. On
October 13, 2009, the Company completed the acquisition of Simo Motor. As of the
closing date, HTFE had completed the registration of the share transfer with the
requisite PRC authorities and had obtained the required business registration
and transfer of licenses of Simo Motor, all as contemplated by the Agreement. On
October 13, 2009, Simo Motor changed its name to Xi’an Tech Full Simo Motor
Co. Ltd.





25





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





The
following table summarizes the net book value and the fair value of the assets
acquired and liabilities assumed at the date of acquisition:


NetBookValue
                
                
                FairValueCurrent
      assets
                
                $
                150,918,962
                
                
                $
                150,918,962Property,
      plant and equipment, net
                
                
                53,417,013
                
                
                
                54,331,338Other
      noncurrent assets
                
                
                6,890,327
                
                
                
                14,116,814Goodwill
                
                
                -
                
                
                
                41,799,976Total
      assets
                
                
                211,226,302
                
                
                
                261,167,090Total
      liabilities
                
                
                131,250,800
                
                
                
                131,250,800Noncontrolling
      interest
                
                
                17,957,814
                
                
                
                17,957,814Net
      assets
                
                $
                62,017,688
                
                
                $
                111,958,476





Based on
an evaluation by an independent appraisal and final asset evaluation by the
management, the purchase price exceeded the fair value of Simo Motor’s net
assets by $41.8 million, which was recognized as goodwill, see Note 9 for
detail.





For
the above acquisition, the acquirer, HTFE and the acquired subsidiaries of the
Company, engaged a third party independent appraiser to evaluate and determine
the fair value of major assets acquired. The third party independent appraiser
is a certified public accountant under the laws of PRC (the “PRC CPA”). The
assets evaluated by the independent appraiser included fixed assets (equipment
and buildings), construction in progress, and intangible assets (land use
rights).  The PRC CPA conducted an on-site visit, inspected each item,
conducted market research and investigation and provided an evaluation report
based on certain asset evaluation policies and regulations issued by the Chinese
government. The Company’s management used the PRC CPA’s appraisal reports as a
reference to assess the fair value of these assets and reported in the financial
statements. For current assets, however, the management used the carrying value
on the acquisition date.




Pro
Forma





The
following unaudited pro forma condensed income statement for the three months
ended March 31, 2010 and 2009 were prepared under generally accepted accounting
principles, as if the acquisition of Simo Motor had occurred the first day of
the respective periods. The pro forma information may not be indicative of the
results that actually would have occurred if the acquisition had been in effect
from and on the date indicated.




For the three months ended March 31 (Unaudited),
                
                2010
                
                
                2009Sales
                
                $
                105,485,157
                
                
                $
                64,488,671Cost
      of Goods Sold
                
                
                69,743,087
                
                
                
                44,794,108Gross
      Profit
                
                
                35,742,070
                
                
                
                19,694,563Operating
      Expenses
                
                
                8,010,953
                
                
                
                6,152,069Income
      from Operations
                
                $
                27,731,117
                
                
                $
                13,542,494Other
      expense (Income), net
                
                
                761,715
                
                
                
                (1,102,807
                )Income
      Tax
                
                
                4,063,361
                
                
                
                1,841,890Net
      Income before noncontrolling interest
                
                $
                22,906,041
                
                
                $
                12,803,411Net
      Income attributable to controlling interest
                
                $
                20,553,688
                
                
                $
                11,570,917





Note
17 – Commitments and contingencies





Commitments





The
Company enters into non-cancelable purchase commitments with some of its
vendors. As of March 31, 2010 and December 31, 2009, the Company was obligated
under the non-cancelable commitments to purchase materials totaling to
$1,487,584 and $456,174, respectively. These commitments are short-term and
expire within one year. The Company has not experienced losses on these purchase
commitments over the years.





26





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





On April
9, 2007, the Company entered into an agreement with Shelton Technology,
LLC.  Under the terms of the agreement, the Company is required to
contribute a total of $3 million in installments to AAG by March 31,
2009.  The Company has invested a total of $2 million to AAG as of
December 31, 2009 and has the remaining $1,000,000 to be
invested.  Based upon a mutual agreement, the Company will contribute
the remaining $1,000,000 to AAG at a later date according to actual
needs.





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 lease and use of 40,800 square meters of State-owned land
in the Shanghai Zhuqiao Airport Industrial Zone (the “Site”). The size of the
land used by HTFE was later revised to a total of approximately 53,000 square
meters. The term of the Land Use Agreement is 50 years and totaled $6.28 million
(RMB 42.84 million) (“Fee”), approximately 93% or $5.85 million (RMB 39,880,000)
of which has been paid with the balance to be paid in installments.





On August
10, 2009, AEM increased its investment capital in its 100% owned subsidiary HTFE
from $57 million to $82 million.  Of the $25 million increase in
capital, $18 Million was paid as of March 31, 2010 with the remaining $7
million of contribution payable by AEM to be paid prior to September
2011.





Contingencies





As of
March 31, 2010, the Company guaranteed bank loans for third parties’ bank loans,
including line of credit, amounting to $18,293,490.





Nature of
                      
                      Guaranteeguarantee
                      
                      amount
                      
                      Guaranty periodDomestic
      Letters of Credit
                      
                      $
                      7,335,000
                      
                      Various
      from January 2009 to April 2010Bank
      loans
                      
                      
                      10,958,490
                      
                      Various
      from January 2009 to October 2010Total
                      
                      $
                      18,293,490





The
Company has evaluated the guarantee and concluded that the likelihood of having
to make payments under the guarantee is remote.





Note
18 – Earnings per share





FASB
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. The
following is a reconciliation of the basic and diluted earnings per share
computations:





Forthethreemonthsended
                                  March312010
                                
                                
                                2009(Unaudited)Net
      income attributable to controlling interest
                                
                                $
                                20,553,688
                                
                                
                                $
                                8,654,334Add:
      Net income attributable to noncontrolling interest
                                
                                
                                2,352,353
                                
                                
                                
                                -Net
      income before noncontrolling interest
                                
                                $
                                22,906,041
                                
                                
                                $
                                8,654,334Weighted
      average shares used in basic computation
                                
                                
                                31,067,471
                                
                                
                                
                                22,102,078Diluted
      effect of stock options and warrants
                                
                                
                                286,392
                                
                                
                                
                                56,495Weighted
      average shares used in diluted computation
                                
                                
                                31,353,863
                                
                                
                                
                                22,158,573Earnings
      per share attributable to controlling interest:Basic
                                
                                $
                                0.66
                                
                                
                                $
                                0.39Diluted
                                
                                $
                                0.66
                                
                                
                                $
                                0.39Earnings
      per share attributable to noncontrolling interest:Basic
                                
                                $
                                0.08
                                
                                
                                $
                                -Diluted
                                
                                $
                                0.07
                                
                                
                                $
                                -





27





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





All stock
options and warrants have been included in the diluted earnings per share
calculation for the three months ended March 31, 2010 and 2009.





Note
19 – Shareholders’ equity





Statutory
reserves





The laws
and regulations of the People’s Republic of China require that before a
Sino-foreign cooperative joint venture enterprise distributes profits to its
partners, it must first satisfy all tax liabilities, provide for losses in
previous years, and make allocations in proportions determined at the discretion
of the board of directors, after the statutory reserve.





Surplus reserve
fund





The
Company is required to transfer 10% of its net income, as determined in
accordance with the PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital. The transfer to this reserve must be made before distribution of
any dividend to shareholders. The Company will transfer at year end 10% of the
year’s net income determined in accordance with PRC accounting rules and
regulations.





