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 September 30, 2009




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




For the
transition period from ________ to ________




Commission
file number   000-51006




HARBIN
ELECTRIC, INC.


(Exact
name of 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. Yesx  Noo




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). Yeso  Noo





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 filero
            Accelerated
      filer x
            Non-accelerated
      filer oSmaller
      reporting companyo




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





APPLICABLE
ONLY TO CORPORATE ISSUERS




State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of November 6, 2009: 30,803,651 shares of common stock, par value $0.00001
per share.













TABLE
OF CONTENTS




PagePart
      I. Financial InformationItem
      1. Financial Statements
              
              1Consolidated
      Balance Sheets As of September 30, 2009 (Unaudited) and December 31,
      2008
              
              1Consolidated
      Statements of Income and Other Comprehensive Income For the Three Months
      and Nine Months Ended September 30, 2009 and 2008
    (Unaudited)
              
              2Consolidated
      Statements of Shareholders’ Equity (Unaudited)
              
              3Consolidated
      Statements of Cash Flows For the Nine Months Ended September 30, 2009 and
      2008 (Unaudited)
              
              4Notes
      to the Consolidated Financial Statements (Unaudited)
              
              5Item
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
              
              33Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
              
              42Item
      4. Controls and Procedures
              
              43Part
      II. Other InformationItem
      1. Legal Proceedings
              
              43Item
      1A. Risk Factors
              
              43Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
              
              47Item
      3. Defaults upon Senior Securities
              
              47Item
      4. Submission of Matters to a Vote of Securities Holders
              
              48Item
      5. Other Information
              
              48Item
      6. Exhibits
              
              48Signatures
              
              49Index
      to Exhibits
              
              50









PART
I. FINANCIAL INFORMATION




Item
1. Financial Statements


HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 
 
 CONSOLIDATED
BALANCE SHEETS
 AS OF
SEPTEMPER 30, 2009 (UNAUDITED) AND DECEMBER 31, 2008


September 30,
                            
                            
                            December 31,2009
                            
                            
                            2008(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                            
                            $
                            154,890,100
                            
                            
                            $
                            48,412,263Restricted
      cash
                            
                            
                            1,026,900
                            
                            
                            
                            513,450Notes
      receivable
                            
                            
                            566,356
                            
                            
                            
                            1,451,977Accounts
      receivable, net of allowance for doubtful accounts of $ 697,602 and
      $153,155 as of September 30, 2009 and December 31, 2008,
      respectively
                            
                            
                            36,446,837
                            
                            
                            
                            30,284,080Inventories
                            
                            
                            12,638,401
                            
                            
                            
                            21,960,084Other
      receivables & prepaid expenses
                            
                            
                            232,203
                            
                            
                            
                            248,552Advances
      on inventory purchases
                            
                            
                            2,858,528
                            
                            
                            
                            3,529,607Total
      current assets
                            
                            
                            208,659,325
                            
                            
                            
                            106,400,013PLANT
      AND EQUIPMENT, net
                            
                            
                            99,735,468
                            
                            
                            
                            94,931,999OTHER
      ASSETS:Debt
      issuance costs, net
                            
                            
                            500,223
                            
                            
                            
                            1,672,279Advances
      on equipment purchases
                            
                            
                            10,817,565
                            
                            
                            
                            10,416,187Advances
      on intangible assets
                            
                            
                            4,207,356
                            
                            
                            
                            1,892,430Goodwill
                            
                            
                            12,273,778
                            
                            
                            
                            12,273,778Other
      intangible assets, net of accumulated amortization
                            
                            
                            5,642,260
                            
                            
                            
                            6,430,397Other
      assets
                            
                            
                            748,832
                            
                            
                            
                            471,220Deposit
      in derivative hedge
                            
                            
                            -
                            
                            
                            
                            1,000,000Total
      other assets
                            
                            
                            34,190,014
                            
                            
                            
                            34,156,291Total
      assets
                            
                            $
                            342,584,807
                            
                            
                            $
                            235,488,303LIABILITIES AND SHAREHOLDERS'
      EQUITYCURRENT
      LIABILITIES:Notes
      payable - short term
                            
                            $
                            2,053,800
                            
                            
                            $
                            1,026,900Accounts
      payable
                            
                            
                            9,022,153
                            
                            
                            
                            8,415,919Short
      term loan – bank
                            
                            
                            4,254,300
                            
                            
                            
                            4,180,950Other
      payables & accrued Liabilities
                            
                            
                            1,750,848
                            
                            
                            
                            2,789,792Customer
      deposits
                            
                            
                            1,581,701
                            
                            
                            
                            1,244,622Taxes
      payable
                            
                            
                            2,844,079
                            
                            
                            
                            2,096,521Interest
      payable
                            
                            
                            39,089
                            
                            
                            
                            800,954Cross
      currency hedge payable
                            
                            
                            -
                            
                            
                            
                            175,986Current
      portion of notes payable, net of debt discount of $2,173,797 and
      $4,420,129 as of September 30, 2009 and December 31, 2008,
      respectively
                            
                            
                            6,926,203
                            
                            
                            
                            1,979,871Total
      current liabilities
                            
                            
                            28,472,173
                            
                            
                            
                            22,711,515LONG
      TERM LIABILITIES:Amounts
      due to original shareholder
                            
                            
                            733,500
                            
                            
                            
                            733,500Notes
      payable, net of debt discount of $0 and $7,969,005 as of September 30,
      2009 and December 31, 2008, respectively
                            
                            
                            -
                            
                            
                            
                            31,630,995Fair
      value of derivative instrument
                            
                            
                            -
                            
                            
                            
                            5,762,958Warrant
      liability
                            
                            
                            3,586,948
                            
                            
                            
                            -Total
      liabilities
                            
                            
                            32,792,621
                            
                            
                            
                            60,838,968COMMITMENTS
      AND CONTINGENCIESSHAREHOLDERS'
      EQUITY:Common
      Stock, $0.00001 par value, 100,000,000 shares authorized, 30,803,651 and
      22,102,078 shares issued and outstanding as of September 30, 2009 and
      December 31, 2008, respectively
                            
                            
                            308
                            
                            
                            
                            220Paid-in-capital
                            
                            
                            216,942,057
                            
                            
                            
                            95,029,290Retained
      earnings
                            
                            
                            56,243,099
                            
                            
                            
                            52,100,479Statutory
      reserves
                            
                            
                            17,900,660
                            
                            
                            
                            14,573,994Accumulated
      other comprehensive income
                            
                            
                            18,706,062
                            
                            
                            
                            12,945,352Total
      shareholders' equity
                            
                            
                            309,792,186
                            
                            
                            
                            174,649,335Total
      liabilities and shareholders' equity
                            
                            $
                            342,584,807
                            
                            
                            $
                            235,488,303





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


-1-


HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
 FOR THE
THREE MONTHS AND NINE MONTHS ENDED SEPTEMBPER 30, 2009 AND 2008
 (UNAUDITED)





Three Months Ended September 30,
                    
                    
                    Nine Months Ended September 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008REVENUES
                    
                    $
                    46,932,031
                    
                    
                    $
                    39,659,669
                    
                    
                    $
                    116,020,408
                    
                    
                    $
                    86,076,927COST
      OF SALES
                    
                    
                    30,170,797
                    
                    
                    
                    25,887,701
                    
                    
                    
                    75,472,120
                    
                    
                    
                    50,089,348GROSS
      PROFIT
                    
                    
                    16,761,234
                    
                    
                    
                    13,771,968
                    
                    
                    
                    40,548,288
                    
                    
                    
                    35,987,579RESEARCH
      AND DEVELOPMENT EXPENSE
                    
                    
                    468,309
                    
                    
                    
                    130,360
                    
                    
                    
                    1,270,111
                    
                    
                    
                    414,731SELLING,
      GENERAL AND  ADMINISTRATIVE EXPENSES
                    
                    
                    3,249,281
                    
                    
                    
                    3,122,419
                    
                    
                    
                    9,393,121
                    
                    
                    
                    8,193,199INCOME
      FROM OPERATIONS
                    
                    
                    13,043,644
                    
                    
                    
                    10,519,189
                    
                    
                    
                    29,885,056
                    
                    
                    
                    27,379,649OTHER
      EXPENSE (INCOME), NETOther
      income, net
                    
                    
                    (1,062,650
                    )
                    
                    
                    (707,993
                    )
                    
                    
                    (3,702,914
                    )
                    
                    
                    (955,182
                    )Interest
      expense, net
                    
                    
                    8,478,316
                    
                    
                    
                    2,058,543
                    
                    
                    
                    10,762,228
                    
                    
                    
                    5,536,054Loss
      on cross currency hedge settlement
                    
                    
                    9,000,000
                    
                    
                    
                    -
                    
                    
                    
                    9,000,000
                    
                    
                    
                    -Gain
      on debt extinguishment
                    
                    
                    (4,155,000
                    )
                    
                    
                    -
                    
                    
                    
                    (4,155,000
                    )
                    
                    
                    -Change
      in fair value of warrant
                    
                    
                    736,546
                    
                    
                    
                    -
                    
                    
                    
                    12,177,915
                    
                    
                    
                    -Total
      other expense, net
                    
                    
                    12,997,212
                    
                    
                    
                    1,350,550
                    
                    
                    
                    24,082,229
                    
                    
                    
                    4,580,872INCOME
      BEFORE PROVISION FOR INCOME TAXES
                    
                    
                    46,432
                    
                    
                    
                    9,168,639
                    
                    
                    
                    5,802,827
                    
                    
                    
                    22,798,777PROVISION
      FOR INCOME TAXES
                    
                    
                    1,954,396
                    
                    
                    
                    1,414,971
                    
                    
                    
                    4,475,821
                    
                    
                    
                    3,460,930NET
      (LOSS) INCOME
                    
                    
                    (1,907,964
                    )
                    
                    
                    7,753,668
                    
                    
                    
                    1,327,006
                    
                    
                    
                    19,337,847OTHER
      COMPREHENSIVE INCOME (LOSS)Foreign
      currency translation adjustment
                    
                    
                    292,230
                    
                    
                    
                    400,094
                    
                    
                    
                    (2,248
                    )
                    
                    
                    8,755,781Change
      in fair value of derivative instrument
                    
                    
                    3,322
                    
                    
                    
                    4,359,163
                    
                    
                    
                    (3,237,042
                    )
                    
                    
                    4,109,529OTHER
      COMPREHENSIVE INCOME, NET
                    
                    
                    295,552
                    
                    
                    
                    4,759,257
                    
                    
                    
                    (3,239,290
                    )
                    
                    
                    12,865,310COMPREHENSIVE  (LOSS)
      INCOME
                    
                    $
                    (1,612,404
                    )
                    
                    $
                    12,512,925
                    
                    
                    $
                    (1,912,284
                    )
                    
                    $
                    32,203,157(LOSS)
      EARNINGS PER SHARE:Basic
                    
                    $
                    (0.07
                    )
                    
                    $
                    0.35
                    
                    
                    $
                    0.06
                    
                    
                    $
                    0.99Diluted
                    
                    $
                    (0.07
                    )
                    
                    $
                    0.34
                    
                    
                    $
                    0.06
                    
                    
                    $
                    0.92WEIGHTED
      AVERAGE NUMBER OF SHARESBasic
                    
                    
                    27,076,669
                    
                    
                    
                    21,981,374
                    
                    
                    
                    23,861,950
                    
                    
                    
                    19,619,000Diluted
                    
                    
                    27,076,669
                    
                    
                    
                    23,075,834
                    
                    
                    
                    24,024,172
                    
                    
                    
                    20,911,930





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


-2-





HARBIN
ELECTRIC, INC. AND SUBSIDIARIES




CONSOLIDATED
STATEMENTS OF SHAREHOLDERS' EQUITY




Common stock
                                    
                                    
                                    Additional
                                    
                                    
                                    Retained earnings
                                    
                                    
                                    Accumulated otherPar
                                    
                                    
                                    paid-in
                                    
                                    
                                    Unrestricted
                                    
                                    
                                    Statutory
                                    
                                    
                                    comprehensiveShares
                                    
                                    
                                    value
                                    
                                    
                                    capital
                                    
                                    
                                    earnings
                                    
                                    
                                    reserves
                                    
                                    
                                    income (loss)
                                    
                                    
                                    TotalBALANCE,
      January 1, 2008
                                    
                                    
                                    18,143,156
                                    
                                    
                                    $
                                    181
                                    
                                    
                                    $
                                    44,970,589
                                    
                                    
                                    $
                                    32,281,312
                                    
                                    
                                    $
                                    9,014,462
                                    
                                    
                                    $
                                    (1,649,969
                                    )
                                    
                                    $
                                    84,616,575Exercise
      of stock warrants at $3.50
                                    
                                    
                                    322,298
                                    
                                    
                                    
                                    3
                                    
                                    
                                    
                                    1,128,040
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,128,043Exercise
      of stock options at $3.10
                                    
                                    
                                    36,624
                                    
                                    
                                    
                                    1
                                    
                                    
                                    
                                    77,499
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    77,500Stock
      issuance for cash at $14.13
                                    
                                    
                                    3,500,000
                                    
                                    
                                    
                                    35
                                    
                                    
                                    
                                    46,290,708
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    46,290,743Stock
      based compensation
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,368,688
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,368,688Net
      income
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    19,337,847
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    19,337,847Adjustment
      to statutory reserve
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (7,243,568
                                    )
                                    
                                    
                                    7,243,568
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Foreign
      currency translation gain
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    8,755,781
                                    
                                    
                                    
                                    8,755,781Net
      change related to cash flow hedge
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    4,109,529
                                    
                                    
                                    
                                    4,109,529BALANCE,
      September 30, 2008 (unaudited)
                                    
                                    
                                    22,002,078
                                    
                                    
                                    
                                    220
                                    
                                    
                                    
                                    93,835,524
                                    
                                    
                                    
                                    44,375,591
                                    
                                    
                                    
                                    16,258,030
                                    
                                    
                                    
                                    11,215,341
                                    
                                    
                                    
                                    165,684,706Exercise
      of stock warrants at $7.80
                                    
                                    
                                    100,000
                                    
                                    
                                    
                                    1
                                    
                                    
                                    
                                    779,999
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    780,000Stock
      based compensation
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    413,766
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    413,766Net
      income
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    6,040,852
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    6,040,852Adjustment
      to statutory reserve
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,684,036
                                    
