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EX-31.2 - Harbin Electric, Incv192921_ex31-2.htm
EX-99.1 - Harbin Electric, Incv192921_ex99-1.htm
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EX-32.1 - Harbin Electric, Incv192921_ex32-1.htm


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 June 30, 2010
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________
 
Commission file number   000-51006
 
HARBIN ELECTRIC, INC.
(Exact name of registrant as specified in its charter)
 
Nevada
98-0403396
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 

  
  No. 9 Ha Ping Xi Lu, Ha Ping Lu Ji Zhong Qu
Harbin Kai Fa Qu, Harbin, People’s Republic of China 150060
(Address of principal executive offices)
 
Telephone: 86-451-86116757
(Issuer’s telephone number)
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   x    No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).       Yes o    No o

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuers classes of common equity, as of August 6, 2010: 31,067,471 shares of common stock, par value $0.00001 per share.
 
 


 
TABLE OF CONTENTS
 
   
Page
 
Part I. Financial Information
 
3
 
       
Item 1. Financial Statements
 
3
 
       
Consolidated Balance Sheets
As of June 30, 2010 (Unaudited) and December 31, 2009
 
3
 
       
Consolidated Statements of Operations and Other Comprehensive Income
For the Three Months and Six Months Ended June 30, 2010 and 2009 (Unaudited)
 
4
 
       
Consolidated Statements of Changes in Equity (Unaudited)
 
5
 
       
Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2010 and 2009 (Unaudited)
 
6
 
       
Notes to the Consolidated Financial Statements (Unaudited)
 
7
 
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
35
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
44
 
Item 4. Controls and Procedures
 
44
 
       
Part II. Other Information
 
44
 
       
Item 1. Legal Proceedings
 
44
 
Item 1A. Risk Factors
 
44
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
49
 
Item 3. Defaults upon Senior Securities
 
49
 
Item 4. Removed and Reserved
 
49
 
Item 5. Other Information
 
49
 
Item 6. Exhibits
 
49
 
Signatures
 
50
 
Index to Exhibits
 
51
 
 
 
2

 
 
PART I. FINANCIAL INFORMATION
 
Item 1. Financial Statements (Unaudited)
 
HARBIN ELECTRIC, INC. AND SUBSIDIARIES

 CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2010 (UNAUDITED) AND DECEMBER 31, 2009

   
June 30,
   
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
       
ASSETS
           
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 40,275,201     $ 92,902,400  
Restricted cash
    5,086,010       3,522,009  
Notes receivable
    317,814       1,086,929  
Accounts receivable, net
    95,484,435       93,322,885  
Inventories, net
    80,865,291       74,913,877  
Other receivables & prepaid expenses
    3,453,818       5,828,453  
Advances on inventory purchases
    13,255,272       11,718,544  
Total current assets
    238,737,841       283,295,097  
                 
PLANT AND EQUIPMENT, net
    182,148,559       156,364,548  
                 
OTHER ASSETS:
               
                 
Debt issuance costs, net
    77,319       359,255  
Advance on non-current assets
    24,167,429       13,666,414  
Goodwill and other intangible assets, net
    73,673,741       75,546,225  
Other assets
    1,216,471       1,722,693  
Total other assets
    99,134,960       91,294,587  
                 
Total assets
  $ 520,021,360     $ 530,954,232  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
Notes payable - short term
  $ 5,747,885     $ 4,533,268  
Accounts payable
    55,833,838       47,099,135  
Short term loans
    46,150,243       44,439,629  
Customer deposits
    15,136,028       18,455,842  
Accrued liabilities and other payables
    7,246,715       12,329,394  
Taxes payable
    9,012,807       8,233,862  
Amounts due to original shareholders
    736,500       28,681,976  
Current portion of notes payable, net
    5,083,486       7,660,210  
Total current liabilities
    144,947,502       171,433,316  
                 
LONG TERM LIABILITIES:
               
Long term bank loans
    -       4,401,000  
Warrant liability
    3,200,179       4,623,558  
                 
Total liabilities
    148,147,681       180,457,874  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
SHAREHOLDERS' EQUITY:
               
Common Stock, $0.00001 par value, 100,000,000 shares authorized,
               
31,067,471 and 31,067,471 shares issued and outstanding
               
as of June 30, 2010 and December 31, 2009, respectively
    310       310  
Paid-in-capital
    213,216,504       218,094,374  
Retained earnings
    110,778,315       69,594,111  
Statutory reserves
    27,913,711       22,869,423  
Accumulated other comprehensive income
    20,051,102       18,638,299  
Total shareholders' equity
    371,959,942       329,196,517  
                 
NONCONTROLLING INTERESTS
    (86,263 )     21,299,841  
                 
Total liabilities and shareholders' equity
  $ 520,021,360     $ 530,954,232  
 
The accompanying notes are an integral part of these consolidated statements.