For the
three months ended March 31, 2010 and 2009, the Company transferred $2,302,999
and $1,249,558, representing 10% of the net income generated by the Company’s
subsidiaries located within PRC determined in accordance with PRC accounting
rules and regulations, to this reserve. The remaining reserve to fulfill
the 50% registered capital requirement amounted to approximately $47.5 million
and $49.7 million as of March 31, 2010 and December 31, 2009,
respectively.





The
surplus reserve fund is non-distributable other than during liquidation and can
be used to fund previous years’ losses, if any, and may be utilized for business
expansion or converted into share capital by issuing new shares to existing
shareholders in proportion to their shareholding or by increasing the par value
of the shares currently held by them, provided that the remaining reserve
balance after such issue is not less than 25% of the registered
capital.




Warrants





Following
is a summary of warrant activity:





Outstanding
      as of January 1, 2009
                  
                  
                  2,030,158Granted
                  
                  
                  -Forfeited
                  
                  
                  -Exercised
                  
                  
                  -Outstanding
      as of March 31, 2009 (Unaudited)
                  
                  
                  2,030,158Granted
                  
                  
                  -Forfeited
                  
                  
                  -Exercised
                  
                  
                  (1,663,461
                  )Outstanding
      as of December 31, 2009
                  
                  
                  366,697Granted
                  
                  
                  -Forfeited
                  
                  
                  -Exercised
                  
                  
                  -Outstanding
      as of March 31, 2010 (Unaudited)
                  
                  
                  366,697





28





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Following
is a summary of the status of warrants outstanding at March 31,
2010:




OutstandingWarrants
                          
                          
                          ExercisableWarrantsExercisePrice
                          
                          Numberof
                            Shares
                          
                          
                          Average
                            Remaining
                            Contractual
                            Life
                          
                          
                          Average
                            ExercisePrice
                          
                          
                          Numberof
                            Shares
                          
                          
                          Average
                            Remaining
                            Contractual
                            Life$
                          10.84
                          
                          
                          366,697
                          
                          
                          
                          2.42
                          
                          
                          $
                          10.84
                          
                          
                          
                          366,697
                          
                          
                          
                          2.42Total
                          
                          
                          366,697
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          366,697





Options





On
November 30, 2009, the Company granted options to an independent director to
purchase an aggregate of 30,000 shares of the Company's common stock, at an
exercise price of $20.02 per share, the closing price of the Company’ s common
stock on November 30, 2009. The fair values of stock options granted to
employees and the independent directors were estimated at the date of grant
using the Black-Scholes option-pricing model with the following
assumptions:




Expected
                    
                    Expected
                    
                    
                    Dividend
                    
                    
                    Risk Free
                    
                    
                    Grant DateLife
                    
                    Volatility
                    
                    
                    Yield
                    
                    
                    InterestRate
                    
                    
                    FairValueEmployees
      - 2006
                    
                    5.0
      yrs
                    
                    
                    66
                    %
                    
                    
                    0
                    %
                    
                    
                    4.13
                    %
                    
                    $
                    8.10Directors
      - 2006
                    
                    5.0
      yrs
                    
                    
                    66
                    %
                    
                    
                    0
                    %
                    
                    
                    4.13
                    %
                    
                    $
                    8.10Executives
      - 2007
                    
                    3.0
      yrs
                    
                    
                    77
                    %
                    
                    
                    0
                    %
                    
                    
                    4.50
                    %
                    
                    $
                    15.60Directors
      - 2009
                    
                    3.0
      yrs
                    
                    
                    70
                    %
                    
                    
                    0
                    %
                    
                    
                    1.15
                    %
                    
                    $
                    9.39




Following
is a summary of stock option activity:


OptionsOutstanding
                    
                    
                    Weighted
                      Average
                      ExercisePrice
                    
                    
                    AggregateIntrinsic
                        ValueOutstanding
      as of December 31, 2008
                    
                    
                    694,583
                    
                    
                    $
                    10.27
                    
                    
                    $
                    -Granted
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Forfeited
                    
                    
                    (25,000
                    )
                    
                    
                    12.40
                    
                    
                    
                    -Exercised
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Outstanding
      as of March 31, 2009 (Unaudited)
                    
                    
                    669,583
                    
                    
                    $
                    10.19
                    
                    
                    $
                    -Granted
                    
                    
                    30,000
                    
                    
                    
                    20.02
                    
                    
                    
                    -Forfeited
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Exercised
                    
                    
                    (344,583
                    )
                    
                    
                    7.15
                    
                    
                    
                    -Outstanding
      as of December 31, 2009
                    
                    
                    355,000
                    
                    
                    $
                    13.97
                    
                    
                    $
                    2,333,600Granted
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Forfeited
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Exercised
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Outstanding
      as of March 31, 2010 (Unaudited)
                    
                    
                    355,000
                    
                    
                    $
                    13.97
                    
                    
                    $
                    2,706,350





29





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES





NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(UNAUDITED)





Following
is a summary of the status of options outstanding at March 31,
2010:





OutstandingOptions
                      
                      
                      ExercisableOptionsExercisePrice
                      
                      Number
                      
                      
                      AverageRemaining
                        ContractualLife
                      
                      
                      Average
                        ExercisePrice
                      
                      
                      Number
                      
                      
                      AverageRemaining
                        ContractualLife$
                      8.10
                      
                      
                      95,000
                      
                      
                      
                      0.85
                      
                      
                      $
                      8.10
                      
                      
                      
                      95,000
                      
                      
                      
                      0.85$
                      15.60
                      
                      
                      230,000
                      
                      
                      
                      0.70
                      
                      
                      $
                      15.60
                      
                      
                      
                      160,667
                      
                      
                      
                      0.70$
                      20.02
                      
                      
                      30,000
                      
                      
                      
                      4.67
                      
                      
                      $
                      20.02
                      
                      
                      
                      16,250
                      
                      
                      
                      4.67Total
                      
                      
                      355,000
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      271,917





On July
12, 2007, the Company’s CEO transferred 280,000 of his own shares to the Company
employees and consultants. The shares vest over 5 to 10 years starting July 12,
2007. The Company valued the shares at $13.73 per share, based on the average
price for the immediately preceding fifteen consecutive trading days before June
16, 2007, the date when the Company and HTFE entered into the asset purchase
agreement with Harbin Taifu Auto Electric Co., Ltd., the trading price of the
stock on the date of transfer, as a capital contribution totaling $3,844,904 by
the CEO, the value was amortized over the vesting
period.




For the
three months ended March 31, 2010 and 2009, stock compensation expense related
to options issued amounted to $254,669, and $341,362, respectively.




Note 20 –
Employee pension





Regulations
in the People’s Republic of China require the Company to contribute to a defined
contribution retirement plan for all employees. All Joint Venture employees are
entitled to a retirement pension amount calculated based upon their salary at
their date of retirement and their length of service in accordance with a
government managed pension plan. The PRC government is responsible for the
pension liability to the retired staff. 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 contributions to employment benefits, including
pension, of $213,763, and $23,776 for the three months ended March 31, 2010 and
2009, respectively.





Note 21 –
Subsequent events





In April
2010, the Company has renewed its guarantee for third parties’ bank loans,
including line of credit, amounting to $10,269,000.





The
Company has performed an evaluation of subsequent events through the date these
consolidated financial statements were issued to determine whether the
circumstances warranted recognition and disclosure of those events or
transactions in the consolidated financial statements as of March 31,
2010.