                                    
                                    
                                    (1,684,036
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Foreign
      currency translation gain
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    758,126
                                    
                                    
                                    
                                    758,126Net
      change related to cash flow hedge
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    971,885
                                    
                                    
                                    
                                    971,885BALANCE,
      December 31, 2008
                                    
                                    
                                    22,102,078
                                    
                                    
                                    
                                    221
                                    
                                    
                                    
                                    95,029,289
                                    
                                    
                                    
                                    52,100,479
                                    
                                    
                                    
                                    14,573,994
                                    
                                    
                                    
                                    12,945,352
                                    
                                    
                                    
                                    174,649,335Cumulative
      effect of reclassificationof
      warrants
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (13,613,718
                                    )
                                    
                                    
                                    6,142,280
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (7,471,438
                                    )BALANCE,
      January 1, 2009as
      adjusted
                                    
                                    
                                    22,102,078
                                    
                                    
                                    
                                    221
                                    
                                    
                                    
                                    81,415,571
                                    
                                    
                                    
                                    58,242,759
                                    
                                    
                                    
                                    14,573,994
                                    
                                    
                                    
                                    12,945,352
                                    
                                    
                                    
                                    167,177,897Exercise
      of stock warrants at $7.80
                                    
                                    
                                    1,428,846
                                    
                                    
                                    
                                    14
                                    
                                    
                                    
                                    26,152,124
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    26,152,138Stock
      based compensation
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    827,218
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    827,218Cashless
      exercise of warrant at $7.80
                                    
                                    
                                    85,227
                                    
                                    
                                    
                                    1
                                    
                                    
                                    
                                    1,055,266
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,055,267Stock
      issuance for cash at $16
                                    
                                    
                                    7,187,500
                                    
                                    
                                    
                                    72
                                    
                                    
                                    
                                    107,491,878
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    107,491,950Net
      income
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,327,006
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,327,006Adjustment
      to statutory reserve
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (3,326,666
                                    )
                                    
                                    
                                    3,326,666
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Foreign
      currency translation gain
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (2,248
                                    )
                                    
                                    
                                    (2,248
                                    )Net
      change related to cash flow hedge
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (3,237,042
                                    )
                                    
                                    
                                    (3,237,042
                                    )Reclassification
      of change in cash flow hedge to earnings
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    9,000,000
                                    
                                    
                                    
                                    9,000,000BALANCE,
      September 30, 2009 (unaudited)
                                    
                                    
                                    30,803,651
                                    
                                    
                                    $
                                    308
                                    
                                    
                                    $
                                    216,942,057
                                    
                                    
                                    $
                                    56,243,099
                                    
                                    
                                    $
                                    17,900,660
                                    
                                    
                                    $
                                    18,706,062
                                    
                                    
                                    $
                                    309,792,186




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


-3-


HARBIN
ELECTRIC, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR THE
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


(UNAUDITED)





2009
                      
                      
                      2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                      
                      $
                      1,327,006
                      
                      
                      $
                      19,337,847Adjustments
      to reconcile net income to cashprovided
      by (used in) operating activities:Depreciation
                      
                      
                      1,943,019
                      
                      
                      
                      1,124,953Amortization
      of intangible assets
                      
                      
                      818,118
                      
                      
                      
                      757,959Amortization
      of debt issuance costs
                      
                      
                      1,172,056
                      
                      
                      
                      480,455Amortization
      of debt discount
                      
                      
                      10,215,337
                      
                      
                      
                      3,557,014Gain
      on debt extinguishment
                      
                      
                      (4,155,000
                      )
                      
                      
                      -Realized
      loss on extinguishment of derivative liability
                      
                      
                      9,000,000
                      
                      
                      
                      -Gain
      on derivative instrument
                      
                      
                      -
                      
                      
                      
                      (318,131
                      )Share-based
      compensation
                      
                      
                      827,218
                      
                      
                      
                      1,368,688Bad
      debt expense
                      
                      
                      544,040
                      
                      
                      
                      -Change
      in fair value of warrants
                      
                      
                      12,177,915
                      
                      
                      
                      -Change
      in operating assets and liabilitiesNotes
      receivable
                      
                      
                      884,957
                      
                      
                      
                      (489,321
                      )Accounts
      receivable
                      
                      
                      (6,702,093
                      )
                      
                      
                      (5,422,500
                      )Inventories
                      
                      
                      9,314,625
                      
                      
                      
                      1,616,743Other
      receivables & prepaid expenses
                      
                      
                      16,337
                      
                      
                      
                      4,090,907Other
      receivables - related parties
                      
                      
                      -
                      
                      
                      
                      (3,364
                      )Advances
      on inventory purchases
                      
                      
                      670,580
                      
                      
                      
                      1,549,898Other
      assets
                      
                      
                      (277,487
                      )
                      
                      
                      (155,561
                      )Accounts
      payable
                      
                      
                      604,793
                      
                      
                      
                      294,195Other
      payables & accrued liabilities
                      
                      
                      (1,037,449
                      )
                      
                      
                      (2,943,839
                      )Other
      payables - related party
                      
                      
                      -
                      
                      
                      
                      (47,572
                      )Customer
      deposits
                      
                      
                      336,826
                      
                      
                      
                      (283,885
                      )Taxes
      payable
                      
                      
                      746,996
                      
                      
                      
                      311,387Interest
      payable
                      
                      
                      (976,940
                      )
                      
                      
                      (1,122,000
                      )Net
      cash  provided by operating activities
                      
                      
                      37,450,854
                      
                      
                      
                      23,703,873CASH
      FLOWS FROM INVESTING ACTIVITIES:Cash
      acquired through acquisition
                      
                      
                      -
                      
                      
                      
                      5,077,545Payment
      for advances on intangible assets
                      
                      
                      (2,313,190
                      )
                      
                      
                      -Payment
      for advances on equipment purchases
                      
                      
                      (401,077
                      )
                      
                      
                      (2,330,053
                      )Purchase
      of intangible assets
                      
                      
                      (30,571
                      )
                      
                      
                      (258
                      )Purchase
      of plant and equipment
                      
                      
                      (758,515
                      )
                      
                      
                      (19,761,402
                      )Additions
      to construction-in-progress
                      
                      
                      (5,945,269
                      )
                      
                      
                      -Payment
      to original shareholders for acquisition
                      
                      
                      -
                      
                      
                      
                      (49,850,250
                      )Net
      cash used in investing activities
                      
                      
                      (9,448,622
                      )
                      
                      
                      (66,864,418
                      )CASH
      FLOWS FROM FINANCING ACTIVITIES:Increase
      in restricted cash
                      
                      
                      (513,065
                      )
                      
                      
                      (2,517,605
                      )Proceeds
      from stock issuance
                      
                      
                      107,491,950
                      
                      
                      
                      46,290,743Proceeds
      received from conversion of warrants and options
                      
                      
                      11,144,999
                      
                      
                      
                      1,205,543Decrease
      in deposit to secure investment in cross currency hedge
                      
                      
                      1,000,000
                      
                      
                      
                      -Payment
      of cross currency hedge
                      
                      
                      (9,000,000
                      )
                      
                      
                      -Proceeds
      from cross currency hedge
                      
                      
                      -
                      
                      
                      
                      145,945Payment
      on notes payable
                      
                      
                      (32,745,000
                      )
                      
                      
                      (4,000,000
                      )Proceeds
      from notes payable-short term
                      
                      
                      4,098,656
                      
                      
                      
                      -Payment
      on notes payable-short term
                      
                      
                      (3,072,526
                      )
                      
                      
                      -Proceeds
      from short term loan
                      
                      
                      4,251,110
                      
                      
                      
                      -Payment
      of short term loan
                      
                      
                      (4,177,815
                      )
                      
                      
                      (716,850
                      )Net
      cash provided by financing activities
                      
                      
                      78,478,309
                      
                      
                      
                      40,407,776EFFECTS
      OF EXCHANGE RATE CHANGE ON CASH
                      
                      
                      (2,704
                      )
                      
                      
                      1,994,144INCREASE
      (DECREASE) IN CASH
                      
                      
                      106,477,837
                      
                      
                      
                      (758,625
                      )Cash
      and cash equivalents, beginning of period
                      
                      
                      48,412,263
                      
                      
                      
                      45,533,893Cash
      and cash equivalents, end of period
                      
                      $
                      154,890,100
                      
                      
                      $
                      44,775,268




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




-4-




HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Note
1 - Basis of Presentation
 
 References
herein to “we,” “us,” “our,” the “Company” and “Harbin Electric” refer to Harbin
Electric, Inc, and its consolidated subsidiaries unless the context specifically
requires otherwise.
 
 Harbin
Electric 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 the other international
markets. The consolidated financial statements of Harbin Electric reflect the
activities of the following subsidiaries.  All
material intercompany transactions have been eliminated.
  Place incorporated
                        
                        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.
                        
                        Shanghai,
      China
                        
                        
                        100
                        %Shanghai
      Tech Full Electric Co., Ltd. (“STFE”)
                        
                        Shanghai,
      China
                        
                        
                        100
                        %Weihai
      Tech Full Simo Motors Co., Ltd. (“Weihai”)
                        
                        Weihai,
      China
                        
                        
                        100
                        %
 
 Since
Weihai was acquired in July 2008, its operating results are reflected in the
consolidated balance sheets as of December 31, 2008, and for the three months
and nine months ended September 30, 2009 and for the three months ended
September 30, 2008.
  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 2008 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, 2008, included in our Annual Report on Form 10-K
filed with the SEC.
  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 September 30, 2009, and our consolidated results
of operations and cash flows for the three and nine months ended
September 30, 2009 and 2008. The results of operations for the three and
nine months ended September 30, 2009 are not necessarily indicative of the
results to be expected for future quarters or the full
year.
  -5-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Note
2 - Summary of Significant Accounting Policies
 
 Use of
estimates
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. For
example, the Company estimates the fair value of its derivative instrument using
the discounted cash flow method. The Company also estimates the fair value of
options using subjective assumptions including estimated length of time
employees will retain their options before exercising them, forfeitures, and
expected volatility of Company’s stock price over the expected term. Changes in
these assumptions materially affect the estimated fair value and the resulting
expense. Actual results could differ from management’s estimates.
 
 Concentration of
risks
 
 The
Company considers all highly liquid investments with original maturities of
three months or less at the time of purchase to be cash equivalents, for cash
flow statement purposes.  Cash includes cash on hand and demand
deposits in accounts maintained with state owned banks within the People’s
Republic of China (“PRC”) and 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 September 30, 2009 and December
31, 2008, the Company had deposits in excess of federally insured limits
totaling $155,203,999 and $47,783,767, 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.
 
 Two major
customers accounted for approximately 31% of the net revenue for the nine months
ended September 30, 2009, with each customer individually accounting for 18% and
13%, respectively. At September 30, 2009, the total receivable balance due from
these customers was $21,913,836, representing 59% of total accounts receivable.
Three major customers accounted for 49% of the net revenue for the nine months
ended September 30, 2008, with each customer individually accounted for 19%, 17%
and 13%, respectively. At September 30, 2008, the total receivable balance due
from these customers was $26,558,664, representing 77% of total accounts
receivable.
 
 Four
major vendors provided approximately 74% of the Company’s purchases of raw
materials for the nine months ended September 30, 2009, with each vendor
individually accounting for 40%, 13%, 11%, and 10%, respectively.  Two
major vendors provided 37% of the Company’s purchase of raw materials for the
nine months ended September 30, 2008, with each vendor individually accounting
for 22% and 15%, respectively. The Company’s accounts payable to these vendors
was $3,227 and $0 at September 30, 2009 and 2008, respectively.
  -6-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 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 represents 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.
 
 Accounts
receivable
 
 During
the normal course of business, the Company extends unsecured credit to its
customers.  Management periodically 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 determine if the allowance for doubtful accounts is
adequate.  An estimate for doubtful accounts is made when collection
of the full amount is no longer probable.  Known bad debts are written
off against allowance for doubtful accounts when identified. The Company’s
existing reserve is consistent with its historical experience and considered
adequate by management.
 
 Inventories
 
 Inventory
is composed of raw material for manufacturing electrical motors, work in process
and finished goods. Inventory is valued at the lower of cost or market value
using the weighted average method. Management compares the cost of inventory
with the market value and an allowance is made for writing down the inventory to
its market value, if lower than cost.
 
 Plant and
equipment
 
 Plant and
equipment are stated at cost. Expenditures for maintenance and repairs are
charged to earnings as incurred; additions, renewals and betterments are
capitalized. When assets are retired or otherwise disposed of, the related cost
and accumulated depreciation are removed from the respective accounts, and any
gain or loss is included in operations. Depreciation of plant and equipment is
provided using the straight-line method for substantially all assets with
estimated lives as follows:
  -7-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Estimated Useful LifeBuildings
                    20
      yearsVehicle
                    5
      yearsOffice
      equipment
                    5
      yearsProduction
      equipment
                    10
      years
 
 Construction
in progress represents the costs incurred in connection with the construction of
buildings or new additions to the Company’s plant facilities.  No
depreciation is provided for construction in progress until such time as the
assets are completed and placed into service. 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 its
review, the Company believes that, as of September 30, 2009 there were no
impairments of its long-lived assets.
 
 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 an indicator of
impairment arises.
 
 Land use
rights - all land in the People’s Republic of China is government
owned.  However, the government grants “land use
rights”.  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.
 
 The
Company evaluates intangible assets for impairment, at least annually and
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable from its estimated future cash flows. Recoverability of
intangible assets, other long-lived assets, and goodwill is measured by
comparing their net book value to the related projected undiscounted cash flows
from these assets, considering a number of factors including past operating
results, budgets, economic projections, market trends and product development
cycles. If the net book value of the asset exceeds the related undiscounted cash
flows, the asset is considered impaired, and a second test is performed to
measure the amount of impairment loss. As of September 30, 2009, management
believes there was no impairment.
  -8-
 
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 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, if 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 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. 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.
  -9-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Shipping
and handling costs are included in selling, general and administrative costs and
totaled $618,070 and $529,030 for the three months ended September 30, 2009
and 2008, respectively, and $1,567,634 and $962,917 for the nine months ended
September 30, 2009, and 2008, respectively.
 