 
3

 
 
HARBIN ELECTRIC, INC. AND SUBSIDIARIES

 CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009
(Unaudited)

   
Three Months Ended June 30
   
Six Months Ended June 30
 
   
2010
   
2009
   
2010
   
2009
 
                         
REVENUES
  $ 105,435,970     $ 38,363,484     $ 210,921,127     $ 69,088,377  
                                 
COST OF SALES
    70,103,783       25,500,208       139,846,870       45,301,323  
                                 
GROSS PROFIT
    35,332,187       12,863,276       71,074,257       23,787,054  
                                 
RESEARCH AND DEVELOPMENT EXPENSE
    362,783       408,520       956,978       801,802  
                                 
SELLING, GENERAL AND  ADMINISTRATIVE EXPENSES
    6,886,054       3,638,936       14,302,812       6,143,840  
                                 
INCOME FROM OPERATIONS
    28,083,350       8,815,820       55,814,467       16,841,412  
                                 
OTHER EXPENSE (INCOME), NET
                               
   Other income, net
    (1,326,675 )     (2,100,885 )     (2,445,961 )     (2,640,264 )
Interest expense, net
    977,858       842,528       2,624,781       2,283,912  
Loss from disposal of subdivision
    623,158       -       623,158       -  
Change in fair value of warrants
    (1,657,457 )     14,014,790       (1,423,379 )     11,441,369  
Total other (income) expense, net
    (1,383,116 )     12,756,433       (621,401 )     11,085,017  
                                 
INCOME BEFORE PROVISION FOR INCOME TAXES
    29,466,466       (3,940,613 )     56,435,868       5,756,395  
                                 
PROVISION FOR INCOME TAXES
    3,790,892       1,478,751       7,854,253       2,521,425  
                                 
NET INCOME BEFORE NONCONTROLLING INTEREST
    25,675,574       (5,419,364 )     48,581,615       3,234,970  
                                 
LESS: NET INCOME ATTRIBUTABLE TO NONCONTROLLING INTEREST
    770       -       2,353,123       -  
                                 
NET INCOME ATTRIBUTABLE TO CONTROLLING INTEREST
    25,674,804       (5,419,364 )     46,228,492       3,234,970  
                                 
OTHER COMPREHENSIVE INCOME (LOSS)
                               
Foreign currency translation adjustment
    1,320,473       (9,110 )     1,412,069       (294,478 )
Foreign currency translation adjustment attributable to noncontrolling interest
    611       -       (191 )     -  
Change in fair value of derivative instrument
    -       (711,288 )     -       (3,240,364 )
                                 
COMPREHENSIVE INCOME
  $ 26,995,888     $ (6,139,762 )   $ 47,640,370     $ (299,872 )
                                 
EARNINGS PER SHARE
                               
Basic
                               
Weighted average number of shares
    31,067,471       22,140,568       31,067,471       22,121,746  
Earnings per share before noncontrolling interest
  $ 0.83     $ (0.24 )   $ 1.56     $ 0.15  
Earnings per share attributable to controlling interest
  $ 0.83     $ (0.24 )   $ 1.49     $ 0.15  
Earnings per share attributable to noncontrolling interest
  $ -     $ -     $ (0.08 )   $ -  
                                 
Diluted
                               
Weighted average number of shares
    31,343,306       22,140,568       31,348,563       22,350,126  
Earnings per share before noncontrolling interest
  $ 0.82     $ (0.24 )   $ 1.55     $ 0.14  
Earnings per share attributable to controlling interest
  $ 0.82     $ (0.24 )   $ 1.47     $ 0.14  
Earnings per share attributable to noncontrolling interest
  $ -     $ -     $ (0.08 )   $ -  
 
The accompanying notes are an integral part of these consolidated statements.