30




Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations





INFORMATION
REGARDING FORWARD LOOKING STATEMENTS





The
following is management’s discussion and analysis of certain significant factors
that have affected aspects of our financial position and results of operations
during the periods included in the accompanying unaudited financial statements.
You should read this in conjunction with the discussion under “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and
the audited financial statements for the year ended December 31, 2009
included in our Annual Report on Form 10-K and the unaudited 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 design,
develop, manufacture, supply, and service a wide range of electric motors, with
a focus on innovation, creativity, and value-added products. Our major product
lines include linear motors, specialty micro-motors, and industrial rotary
motors. Our products are purchased by a broad range of customers including those
customers in the energy industry, factory automation, food processing, packaging
industries, power generation systems, and mass transportation and freight
transportation systems, petrochemical, metallurgical, mining, textile, and
agricultural industries. We supply domestic China and other international
markets.




We
currently operate the following four manufacturing facilities in China with an
employee base of approximately 4,350 engineers, production technicians and other
employees:





·
            Harbin
      Tech Full Electric Co., Ltd. (“Harbin Tech Full”) is located in the
      government-designated Development Zone in the city of Harbin with
      approximately 50,000 square meters of land and manufactures linear motors
      and linear motor integrated
systems.





·
            Shanghai
      Tech Full Electric Co., Ltd. (“Shanghai Tech Full”) is located in the
      Shanghai Zhuqiao Airport Industrial Zone with 40,800 square meters of land
      and manufactures specialty
micro-motors.





·
            Weihai
      Tech Full Simo Motor Co., Ltd. (“Weihai Tech Full Simo”) is located in
      Weihai with approximately 150,000 square meters of land and primarily
      manufactures small to medium sized industrial rotary
    motors.




·
            Xi’an
      Tech Full Simo Motor Co., Ltd. (“Xi’an Tech Full Simo”) was acquired in
      October 2009 and manufactures primarily medium to large sized industrial
      rotary motors. Xi’an Tech Full Simo is located in Xi’an city’s Economy and
      Technology Development Zone and occupies approximately 200,000 square
      meters of land.





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.




CRITICAL
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, require
significant judgments and estimates on the part of management. Our critical
accounting policies and estimates present an analysis of the uncertainties
involved in applying a principle, while the accounting policies note to the
financial statements (Note 2) describe the method used to apply the accounting
principle.





Accounts
Receivable





The
Company maintains 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 estimated loss rate is based on our historical
loss experience and also contemplates current market conditions. Delinquent
account balances are written-off after management has determined that the
likelihood of collection is not probable, and known bad debts are written off
against allowance for doubtful accounts when identified.


31





Inventories





Inventories
are valued at the lower of cost or market value, as determined on a first-in,
first-out basis, using the weighted average method. Management compares the cost
of inventories with the market value and an allowance is made for writing down
the inventory to its market value, if lower than cost. 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. When inventories are written-down
to the lower of cost or market, it is not marked up subsequently based on
changes in underlying facts and circumstances.  Inventory is composed
of raw material for manufacturing electrical motors, work in process and
finished goods within the Company’s warehouse premise or consigned at a customer
site.





Inventory
levels are maintained based on projections of future demand and market
conditions. Any sudden decline in demand and/or rapid product improvements and
technological changes can result in excess and/or obsolete inventories. To the
extent we increase our reserves for future periods, operating income will be
reduced. 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 such exposure,
sometimes we require a binding purchase order or a signed agreement by our
customers agreeing to pay for and take possession of finished
goods inventory parts for the duration of the agreement.





Revenue
Recognition




The
Company recognizes sales 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. For products that are required to be
examined by customers, sales revenue is recognized after the customer
examination is passed. Payments received before all of the relevant criteria for
revenue recognition are recorded as customer deposits.





In
addition, revenue recognition could be negatively impacted by returns. For our
linear motor and specialty micro-motor businesses, our products are 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.  We charge such costs to cost of goods sold. For our
industrial rotary motor business, our products are standardized products
and returns are allowed within three days upon receipt of products by customers.
We provide product warranty for repair one year from the date of shipment.
Historically, the returns and defects have not been material. Should returns
increase in the future it would be necessary to adjust the estimates, in which
case recognition of revenues could be delayed.





Stock-Based
Compensation




We are
required to estimate the fair value of share-based awards on the date of grant.
The value of the award is principally recognized as expense ratably over the
requisite service periods. The fair value of our restricted stock units is based
on the closing market price of our common stock on the date of grant. We have
estimated the fair value of stock options and stock purchase rights as of the
date of grant or assumption using the Black-Scholes option pricing model, which
was developed for use in estimating the value of traded options that have no
vesting restrictions and that are freely transferable. The Black-Scholes model
considers, among other factors, the expected life of the award and the expected
volatility of our stock price. We evaluate the assumptions used to value stock
options and stock purchase rights on a quarterly basis. The fair values
generated by the Black-Scholes model may not be indicative of the actual fair
values of our equity awards, as it does not consider other factors important to
those awards to employees, such as continued employment, periodic vesting
requirements and limited transferability.





The
Company is required to measure the cost of the equity instruments issued in
exchange for the receipt of goods or services from other than employees at the
estimated fair market value of the consideration received or the estimated fair
value of the equity instruments issued, whichever is more reliably determinable.
The value of equity instruments issued for consideration other than employee
services is determined on the earlier of a performance commitment or completion
of performance by the provider of goods or services.





Stock
compensation expense is recognized based on awards expected to vest. GAAP
requires forfeitures to be estimated at the time of grant and revised in
subsequent periods, if necessary, when actual forfeitures differ from those
estimates.  There were no estimated forfeitures as the Company has a
short history of issuing options.





Derivative
instrument





The
Company has used a cross currency interest rate swap, 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.  Cash flow hedges are defined by GAAP as
derivative instruments designated as and used to hedge the exposure to
variability in expected future cash flows that is attributable to a particular
risk. For derivative instruments that are designated and qualify as a cash flow
hedge, the effective portion of the gain or loss on the derivative is reported
as a component of other comprehensive income, net of income taxes and
reclassified into earnings in the same period or periods during which the hedged
transaction affects earnings. Gains and losses on the derivatives representing
either hedge ineffectiveness or hedge components excluded from the assessment of
effectiveness are recognized in current earnings.


32


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. Any portion
deemed ineffective is recorded in earnings with the effective portion reflected
in accumulated other comprehensive.





Fair
Value of Financial Instruments





On
January 1, 2008, the Company adopted FASB’s accounting standard related to fair
value measurements and began recording financial assets and liabilities subject
to recurring fair value measurement at the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants. On January 1, 2009 the Company began recording
non-recurring financial as well as all non-financial assets and liabilities
subject to fair value measurement under the same principles. These fair value
principles prioritize valuation inputs across three broad levels.





Recent
Accounting Pronouncement





In
January 2010, FASB issued ASU No. 2010-01 – Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify that the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a potential limitation on the total
amount of cash that all shareholders can elect to receive in the aggregate is
considered a share issuance that is reflected in EPS prospectively and is not a
stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings
Per Share). The amendments in this update are effective for interim and
annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. The Company does not expect the adoption of this ASU to
have a material impact on its consolidated financial
statements.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect accounting and reporting by an entity that exchanges
a group of assets that constitutes a business or nonprofit activity for an
equity interest in another entity.  The amendments in this update are
effective beginning in the period that an entity adopts SFAS No. 160,
“Non-controlling Interests in Consolidated Financial Statements – An Amendment
of ARB No. 51.” If an entity has previously adopted SFAS No. 160 as of the date
the amendments in this update are included in the Accounting Standards
Codification, the amendments in this update are effective beginning in the first
interim or annual reporting period ending on or after December 15, 2009.
The amendments in this update should be applied retrospectively to the first
period that an entity adopted SFAS No. 160. The Company does not expect the
adoption of this ASU to have a material impact on the Company’s consolidated
financial statements.