 Income
taxes
  The
Company reports income taxes pursuant to FASB’s accounting standard for income
taxes. Under  the asset and liability method of accounting for income taxes
as required by this accounting standard, 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.  FASB’s accounting standard for accounting for uncertainty
in income taxes 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.  $137,122 and $0 was recorded as deferred tax amounts as
of September 30, 2009 and December 31, 2008, respectively.
 
 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 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 and 15% beginning January 1, 2011. Hengda is currently at a
25% income tax rate.
  -10-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 The
Company’s subsidiaries were paying the following tax rate for the three months
and nine months ended:
  September 30, 2009
                            (Unaudited)
                          
                          
                          September 30, 2008
                            (Unaudited)Subsidiaries
                          
                          Income Tax
                            Exemption
                          
                          
                          Effective
                            Income
                            Tax Rate
                          
                          
                          Income Tax
                            Exemption
                          
                          
                          Effective
                            Income
                            Tax RateHTFE
                          
                          
                          15
                          %
                          
                          
                          10
                          %
                          
                          
                          15
                          %
                          
                          
                          10
                          %Weihai
                          
                          
                          -
                          %
                          
                          
                          25
                          %
                          
                          
                          -
                          % (a)
                          
                          
                          25
                          % (a)
 
 (a)
Weihai was acquired in July 2008 and the tax rate only applied to its
results of operations included in the consolidated financial statements, which
is the three-month period ended September 30, 2008.
 
 The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the three months ended September 30:
  2009
                        
                        
                        2008U.S.
      Statutory rates
                        
                        
                        34
                        %
                        
                        
                        34
                        %Foreign
      income not recognized in USA
                        
                        
                        -34
                        
                        
                        
                        -34China
      income taxes
                        
                        
                        25
                        
                        
                        
                        25China
      income tax exemption
                        
                        
                        -14
                        
                        
                        
                        -14Other
      item (b)
                        
                        
                        4,198
                        
                        
                        
                        4Effective
      income taxes
                        
                        
                        4,209
                        %
                        
                        
                        15
                        %
 
 (b)  The
4198 % and 4%  represents the $15,803,904 and $2,750,771 of expenses
incurred by Harbin Electric and its subsidiaries AEM and AAG that are not
subject to PRC income tax for the three months ended September 30, 2009 and
2008, respectively.
 
 The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the nine months ended September 30:
  2009
                  
                  
                  2008U.S.
      Statutory rates
                  
                  
                  34
                  %
                  
                  
                  34
                  %Foreign
      income not recognized in USA
                  
                  
                  -34
                  
                  
                  
                  -34China
      income taxes
                  
                  
                  25
                  
                  
                  
                  25China
      income tax exemption
                  
                  
                  -14
                  
                  
                  
                  -15Other
      item (c)
                  
                  
                  66
                  
                  
                  
                  5Effective
      income taxes
                  
                  
                  77
                  %
                  
                  
                  15
                  %
 
 (c)  The
66 % and 5% represent the $30,941,952 and $9,587,833 of expenses incurred
by Harbin Electric and its subsidiaries AEM and AAG that are not subject to PRC
income tax for the nine months ended September 30, 2009 and 2008,
respectively.
  -11-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 The
estimated tax savings for the three months ended September 30, 2009 and 2008
amounted to $2,111,267 and $1,482,029, respectively. The net effect on earnings
per share had the income tax been applied would decrease earnings per share from
$(0.07) to $(0.14) in 2009 and $0.35 to $0.28 in 2008.
 
 The
estimated tax savings for the nine months ended September 30, 2009 and 2008
amounted to $4,973,700 and $4,652,412, respectively. The net effect on earnings
per share had the income tax been applied would decrease earnings per share from
$0.06 to $(0.15) in 2009 and $0.99 to $0.75 in 2008,
respectively.
 
 Harbin
Electric, Inc., Advanced Electric Motors, Inc. and Advanced Automation Group,
LLC were organized in the United States and have incurred net operating losses
for income tax purposes for the nine months ended September 30,
2009.  The net operating loss carry forwards for United States income
taxes amounted to $27,366,726 which may be available to reduce future years’
taxable income.  These carry forwards will expire, if not utilized,
from 2024 through 2029.  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 nine months
ended September 30, 2009 was an decrease of approximately $551,941.
Management will review this valuation allowance periodically and make
adjustments accordingly.
 
 The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $ 111,690,248 as of September 30, 2009, 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.
 
 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 $18,237,779 and $10,740,918 for the nine
months ended September 30, 2009 and $14,853,031 and $9,563,848 for the same
period of 2008, respectively. VAT on sales and VAT on purchases amounted to
$5,542,376 and $3,154,460 for the three months ended September 30, 2009 and
$7,986,221 and $5,843,987 for the same period of 2008,
respectively.  Sales and purchases are recorded net of VAT collected
and paid as the Company acts as an agent for the government.
  -12-
 
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Taxes
payable consisted of the following:
 
 September 30,
                      2009
                      (Unaudited)
                    
                    
                    December 31,
                      2008VAT
      tax payable
                    
                    $
                    1,193,486
                    
                    
                    $
                    1,019,771Individual
      income tax payable
                    
                    
                    9,368
                    
                    
                    
                    4,281Corporation
      income tax payable
                    
                    
                    1,557,618
                    
                    
                    
                    956,583Other
      miscellaneous tax payable
                    
                    
                    83,607
                    
                    
                    
                    115,886Total
                    
                    $
                    2,844,079
                    
                    
                    $
                    2,096,521
 
 Advertising
costs
 
 The
Company expenses the cost of advertising as incurred in selling, general and
administrative costs. The Company incurred $10,983 and $176 for the three
months ended September 30, 2009 and 2008, respectively. The
Company incurred $68,088 and $6,105 for the nine months ended September 30, 2009
and 2008, respectively.
 
 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. 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
September 30, 2009, the outstanding principal on the Company’s note payable,
evaluated under these accounting standards, amounted to $6,926,203.
 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.
  -13-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Effective
January 1, 2009, 2,030,158 warrants previously treated as equity pursuant
to the derivative treatment exemption are 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
Renminbi.  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.
 
 As such,
effective January 1, 2009, 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 $7.5
million to warrant liabilities to recognize the fair value of such warrants. In
May 2009, 234,615 warrants were exercised through cashless
conversion.  In August of 2009, another 1,428,846 warrants were
exercised.  As of September 30, 2009, the Company has 366,697 warrants
outstanding. The fair value of the outstanding warrants was approximately $3.6
million.  The Company recognized approximately $12.2 million of
loss from the change in fair value of the warrants for the nine months ended
September 30, 2009 and $0.7 million of loss from change in fair value of the
same amount of warrants for the three months ended September 30, 2009,
respectively.
 
 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:
 
 September 30, 2009
                      
                      
                      January 1, 2009(Unaudited)Annual
      dividend yield
                      
                      
                      -
                      
                      
                      
                      -Expected
      life (years)
                      
                      
                      2.92
                      
                      
                      
                      3.67Risk-free
      interest rate
                      
                      
                      1.41
                      %
                      
                      
                      1.20
                      %Expected
      volatility
                      
                      
                      70
                      %
                      
                      
                      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.
 
 Carrying
                                  Value as of
                                  September 30,
                                  2009
                                
                                Fair Value Measurements at September 30, 2009
                                  Using Fair Value Hierarchy(Unaudited)
                                
                                Level 1
                                
                                Level 2
                                
                                Level 3Fair
      value of warrant liabilities
                                
                                $
                                3,586,948
                                
                                
                                
                                $
                                3,586,948
  -14-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 A summary
of warrant activity for the nine months ended September 30, 2009 is
provided elsewhere in this footnote and in Note 14.  Other than
the derivative instruments, the Company did not identify any assets and
liabilities that are required to be presented on the balance sheet at fair
value.
 
 Derivative
instrument
 
 The
Company uses 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 FASB’s
accounting standards related to Derivative Instruments and Hedging Activities 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.
 
 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.  For the nine months ended
September 30, 2009, $9 million was transferred from accumulated other
comprehensive income to other expenses due to termination of currency
hedge.
 
 Foreign currency
transactions
 
 The
reporting currency of the Company is the US dollar.  The functional
currency of PRC subsidiaries is the Chinese Renminbi. The financial statements
of PRC subsidiaries are translated to United States dollars using quarter-end
exchange rates as to assets and liabilities and average exchange rates as to
revenues, expenses and cash flows.  Capital accounts are translated at
their historical exchange rates when the capital transaction
occurred.  Translation adjustments resulting from this process are
included in accumulated other comprehensive income in the statement of
shareholders’ equity.  Transaction gains and losses that arise from
exchange rate fluctuations on transactions denominated in a currency other than
the functional currency are included in the results of operations as
incurred.
  -15-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Translation
adjustments resulting from this process amounted to a loss of $(2,248) and
a gain of $8,755,781 for the nine months ended September 30, 2009 and 2008,
respectively.  The balance sheet amounts with the exception of equity
at September 30, 2009 were translated 6.84 RMB to $1.00 as compared to 6.82 RMB
at December 31, 2008.  The equity accounts were stated at their
historical exchange rate.  The average translation rates applied to
the income and cash flow statement amounts for the nine months ended September
30, 2009 and 2008 were 6.84 RMB and 7.00 RMB to $1.00,
respectively.
  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. Transaction gain of $432,657 and loss of
$(465,560) were recognized during three months ended September 30, 2009 and
2008. The amount has recorded in the statement of operations during the period,
respectively. Transaction gain of $227,967 and loss of $(465,560) were
recognized during nine months ended September 30, 2009 and 2008,
respectively.
 
 Note
3 – Recent Accounting Pronouncements
 
 In
December 2007, the FASB issued revised business combinations guidance. The
revised guidance retains the fundamental requirements of the previous guidance
in that the acquisition method of accounting be used for all business
combinations, that an acquirer be identified for each business combination and
for goodwill to be recognized and measured as a residual. The revised guidance
expands the definition of transactions and events that qualify as business
combinations to all transactions and other events in which one entity obtains
control over one or more other businesses. The revised guidance broadens the
fair value measurement and recognition of assets acquired, liabilities assumed
and interests transferred as a result of business combinations..The guidance
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. The Company has adopted the guidance and believes that
if the Company consummated a business combination transaction, the Company’s
adoption of the guidance would have a material impact on the consolidated
financial statements.
 
 In
January 2009, the FASB issued an accounting standard which amended the
impairment model by removing its exclusive reliance on “market participant”
estimates of future cash flows used in determining fair value. Changing the cash
flows used to analyze other-than-temporary impairment from the “market
participant” view to a holder’s estimate of whether there has been a “probable”
adverse change in estimated cash flows allows companies to apply reasonable
judgment in assessing whether an other-than-temporary impairment has occurred.
The adoption of this accounting standard did not have a material impact on the
Company’s consolidated financial statements because all of the investments in
debt securities are classified as trading securities.
 
 In April
2009, the FASB issued authoritative guidance related to the determination of
fair value when the volume and level of activity for an asset or liability has
significantly decreased, the identification of transactions that are not
orderly, the recognition and presentation of other-than-temporary impairments,
and the disclosure of the fair value of financial instruments on an interim
basis. The adoption of the guidance 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
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 In April
2009, the FASB issued an accounting standard to make the other-than-temporary
impairments guidance more operational and to improve the presentation of
other-than-temporary impairments in the financial statements. This standard will
replace the existing requirement that the entity’s management assert it has both
the intent and ability to hold an impaired debt security until recovery with a
requirement that management assert it does not have the intent to sell the
security, and it is more likely than not it will not have to sell the security
before recovery of its cost basis. This standard provides increased disclosure
about the credit and noncredit components of impaired debt securities that are
not expected to be sold and also requires increased and more frequent
disclosures regarding expected cash flows, credit losses, and an aging of
securities with unrealized losses. Although this standard does not result in a
change in the carrying amount of debt securities, it does require that the
portion of an other-than-temporary impairment not related to a credit loss for a
held-to-maturity security be recognized in a new category of other comprehensive
income and be amortized over the remaining life of the debt security as an
increase in the carrying value of the security. This standard became effective
for interim and annual periods ending after June 15, 2009. The adoption of
this standard did not have a material impact on the Company’s consolidated
financial statements.
 
 In April
2009, the FASB issued an accounting standard that requires disclosures about
fair value of financial instruments not measured on the balance sheet at fair
value in interim financial statements as well as in annual financial statements.
Prior to this accounting standard, fair values for these assets and liabilities
were only disclosed annually. This standard applies to all financial instruments
within its scope and requires all entities to disclose the method(s) and
significant assumptions used to estimate the fair value of financial
instruments. This standard does not require disclosures for earlier periods
presented for comparative purposes at initial adoption, but in periods after the
initial adoption, this standard requires comparative disclosures only for
periods ending after initial adoption. The adoption of this standard did not
have a material impact on the disclosures related to its consolidated financial
statements.
 
 In May
2009, the FASB an accounting standard which provides guidance to establish
general standards of accounting for and disclosures of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. The standard also requires entities to disclose the date
through which subsequent events were evaluated as well as the rationale for
why that date was selected. The standard is effective for interim and annual
periods ending after June 15, 2009, and accordingly, the Company adopted
this Standard during the second quarter of 2009. The standard requires that
public entities evaluate subsequent events through the date that the
financial statements are issued.
 
 In June
2009, the FASB issued an accounting standard amending the accounting and
disclosure requirements for transfers of financial assets. This accounting
standard requires greater transparency and additional disclosures for transfers
of financial assets and the entity’s continuing involvement with them and
changes the requirements for derecognizing financial assets. In addition, it
eliminates the concept of a qualifying special-purpose entity (“QSPE”). This
accounting standard is effective for financial statements issued for fiscal
years beginning after November 15, 2009. The Company has not completed the
assessment of the impact this new standard will have on the Company’s
financial condition, results of operations or cash flows.
  -17-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 In June
2009, the FASB also issued an accounting standard amending the accounting and
disclosure requirements for the consolidation of variable interest entities
(“VIEs”). The elimination of the concept of a QSPE, as discussed above, removes
the exception from applying the consolidation guidance within
this accounting standard. Further, this accounting standard requires a
company to perform a qualitative analysis when determining whether or not it
must consolidate a VIE. It also requires a company to continuously reassess
whether it must consolidate a VIE. Additionally, it requires enhanced
disclosures about a company’s involvement with VIEs and any significant
change in risk exposure due to that involvement, as well as how its involvement
with VIEs impacts the company’s financial statements. Finally, a company will be
required to disclose significant judgments and assumptions used to determine
whether or not to consolidate a VIE. This accounting standard is effective
for financial statements issued for fiscal years beginning after November 15,
2009.  The Company has not completed their assessment of the
impact that this pronouncement will have on the Company’s financial condition,
results of operations or cash flows.
 