 
4

 
 
HARBIN ELECTRIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Unaudited)
 
   
Common stock
   
Additional
   
Retained earnings
   
Accumulated other
             
         
Par
   
paid-in
   
Unrestricted
   
Statutory
   
comprehensive
   
Noncontrolling
       
   
Shares
   
value
   
capital
   
earnings
   
reserves
   
income (loss)
   
interest
   
Total
 
                                                 
BALANCE, January 1, 2009
    22,102,078     $ 220     $ 95,029,290     $ 52,100,479     $ 14,573,994     $ 12,945,352       -     $ 174,649,335  
                                                                 
Reclassification of warrant liabilities to equity
                    (13,613,718 )     6,142,280                               (7,471,438 )
Amortization of stock compensation
                    584,290                                       584,290  
Non cash exercise of warrant at $12.25
    85,227       1       1,055,266                                       1,055,267  
Net income
                            3,234,970                               3,234,970  
Adjustment to statutory reserve
                            (1,994,565 )     1,994,565                       -  
Foreign currency translation gain
                                            (294,478 )             (294,478 )
Net change related to cash flow hedge
                                            (3,240,364 )             (3,240,364 )
BALANCE, June 30, 2009 (Unaudited)
    22,187,305       221       83,055,128       59,483,164       16,568,559       9,410,510       -       168,517,582  
                                                                 
Exercise of stock warrants at $7.80
    1,428,846       14       26,122,124                                       26,122,138  
Amortization of stock compensation
                    626,747                                       626,747  
Stock issuance for cash at $16
    7,187,500       72       107,521,878                                       107,521,950  
Noncontrolling interest in acquiree
                                                    17,957,815       17,957,815  
Net income
                            16,411,811                       3,491,414       19,903,225  
Exercise of stock options at $3.10
    65,000       1       201,499                                       201,500  
Exercise of stock options at $8.10
    70,000       1       566,999                                       567,000  
Cashless exercise of options
    128,820       1       (1 )                                     -  
Adjustment to statutory reserve
                            (6,300,864 )     6,300,864                       -  
Dividend distribution
                                                    (150,071 )     (150,071 )
Foreign currency translation gain
                                            224,467       683       225,150  
Net change related to cash flow hedge
                                            3,322               3,322  
Reclassification of change in cash flow hedge to earnings
                                            9,000,000               9,000,000  
BALANCE, December 31, 2009
    31,067,471       310       218,094,374       69,594,111       22,869,423       18,638,299       21,299,841       350,496,358  
                                                                 
Amortization of stock compensation
                    509,338                                       509,338  
Net income
                            46,228,492                       2,353,123       48,581,615  
Adjustment to statutory reserve
                            (5,044,288 )     5,044,288                       -  
Deconsolidation of subsidiaries
                                            23       (1,604,613 )     (1,604,590 )
Acquisition of noncontrolling interest
                    (5,387,208 )                     711       (22,134,423 )     (27,520,920 )
Foreign currency translation gain
                                            1,412,069       (191 )     1,411,878  
BALANCE, June 30, 2010 (Unaudited)
    31,067,471     $ 310     $ 213,216,504     $ 110,778,315     $ 27,913,711     $ 20,051,102       (86,263 )   $ 371,873,679  
 
The accompanying notes are an integral part of these consolidated statements.

 
5

 
 
HARBIN ELECTRIC, INC. AND SUBSIDIARIES

 CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009
(Unaudited)

   
Six Months Ended June 30,
 
   
2010
   
2009
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income attibutable to noncontrolling interest
  $ 2,353,123     $ -  
Net income attibutable to controlling interest
    46,228,492       3,234,970  
Consolidated net income
    48,581,615       3,234,970  
Adjustments to reconcile net income to cash
               
provided by (used in) operating activities:
               
Depreciation
    3,829,181       1,287,510  
Amortization of intangible assets
    753,764       524,960  
Amortization of debt issuance costs
    281,936       271,220  
Amortization of debt discount
    1,223,276       2,007,648  
(Recovery of) provision for accounts receivable
    (29,116 )     647,729  
(Recovery of) inventory reserve
    (387,200 )     -  
Share-based compensation
    509,338       584,290  
Loss on disposal of equipment
    69,119       -  
Gain on cashless conversion of warrants
    -       (11,595 )
Change in fair value of warrants
    (1,423,379 )     11,441,369  
Loss from disposal of subdivision
    623,158       -  
Change in operating assets and liabilities
               