In
January 2010, FASB issued ASU No. 2010-06 – Improving Disclosures about Fair
Value Measurements. This update provides amendments to Subtopic 820-10 that
requires new disclosure as follows: 1) Transfers in and out of Levels 1 and
2.  A reporting entity should disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers.  2)  Activity in
Level 3 fair value measurements.  In the reconciliation for fair value
measurements using significant unobservable inputs (Level 3), a reporting entity
should present separately information about purchases, sales, issuances, and
settlements (that is, on a gross basis rather than as one net number). This
update provides amendments to Subtopic 820-10 that clarify existing disclosures
as follows: 1) Level of disaggregation. A reporting entity should provide
fair value measurement disclosures for each class of assets and liabilities. A
class is often a subset of assets or liabilities within a line item in the
statement of financial position. A reporting entity needs to use judgment in
determining the appropriate classes of assets and liabilities.
2) Disclosures about inputs and valuation techniques. A reporting
entity should provide disclosures about the valuation techniques and inputs
used to measure fair value for both recurring and nonrecurring fair value
measurements. Those disclosures are required for fair value measurements that
fall in either Level 2 or Level 3. The new disclosures and clarifications
of existing disclosures are effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements. These disclosures are effective for fiscal years
beginning after December 15, 2010, and for interim periods within those fiscal
years. The Company is currently evaluating the impact of this ASU, however, the
Company does not expect the adoption of this ASU to have a material impact on
its consolidated financial statements.





In
February 2010, the FASB issued Accounting Standards Update 2010-09, “Subsequent
Events (Topic 855): Amendments to Certain Recognition and Disclosure
Requirements,” or ASU 2010-09. ASU 2010-09 primarily rescinds the requirement
that, for listed companies, financial statements clearly disclose the date
through which subsequent events have been evaluated. Subsequent events must
still be evaluated through the date of financial statement issuance; however,
the disclosure requirement has been removed to avoid conflicts with other SEC
guidelines. ASU 2010-09 was effective immediately upon issuance and was adopted
in February 2010. The adoption of ASU 2010-09 did not have a material
impact on our consolidated financial statements.


33





In March
2010, FASB issued ASU No. 2010-10 – Amendments for Certain Investment
Funds. This update defers the effective date of the amendments to the
consolidation requirements made by FASB Statement 167 to a reporting entity’s
interest in certain types of entities. The deferral will mainly impact the
evaluation of reporting enterprises’ interests in mutual funds, private equity
funds, hedge funds, real estate investment entities that measure their
investment at fair value, real estate investment trusts, and venture capital
funds. The ASU also clarifies guidance in Statement 167 that addresses whether
fee arrangements represent a variable interest for all service providers and
decision makers. The ASU is effective for interim and annual reporting periods
in fiscal year beginning after November 15, 2009. The adoption of this ASU did
not have a material impact on the Company’s consolidated financial
statements.





In March
2010, FASB issued ASU No. 2010-11 – Scope Exception Related to Embedded
Credit Derivatives. Embedded credit-derivative features related only to the
transfer of credit risk in the form of subordination of one financial instrument
to another are not subject to potential bifurcation and separate accounting as
clarified by recently issued FASB guidance. Other embedded credit-derivative
features are required to be analyzed to determine whether they must be accounted
for separately. This update provides guidance on whether embedded
credit-derivative features in financial instruments issued by structures such as
collateralized debt obligations (CDOs) and synthetic CDOs are subject to
bifurcation and separate accounting. The guidance is effective at the beginning
of a company’s first fiscal quarter beginning after June 15, 2010. The Company
does not expect the adoption of this ASU to have a material impact on the
Company’s consolidated financial statements.





RESULTS
OF OPERATIONS




Revenues





For the
first quarter of 2010, total revenues were $105.49 million, up 243% compared
with $30.72 million in the first quarter of 2009, which was negatively impacted
by the global financial crisis. The significant sales growth was mainly the
result of higher sales across all product lines, driven by strong economic
recovery in China and a contribution of $45.03 million from Xi’an Tech Full Simo
which was acquired in October 2009. By product line, linear motor sales were up
60% driven by higher oil pumps sales (105 units in the first
quarter of 2010 compared to 60 units in the first quarter of 2009) and
sales from linear motor propulsion systems developed for coal transportation
trains ($5.48 million), which started to contribute in the fourth quarter of
2009. Sales of specialty micro motors were up 165% from the first quarter of
2009. Sales of industrial rotary motors increased from $10.85 million to $67.50
million including $45.03 million from Xi’an Tech Full Simo. Sales of rotary
motors at Weihai Tech Full Simo more than doubled.




International
sales totaled $7.06 million for the quarter, up 117% compared with $3.26 million
in the first quarter of 2009, when the global economic downturn hit our
international business severely. The international sales growth was driven by
increased sales in our specialty micro motor and rotary motor
products.





The
following table presents the revenue contribution by percentage for each major
product line in the first quarter of 2010 in comparison with the first
quarter of 2009.





PercentofTotalRevenuesProduct Line
                              
                              
                              1Q10
                              
                              
                              
                              1Q09Linear
      Motors and Related Systems
                              
                              
                              18.8
                              %
                              
                              
                              40.3
                              %Specialty
      Micro-Motors
                              
                              
                              15.4
                              %
                              
                              
                              19.9
                              %Rotary
      Motors
                              
                              
                              64.0
                              %
                              
                              35.3
                              %Weihai
                              
                              
                              21.3
                              %
                              
                              
                              35.3
                              %Xi’an
                              
                              
                              42.7
                              %
                              
                              
                              NAOthers
                              
                              
                              1.8
                              %
                              
                              
                              4.5
                              %Total
                              
                              
                              100
                              %
                              
                              
                              100
                              %International
      Sales
                              
                              
                              6.7
                              %
                              
                              
                              10.6
                              %




Net
Income





The
Company recorded a net income available to controlling interest of $20.55
million, or $0.66 per diluted share. This compared with a net income
available to controlling interest of $8.65 million, or $0.39 per diluted share
in the first quarter of 2009. The net income available to controlling interest
was 137% higher and net earnings per share were 69% higher than that of prior
year.  The higher net income was primarily driven by higher sales across
all product lines, contributions from the acquisition of Xi’an Tech Full Simo,
and higher other income.


34





Total
weighted average diluted share count was 31.4 million shares in the first
quarter of 2010 compared to 22.2 million shares in the first quarter of
2009. The increase was mainly due to the 7.2 million common shares issued in
August 2009 in an equity financing.





The
management of Harbin Electric uses non-GAAP adjusted net earnings to measure the
performance of the Company’s business internally by excluding non-recurring
items as well as special non-cash charges.  The Company’s management
believes that these non-GAAP adjusted financial measures allow management to
focus on managing business operating performance because these measures
reflect the essential operating activities of Harbin Electric and provide a
consistent method of comparison to historical periods. The Company believes that
providing the non-GAAP measures that management uses internally to its
investors is useful to investors for a number of reasons. The non-GAAP measures
provide a consistent basis for investors to understand Harbin Electric's
financial performance in comparison to historical periods without variation of
non-recurring items and non-operating related charges. In addition, it allows
investors to evaluate the Company's performance using the same methodology and
information as that used by management. Non-GAAP measures are subject to
inherent limitations because they do not include all of the expenses included
under GAAP and because they involve the exercise of judgment of which charges
are excluded from the non-GAAP financial measure. However, the management of
Harbin Electric compensates for these limitations by providing the relevant
disclosure of the items excluded.