 In June
2009, the FASB issued an accounting standard which establishes the FASB
Accounting Standards CodificationTM (the “Codification”) as the source of
authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
conformity with U.S. GAAP. The Codification does not change current U.S.
GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by
providing all the authoritative literature related to a particular topic in
one place. The Codification is effective for interim and annual periods ending
after September 15, 2009, and as of the effective date, all existing
accounting standard documents will be superseded. The Codification is effective
for the Company in the third quarter of 2009, and accordingly, the
Company’s Quarterly Report on Form 10-Q for the quarter ending September 30,
2009 and all current and subsequent public filings will reference
the Codification as the sole source of authoritative
literature.
 
 In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. This ASU is effective for the
first reporting period, including interim periods, beginning after the issuance
of this ASU. The adoption of this ASU did not have a material impact on the
Company’s consolidated financial statements.
 
 In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning
of those fiscal years. The Company is currently evaluating the impact of
this ASU on its consolidated financial statements.
  -18-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Note
4 – Inventories
  The
following is a summary of Inventories by major category:
 
 September 30,
                      
                      
                      December 31,2009
                        (Unaudited)
                      
                      
                      2008Raw
      and packing materials
                      
                      $
                      3,985,418
                      
                      
                      $
                      2,702,417Work
      in process
                      
                      
                      3,837,483
                      
                      
                      
                      7,978,350Finished
      goods
                      
                      
                      4,815,500
                      
                      
                      
                      11,279,317Total
                      
                      $
                      12,638,401
                      
                      
                      $
                      21,960,084
 
 Note
5 – Plant and equipment
  The
following table presents details of our property and equipment:
 
 September 30,
                        
                        
                        December 31,2009
                        
                        
                        2008(Unaudited)Buildings
                        
                        $
                        26,450,313
                        
                        
                        $
                        26,440,241Office
      equipment
                        
                        
                        1,015,897
                        
                        
                        
                        925,372Production
      equipment
                        
                        
                        8,571,235
                        
                        
                        
                        7,908,020Vehicles
                        
                        
                        1,474,782
                        
                        
                        
                        1,472,593Construction
      in progress
                        
                        
                        67,084,561
                        
                        
                        
                        61,095,712Total
                        
                        
                        104,596,788
                        
                        
                        
                        97,841,938Less:
      accumulated depreciation
                        
                        
                        (4,861,320
                        )
                        
                        
                        (2,909,939
                        )Property
      and equipment, net
                        
                        $
                        99,735,468
                        
                        
                        $
                        94,931,999
 
 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 Harbin manufacture
plant.  The Company expects the Shanghai plant to be completed on or
before the end of year 2010.
  Depreciation
expense for the three months ended September 30, 2009 and 2008 amounted to
$655,509 and $691,247, respectively. Depreciation expense for the nine
months ended September 30, 2009 and 2008 amounted to $1,943,019 and
$1,124,593, respectively.
 
 As of
September 30, 2009 and December 31, 2008, a total of $6,605,485 and
$3,634,014, of interest was capitalized into construction in progress,
respectively.
  -19-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Note 6 – Goodwill and other
intangible assets
 
 Net
intangible assets consist of the following at September 30, 2009
and December 31, 2008:
 
 September 30,
                            2009
                          
                          
                          December 31,
                            2008(Unaudited)Goodwill
                          
                          $
                          12,273,778
                          
                          
                          $
                          12,273,778Land
      use rights
                          
                          
                          1,543,206
                          
                          
                          
                          1,531,202Patents
                          
                          
                          6,629,028
                          
                          
                          
                          6,629,028Less:
      accumulated amortization
                          
                          
                          (2,529,974
                          )
                          
                          
                          (1,729,833
                          )Intangible
      assets, net
                          
                          $
                          17,916,038
                          
                          
                          $
                          18,704,175
 
 Amortization
expense for the three months ended September 30, 2009 and 2008 amounted to
$293,158 and $252,442, respectively. Amortization expense for the nine
months ended September 30, 2009 and 2008 amounted to $818,118 and $757,959,
respectively.
 
 Note
7 – Advance for intangible assets
 
 The
advances for intangible assets consisted of land use right prepayment. As of
September 30, 2009 and December 31, 2008, advances for intangible assets
amounted to $4,207,356 and $1,892,430, 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 (RMB42,840,000)
("Fee"), approximately 67% or $4.21 million (RMB 21,320,000) has been paid as of
September 30, 2009  with the remaining balance payable in installments
This investment amount includes fees, improvement costs, constructing a factory
building and installing necessary equipment. HTFE shall register a Sino-foreign
joint venture company at the location of Shanghai Lingang, with taxes payable at
the same location. HTFE has agreed to compensate Shanghai Lingang for certain
local taxes due to the local tax authority in connection with applicable tax
generation requirements.
  Note
8 – Additional product sales information
 
 The
Company has a single operating segment. The majority of the Company’s revenue
was generated from sales in PRC. Summarized financial information concerning the
Company’s revenues based on geographic areas for the three months and
nine months ended September 30, 2009 and 2008 are as
follows:
  -20-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Three Months ended September 30,2009
                      
                      
                      2008Unaudited
                      
                      
                      UnauditedGeographic
      AreaChina
                      
                      $
                      43,634,474
                      
                      
                      $
                      33,600,231International
                      
                      
                      3,297,557
                      
                      
                      
                      6,059,438Total
      sales
                      
                      
                      46,932,031
                      
                      
                      
                      39,659,669Cost
      of sales - China
                      
                      
                      28,331,369
                      
                      
                      
                      22,557,370Cost
      of sales - International
                      
                      
                      1,839,428
                      
                      
                      
                      3,330,331Total
      cost of sales
                      
                      
                      30,170,797
                      
                      
                      
                      25,887,701Gross
      profit
                      
                      $
                      16,761,234
                      
                      
                      $
                      13,771,968
 
 Nine Months ended September 30,2009
                  
                  
                  2008Unaudited
                  
                  
                  UnauditedGeographic
      AreaChina
                  
                  $
                  105,878,950
                  
                  
                  $
                  73,121,626International
                  
                  
                  10,141,458
                  
                  
                  
                  12,955,301Total
      sales
                  
                  
                  116,020,408
                  
                  
                  
                  86,076,927Cost
      of sales - China
                  
                  
                  69,776,860
                  
                  
                  
                  42,893,503Cost
      of sales - International
                  
                  
                  5,695,260
                  
                  
                  
                  7,195,845Total
      cost of sales
                  
                  
                  75,472,120
                  
                  
                  
                  50,089,348Gross
      profit
                  
                  $
                  40,548,288
                  
                  
                  $
                  35,987,579
 
 Note
9 – 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.
 
 The Notes
are governed by an indenture, dated August 30, 2006, entered into among the
Company, AEM as guarantor, and The Bank of New York, as trustee for the Notes
(the “Indenture”). Of the $50 million aggregate principal amount of the Notes,
Citadel subscribed to $38 million of the principal amount of the Notes, which
were scheduled to mature on September 1, 2012 (the “2012 Notes”), and
Merrill Lynch subscribed to $12 million of the principal amount of the Notes,
which were scheduled to mature on September 1, 2010 (the “2010 Notes”).
Pursuant to the indenture, AEM has agreed, and all of the Company’s other
existing and future subsidiaries (other than subsidiaries domiciled in the
People's Republic of China) are obligated, to guarantee, on a senior secured
basis, to the Investors and to the trustee the payment and performance of our
obligations under the Notes.
  -21-
 
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 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 bore an additional 4%
interest on any overdue principal and premium, if any, including interest on
overdue interest, to the extent permitted by law.
  The 2010
Notes were redeemable at the option of the Company, in whole but not in part, at
any time after September 1, 2007, initially at 106% of the principal amount
thereof and declining to 100% of the principal amount on September 1, 2009. The
2010 Notes were subject to mandatory redemption semi-annually commencing March
1, 2008 in the principal amount of $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 bear an additional 4%
interest on any overdue principal and premium, if any, including interest on
overdue interest, to the extent permitted by law. The 2012 Notes are redeemable
at the option of the Company, in whole but not in part, at any time after
September 1, 2007, initially at 106% of the principal amount thereof and
declining to 100% of the principal amount on September 1, 2011. The 2012 Notes
are subject to mandatory redemption semi-annually commencing September 1, 2009
in the principal amount $2,400,000 on September 1, 2009, $3,800,000 on March 1,
2010, $9,900,000 on September 1, 2010 and March 1, 2011, and $4,000,000 on
September 1, 2011, March 1, 2012 and September 1, 2012, in each instance at a
price equal to 100% of such principal amount. Holders of the 2012 Notes may
require the Company to repurchase such Notes at 100% of the principal amount
thereof at any time after September 1, 2011.
 
 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 Note
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 Note Repurchase and (ii) the Proposed 2012 Note
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 $606,997representing 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 on September 1, 2009, the 2012 Note balance
as of September 30, 2009 amounted to $9,100,000, which will be fully paid off in
2010.
  -22-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (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
long-term borrowings disclosed for each of the five years following September
30, 2009:
 
 Contractual Obligations
                  
                  2012 Notes
                  
                  
                  2010 Notes
                  
                  
                  Total2010
                  
                  $
                  9,100,000
                  
                  
                  $
                  -
                  
                  
                  $
                  9,100,000Thereafter
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  $
                  9,100,000
                  
                  
                  $
                  -
                  
                  
                  $
                  9,100,000
 
 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
nine months ended September 30, 2009, 234,615 of 2009 Warrants outstanding were
exercised by cashless transaction and 85,227 shares of common stock were issued
upon this exercise.  In addition, the remaining 1,428,846 of the
First Tranche 2012 Warrants were exercised at price of $7.80.
 
 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. $8,207,689 and $1,254,143 were
amortized to interest expense for the three months ended September 30, 2009 and
2008, respectively and $10,215,337 and $3,557,014 were amortized to interest
expense for the nine months ended September 30, 2009 and 2008,
respectively. The carrying value of the debt is as follows as
of September 30, 2009 and December 31, 2008:
  -23-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 September 30, 2009
                      
                      
                      December 31, 2008(Unaudited)Principal
      amount
                      
                      $
                      9,100,000
                      
                      
                      $
                      46,000,000Less
      unamortized discount
                      
                      
                      (2,173,797
                      )
                      
                      
                      (12,389,134
                      )Notes
      payable, net
                      
                      $
                      6,926,203
                      
                      
                      $
                      33,610,866
 
 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. $900,836 and $128,507 were amortized to interest expense for the
three months ended September 30, 2009 and 2008,
respectively.   $1,172,056 and $480,455 were amortized to
interest expense for the nine months ended September 30, 2009 and 2008,
respectively. As of September 30, 2009 and December 31, 2008, unamortized debt
issuance costs totaled $500,223 and $1,672,279, respectively.
 
 The
Company’s short term loan as of September 30, 2009 and December 31, 2008 are as
follows:
 
 September 30,
                                          2009
                                        
                                        
                                        December 31,
                                          2008(Unaudited)Loan
      from Agriculture Bank in city of Wendeng, due October 2009. Monthly
      interest-only payments at 8.36% per annum, secured by
    assets
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        3,007,350Loan
      from CITIC Bank in city of Wendeng, due June 2010. Monthly interest-only
      payments at 5.310% per annum, secured by assets
                                        
                                        
                                        3,080,300
                                        
                                        
                                        
                                        -Loan
      from Commercial Bank in city of Wendeng, due August 2009. Monthly
      interest-only payments at 7.47% per annum, guaranteed loan
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,173,600Loan
      from Commercial Bank in city of Wendeng, due August 2010. Monthly
      interest-only payments at 4.8675% per annum, guaranteed
    loan
                                        
                                        
                                        586,000
                                        
                                        
                                        
                                        -Loan
      from Commercial Bank in city of Wendeng, due September 2010. Monthly
      interest-only payments at 4.8675% per annum, guaranteed
    loan
                                        
                                        
                                        586,000
                                        
                                        
                                        
                                        -Total
      Short term loan - bank
                                        
                                        $
                                        4,254,300
                                        
                                        
                                        $
                                        4,180,950
  Net
interest expense for the nine months and three months ended September 30, 2009
and 2008 was comprised of the following:
  -24-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 For
      the nine months ended September 30,
                  
                  2009
                  
                  
                  2008Amortization
      of debt discount
                  
                  $
                  10,215,337
                  
                  
                  $
                  3,557,014Amortization
      of debt issuance costs
                  
                  
                  1,172,056
                  
                  
                  
                  480,457Interest
      expense
                  
                  
                  226,319
                  
                  
                  
                  1,997,550Interest
      earned on cash deposits
                  
                  
                  (623,517
                  )
                  
                  
                  (947,269
                  )Interest
      expense on derivative instrument
                  
                  
                  -
                  
                  
                  
                  448,302Foreign
      currency transaction gain
                  
                  
                  (227,967
                  )
                  
                  
                  -Interest
      expense, net
                  
                  $
                  10,762,228
                  
                  
                  $
                  5,536,054
 
 For
      the three months ended September 30,
                  
                  2009
                  
                  
                  2008Amortization
      of debt discount
                  
                  $
                  8,207,689
                  
                  
                  $
                  1,254,143Amortization
      of debt issuance costs
                  
                  
                  900,836
                  
                  
                  
                  128,509Interest
      expense
                  
                  
                  54,335
                  
                  
                  
                  572,331Interest
      earned on cash deposits
                  
                  
                  (251,887
                  )
                  
                  
                  (537,473
                  )Interest
      expense on derivative instrument
                  
                  
                  -
                  
                  
                  
                  641,033Foreign
      currency transaction loss
                  
                  
                  (432,657
                  )
                  
                  
                  -Interest
      expense, net
                  
                  $
                  8,478,316
                  
                  
                  $
                  2,058,543
 
 Note
10 – 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.
These exposures are managed, in part, with the use of a financial
derivative. 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 Renminbi 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 September 30, 2009 and 2008, gain of $3,322 and $4,359,163 was
recorded on the derivative instrument, respectively, in other comprehensive
income.  For the nine months ended September 30, 2009 and 2008,
($3,237,042) and $4,109,529 was recorded as (loss) gain on the derivative
instrument, respectively, in other comprehensive income.
 