Notes receivable
    770,358       964,911  
Accounts receivable
    (2,750,252 )     4,816,100  
Inventories
    (6,358,437 )     6,776,920  
Other receivables & prepaid expenses
    2,328,104       24,422  
Advances on inventory purchases
    (1,498,028 )     (264,438 )
Other assets
    125,988       (343,857 )
Accounts payable
    9,370,961       (384,241 )
Customer deposits
    (2,803,473 )     (42,712 )
Accrued liabilities & other payables
    (4,798,093 )     (958,470 )
Taxes payable
    719,344       461,321  
Net cash  provided by operating activities
    49,138,164       31,038,057  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Payment for advances on intangible assets
    -       (1,234,119 )
Payment for advances on equipment purchases
    (10,386,470 )     -  
Purchase of intangible assets
    (110,507 )     -  
Purchase of plant and equipment
    (1,637,564 )     (268,408 )
Proceeds from sale of equipments and vehicles
    90,892          
Additions to construction-in-progress
    (28,558,099 )     (4,057,555 )
Addition to loan receivable - related party
    -       (4,250,530 )
Payment to original shareholders for acquisition
    (27,946,571 )     -  
Payment to acquire noncontrolling interests
    (26,550,890 )     -  
Deconsolidation of cash held in disposed subdivisions
    (602,948 )     -  
Proceeds from sale of controlling interests in subsidiaries
    718,781       -  
Net cash used in investing activities
    (94,983,376 )     (9,810,612 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Decrease in restricted cash
    (1,543,179 )     (510,064 )
Payment on cross currency hedge
    -       (332,027 )
Payment on notes payable
    (3,800,000 )     (2,000,000 )
Proceeds from notes payable-short term
    4,271,647       1,020,127  
Payment on notes payable-short term
    (3,080,524 )     -  
Proceeds from short term loans
    6,307,670       3,077,970  
Repayment of short term loans
    (9,094,780 )     (3,004,685 )
Net cash used in financing activities
    (6,939,166 )     (1,748,679 )
                 
EFFECTS OF EXCHANGE RATE CHANGE ON CASH
    157,179       (89,705 )
                 
(DECREASE) INCREASE IN CASH
    (52,627,199 )     19,389,061  
                 
Cash and cash equivalents, beginning of period
    92,902,400       48,412,263  
                 
Cash and cash equivalents, end of period
  $ 40,275,201     $ 67,801,324  

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

 
6

 
 
HARBIN ELECTRIC, INC. AND SUBSIDIARIES

 
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)
 
Note 1 - Nature of Business

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

Recent development

In October 2009, Harbin Electric acquired 100% of Xi’an Tech Full Simo Motor Co., Ltd. (“Simo Motor”). Simo Motor formerly known as Xi’an Simo Motor Incorporation (Group), was initially established in 1955 as a State-Owned Enterprise and one of the major backbone companies of China’s electric motor industry. In January 2004, Simo Motor was privatized as a shareholding company from the former Xi’an Electric Motor Works under the corporate laws of the People’s Republic of China (“PRC”). Simo Motor develops and manufactures various industrial motors. Simo Motor sells its products primarily in China and also in certain international markets. Simo Motor has been developed to a large enterprise group which consisted of 15 wholly-owned and 8 majority-owned subsidiaries mainly engaged in manufacturing and selling of electric motors. As a result, Simo Motor’s ownership to all subsidiaries averaged to 87.2%. Subsequently, Simo Motor acquired 4 of the 8 majority-owned subsidiaries and sold 3 of the 8 majority-owned subsidiaries, effective April 1, 2010, as described below.

On June 3, 2010, Simo Motor entered into four Share Purchase Agreements with certain shareholders of four subsidiaries of Simo Motor pursuant to which Simo Motor agreed to acquire all of the equity interests of these subsidiaries that are not currently held by Simo Motor.  Pursuant to these Share Purchase Agreements, effective April 1, 2010, Simo Motor would own 100% of the outstanding equity of Xi’an Tech Full Lamination Co., Ltd. (“Lamination”), Xi’an Simo A’Da Motor Co., Ltd. (“A’Da Motor”), Xi’an Tech Full Simo Moulds Co., Ltd. (“Moulds”), and Xi’an Tech Full Simo Transportation Co., Ltd. (“Transportation”).  See Note 4 for further discussion. These transactions were closed in the months of June and July 2010. The aggregate purchase price for these equity interests in Lamination, A’Da Motor, Moulds, and Transportation is RMB188.2 million ($27.60 million), of which $26.50 million was paid in the months of May and June 2010 with the remaining $1.10 million paid in July 2010.