The
following table provides the non-GAAP financial measure and a reconciliation of
the non-GAAP measure to the GAAP net income.




ThreeMonthsEndedMarch 312010
                            
                            
                            2009Net
      Income Attributable to Controlling Interest
                            $
                            20,553,688
                            
                            
                            $
                            8,654,334Add
      Back (Deduct):Change
      in fair value of warrant
                            $
                            234,078
                            
                            
                            $
                            (2,573,421
                            )Adjusted
      Net Income Attributable to Controlling Interest
                            $
                            20,787,766
                            
                            
                            $
                            6,080,913Diluted
      EPS Attributable to Controlling Interest
                            $
                            0.66
                            
                            
                            $
                            0.39Add
      Back (Deduct):Change
      in fair value of warrant
                            $
                            0.00
                            
                            
                            $
                            (0.12
                            )Adjusted
      Diluted EPS Attributable to Controlling Interest
                            $
                            0.66
                            
                            
                            $
                            0.27




Due to a
change in fair value of warrants related to the debt issued in 2006, the Company
recorded a loss of $234,078 non-cash item in the first quarter of 2010, compared
to a gain of $2.57 million in the first quarter of 2009.  Excluding
this non-cash item, the adjusted net income available to controlling interest
was $20.79 million ($0.66 per diluted share) for the quarter, compared to $6.08
million ($0.27 per diluted share) in the first quarter of 2009.





Gross
Profit Margin





The
following table presents the average gross profit margin by product line for the
first quarter of 2010, in comparison to the first quarter of 2009.




Gross Profit MarginProduct Line
                              
                              
                              1Q10
                              
                              
                              
                              1Q09Linear
      Motors and Related Systems
                              
                              
                              59.8
                              %
                              
                              
                              54.1
                              %Specialty
      Micro-Motors
                              
                              
                              38.2
                              %
                              
                              
                              40.1
                              %Rotary
      MotorsWeihai
                              
                              
                              12.7
                              %
                              
                              
                              10.1
                              %Xi’an
                              
                              
                              31.1
                              %
                              
                              
                              NAOthers
                              
                              
                              41.3
                              %
                              
                              
                              49.3
                              %Corporate
      Average
                              
                              
                              33.9
                              %
                              
                              
                              35.6
                              %





The
slight decline in overall gross margin was primarily due to a change in product
mix, where the contribution of lower gross margin rotary motor business
increased significantly. The percentage of total sales from the lower margin
rotary motor business increased to 63.9% in the first quarter of 2010 from 35.3%
in the first quarter of 2009, due to the acquisition of Xi’an Tech Full Simo. By
product line, higher gross margin for linear motors is attributable to
increased sales of oil pumps and sales of linear motor systems for coal
transportation, which have higher gross margin relative to other types of linear
motors. The gross margin for specialty micro-motors declined slightly primarily
as a result of moving the production from Harbin to Shanghai, where
manufacturing costs such as labor and fixed costs are relatively higher,
particularly at the start-up stage. Increased sales and improved manufacturing
efficiency contributed to higher gross margin at our Weihai
facility.


35





Operating
Income





Operating
income in the first quarter of 2010 totaled $27.73 million, compared with $8.03
million in the first quarter of 2009, representing a 246% year over year growth.
Higher operating income was mainly due to increased sales and the acquisition of
Xi’an Tech Full Simo. Total operating costs including selling, general and
administrative (“SG&A”) expenses and research & development (R&D)
expenses totaled $8.01 million, compared with $2.90 million a year ago. The
higher operating costs were mainly due to the addition of Xi’an Tech Full Simo,
higher expenses related to higher sales such as shipping and handling costs,
higher depreciation expense, and higher costs associated with the production
start-up at our Shanghai facility. As a percentage of total sales, total
operating costs decreased from 9.4% to 7.6%. Operating margin was relatively
stable at 26.3% and 26.1% in the first quarter of 2010 and 2009,
respectively.





Other
Income, net





Other
income totaled $1.12 million in the current quarter compared to $0.54 million in
the first quarter of 2009. The other income mainly consisted of income from
recycling scrap materials and selling production waste and a government subsidy
representing a 2.5% tax rate reduction granted to Harbin Tech Full
to encourage its high-technology related businesses.





Interest
expense





Net
interest expense was $1.65 million for the current quarter. This included
$1.05 million amortization of debt discount and debt issuance cost in connection
with the Company’s 2012 Notes issued in 2006, $0.80 million interest expense and
$0.2 million interest income. This compares to net interest expense of $1.44
million for the first quarter of 2009. In all periods, net interest expense
included non-cash amortization expense of debt discount and debt issuance
cost.





Income
Taxes





The
income tax provision was $4.06 million for the current quarter, compared with
$1.04 million for the first quarter of 2009, The increase in income tax was
attributable to the taxable income contributed by Xi’an Tech Full Simo that was
acquired in October 2009, higher income due to the start-up of Shanghai Tech
Full in the fourth quarter of 2009, and higher income at our Harbin and Weihai
facilities.




Liquidity
and Capital Resources





A major
factor in the Company’s liquidity and capital resource planning is its
generation of operating cash flow, which is strongly dependent on the demand for
our products.  This is supplemented by our financing activities in the
capital markets including potentially debt and equity, which support major
acquisitions and capital investments for business growth.





Our
liquidity position remains adequate, with $77.82 million in cash and cash
equivalents as of March 31, 2010, compared to $92.90 million as of December 31,
2009. Cash provided by operating activities totaled $17.34 million in the
current quarter, compared to $22.88 million in the first quarter of 2009. Net
cash used in investing activities including making the remaining payment for the
acquisition of Xi’an Tech Full Simo totaled approximately $29.32 million,
compared to $4.80 million in the first quarter of 2009.  During the
quarter, the Company also repaid $3.8 million aggregate principal amount of its
2012 Notes issued in 2006. Total cash used in financing activities amounted to
$3.11 million and $2.84 million for the three months ended March 31, 2010 and
2009.





Cash
Provided by Operating Activities





Cash
provided by operating activities totaled $17.34 million. The major components of
cash provided by operating activities are consolidated net income (net income
attributable to both controlling and non-controlling interest) adjusted for
non-cash income and expense items and changes in operating assets and
liabilities.





Financing
Activities





On August
29, 2006, the Company, Advanced Electric Motors, Inc. (“AEM”), Citadel Equity
Fund Ltd. (“Citadel”) and Merrill Lynch International (“Merrill Lynch” and,
together with Citadel, the “Investors”) entered into a purchase agreement (the
“Purchase Agreement”) relating to the purchase and sale of (a) $50.0 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. Interest on the Notes is payable
semi-annually in arrears, commencing March 1, 2007.





The Notes
are governed by an indenture, dated August 30, 2006, entered among the Company,
AEM, as guarantor, and The Bank of New York, as trustee for the Notes (the
“Indenture”). 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 were scheduled to mature on September 1, 2012 (the “2012
Notes”), and Merrill Lynch subscribed to $12.0 million of the principal amount
of the Notes, which were schedule to 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.


36


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 by pledging all the shares of AEM common stock held by us.





The 2010
Notes bore interest, payable semi-annually in arrears, commencing March 1, 2007,
at a rate equal to LIBOR plus 4.75%. The 2010 Notes were subject to mandatory
redemption semi-annually commencing March 1, 2008 in the principal amount
$2,000,000 at a 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%. The 2012 Notes are subject to mandatory
redemption semi-annually commencing September 1, 2009 in the principal amounts
of $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,
March 1, 2012 and September 1, 2012, in each instance at price equal to 100% of
such principal amount.