 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 unwind with
$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.
  -25-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 During
the three months ended September 30, 2009, the Company recognized $556,500 of
loss from derivative transactions.  During the nine months ended
September 30, 2009, the Company paid $1,299,764 as hedging payment and the
Company recognized $1,123,778 of loss from derivative
transactions.
 
 Changes
of cross currency hedge are as follows:
 
 Cross
      currency hedge receivable balance at December 31,
2008
                  
                  $
                  175,986Proceeds
      from cross currency hedge
                  
                  
                  -Payments
      for cross currency hedge
                  
                  
                  (1,299,764
                  )Loss
      from derivative transactions
                  
                  
                  1,123,778Cross
      currency hedge payable balance at September 30, 2009
      (Unaudited)
                  
                  $
                  -
 
 Note
11 – Business combinations
 
 On July
10, 2008, the Company’s subsidiary HTFE entered into an Equity and Assets
Transfer Agreement (the “Agreement”) with respect to the acquisition by HTFE of
Weihai Tech Full Simo Motors Co., Ltd., a PRC corporation (“Weihai”) for an
aggregate price of approximately $54.7 million (RMB 375 million), payable
in cash. In
connection with the acquisition of Weihai by Harbin Tech Full, an independent
third party appraiser was engaged by Harbin Tech Full to perform an appraisal of
certain of the assets of Weihai to be acquired by the Company. The assets
evaluated included fixed assets (equipment and buildings), construction in
progress, and intangible assets (land-use rights). The appraiser conducted an
on-site visit, inspected each item, conducted market research and investigation,
followed some asset evaluation policies and regulations issued by the Chinese
government, and provided an evaluation report. The Company’s management also
performed an internal evaluation, taking into account of the appraiser’s
evaluation report, to determine the fair value of these assets reported in the
financial statements.  For current assets, the management used the adjusted
book value. Based on this evaluation, the management determined that the
purchase price exceeded the fair value of Weihai’s net assets by $12.3 million,
which was recognized as goodwill. The
results of operations of the acquired company is included in the
consolidated statement of income for the three months and nine months
ended September 30, 2009 and in the consolidated statement of income for the
three months ended September 30, 2008.
 
 Amounts
due to original shareholders represent the unpaid portion for the acquisition of
Weihai As of September 30, 2009, HTFE had payables of $733,500 (RMB 5 million),
which will be paid within two years from the acquisition date.
 
 The
following table summarizes the net book value and the fair value of the assets
acquired and liabilities assumed at the date of acquisition:
 
 Net Book Value
                    
                    
                    Fair
      ValueCurrent
      assets
                    
                    $
                    43,572,481
                    
                    
                    $
                    43,572,481Property,
      plant and equipment, net
                    
                    
                    22,350,703
                    
                    
                    
                    22,350,703Other
      noncurrent assets
                    
                    
                    1,201,828
                    
                    
                    
                    1,201,828Goodwill
                    
                    
                    -
                    
                    
                    
                    12,273,778Total
      assets
                    
                    
                    67,125,012
                    
                    
                    
                    79,398,790Total
      liabilities
                    
                    
                    24,590,248
                    
                    
                    
                    24,590,248Net
      assets
                    
                    $
                    42,534,764
                    
                    
                    $
                    54,808,542
  -26-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Pro
Forma
 
 The
following unaudited pro forma condensed income statement for the nine and three
months ended September 30, 2009 and 2008 were prepared under generally accepted
accounting principles, as if the acquisition of Hengda 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 nine months ended September 30,
                                  
                                  2009
                                  
                                  2008Sales
                                  
                                  $
                                  116,020,408
                                  
                                  $
                                  110,342,355Cost
      of Goods Sold
                                  
                                  
                                  75,472,120
                                  
                                  
                                  70,990,219Gross
      Profit
                                  
                                  
                                  40,548,288
                                  
                                  
                                  39,352,136Operating
      Expenses
                                  
                                  
                                  10,663,232
                                  
                                  
                                  9,406,616Income
      from Operations
                                  
                                  
                                  29,885,056
                                  
                                  
                                  29,945,520Other
      expense, net
                                  
                                  
                                  24,082,229
                                  
                                  
                                  2,591,587Income
      Tax
                                  
                                  
                                  4,475,821
                                  
                                  
                                  4,601,720Net
      Income
                                  
                                  $
                                  1,327,006
                                  
                                  $
                                  22,752,213
 
 Note
12 – Commitments and contingencies
 
 The
Company enters into non-cancelable purchase commitments with its vendors. As of
September 30, 2009 and December 31, 2008, the Company was obligated under the
non cancelable commitments to purchase materials totaling to $3,437,762 and
$305,100, respectively.  These commitments are short-term and expire
within one year.  The Company has experienced no losses on these
purchase commitments over the years.
 
 On April
9, 2009, 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 September 30, 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 67% or $4.2 million (RMB 28.7
million) of which has been paid with the balance payable in installments. The
amount paid is recorded as advances on intangible assets for $4,207,356 and
$1,481,670 as of September 30, 2009 and December 31, 2008,
respectively.
  -27-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Note
13 – 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:
 
 For
      the three months ended September 30:
                    
                    2009
                    
                    
                    2008Net
      (loss) income for basic and diluted earnings per
share
                    
                    $
                    (1,907,964
                    )
                    
                    $
                    7,753,668Weighted
      average shares used in basic computation
                    
                    
                    27,076,669
                    
                    
                    
                    21,981,374Diluted
      effect of stock options and warrants
                    
                    
                    -
                    
                    
                    
                    1,094,460Weighted
      average shares used in diluted computation
                    
                    
                    27,076,669
                    
                    
                    
                    23,075,834(Loss)
      Earnings per share:Basic
                    
                    $
                    (0.07
                    )
                    
                    $
                    0.35Diluted
                    
                    $
                    (0.07
                    )
                    
                    $
                    0.34
 
 2009
                
                
                2008Net
      income for basic and diluted earnings per share
                
                $
                1,327,006
                
                
                $
                19,337,847Weighted
      average shares used in basic computation
                
                
                23,861,950
                
                
                
                19,619,000Diluted
      effect of stock options and warrants
                
                
                162,222
                
                
                
                1,292,930Weighted
      average shares used in diluted computation
                
                
                24,024,172
                
                
                
                20,911,930Earnings
      per share:Basic
                
                $
                0.06
                
                
                $
                0.99Diluted
                
                $
                0.06
                
                
                $
                0.92
 
 For the
three months ended September 30, 2009, a total of 260,000 options were excluded
from diluted earnings per share due to the anti-dilutive effect. All other stock
options and warrants have been included in the diluted earnings per share
calculation.  For the nine months ended September 30, 2009, a total of
260,000 options were excluded from diluted earnings per share due to the
anti-dilutive effect. All other stock options and warrants have been included in
the diluted earnings per share calculation.
 
 Note
14 – Shareholders’ equity
 
 Common
stock
 
 On August
5, 2009, the Company closed an offering of 6,250,000 shares of its common stock
at a public offering price of $16.00 per share. The Company received net
proceeds of approximately $93.4 million from the offering, after deducting
underwriting discounts and estimated offering expenses.
  -28-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 On August
17, 2009, the Company issued an additional 937,500 shares of common stock at the
public offering price of $16.00 per share, pursuant to the over-allotment option
exercised in full by Roth Capital Partners, LLC in connection with its public
offering that closed on August 4, 2009. The exercise of the over-allotment
option brings the total number of shares sold by the Company in this public
offering to 7,187,500 and the total gross proceeds to $115 million. The
aggregate net proceeds received by the Company totaled approximately $107.5
million, after deducting underwriting discounts and commissions and offering
expenses payable by the Company.
 
 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
nine months ended September 30, 2009, the Company transferred $3,326,666
representing 10% of the current quarter’s 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 $34.6 million
and $25.4 million as of September 30, 2009 and December 31, 2008,
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.
  -29-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Warrants
 
 Following
is a summary of warrant activity:
 
 Outstanding
      as of January 1, 2008
                    
                    
                    2,454,960Granted
                    
                    
                    -Forfeited
                    
                    
                    (2,504
                    )Exercised
                    
                    
                    (322,298
                    )Outstanding
      as of September 30, 2008 (Unaudited)
                    
                    
                    2,130,158Granted
                    
                    
                    -Forfeited
                    
                    
                    -Exercised
                    
                    
                    (100,000
                    )Outstanding
      as of December 31, 2008
                    
                    
                    2,030,158Granted
                    
                    
                    -Forfeited
                    
                    
                    -Cancelled
                    
                    
                    -Exercised
                    
                    
                    (1,663,461
                    )Outstanding
      as of September 30, 2009 (Unaudited)
                    
                    
                    366,697
 
 Following
is a summary of the status of warrants outstanding at September 30,
2009:
 
 Outstanding Warrants
                          
                          
                          Exercisable WarrantsExercise Price
                          
                          Number of Shares
                          
                          
                          Average
                            Remaining
                            Contractual Life
                          
                          
                          Average
                            Exercise Price
                          
                          
                          Number of Shares
                          
                          
                          Average
                            Remaining
                            Contractual Life$
                          10.84
                          
                          
                          366,697
                          
                          
                          
                          2.92
                          
                          
                          $
                          10.84
                          
                          
                          
                          366,697
                          
                          
                          
                          2.92Total
                          
                          
                          366,697
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          366,697
 
 Options
 
 Following
is a summary of stock option activity:
 
 Options
                    Outstanding
                  
                  
                  Weighted
                    Average
                    Exercise Price
                  
                  
                  Aggregate Intrinsic
                    ValueOutstanding
      as of January 1, 2008
                  
                  
                  761,250
                  
                  
                  $
                  9.69
                  
                  
                  $
                  12,370,313Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  (26,667
                  )
                  
                  
                  8.1
                  
                  
                  
                  -Exercised
                  
                  
                  (40,000
                  )
                  
                  
                  3.10
                  
                  
                  
                  -Outstanding
      as of September 30, 2008 (Unaudited)
                  
                  
                  694,583
                  
                  
                  $
                  10.27
                  
                  
                  $
                  1,097,441Granted
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      as of December 31, 2008
                  
                  
                  694,583
                  
                  
                  $
                  10.27
                  
                  
                  $
                  -Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  (25,000
                  )
                  
                  
                  12.40
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      as of September 30, 2009 (Unaudited)
                  
                  
                  669,583
                  
                  
                  $
                  10.19
                  
                  
                  $
                  4,479,510
  -30-
 
 HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Following
is a summary of the status of options outstanding at September 30,
2009:
 
 Outstanding Options
                          
                          
                          Exercisable OptionsExercise Price
                          
                          Number
                          
                          
                          Average
                            Remaining
                          
                          
                          Average Exercise
                            Price
                          
                          
                          Number
                          
                          
                          Average
                            Remaining$
                          3.10
                          
                          
                          110,000
                          
                          
                          
                          0.33
                          
                          
                          $
                          3.10
                          
                          
                          
                          110,000
                          
                          
                          
                          0.33$
                          8.10
                          
                          
                          299,583
                          
                          
                          
                          1.33
                          
                          
                          $
                          8.10
                          
                          
                          
                          299,583
                          
                          
                          
                          1.33$
                          15.60
                          
                          
                          260,000
                          
                          
                          
                          1.22
                          
                          
                          $
                          15.60
                          
                          
                          
                          156,000
                          
                          
                          
                          1.22Total
                          
                          
                          669,583
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          565,583
 
 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 September 30, 2009 and 2008, a total of $99,556 and $99,556
has been expensed and included in the stock compensation expenses,
respectively. For the nine months ended September 30, 2009 and 2008, a
total of $298,667 and $298,667 has been expensed and included in the stock
compensation expenses, respectively.
 
 For nine
months ended September 30, 2009 and 2008, stock compensation expense amounted to
$827,218 and $1,368,688, respectively.
 
 Note
15 – Supplemental disclosure of cash flows
 
 The
Company prepares its statements of cash flows using the indirect method as
defined under the FASB’s accounting standard. The following information relates
to non-cash activities for 2009 and 2008.
 
 Total
interest paid amounted to $11,050,500 and $3,216,311 for the nine months ended
September 30, 2009 and 2008, respectively.
 
 Total
income tax paid amounted to $3,503,929 and $3,288,915 for the nine months
ended September 30, 2009 and 2008, respectively.
  -31-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 (UNAUDITED)
 
 Note 16 –
Employee pension
 
 Regulations
in the People’s Republic of China require the Company to contribute to a defined
contribution retirement plan for all employees. The Company’s 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
China 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 $277,638 and $195,614 for the nine months ended
September 30, 2009 and 2008, respectively. The Company made contributions to
employment benefits, including pension, of $107,965 and $146,336 for the three
months ended September 30, 2009 and 2008, respectively.
 
 Note 17–
Subsequent Events
 
 On
October 2, 2009, HTFE entered into an Equity Acquisition Agreement (the
“Agreement”) with Xi’an Simo Electric Co. Ltd. (“the Company”) 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 profit s of Simo
Motor.  Pursuant to the Agreement, Harbin Tech Full shall be 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. 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.
 On
October 22, 2009, the Company utilized approximately $84 million (RMB
572,665,304) of the net cash proceeds from its public offering in August 2009 in
connection with its acquisition of Xi’an Tech Full Simo Motor Company, Ltd. The
Company may be required to make an additional cash purchase price payment within
seven months of the closing date of the acquisition.
 We have
performed an evaluation of subsequent events for the accompanying financial
statements and notes included through November 9, 2009, the date these
consolidated financial statements were issued, to determine whether the
circumstances warranted recognition and disclosure of those events or
transactions in the financial statements as of September 30,
2009.


-32-
  HARBIN
ELECTRIC, INC. AND SUBSIDIARIES
 
 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, 2008
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 oil services, factory automation, food processing, packaging
industries, logistic systems, mass transportation systems, petrochemical,
metallurgical, mining, textile, and agricultural industries. We supply domestic
China and other international markets. We operate three major manufacturing
facilities in China, covering approximately 240,000 meters of land, and have an
employee base of approximately 1800 engineers, production technicians and other
employees.
 
 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
 
 We use
estimates in determining our allowance for bad debts that are based on our
historical collection experience, current trends, credit policy and a percentage
of our accounts receivable by aging category. In determining these percentages,
we review historical write-offs in our receivables. In determining the
appropriate reserve percentages, we also review current trends in the credit
quality of our customers, as well as changes in our internal credit
policies.
 