In addition, Simo Motor also entered into three Share Purchase Agreements, each dated as of June 3, 2010 with certain shareholders of three subsidiaries of Simo Motor pursuant to which Simo Motor agreed to sell its equity interests in such subsidiaries to these shareholders.  Pursuant to these three Share Purchase Agreements, effective April 1, 2010, Simo Motor would no longer own any of the outstanding equity of Tianjin Simo Electric Co., Ltd. (“Tianjin Simo”), Xi’an Simo Science and Technology Development Co., Ltd. (“Science and Technology”), and Xi’an Simo Imports and Exports Co., Ltd. (“Imports and Exports”).  See Note 3 for further discussion. These transactions were closed in the months of June and July 2010. The aggregate sales price to be received by Simo Motor for these equity interests in Tianjin Simo, Science and Technology, and Imports and Exports is RMB12.55 million ($1.84 million). The Company received $0.72 million in June 2010 with the remaining $1.12 received in July 2010.

Note 2 - Summary of Significant Accounting Policies

Basis of presentation

The consolidated financial statements of Harbin Electric Inc. reflect the activities of the following subsidiaries.  All material intercompany transactions have been eliminated.
 
     
Place incorporated
   
Ownership
percentage
 
Advanced Electric Motors, Inc. (“AEM”)
 
Delaware, USA
    100 %
Harbin Tech Full Electric Co., Ltd. (“HTFE”)
 
Harbin, China
    100 %
Advanced Automation Group, LLC (“AAG”)
 
Delaware, USA
    100 %
Advanced Automation Group Shanghai Co., Ltd. (“SAAG”)
 
Shanghai, China
    100 %
Shanghai Tech Full Electric Co., Ltd. (“STFE”)
 
Shanghai, China
    100 %
Weihai Tech Full Simo Motor Co., Ltd. (“Weihai”)
 
Weihai, China
    100 %
Xi’an Tech Full Simo Motor Co., Ltd. (“Simo Motor”)
 
Xi’an, China
    100 %

 
7

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

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

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

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 June 30, 2010, our consolidated results of operations for the three months and six months ended June 30, 2010 and 2009, and our consolidated results of cash flows for the six months ended June 30, 2010 and 2009. The results of operations for the three months and six months ended June 30, 2010 are not necessarily indicative of the results to be expected for future quarters or the full year.

Use of estimates

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

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

Foreign currency transactions

Our reporting currency is the US dollar.  The functional currency of PRC subsidiaries is the Chinese Renminbi (“RMB”). Our results of operations and financial position of the PRC subsidiaries are translated to United States dollars using the end of period exchange rates as to assets and liabilities and weighted average exchange rates as to revenues, expenses and cash flows. Capital accounts are translated at their historical exchange rates when the capital transaction occurred. The resulting currency translation adjustments are recorded as a component of accumulated other comprehensive income (loss) within stockholders’ equity.  As a result, translation adjustments amount related to assets and liabilities reported on the consolidated statement of cash flows will not necessarily agree with changes in the corresponding consolidated balances on the balance sheet. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

 
8

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

Translation adjustments resulting from this process amounted to a gain of $1,320,473 and a loss of $9,110 for the three months ended June 30, 2010 and 2009, respectively. Translation adjustments resulting from this process amounted to a gain of $1,412,069 and a loss of $294,478 for the six months ended June 30, 2010 and 2009, respectively. The balance sheet amounts with the exception of equity at June 30, 2010 and December 31, 2009 were translated at 6.789 RMB to $1.00 and 6.837 RMB to $1.00, respectively.  The equity accounts were stated at their historical exchange rate.  The average translation rates applied to the revenues, expenses and cash flows statement amounts for the six months ended June 30, 2010 and 2009 were 6.817 RMB and 6.843 RMB to $1.00, respectively.  
 
Transaction loss of $35,796 and gain of $87,619 were recognized during the three months ended June 30, 2010 and 2009, respectively. Transaction loss of $38,478 and $204,690 were recognized during the six months ended June 30, 2010 and 2009, respectively.