In 2009,
the Company repurchased the entire 2010 Notes and repurchased part of the 2012
Notes. During the first quarter of 2010, the Company paid $3.8 million principle
amount of the 2012 Notes according to the mandatory redemption
schedule.  At March 31, 2010, only a total of $5.3 million principle
amount of the 2012 Notes remains outstanding and is due on September 1, 2010
according to the mandatory redemption schedule.





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 at any time through
the maturity date of such Warrant.





As of
March 31, 2010, a total of 366,697 Second Tranche 2012 Warrants remained
outstanding.





Investment
Activities





On
October 2, 2009, Harbin Tech Full, a wholly-owned subsidiary of the Company,
entered  into an Equity Acquisition Agreement (the “Agreement”) with
Xi’an Simo Electric Co. Ltd. (“Xi’an Simo”) and Shaanxi Electric Machinery
Association (“Shaanxi Electric” and collectively with Xi’an Simo, the “Selling
Shareholders”) whereby Harbin Tech Full agreed to acquire (i) 100% of the
outstanding shares of Xi’an Simo Motor Incorporation (Group) (“Simo Motor”),
which is 99.94% owned by Xi’an Simo and 0.06% owned by Shaanxi Electric, and
(ii) all corresponding assets of Simo Motor, including but not limited to, all
of the manufacturing equipment, real-estate, land use rights, stocks, raw
materials, automobiles, intellectual property, receivables, other receivables,
payables, business contracts and external investments owned by Simo Motor for a
purchase price of equal to no less than six (6) times and no more than eight (8)
times the 2008 audited net profits of Simo Motor. Pursuant to the Agreement,
Harbin Tech Full was required to make a payment to the Selling Shareholders
equivalent to six (6) times the 2008 audited net profit of Simo Motor within ten
(10) business days after the effectiveness of the Agreement. Upon verification
of the assets and capital of Simo Motor within seven months of the closing date
of the acquisition, Harbin Tech Full may be required to make an additional
payment to the Selling Shareholders in an amount not to exceed two (2) times the
2008 audited net profit of Simo Motor.





On
October 13, 2009, the Company completed the acquisition of Simo Motor. On
October 22, 2009, the Company paid approximately $84.0 million (RMB
572.7 million) to the Selling Share holders. As of the closing date, Harbin
Tech Full had completed the registration of the share transfer with the
requisite PRC authorities and had obtained the required business registration
and transfer of licenses of Simo Motor, all as contemplated by the Agreement. On
October 13, 2009, Simo Motor changed its name to Xi’an Tech Full Simo Motor Co.
Ltd.





During
the first quarter of 2010, the Company made an additional cash payment in an
amount of $27.94 million to the Selling Shareholders representing the unpaid
portion for the acquisition of Xi’an Tech Full Simo. The acquisition of Xi’an
Tech Full Simo is fully paid for after this payment pursuant to the
Agreement.





Contractual
Obligations





As of
March 31, 2010, a total of $5.3 million principal amount of the 2012 Notes
remains outstanding. The Company expects to follow the mandatory redemption
schedule with respect to the 2012 Notes and pay off the 2012 Notes on
September 1, 2010.





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 lease and 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. In June 2009, the Land Use Agreement was revised
with the land size increased to a total of approximately 53,000 square
meters. The aggregate amount HTFE shall pay to Shanghai Lingang is now
approximately $6.28 million (RMB42.84 million) ("Fee"), approximately 93% or
$5.85 million (RMB 39.88 million) has been paid as of March 31, 2010 with the
balance payable in installments.


37





In
October 2008, the Company, through its wholly-owned subsidiary Advanced
Automation Group, LLC (“AAG”), formed Advanced Automation Group Shanghai, Ltd.
(“AAG Shanghai”), a wholly-owned subsidiary in China, to design, develop,
manufacture, sell and service custom industrial automation controllers for
linear motors. The registered capital is $1 million. AAG has invested $500,000
in AAG Shanghai through March 31, 2010.





The
Company entered into an agreement (“Original Agreement”) with Shelton
Technology, LLC on April 9, 2007 whereby the Company and Shelton agreed to work
together through the Company’s wholly-owned subsidiary, Advanced Automation
Group, LLC (“AAG”), to design, develop and manufacture custom industrial
automation controllers.  Pursuant to the Original Agreement, the
Company is required to invest a total of $3 million in AAG while Shelton
contributes 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 which ended August 31, 2008. The
Company and Shelton entered into a first amendment to the Original Agreement on
December 11, 2008 to extend the term of the Original Agreement from August 31,
2008 to December 31, 2008. On April 21, 2009, the Company and Shelton entered
into a second amendment to the Original Agreement to further extend the term to
June 30, 2009. On December 7, 2009, the Company and Shelton entered into the
third amendment to the Original Agreement to further extend the term to December
31, 2009. The Company has contributed a total of $2.0 million to AAG as of
December 31, 2009. The remaining $1.0 million contribution to AAG is to be made
at a mutually agreed later date.   The Company and Shelton
are continuing their joint work and are currently in process of developing a new
agreement to extend the arrangement between them with respect to this
work.





The
Company enters into non-cancelable purchase commitments with its vendors. As of
March 31, 2010, and December 31, 2009, the Company was obligated under the
non-cancelable commitments to purchase materials totaling to $1,487,584and $456,174,
respectively. These commitments are short-term and expire within one year. The
Company has experienced no losses on these purchase commitments over the
years.





Off-balance
Sheet Arrangements





None.





Item
3. Quantitative and Qualitative Disclosures about Market Risk





Information
relating to quantitative and qualitative disclosures about market risk is
provided in the Company’s 2009 Annual Report on Form 10-K, which information is
incorporated herein by reference. There have been no material changes in the
Company’s exposure to market risk since December 31, 2009.





Item
4. Controls and Procedures





(a)
Evaluation of Disclosure Controls and Procedures





We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed pursuant to the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules, regulations and related forms, and
that such information is accumulated and communicated to our principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure.





Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, the Company
conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures as of March 31, 2010, as such term is defined
in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on this evaluation, our
principal executive officer and principal financial officer have concluded that
during the period covered by this report, the Company’s disclosure controls and
procedures are effective as of such date at a reasonable assurance level to
ensure that information required to be disclosed by us in our Exchange Act
reports is recorded, processed, summarized, and reported within the time periods
specified in the SEC’s rules and forms, and that such information is
accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure.





(b) Changes
in Internal Control over Financial Reporting





There
have been no changes in our internal control over financial reporting that
occurred during the three months ended March 31, 2010 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





We are
not currently a party to any material legal proceedings. From time to time,
however, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business.


38


Item
1A. Risk Factors





An
investment in our common stock is very risky. You should carefully consider the
risk factors described below before making an investment decision. 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. Additional risks and uncertainties not currently foreseeable to us
may also impair our business operations.




GENERAL
RISKS RELATING TO OUR BUSINESS





Our
rapid growth may strain our resources.




Our
revenues increased by 243% from the first quarter of 2009 and 85% in the year
ended December 31, 2009 versus the year ended December 31, 2008. However,
it is unlikely that we will maintain such growth in the long term and we cannot
assure any growth of our business for any period. Our rapid expansion will place
significant strain on our management and our operational, accounting, and
information systems as well as our financial resources. 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 hire,
train, motivate, and manage our employees. In addition, we may require
additional financial resources to fund our growing working capital needs. Our
failure to manage our growth could disrupt our operations and ultimately prevent
us from generating the profits we expect.