 We
maintain reserves for potential credit losses on accounts receivable. Management
reviews the composition of accounts receivable and analyzes historical bad
debts, customer concentrations, customer credit worthiness, current economic
trends and changes in customer payment patterns to evaluate the adequacy of
these reserves. Reserves are recorded primarily on a specific identification
basis. Additional allowances for doubtful accounts may be required if there is
deterioration in past due balances, if economic conditions are less favorable
than anticipated, or for customer-specific circumstances, such as financial
difficulty. Delinquent account balances are written-off after management has
determined that the likelihood of collection is not probable, known bad
debts are written off against allowance for doubtful accounts when
identified.
 
 Inventories
  Inventory
levels are based on projections of future demand and market conditions.
Inventory is valued at the lower-of-cost-or-market using the weighted average
method. Management compares the cost of inventory with the market value and an
allowance is made for writing down the inventory to its market value, if lower
than cost. 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
inventory is written-down to the lower-of-cost-or-market, it is not marked up
subsequently based on changes in underlying facts and
circumstances.
  -33-
  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, we
require a binding purchase order or a signed agreement by our customer agreeing
to pay for and take possession of finished goods inventory parts for the
duration of the agreement.
  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, our 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 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.
 
 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, if actual forfeitures differ from those
estimates.  There were no estimated forfeitures as the Company has a
short history of issuing options.
 
 Derivative
Financial Instruments
 
 The
Company used a cross-currency interest rate swap to hedge its exposure under the
2012 Notes. The derivative is initially recognized in the balance sheet at cost
and subsequently re-measured at fair value each reporting period. Changes in the
fair values of derivatives accounted for as cash flow hedges, to the extent they
qualify for hedge accounting, are recorded in accumulated other comprehensive
income, net of deferred taxes; changes in fair values of derivative financial
instruments not qualifying as hedges are reported in income.
 
 At the
inception of a hedge transaction, the Company documents the relationship between
hedging instruments and hedged items, as well as its risk management objective
and the strategy for undertaking the hedge. 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 to hedge
are highly effective in offsetting changes in fair values or cash flows of
hedged items.
 
 The
Company terminated the cross-currency interest rate swap agreement during the
third quarter of 2009. Therefore, this derivative financial instrument is no
longer recognized in the quarterly financial statements as a liability beginning
in the third quarter of 2009.
 
 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.
  -34-
  New
accounting pronouncements adopted
 
 In
December 2007, the FASB issued revised business combinations guidance. The
revised guidance retains the fundamental requirements of the previous guidance
in that the acquisition method of accounting be used for all business
combinations, that an acquirer be identified for each business combination and
for goodwill to be recognized and measured as a residual. The revised guidance
expands the definition of transactions and events that qualify as business
combinations to all transactions and other events in which one entity obtains
control over one or more other businesses. The revised guidance broadens the
fair value measurement and recognition of assets acquired, liabilities assumed
and interests transferred as a result of business combinations..The guidance
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. The Company has adopted the guidance and believes that
if the Company consummated a business combination transaction, the Company’s
adoption of the guidance would have a material impact on the consolidated
financial statements.
 
 In
January 2009, the FASB issued an accounting standard which amended the
impairment model by removing its exclusive reliance on “market participant”
estimates of future cash flows used in determining fair value. Changing the cash
flows used to analyze other-than-temporary impairment from the “market
participant” view to a holder’s estimate of whether there has been a “probable”
adverse change in estimated cash flows allows companies to apply reasonable
judgment in assessing whether an other-than-temporary impairment has occurred.
The adoption of this accounting standard did not have a material impact on the
Company’s consolidated financial statements because all of the investments in
debt securities are classified as trading securities.
 
 In April
2009, the FASB issued authoritative guidance related to the determination of
fair value when the volume and level of activity for an asset or liability has
significantly decreased, the identification of transactions that are not
orderly, the recognition and presentation of other-than-temporary impairments,
and the disclosure of the fair value of financial instruments on an interim
basis. The adoption of the guidance did not have a material impact on the
Company’s consolidated financial statements.
 
 In April
2009, the FASB issued an accounting standard to make the other-than-temporary
impairments guidance more operational and to improve the presentation of
other-than-temporary impairments in the financial statements. This standard will
replace the existing requirement that the entity’s management assert it has both
the intent and ability to hold an impaired debt security until recovery with a
requirement that management assert it does not have the intent to sell the
security, and it is more likely than not it will not have to sell the security
before recovery of its cost basis. This standard provides increased disclosure
about the credit and noncredit components of impaired debt securities that are
not expected to be sold and also requires increased and more frequent
disclosures regarding expected cash flows, credit losses, and an aging of
securities with unrealized losses. Although this standard does not result in a
change in the carrying amount of debt securities, it does require that the
portion of an other-than-temporary impairment not related to a credit loss for a
held-to-maturity security be recognized in a new category of other comprehensive
income and be amortized over the remaining life of the debt security as an
increase in the carrying value of the security. This standard became effective
for interim and annual periods ending after June 15, 2009. The adoption of
this standard did not have a material impact on the Company’s consolidated
financial statements.
 
 In April
2009, the FASB issued an accounting standard that requires disclosures about
fair value of financial instruments not measured on the balance sheet at fair
value in interim financial statements as well as in annual financial statements.
Prior to this accounting standard, fair values for these assets and liabilities
were only disclosed annually. This standard applies to all financial instruments
within its scope and requires all entities to disclose the method(s) and
significant assumptions used to estimate the fair value of financial
instruments. This standard does not require disclosures for earlier periods
presented for comparative purposes at initial adoption, but in periods after the
initial adoption, this standard requires comparative disclosures only for
periods ending after initial adoption. The adoption of this standard did not
have a material impact on the disclosures related to its consolidated financial
statements.
 
 In May
2009, the FASB an accounting standard which provides guidance to establish
general standards of accounting for and disclosures of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. The standard also requires entities to disclose the date
through which subsequent events were evaluated as well as the rationale for
why that date was selected. The standard is effective for interim and annual
periods ending after June 15, 2009, and accordingly, the Company adopted
this Standard during the second quarter of 2009. The standard requires that
public entities evaluate subsequent events through the date that the
financial statements are issued.
 
 In June
2009, the FASB issued an accounting standard amending the accounting and
disclosure requirements for transfers of financial assets. This accounting
standard requires greater transparency and additional disclosures for transfers
of financial assets and the entity’s continuing involvement with them and
changes the requirements for derecognizing financial assets. In addition, it
eliminates the concept of a qualifying special-purpose entity (“QSPE”). This
accounting standard is effective for financial statements issued for fiscal
years beginning after November 15, 2009. The Company has not completed the
assessment of the impact this new standard will have on the Company’s
financial condition, results of operations or cash flows.
 
 In June
2009, the FASB also issued an accounting standard amending the accounting and
disclosure requirements for the consolidation of variable interest entities
(“VIEs”). The elimination of the concept of a QSPE, as discussed above, removes
the exception from applying the consolidation guidance within
this accounting standard. Further, this accounting standard requires a
company to perform a qualitative analysis when determining whether or not it
must consolidate a VIE. It also requires a company to continuously reassess
whether it must consolidate a VIE. Additionally, it requires enhanced
disclosures about a company’s involvement with VIEs and any significant
change in risk exposure due to that involvement, as well as how its involvement
with VIEs impacts the company’s financial statements. Finally, a company will be
required to disclose significant judgments and assumptions used to determine
whether or not to consolidate a VIE. This accounting standard is effective
for financial statements issued for fiscal years beginning after November 15,
2009.  The Company has not completed their assessment of the
impact that this pronouncement will have on the Company’s financial condition,
results of operations or cash flows.
  -35-
 
 In June
2009, the FASB issued an accounting standard which establishes the FASB
Accounting Standards CodificationTM (the “Codification”) as the source of
authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
conformity with U.S. GAAP. The Codification does not change current U.S.
GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by
providing all the authoritative literature related to a particular topic in
one place. The Codification is effective for interim and annual periods ending
after September 15, 2009, and as of the effective date, all existing
accounting standard documents will be superseded. The Codification is effective
for the Company in the third quarter of 2009, and accordingly, the
Company’s Quarterly Report on Form 10-Q for the quarter ending September 30,
2009 and all current and subsequent public filings will reference
the Codification as the sole source of authoritative
literature.
 
 In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. This ASU is effective for the
first reporting period, including interim periods, beginning after the issuance
of this ASU. The adoption of this ASU did not have a material impact on the
Company’s consolidated financial statements.
 
 In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The Company is currently evaluating the impact of this ASU on its
consolidated financial statements.
  RESULTS
OF OPERATIONS
 
 THREE
MONTHS ENDED SEPTEMBER 30, 2009
  Revenues
 
 For the
third quarter of 2009, total revenues were $46.93 million, compared with $39.66
million in the third quarter of 2008 and $38.36 million in the second quarter of
2009, reflecting an 18% growth year-over-year and 22% growth
sequentially.
 
 Compared
with the third quarter of 2008, the sales growth was driven by growth in linear
motor and industrial rotary motor business. Linear motor sales were up 18%
mainly due to significant higher sales of oil pumps to Daqing oil field, with
259 units sold versus 64 units in the third quarter of 2008. Higher
sales in oil pumps more than offset the sales decline in other linear motors and
related systems. Industrial rotary motor sales were up 37%, reflecting continued
strong demand in rotary motors.
  Compared
with the second quarter of 2009, total sales grew 22%, driven by a 42% growth in
linear motors and a 22% growth in the industrial rotary motor businesses, while
the sales in specialty micro-motors and other products remained relatively flat.
Robust sales in oil pumps were the major contributor to the sales growth of
linear motors (259 units of oil pumps in the third quarter of 2009 versus 105
units in the second quarter of 2009).
 
 International
sales totaled $3.30 million for the quarter, down 45% and 7% compared with $6.06
million and $3.58 million in the third quarter of 2008 and the second quarter of
2009, respectively, reflecting a slower recovery of economic activities in North
America.
 
 The
following table presents the revenue contribution by percentage for each major
product line in the third quarter of 2009 in comparison with the third
quarter of 2008 and the second quarter of 2009.
 
 
 Percent
      of Total Revenues (%)Product
      Line
                
                
                3Q09
                
                
                
                3Q08
                
                
                
                2Q09Linear
      Motors and Related Systems
                
                
                35.0
                %
                
                
                35.0
                %
                
                
                30.1
                %Specialty
      Micro-Motors
                
                
                18.0
                %
                
                
                23.0
                %
                
                
                22.3
                %Rotary
      Motors
                
                
                44.0
                %
                
                38.0
                %
                
                
                44.1
                %Others
                
                
                3.0
                %
                
                
                4.0
                %
                
                
                3.5
                %Total
                
                
                100
                %
                
                
                100
                %
                
                
                100
                %International
      Sales
                
                
                7.0
                %
                
                
                15.3
                %
                
                
                9.3
                %
  -36-
  Net
Income
 
 The
Company recorded a net loss of $1.91 million, or a loss of $0.07 per diluted
share, in the quarter, which included special non-cash and non-recurring items
totaling a net loss of $12.86 million or $(0.47) per diluted share. This
compared with a net income of $7.75 million, or $0.34 per diluted share, in
the third quarter of 2008 and a net loss of $5.42 million, or $(0.24) per
diluted share, in the second quarter of 2009, which included special non-cash
charges and non-recurring items totaling a net loss of $12.84 million or $(0.58)
per diluted share.
 
 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 the 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
the 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.
  Three
      Months EndedSeptember
      30
                  
                  
                  June
      302009
                  
                  
                  2008
                  
                  
                  2009Net
      Income (Loss)
                  
                  $
                  (1,907,964
                  )
                  
                  $
                  7,753,668
                  
                  
                  $
                  (5,419,364
                  )Deduct:Other
      Income - Government grant
                  
                  $
                  0
                  
                  
                  $
                  0
                  
                  
                  $
                  (1,172,560
                  )Gain
      on debt repurchase
                  
                  $
                  (4,155,000
                  )
                  
                  $
                  0
                  
                  
                  $
                  0Add
      Back:Amortization
      associated with debt repurchase
                  
                  $
                  7,279,487
                  
                  
                  $
                  0
                  
                  
                  $
                  0Loss
      on cross currency interest rate swap settlement
                  
                  $
                  9,000,000
                  
                  
                  $
                  0
                  
                  
                  $
                  0Change
      in fair value of warrant
                  
                  $
                  736,546
                  
                  
                  $
                  0
                  
                  
                  $
                  14,014,790Adjusted
      Net Income
                  
                  $
                  10,953,069
                  
                  
                  $
                  7,753,668
                  
                  
                  $
                  7,422,866Diluted
      EPS
                  
                  $
                  (0.07
                  )
                  
                  $
                  0.34
                  
                  
                  $
                  (0.24
                  )Deduct:Other
      Income - Government grant
                  
                  $
                  0.00
                  
                  
                  $
                  0.00
                  
                  
                  $
                  (0.05
                  )Gain
      on debt repurchase
                  
                  $
                  (0.15
                  )
                  
                  $
                  0.00
                  
                  
                  $
                  0.00Add
      back:Amortization
      associated with debt repurchase
                  
                  $
                  0.27
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.00Loss
      on cross currency interest rate swap settlement
                  
                  $
                  0.33
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.00Change
      in fair value of warrant
                  
                  $
                  0.02
                  
                  
                  $
                  0.00
                  
                  
                  $
                  0.62Adjusted
      Diluted EPS
                  
                  $
                  0.40
                  
                  
                  $
                  0.34
                  
                  
                  $
                  0.33
  During
the third quarter of 2009, the Company repurchased $26.5 million 2012 Notes at a
discount of 15% and the remaining $6 million 2010 Notes at a discount of 3%,
which resulted in a total gain of $4.16 million. As a result of the debt
repurchase, the Company recorded a $7.28 million additional amortization of debt
discount and debt issuance costs associated with the repurchased portion of the
debt. During the quarter, the Company also terminated the cross currency
interest rate swap agreement that was intended as a cash flow hedge on the
scheduled payments of the $38 million 2012 Notes. As a result, $9 million 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.
 