Concentration of risks

The Company considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents, for cash flow statement purposes.  Cash includes cash on hand and demand deposits in accounts maintained with state owned banks within the PRC and with banks in the United States. The Company maintains balances at financial institutions which, from time to time, may exceed Federal Deposit Insurance Corporation insured limits for the banks located in the Unites States. Balances at financial institutions or state owned banks within the PRC are not insured. As of June 30, 2010 and December 31, 2009, the Company had deposits in excess of federally insured limits totaling $44,852,731 and $92,701,730, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts.

No customer accounted for more than 10% of the net revenue for the three months ended June 30, 2010. Two major customers accounted for approximately 27% of the net revenue for the three months ended June 30, 2009, with each customer individually accounting for 15% and 12%, respectively.

No customer accounted for more than 10% of the net revenue for the six months ended June 30, 2010.  Two major customers accounted for approximately 27% of the net revenue for the six months ended June 30, 2009, with each customer individually accounting for 14% and 13%, respectively. At June 30, 2009, the total receivable balance due from these customers was $11,002,527, representing 43% of total accounts receivable.  
   
No vendor accounted for more than 10% of the raw material purchases for the three months ended June 30, 2010. One major vendor provided 13% of the Company’s purchase of raw materials for the three months ended June 30, 2009.

No vendor accounted for more than 10% of the raw material purchases for the six months ended June 30, 2010. One major vendor provided 25% of the Company’s purchase of raw materials for the six months ended June 30, 2009. The Company’s accounts payable to this vendor was $0 at June 30, 2009.

The Company's operations are carried out in the PRC. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic, and legal environments in the PRC, and by the general state of the PRC's economy. The Company's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in the North America and Western Europe. These include risks associated with, among others, the political, economic and legal environments, and foreign currency exchange. The Company's results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

 
9

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

Restricted cash

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

Notes receivable

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

Accounts receivable

Accounts receivable are presented net of an allowance for bad debts account. The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends, and changes in customer payment patterns to evaluate the adequacy of these reserves. The estimated loss rate is based on our historical loss experience and also considerations of current market conditions. Delinquent account balances are written-off after management has determined that the likelihood of collection is not probable, and known bad debts are written off against allowance for doubtful accounts when identified.

Inventories

Inventories are valued at the lower of cost or market value, as determined on a first-in, first-out basis, using the weighted average method. Management compares the cost of inventories with the market value and an allowance is made for writing down the inventory to its market value, if lower than cost. On an ongoing basis, inventories are reviewed for potential write-down for estimated obsolescence or unmarketable inventories equal to the difference between the costs of inventories and the estimated net realizable value based upon forecasts for future demand and market conditions. When inventories are written-down to the lower of cost or market, it is not marked up subsequently based on changes in underlying facts and circumstances.  Inventories are composed of raw material for manufacturing electrical motors, work in process, and finished goods within the Company’s warehouse premise or consigned at a customer site.

Plant and equipment

Plant and equipment are stated at cost, net of depreciation. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When assets are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation of plant and equipment is provided using the straight-line method for substantially all assets with estimated lives as follows: 

 
Estimated Useful Life
Buildings
20 - 40  years
Vehicle
5 -10  years
Office equipment
5 - 6  years
Production equipment
10 - 12  years

Construction in progress represents the costs incurred in connection with the construction of buildings or new additions to the Company’s plant facilities.  No depreciation is provided for construction in progress until such time as the assets are completed and placed into service. Maintenance, repairs and minor renewals are charged directly to expense as incurred. Major additions and betterment to buildings and equipment are capitalized. Interest incurred during construction is capitalized into construction in progress. All other interest is expensed as incurred.

 
10

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

The Company recognizes an impairment loss when estimated cash flows generated by those assets are less than the carrying amounts of the asset. Based on management review, the Company believes that there were no impairments as of June 30, 2010 and December 31, 2009.

Goodwill and other intangible assets

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

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

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

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

Our impairment test consists of a comparison of the fair value of the intangible asset with its carrying amount. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to the excess.  As of June 30, 2010, management believes there was no impairment.

Accounting for long-lived assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We assess the recoverability of the assets based on the undiscounted future cash flow the assets are expected to generate and recognize an impairment loss when estimated undiscounted future cash flow expected to result from the use of the asset plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When we identify an impairment, we reduce the carrying amount of the asset to its estimated fair value based on a discounted cash flow approach or, when available and appropriate, to comparable market values.  As of June 30, 2010, management believes there was no impairment.