Our
debt may constrict our future operations and cash flows.





As of
March 31, 2010, we had $5.30 million debt principal outstanding under our
Guaranteed Senior Secured Floating Rate Notes due 2012 (the “Notes”) issued in
August 2006. Additionally, our PRC subsidiaries had a total of approximately
$50.05 million loans outstanding as of March 31, 2010. These loans were obtained
from local PRC banks and unrelated individual companies. They are used to
support our working capital. These obligations could have important consequences
to you. For example, they 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 for the Notes
      is variable; 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. Furthermore, our obligations under the Notes are secured
by our shares of Advanced Electric Motors, Inc., our Delaware subsidiary through
which we own our PRC operating subsidiaries. These security interests could
result in our loss of the business, if we default on the Notes.





Covenants
in the Indenture governing our Notes and the Purchase Agreement pursuant to
which the Notes were initially sold, restrict our ability to engage in or enter
into a variety of transactions.





Our Notes
were issued pursuant to an Indenture, dated as of August 30, 2006, between us
and The Bank of New York, as Trustee. The Indenture 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, create liens on our assets to
secure debt, make capital expenditures, incur additional indebtedness
and pay dividends. The Indenture also requires us to maintain certain
financial ratios. 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.





The
Purchase Agreement dated August 29, 2006, pursuant to which the Notes were
initially sold, provides that the initial purchasers of the Notes and their
assignees have a right of first offer for so long as such persons continue to
hold any Notes with respect to any issuances of new equity securities by us
other than shares of stock issued to employees, officers and directors pursuant
to bona fide employee benefit plans. The rights of first offer contained in the
Purchase Agreement could adversely impact our ability to do future equity
offerings.





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 the
members of our senior management. 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.


39


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.





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




No vendor
accounted for more than 10% of the raw material purchases for the three months
ended March 31, 2010. Two major vendors provided 25% of the Company’s purchase
of raw materials for the three months ended March 31, 2009, with each vendor
individually accounting for 17% and 8%, respectively. 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. An inability to obtain our key source supplies for the
manufacture of our products might require us to delay shipments of products,
harm customer relationships or force us to curtail or cease
operations.





We
may experience material disruptions to our manufacturing operation.





While we
seek to operate our facilities in compliance with applicable rules and
regulations and take measures to minimize the risks of disruption at our
facilities, a material disruption at one of our manufacturing facilities could
prevent us from meeting customer demand, reduce our sales and/or
negatively impact our financial results. Any of our manufacturing
facilities, or any of our machines within an otherwise operational facility,
could cease operations unexpectedly due to a number of events,
including:





·
            unscheduled
      maintenance outages;


·
            prolonged
      power failures;


·
            an
      equipment failure;


·
            disruptions
      in the transportation infrastructure including roads, bridges, railroad
      tracks;


·
            fires,
      floods, earthquakes, or other catastrophes;
and


·
            other
      operational problems.





We
may not be able to adequately protect and maintain our intellectual property,
which could weaken our competitive position.





Our
success will depend on our ability to continue to develop and market electric
motor products. We have been granted 20 patents in China relating to linear
motor and automobile specialty micro-motor applications. No assurance can be
given that such patents will not be challenged, invalidated, infringed or
circumvented, or that such intellectual property rights will provide a
competitive advantage to us. The implementation and enforcement of PRC
intellectual property laws historically have not been vigorous or consistent,
primarily because of ambiguities in the PRC laws and a relative lack of
developed enforcement mechanisms. Accordingly, intellectual property rights
and confidentiality protections in the PRC are not as effective as in the United
States and other countries. Policing the unauthorized use of proprietary
technology is difficult and expensive, and we might need to resort to litigation
to enforce or defend patents issued to us or to determine the enforceability,
scope and validity of our proprietary rights or those of others. Such litigation
will require significant expenditures of cash and management efforts and could
harm our business, financial condition and results of operations. An adverse
determination in any such litigation will impair our intellectual property
rights and may harm our business, competitive position, business prospects and
reputation. In addition, since we have chosen to secure patents only in China,
we may not be in a position to protect our inventions and technology in other
countries in which we sell our product, which could result in increased
competition and lower pricing for our products.





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 revenues are
derived from our operations in China. Accordingly, our results of operations and
prospects are subject, to a significant extent, to economic, political and legal
developments in China.





While
China’s economy has experienced significant growth in the past 30 years, it 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 government control over capital investments or changes in tax
regulations.


40





The
economy of China has been changing from a planned economy to a more
market-oriented economy. In recent years, the Chinese government has implemented
measures emphasizing market forces for economic reform, reduction of state
ownership of productive assets, and 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.





PRC
laws and regulations governing our current business operations are sometimes
vague and uncertain and any changes in such laws and regulations may harm our
business.





There are
substantial uncertainties regarding the interpretation and application of PRC
laws and regulations including, but not limited to, the laws and regulations
governing our business, and the enforcement and performance of our arrangements
with customers in the event of the imposition of statutory liens, death,
bankruptcy and criminal proceedings. We are considered foreign persons or
foreign funded enterprises under PRC laws and, as a result, we are required to
comply with PRC laws and regulations. These laws and regulations are sometimes
vague and may be subject to future changes, and their official interpretation
and enforcement may involve substantial uncertainty. The effectiveness of newly
enacted laws, regulations or amendments may be delayed, resulting in detrimental
reliance. New laws and regulations that affect existing and proposed future
businesses may also be applied retroactively. We cannot predict what effect the
interpretation of existing or new PRC laws or regulations may have on our
business.





Inflation
in the PRC could negatively affect our profitability and growth.





The PRC
economy has experienced rapid growth. Rapid economic growth could lead to growth
in the money supply and rising inflation. If prices for our products rise at a
rate that is insufficient to compensate for the rise in the cost of supplies, it
may harm our profitability. In order to control inflation in the past, the PRC
government has imposed controls on bank credit, limits on loans for fixed assets
and restrictions on state bank lending. Such policies can lead to a slowing of
economic growth. In October 2004, the People’s Bank of China, the PRC’s central
bank, raised interest rates for the first time in nearly a decade and indicated
in a statement that the measure was prompted by inflationary concerns in the
Chinese economy. Repeated rises in interest rates by the central bank would
likely slow economic activity in China which could, in turn, materially increase
our costs and also reduce demand for our products.





PRC
regulations relating to mergers, offshore companies, and Chinese stockholders,
if applied to us, may limit our ability to operate our business as we see
fit.





Regulations
govern the process by which we may participate in an acquisition of assets or
equity interests. Depending on the structure of the transaction, the new
regulation will require Chinese parties to make a series of applications and
supplemental applications to various government agencies. In some instances, the
application process may require the presentation of economic data concerning a
transaction, including appraisals of the target business and evaluations of the
acquirer, which are designed to allow the government to assess the
transaction. Government approvals will have expiration dates by which a
transaction must be completed and reported to the government agencies.
Compliance with the new regulations is likely to be more time consuming and
expensive than in the past and the government can now exert more control over
the combination of two businesses. Accordingly, due to the PRC regulations, our
ability to engage in business combination transactions in China through our
Chinese subsidiaries has become significantly more complicated, time consuming
and expensive, and we may not be able to negotiate transactions that are
acceptable to us or sufficiently protective of our interests in a
transaction.





If
preferential tax concessions granted by the PRC government change or expire, our
financial results and results of operations could be materially and adversely
affected.