 The
adjusted net income of $10.95 million, or the adjusted EPS of $0.40 per
diluted share, for the third quarter of 2009 in the table above excluded a gain
of $4.16 million on debt repurchase, a loss of $7.28 million additional
amortization of debt discount and debt issuance costs associated with the
repurchase of 2010 Notes and 2012 Notes, a loss of $9 million due to the
termination of the cross currency interest rate swap, and a loss of $0.74
million due to change in fair value of the warrants outstanding.  This
adjusted net income compared, on the same basis, with the net income of $7.75
million, or $0.34 per diluted share, in the third quarter of 2008 and the
adjusted net income of $7.42 million, or $0.33 per diluted share, in the
second quarter of 2009.
  -37-
  Compared
to the third quarter of 2008, the higher adjusted net income was primarily
driven by higher sales. Other factors such as higher gross margin, higher
non-operating income, and, relatively lower operating cost and lower interest
expense also contributed.
 
 Compared
to the second quarter of 2009, the higher adjusted net income was mainly
attributable to higher sales, higher gross margin, and relatively lower
operating cost.
 
 Gross
Profit Margin
 
 The
following table presents the average gross profit margin by product line for the
third quarter of 2009, in comparison to the third quarter of 2008 and the second
quarter of 2009. The improvement in overall gross profit margin was primarily
due to changes in product mix where sales of higher gross margin oil pumps
increased sharply in the quarter. The slight decline in gross margin in the
industrial rotary motor business was mainly due to higher raw material
costs.
  Gross
      Profit Margin (%)Product
      Line
                
                
                3Q09
                
                
                
                3Q08
                
                
                
                2Q09Linear
      Motors and Related Systems
                
                
                62.1
                %
                
                
                53.9
                %
                
                
                56.9
                %Specialty
      Micro-Motors
                
                
                40.4
                %
                
                
                40.6
                %
                
                
                40.4
                %Rotary
      Motors
                
                
                11.8
                %
                
                12.3
                %
                
                
                13.2
                %Others
                
                
                48.1
                %
                
                
                47.1
                %
                
                
                48.0
                %Corporate
      Average
                
                
                35.7
                %
                
                
                34.7
                %
                
                
                33.5
                %International
      Business
                
                
                44.2
                %
                
                
                45.0
                %
                
                
                42.6
                %
 
 Operating
Profit
 
 Operating
profits of $13.04 million in the third quarter of 2009 increased from $10.52
million in the third quarter of 2008 and $8.82 million in the second quarter of
2009, representing a 24% year over year growth and a 48% growth
sequentially.
 
 Compared
to the third quarter of 2008, higher operating profit benefited
from increased sales and improved gross margin. Total operating costs
including selling, general and administrative (“SG&A”) expenses and research
& development (R&D) expenses, were $3.72 million for the current
quarter, compared to $3.25 million for the same quarter in 2008. As a percentage
of total sales, operating costs decreased from 8.2% to 7.9%. Operating
margin was improved to 27.8% from 26.5% in the same quarter of last year.
The margin improvement was primarily attributable to a higher gross margin
and relatively lower operating costs.
 
 Compared
to the second quarter of 2009, operating
profits increased by $4.23 million, primarily driven by higher
sales, higher gross margin, and lower SG&A expenses. Operating margin
improved to 27.8% from 23.0% in the previous quarter, driven by higher
gross margin and lower SG&A expenses. As a percentage of total sales,
operating costs declined to 7.9% from 10.6% in the last quarter.
 
 Interest
expense
 
 Net
interest expense was $8.48 million for the current quarter, which included
$8.21 million amortization of debt discount, of which $6.60 million was related
to the debt repurchase, and $0.90 million to amortization of debt issuance
costs, of which $0.68 million was related to the debt repurchase. Excluding
these special charges, net interest expense was $1.20 million. This compares to
net interest expense of $2.06 million for the third quarter of 2008 and $0.84
million for the second 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 $1.95 million for the current quarter, compared with
$1.41 million and $1.48 million for the third quarter of 2008 and the second
quarter of 2009, respectively.
  NINE
MONTHS ENDED SEPTEMBER 30, 2009
  Revenues
 
 For the
nine months ended September 30, 2009, the Company reported total revenues of
$116.02 million, compared with $86.08 million for the nine months ended
September 30, 2008, up 35% year-over-year.  International sales
totaled $10.14 million, or 8.7% of total sales, for the current period, compared
with $12.96 million in the corresponding period of prior yeas.
 
 Compared
with the nine months ended September 30, 2008, the sales growth was primarily
attributable to the $33.38 million higher sales in the industrial rotary motors.
This business was acquired in July 2008. Therefore, the nine month sales in 2008
only included one quarter of sales contribution from this business, while the
nine month sales in 2009 benefited from three quarters of sales contribution
from the business. Linear motor sales were up 8%, primarily due to higher oil
pump sales (424 units in the nine months ended September 30, 2009 compared to
183 units in the nine months ended September 30, 2008), partially offset by
lower sales in other linear motors. Specialty micro-motor sales declined 14%
year over year, with export sales down 26% and domestic sales down 9%,
reflecting a slower recovery in export market.
  -38-
  Net
Income
 
 The
Company recorded a net income of $1.33 million, or $0.06 per diluted share,
in the nine months ended September 30, 2009, which included special
non-cash and non-recurring items totaling a net loss of $23.13 million or
$(0.96) per diluted share. This compared with a net income of $19.34
million, or $0.92 per diluted share, in the nine months ended September 30,
2008.
  The
following table presents the adjusted net income and a reconciliation of the
non-GAAP measure to the GAAP net income.
 
 Nine
      Months Ended September 302009
                  
                  
                  2008Net
      Income (Loss)
                  
                  $
                  1,327,006
                  
                  
                  $
                  19,337,84779Deduct:Other
      Income - Government Grant
                  
                  $
                  (1,172,560
                  )
                  
                  $
                  0Gain
      on debt repurchase
                  
                  $
                  (4,155,000
                  )
                  
                  $
                  0Add
      back:Amortization
      associated with debt repurchase
                  
                  $
                  7,279,487
                  
                  
                  $
                  0Loss
      on cross currency interest rate swap settlement
                  
                  $
                  9,000,000
                  
                  
                  $
                  0Change
      in fair value of warrant
                  
                  $
                  12,177,915
                  
                  
                  $
                  0Adjusted
      Net Income
                  
                  $
                  24,456,848
                  
                  
                  $
                  19,337,847Diluted
      EPS
                  
                  $
                  0.06
                  
                  
                  $
                  0.92Deduct:Other
      Income - Government Grant
                  
                  $
                  (0.05
                  )
                  
                  $
                  0.00Gain
      on debt repurchase
                  
                  $
                  (0.17
                  )
                  
                  $
                  0.00Add
      back:Amortization
      associated with debt repurchase
                  
                  $
                  0.30Loss
      on cross currency interest rate swap settlement
                  
                  $
                  0.37Change
      in fair value of warrant
                  
                  $
                  0.51
                  
                  
                  $
                  0.00Adjusted
      EPS
                  
                  $
                  1.02
                  
                  
                  $
                  0.92
  The
adjusted net income of $24.46 million, or the adjusted EPS of $1.02 per diluted
share, for the nine months ended September 30, 2009 in the table above
excluded a gain of $1.17 million (RMB 8 million) government grant, a gain of
$4.16 million on debt repurchase, a loss of $7.28 million additional
amortization of debt discount and debt issuance costs associated with the
repurchase of 2010 Notes and 2012 Notes, a loss of $9 million due to the
termination of the cross currency interest rate swap, and a loss of $12.18
million due to change in fair value of the warrants outstanding. This adjusted
net income compared, on the same basis, with the net income of $19.34 million,
or $0.92 per diluted share, in the nine months ended September 30, 2008. The
higher adjusted net income for the current period primarily benefited from
contributions of industrial rotary motor business, higher oil pump
sales, higher other income, reduced operating costs as a percent of total
sales, and lower interest expenses.
 
 Operating
Profit
 
 Operating
profits were $29.89 million and $27.38 million in the nine months ended
September 30, 2009 and 2008, respectively, up 9% year over year.  This
gave an operating margin of 25.8% in the current period versus 31.8% in the
corresponding period of last year. The decline in operating margin was
mainly due to changes in product mix where lower gross margin industrial
rotary motor business contributed more to the sales.
 
 Total
operating costs including selling, general and administrative (“SG&A”)
expenses and research & development (R&D) expenses, increased to $10.66
million from $8.61 million for the same period last year, mainly due to higher
shipping and handling costs, higher depreciation expense and other
administrative costs associated with higher sales activities. However, as a
percentage of total sales, the operating costs were reduced to 9.2% from
10.0% in the corresponding period in 2008.
 
 Interest
expense
 
 Net
interest expense was $10. 76 million for the nine months ended September
30, 2009. This included $10.22 million amortization of debt discount, of which
$6.60 million was related to the debt repurchase, and $1.18 million to
amortization of debt issuance costs, of which $0.68 million was related to the
debt repurchase. Excluding these special charges, net interest expense was $3.48
million. This compares to net interest expense of $5.54 million for the same
period in 2008. In all periods, net interest expense included non-cash
amortization expense of debt discount and debt issuance cost.  The
lower interest expense in the current period was mainly due to lower debt
amount and higher capitalization of interest expense.
 
 Income
Taxes
 
 The
income tax provision was $4.48 million for the nine months ended September 30,
2009, compared with $3.46 million for the nine months ended September 30,
2008.
  -39-
  Liquidity
and Capital Resources
 
 A major
factor of 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 supports major
acquisitions and capital investments for business growth.
 
 Our
liquidity position remains strong, supported by approximately
$154.9 million in cash and cash equivalents as of September 30, 2009,
compared to $48.4 million as of December 31, 2008. The increase in cash and cash
equivalents was mainly driven by cash generated from operations, cash proceeds
from the conversion of outstanding warrants, and cash proceeds from the
issuance of 7,187,500 shares of common stock at $16/share in a public
offering during the third quarter.  Cash provided by operating
activities totaled $37.5 million for the nine months ended September 30, 2009.
Net proceeds from the conversion of warrants totaled $11.1 million. Net proceeds
from stock issuance totaled $107.5 million.
 
 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.
 
 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.  We
made $4 million in principal payments in 2008 and another $2 million in
principal payments in March 2009 for the 2010 Notes.
 
 On July
14, 2009, the Company entered into a Letter Agreement with Merrill Lynch and ABN
AMRO Bank N.V., London Branch, pursuant to which Merrill Lynch and ABN/AMRO each
agreed to waive each and every applicable provision of the Indenture but only to
the fullest extent necessary solely to permit the Company to repurchase, all
(but not part), of the remaining $6 million 2010 Notes held by Merrill
Lynch ($3 million) and ABN AMRO Bank N.V., London Branch ($3 million) on or
prior to July 31, 2009 for a repurchase price equal to 97% of the aggregate
principal amount of the 2010 Notes plus accrued and unpaid interest to but
excluding the repurchase date.  On July 31, 2009, the Company paid a
total of $5,983,844 to repurchase the 2010 Notes, which was comprised of
$5,820,000 representing 97% of the $6,000,000 aggregate principal amount of the
2010 Notes held by the Merrill Lynch and ABN AMRO Bank N.V., London Branch plus
$163,844 representing accrued and unpaid interest on the 2010 Notes to but
excluding the repurchase date of the 2010 Notes.  On August 5, 2009,
the 2010 Notes were cancelled.
 
 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. We made a mandatory redemption of $2.4 million principal
amount of the 2012 Notes on September 1, 2009.
 
 On June
1, 2009, the Company and Citadel Equity Fund Ltd. (“Citadel”) entered into a
Letter Agreement (the “Citadel Agreement”), pursuant to which Citadel agreed to
waive each and every applicable provision of the Indenture but only to the
fullest extent necessary solely to permit the Company to repurchase, at its
option, all (but not part), of the $26.5 million 2012 Notes held by Citadel
(“Citadel Notes”) on or prior to August 31, 2009 for  repurchase price
equal to 85% of the aggregate principal amount of the Citadel Notes plus accrued
and unpaid interest to but excluding the repurchase date.  On August
7, 2009, the Company paid a total of $23,131,997.22 to repurchase the
Citadel Notes, which amount was comprised of $22,525,000 representing 85% of the
$26,500,000 aggregate principal amount of the 2012 Notes held by Citadel plus
$606,997.22 representing accrued and unpaid interest on the Citadel Notes to but
excluding the repurchase date. On August 11, 2009, the Citadel Notes were
cancelled.
 
 During
the nine months ended September 30, 2009, the Company used total of $32,745,000
cash to repurchase and repay a total of $36,900,000 aggregate principal amount
of the 2010 and 2012 Notes, including the mandatory redemption of $2.4 million
principal amount of the 2012 Notes on September 1, 2009.
  -40-
  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.
 
 During
the nine months ended September 30, 2009, a total of 1,663,461 warrants were
exercised including 1,428,846 of First Tranche 2012 Warrants and 234,615 of 2009
Warrants.  The 1,428,836 First Tranche 2012 Warrants were exercised in
consideration for an exercise price paid in cash. The Company received net cash
proceeds of $11,144,999 as a result of such exercise. As of September 30, 2009,
a total of 366,697 Second Tranche 2012 Warrants remained outstanding. None of
Second Tranche 2012 Warrants and 2009 Warrants remains outstanding.
 
 On August
4, 2009, the Company completed the sale of 6,250,000 shares of its common stock
in an underwritten public offering at a public offering price of $16.00 per
share.  The Company received net proceeds, after deducting
underwriting commissions and fees and expenses associated with the offering, of
$93,416,950.
 
 On August
17, 2009, the Company completed the sale of additional 937,500 shares of its
common stock at $16 per share pursuant to the over-allotment option in
connection with its public offering that closed on August 4, 2009. Net proceeds
from the over-allotment sale totaled $14,075,000, after deducting underwriting
commissions and fees and expenses associated with the offering.
 
 On
October 22, 2009, the Company utilized approximately $84 million (RMB
572,665,304) of the net cash proceeds from its August public offering in
connection with its acquisition of Xi’an Tech Full Simo Motor Co.
Ltd.  The Company may be required to make an additional cash purchase
price payment within seven (7) months of the closing date of the
acquisition.  See “Other Information” for a description of the
acquisition.
  Cross-currency
interest rate hedge
 
 The
Company's operations are exposed to a variety of global market risks, including
changes in foreign currency exchange rates and interest rates. These exposures
are managed, in part, with the use of a financial derivative. 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.
 
 On April
17, 2007, the Company entered a cross-currency interest rate swap agreement (the
“Transaction”) with Merrill Lynch, effectively exchanging the LIBOR plus 3.35%
variable rate interest payable on the $38 million principal amount of 2012 Notes
for a 7.2% RMB fixed interest rate. The agreement requires semi-annual payments
on March 1 and September 1 through the maturity of the agreement on
September 1, 2012. Merrill Lynch required the Company to deposit $1,000,000 to
secure the agreement. The deposit may be increased to $2,500,000, if the
exchange rate for Renminbi to USD falls below 6.5, and to $4,000,000, if the
exchange rate falls below 5.5. This swap is designated and qualified as a
cash flow hedge.
 
 On
September 16, 2009, the Company entered an agreement with Merrill Lynch to
terminate the SWAP (“Unwind Term”), pursuant to which the Company was
required to make a termination payment of $9 million
(“Termination Payment”) to Merrill Lynch on September 21, 2009. Upon
receipt of the Termination Payment by Merrill Lynch, Merrill Lynch and the
Company were deemed to have agreed, as of September 21, 2009, (i) the
Transaction and all of the respective rights and obligations of Merrill
Lynch and the Company were cancelled and terminated; (ii) Merrill Lynch
released and discharged the Company from and agreed not to bring
a  claim against the Company with respect to any obligations
arising and to be performed in connection with the Transaction after
September 21, 2009; and (iii) the Company released and discharged Merrill
Lynch from and agreed not to bring a claim against Merrill Lynch with
respect to any obligations arising and to be performed in connection with the
Transaction and the Guaranty thereof after September 21, 2009. On September
21, 2009, the Company made the Termination Payment of $9 million to Merrill
Lynch.
  Contractual
Obligations
 
 The
Company enters into non-cancelable purchase commitments with its vendors. As of
September 30, 2009, and December 31, 2008, the Company was obligated under the
non-cancelable commitments to purchase materials totaling to $3,437,762 and
$305,100, respectively. These commitments are short-term and expire within one
year. The Company has experienced no losses on these purchase commitments over
the years.
 
 The
Company entered into an 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.  Under the terms of the agreement, the Company is
required to contribute a total of $3 million in installments in AAG by
March 31, 2009 while Shelton contributed to AAG, an exclusive worldwide
royalty-free license for motorized automation technology.  The Company
has invested a total of $2.0 million in AAG as of September 30, 2009 and has the
remaining $1.0 million to be invested.  Based upon a mutual agreement,
the Company will contribute the remaining $1.0 million to AAG at a later date to
be addressed in a new agreement that the Company and Shelton are currently
developing.
  -41-
  As
discussed in Note 10, the Company entered into a swap agreement that required a
$1,000,000 deposit to secure the Transaction.  On September 21, 2009,
the Company terminated the Transaction and the $1,000,000 cash deposit was
returned to the Company.
 
 As
discussed in Note 9, the 2010 Notes are subject to mandatory redemption
semi-annually commencing March 1, 2008 in the principal amount of $2,000,000 at
a price equal to 100% of such principal amount.  As of August 5, 2009,
the 2010 Notes have been repurchased by the Company and are no longer
outstanding. The 2012 Notes are subject to mandatory redemption semi-annually
commencing September 1, 2009 in the principal amount $2,400,000 on September 1,
2009, $3,800,000 on March 1, 2010, $9,900,000 on September 1, 2010 and March 1,
2011, and $4,000,000 on September 1, 2011, March 1, 2012 and September 1,
2012, in each instance at a price equal to 100% of such principal amount.
Holders of the 2012 Notes may require the Company to repurchase such Notes at
100% of the principal amount thereof at any time after September 1, 2011. As of
August 11, 2009, an aggregate principal amount of $26,500,000 of the 2012 Notes
has been repurchased by the Company. On September 1, 2009, the Company redeemed
additional $2,400,000 million principal amount of the 2012 Notes pursuant to the
mandatory redemption schedule set forth in the Indenture governing the 2012
Notes. As of September 30, 2009, a total of $9,100,000 2012 Notes remained
outstanding. The Company expects to follow the mandatory redemption
schedule with respect to the 2012 Notes and pay off the remainder of the
2012 Notes on September 1, 2010.
 
 In
August 2006 the Company’s subsidiary Harbin Tech Full entered into a
Research & Development Agreement with the Institute of Electrical
Engineering of the Chinese Academy of Sciences (“R&D Agreement”). Under the
R&D Agreement with IEECAS, Harbin Tech Full has discretion to invest
approximately $2.19 million (RMB 15 million) in this joint development project
as needed. Of this amount, approximately $1.46 million (RMB 10 million) has been
invested to date with the balance to be invested as needed.
 
 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 67% or
$4.2 million (RMB 28.7 million) has been paid as of September 30, 2009 with the
balance payable in installments. The amount paid is recorded as advances on
intangible assets for $4,207,356 and $1,481,670 as of September 30, 2009 and
December 31, 2008, respectively.
 
 In
September 2006 the Company’s subsidiary Harbin Tech Full signed a Land Use
Agreement for a plot of land in Shanghai. Harbin Tech Full is obligated to
invest approximately $2.74 million. Of this amount, 92% or $2.70 million has
been paid with the balance payable upon completion of certain regulatory
applications and receipt of a regulatory permit.
  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 September 30, 2009.
 
 Pursuant
to the original agreement (“Original Agreement”) signed in April 2007 between
the Company and Shelton Technology, LLC (“Shelton”), whereby the Company and
Shelton agreed to work together through AAG to design, develop and manufacture
custom industrial automation controllers, 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. The Company has
contributed a total of $2.0 million to AAG as of September 30, 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.
 
 Off-balance
sheet arrangement
 
 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 2008 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, 2008.
  -42-
  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 the end of the period
covered by this report, 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 nine months ended September 30, 2009 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.
  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
 
 We
depend on a few key customers, the loss of any of which could cause a
significant decline in our revenues.
  Two major
customers accounted for approximately 31% of net revenue for the nine months
ended September 30, 2009. Three major customers accounted for 49% of net revenue
for the nine months ended September 30, 2008. The loss of any of our major
customers, or a significant reduction in sales to any such customers, would
adversely affect our revenues and profitability.
 
 Economic
and industry conditions have had and may continue to have an adverse effect on
our business.
 
 The
worldwide economy is currently in significant turmoil. To the extent the
downturn continues or worsens, we could experience a reduction in our sales
growth, an increase in our bad debt expense and other adverse affects. Further,
because we continue to build our infrastructure, if our sales were to
decline or even fail to grow at the rate we anticipate, our profitability would
be impacted, and the impact could be material if we are unable to dramatically
reduce our costs.
 
 Further,
we operate in industries that have been particularly impacted by the global
economic downturn. For example, approximately 28% of our 2008 revenues were
derived from the automotive industry. Although the China automotive industry
remains strong, automotive manufacturers in the U.S., European and some other
countries have experienced significant production cuts and capacity reductions,
and in some cases bankruptcies. Continuing adverse conditions in industries we
serve could affect our results of operations.
 
 Our
rapid growth may strain our resources.
  Our
revenues increased by 85% for the year ended December 31, 2008 versus the year
ended December 31, 2007, and 62% in 2007 over 2006. In the third quarter of
2009, our revenues increased 18% versus the same quarter of 2008. However, it is
unlikely that we will maintain such growth in the long term and 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. We expect that we will need to continue to improve our
financial controls, operating procedures, and management information systems. We
will also need to effectively train, motivate, and manage our employees. Our
failure to manage our growth could disrupt our operations and ultimately prevent
us from generating the profits we expect.
  -43-
  Our
debt may constrict our operations, and cash flows and capital resources may be
insufficient to make required payments on our indebtedness and future
indebtedness.
 
 As
of September 30, 2009, we had approximately $9.1 million debt outstanding
under our Guaranteed Senior Secured Floating Rate Notes (the “Notes”) issued in
August 2006. This debt could have important consequences to you. For example, it
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 a portion
      of our debt is variable; and
 
 ·
              restrict
      us from making strategic acquisitions or pursuing business
      opportunities.
 
 Furthermore,
our obligations under the 2012 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 the loss of our
business, if we default on the 2012 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 2012
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.
  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.
  Four
major vendor provided approximately 74% of the Company’s purchases of raw
materials for the nine months ended September 30, 2009. Two major vendors
provided approximately 37% of the Company’s purchases of raw materials for the
nine months ended September 30, 2008. Any material change in the spot and
forward rates for raw materials could have a material adverse effect on our cost
of sales and profitability. 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 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.
 
 We
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.
  -44-
   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.
 
 We
do not anticipate paying cash dividends on our common stock.
  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. Debt covenants and PRC capital and currency regulations may also
limit our ability to pay dividends.
  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 35.7% of our issued
and outstanding common stock as of September 30, 2009. 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.
  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.
 
 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.
  -45-
 
 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.
 
 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 would be materially and adversely
affected.
  Our
results of operation may be adversely affected by changes to or expiration of
preferential tax concessions that one of our Chinese subsidiaries, Harbin Tech
Full currently enjoys. 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 and Foreign Invested Enterprises
(“FIEs”), such as Harbin Tech Full, 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 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 were subject to
a 10% preferential tax rate until December 31, 2010. As a result, the estimated
tax savings for the nine months ended September 30, 2009 and 2008 amounted to
approximately $4,973,700 and $4,652,412, 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.
  Fluctuations
in the value of the RMB could materially affect our financial condition and
results of operations.
  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.
  -46-
  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 we inform
our personnel that such practices are illegal, 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.
 
 We are
dependent on our relationship with the local government in the province in which
we operate our business.  Chinese government has exercised and
continues to exercise substantial control over virtually every sector of the
Chinese economy through regulation and state ownership.  Our ability
to operate in China may be harmed by changes in its laws and regulations,
including those relating 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 or interpretations.  Accordingly,
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 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 the
U.S. court.
  The
legal system in China has inherent uncertainties that may limit the legal
protections available in the event of any claims or disputes with third
parties.
 
 The legal
system in China is based on written statutes. Prior court decisions may be cited
for reference but have limited precedential value. Since 1979, the central
government has promulgated laws and regulations dealing with economic matters
such as foreign investment, corporate organization and governance, commerce,
taxation and trade. As China’s foreign investment laws and regulations are
relatively new and the legal system is still evolving, the interpretation of
many laws, regulations and rules is not always uniform and enforcement of these
laws, regulations and rules involve uncertainties, which may limit the remedies
available in the event of any claims or disputes with third parties. In
addition, any litigation in China may be protracted and result in substantial
costs and diversion of resources and management attention.
 
 Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds
 
 None.
 
 Item 3. Defaults upon Senior
Securities
  None.
  -47-
  Item 4. Submission of Matters to a Vote of
Securities Holders
  (a)
              The
      Annual Meeting of Shareholders of Harbin Electric, Inc. was held on August
      20, 2009.
 
 (b)
              Five
      directors were elected: Tianfu Yang (Chairman of the Board), Lanxiang Gao,
      Ching Chuen Chan, David Gatton, and Yunyue
Ye.
 
 (c)
              Shareholders
      ratified the appointment of Moore Stephens Wurth Frazer and Torbet, LLP as
      the Company’s independent registered public accounting firm for the year
      ended December 31, 2009.
  Item 5. Other
Information
 
 On
October 2, 2009, Harbin Tech Full Electric Co. Ltd., a PRC company (“Harbin Tech
Full”) and 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. 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.
 
 Item
6. Exhibits.
  The
exhibits listed on the Exhibit Index are being furnished with this
report.
  -48-
  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:
      November 9, 2009
              By:
              /s/ Tianfu
      YangTianfu
      YangChief
      Executive Officer, Director and
                Chairman
      of the Board
                (Principal
      Executive Officer)
  Date:
      November 9, 2009
              By:
              /s/ Zedong
      XuZedong
      XuChief
      Financial Officer
                (Principal
      Accounting Officer)
  -49-
  EXHIBIT
INDEX
 
 Exhibits:
  Exhibit Number
              
              Description
              
              Method of Filing1.1
              
              Underwriting
      Agreement by and between the Company and Roth Capital Partners, LLC, dated
      as of July 30, 2009.
              
              Filed
      as Exhibit 1.1 to the current report on Form 8-K filed with the Commission
      on July 30, 2009 and incorporated herein by reference.10.1
              
              Letter
      Agreement by and between the Company and Citadel Equity Fund Ltd., dated
      as of June 1, 2009.
              
              Filed
      as Exhibit 10.1 to the current report on Form 8-K filed with the
      Commission on June 5, 2009 and incorporated herein by
      reference.10.2
              
              Letter
      Agreement by and between the Company, Merrill Lynch International and ABN
      AMRO Bank N.V., London Branch, dated as of July 14, 2009.
              
              Filed
      as Exhibit 10.1 to the current report on Form 8-K filed with the
      Commission on July 20, 2009 and incorporated herein by
      reference.10.3
              
              Letter
      Agreement by and between the Company, Abax Jade Ltd. and Abax Nai Xin A
      Ltd., dated as of July 14, 2009.
              
              Filed
      as Exhibit 10.2 to the current report on Form 8-K filed with the
      Commission on July 20, 2009 and incorporated herein by
      reference.10.4
              
              Equity
      Acquisition Agreement between Harbin Tech Full Electric Co. Ltd., Xi’an
      Simo Electric Co. Ltd. and Shaanxi Electric Machinery Association dated
      October 2, 2009.
              
              Filed
      as Exhibit 10.1 to the current report on Form 8-K filed with the
      Commission on October 7, 2009 and incorporated herein by
      reference.10.5
              
              SWAP
      Termination Agreement between the Company and Merrill Lynch International,
      dated as of September 16, 2009.
              
              Filed
      herewith as Exhibit 10.5.31.1
              
              Certification
      by the Chief Executive Officer pursuant to Rule 13a-14(a) or
      15d-14(a)
              
              Filed
      herewith as Exhibit 31.1.31.2
              
              Certification
      by the Chief Financial Officer pursuant to Rule 13a-14(a) or
      15d-14(a)
              
              Filed
      herewith as Exhibit 31.2.32.1
              
              Certification
      of the Chief Executive Officer and the Chief Financial Officer pursuant 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002
              
              Filed
      herewith as Exhibit 32.1.
 
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