Our
results of operation may be adversely affected by changes to or expiration of
preferential tax concessions that our Chinese subsidiaries currently enjoy. The
statutory tax rate generally applicable to domestic Chinese companies was 33%
before January 1, 2008. On January 1, 2008, the new Chinese Enterprise Income
Tax (“EIT”) law replaced the existing laws for Domestic Enterprises (“DES”),
such as Weihai Tech Full Simo Motor Co. Ltd. and Xi’an Tech Full Simo Motor Co.,
Ltd., and Foreign Invested Enterprises (“FIEs”), such as Harbin Tech Full
Electric Co., Ltd., Shanghai Tech Full Electric Co., Ltd., and Advanced
Automation Group Shanghai, Ltd. The new standard EIT rate of 25% is now
applicable to both DES and FIEs. The PRC government provides reduced tax rates
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.  These preferential tax
rates are generally graduated, starting at 0% and increasing to the standard EIT
rate of 25% over time.  Our operations under Harbin Tech Full Electric
Co., Ltd. were subject to a 10% preferential tax rate until December 31, 2010.
Our operations under Shanghai Tech Full Electric Co., Ltd. were subject to 0%
preferential tax rate in 2009 and is subject to 11% in 2010. Our operations
under Xi’an Tech Full Simo Motor Co., Ltd. were subject to a 15% preferential
tax rate. As a result, the estimated tax savings for the three months ended
March 31, 2010, and 2009 amounted to $3,120,440 and $1,305,422,
respectively. Tax laws in China are subject to interpretations by relevant
tax authorities. Preferential tax rates 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.


41





Fluctuation
in the value of the RMB may have a material adverse effect on your
investment.





The value
of RMB against the U.S. dollar and other currencies may fluctuate and is
affected by, among other things, changes in political and economic conditions.
Our revenues and costs are mostly denominated in RMB. Any significant
fluctuation in value of RMB may materially and adversely affect our cash flows,
revenues, earnings and financial position, and the value of our stock in U.S.
dollars. For example, an appreciation of RMB against the U.S. dollar would make
any new RMB denominated investments or expenditures more costly to us, to the
extent that we need to convert U.S. dollars into RMB for such purposes. 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.





We
must comply with the Foreign Corrupt Practices Act.





We are
required to comply with the United States Foreign Corrupt Practices Act, which
prohibits U.S. companies from engaging in bribery or other prohibited payments
to foreign officials for the purpose of obtaining or retaining business. Foreign
companies, including some of our competitors, are not subject to these
prohibitions. Corruption, extortion, bribery, pay-offs, theft and other
fraudulent practices occur from time-to-time in mainland China. If our
competitors engage in these practices, they may receive preferential treatment
from personnel of some companies, giving our competitors an advantage in
securing business or from government officials who might give them priority in
obtaining new licenses, which would put us at a disadvantage. Although the
Company educates  our employees not to engage in these illegal
practices, we can not assure you that our employees or other agents will not
engage in such conduct for which we might be held responsible. If our employees
or other agents are found to have engaged in such practices, we could suffer
severe penalties.





The
Chinese government exerts substantial influence over the manner in which we must
conduct our business activities.





Our
ability to operate in China may be harmed by changes in its laws and
regulations, including those related to taxation, environmental regulations,
land use rights, property and other matters. We believe that our operations in
China are in material compliance with all applicable legal and regulatory
requirements. However, the central or local governments of these jurisdictions
may impose new, stricter regulations or interpretations of existing regulations
that would require additional expenditures and efforts on our part to ensure our
compliance with such regulations and interpretations. Government actions in
the future, including any decision not to continue to support recent economic
reforms and to return to a more centrally planned economy or regional or local
variations in the implementation of economic policies, could have a significant
effect on economic conditions in China or particular regions thereof, and could
require us to divest ourselves of any interest we then hold in Chinese
properties.





We
are subject to environmental laws and regulations in the PRC.





We are
subject to environmental laws and regulations in the PRC. Any failure by us to
comply fully with such laws and regulations will result in us being subject to
penalties and fines or being required to pay damages. Although we believe we are
currently in compliance with the environmental regulations in all material
respects, any change in the regulations may require us to acquire equipment or
incur additional capital expenditure or costs in order to comply with such
regulations. Our profits will be adversely affected if we are unable to pass on
such additional costs to our customers.





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 over and enforce liabilities
against our officers, directors and assets based in the PRC.





Because
most of 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 a
U.S. court.


42


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.





RISKS
ASSOCIATED WITH OUR COMMON STOCK




Our
common stock may be affected by limited trading volume and may fluctuate
significantly.




Our
common stock is traded on the Nasdaq Global Select Market. Although an active
trading market has developed for our common stock, there can be no assurance
that an active trading market for our common stock will be sustained. Failure to
maintain an active trading market for our common stock may adversely affect our
stockholders’ ability to sell our common stock in short time periods, or at
all. In addition, sales of substantial amounts of our common stock in the public
market could harm the market price of our common stock. Our common stock has
experienced, and may experience in the future, significant price and volume
fluctuations, which could adversely affect the market price of our common
stock.





We
do not anticipate paying cash dividends on our common stock in the foreseeable
future.




We do not
anticipate paying cash dividends in the foreseeable future. Presently, we intend
to retain all of our earnings, if any, to finance development and expansion of
our business. The Indenture pursuant to which the Notes were issued prohibits us
from paying any dividends on our capital stock while the Notes remain
outstanding. PRC capital and currency regulations may also limit our ability to
pay dividends. Consequently, the only opportunity for investors to achieve a
positive return on your investment in us will be if the market price of our
common stock appreciates.





Our
directors and officers control approximately one third of our common stock and,
as a result, they may exercise some 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, beneficially owned, as a group, approximately 35.08% of our issued
and outstanding common stock as of March 31, 2010. This 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 one or several controlling stockholders. Furthermore, our directors
and officers, as a group, have the ability to significantly influence
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.





Your
percentage ownership in us may be diluted by future issuances of capital stock,
which could reduce your influence over matters on which stockholders
vote.




Subject
to any applicable stockholder approval requirements imposed by the Nasdaq Stock
Market, our board of directors has the authority to issue all or any part of our
authorized but unissued shares of common stock. Issuances of common stock would
reduce your influence over matters on which our stockholders
vote.





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





None.





Item 3. Defaults upon Senior
Securities




None.




Item 4. Removed and
Reserved







43


Item 5. Other
Information




The
Company hereby supplements the biographical information of Boyd Plowman, an
independent director of the Company, previously contained in the Company’s
Annual Report on Form 10-K for its fiscal year ended December 31, 2009 to
include the following information that was inadvertently omitted. On March 9,
2009, Fleetwood Enterprises, Inc. (“Fleetwood”) a company at which, Boyd
Plowman, was employed from 1969 until 1987 and from 1997 until his retirement in
September 2008 and where he served as Executive Vice President and Chief
Financial Officer, filed a voluntary Chapter 11 petition for itself and for
certain of its subsidiaries in the U.S. Bankruptcy Court for the Central
District of California.





Item 6. Exhibits.




The
exhibits listed on the Exhibit Index are being furnished with this
report.


44




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:
      May 10, 2010
              By:
              /s/ Tianfu
  YangTianfu
      YangChief
      Executive Officer, Director and Chairman of the Board
                (Principal
      Executive Officer)




Date:
      May 10, 2010
              By:
              /s/ Zedong XuZedong
      XuChief
      Financial Officer
                (Principal
      Accounting Officer)


45




EXHIBIT
INDEX





Exhibits:




Exhibit Number
                  
                  Description
                  
                  Method of Filing31.1
                  
                  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
      dated May 10, 2010 - announcing the Company’s results of operations
      for the first quarter of 2010.
                  
                  Filed
      herewith as Exhibit
99.1.




46