Stock-based compensation

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

 
11

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

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

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

Revenue recognition

The Company recognizes sales at the date of shipment to customers when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations of the Company exist and collectability is reasonably assured. For products that are required to be examined by customers, sales revenue is recognized after the customer examination is passed. Payments received before all of the relevant criteria for revenue recognition are recorded as customer deposits.

In addition, revenue recognition could be negatively impacted by returns. For our linear motor and specialty micro-motor businesses, our products are custom products which are customer specific, and no returns are allowed. We warrant our product for repair, only in the event of defects for two years from the date of shipment.  We charge such costs to cost of goods sold. For our industrial rotary motor business, our products are standardized products and returns are allowed within three days upon receipt of products by customers. We provide product warranty for repair one year from the date of shipment. Historically, the returns and defects have not been material. Should returns increase in the future it would be necessary to adjust the estimates, in which case recognition of revenues could be delayed.

Shipping and handling costs are included in selling, general and administrative costs and totaled $1,212,761 and $485,201 for the three months ended June 30, 2010 and 2009, respectively. For the six months ended June 30, 2010 and 2009, shipping and handling costs totaled $2,045,176 and $949,564, respectively.

Income taxes

The Company utilizes the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.  GAAP also requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. As of January 1, 2007, income tax positions must meet a more-likely-than-not recognition threshold to be recognized.  A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 
12

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.  No material deferred tax amounts were recorded at June 30, 2010 and December 31, 2009, respectively. Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the year incurred.  No significant penalties or interest relating to income taxes have been incurred during the three and six months ended June 30, 2010 and 2009.  GAAP also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures, and transition.

The charge for taxation is based on the results for the reporting period as adjusted for items, which are non-assessable or disallowed.  It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

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

The Company’s subsidiaries were paying the following tax rate for the three and six months ended June 30:

   
2010
   
2009
 
Subsidiaries
 
Income
Tax
Exemption
   
Effective
Income
Tax Rate
   
Income
Tax
Exemption
   
Effective
Income
Tax Rate
 
HTFE
    15 %     10 %     15 %     10 %
                                 
Weihai
    0 %     25 %     0 %     25 %
                                 
STFE
    14 %     11 %     25 %     0 %
                                 
Simo Motor (a)
    10 %     15 %     n/a       n/a  
 
(a) Simo Motor was acquired in October 2009 and the tax rate only applied to its results of operations included in the consolidated financial statements, which are for the three months and six months ended June 30, 2010.
   
The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the three months ended June 30:
 
   
2010
   
2009
 
             
U.S. statutory reserve rates
    34.0 %     34.0 %
Foreign income not recognized in U.S.
    -34.0 %     -34.0 %
China income taxes
    25.0 %     25.0 %
Tax exemption
    -9.4 %     -13.0 %
Other items (b)
    -2.7 %     -50.0 %
Effective income taxes
    12.9 %     -38.0 %

 
13

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

(b)  The (2.7) % represents the $786,587 of gain incurred by the Company and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the three months ended June 30, 2010. The (50)% represents the $15,269,121 of expenses incurred by the Company and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the three months ended June 30, 2009.

The following table reconciles the U.S. statutory rates to the Company’s effective tax rate for the six months ended June 30:
 
   
2010
   
2009
 
             
U.S. statutory reserve rates
    34.0 %     34.0 %
Foreign income not recognized in U.S.
    -34.0 %     -34.0 %
China income taxes
    25.0 %     25.0 %
Tax exemption
    -11.6 %     -13.0 %
Other items (c)
    0.5 %     32.0 %
Effective income taxes
    13.9 %     44.0 %

(c)  The 0.5 % represents the $279,410 of expenses incurred by the Company and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the six months ended June 30, 2010. The 32% represents the $15,138,049 of expenses incurred by the Company and its US subsidiaries AEM and AAG that are not subject to PRC income tax for the six months ended June 30, 2009.

The estimated tax savings for the six months ended June 30, 2010 and 2009 amounted to $6,806,723 and $2,865,216, respectively. The net effect on earnings per share attributable to controlling interest had the income tax been applied would decrease earnings per share from $1.49 to $1.27 for the six months ended June 30, 2010, and $0.15 to $0.02 for the six months ended June 30, 2009.

Harbin Electric, AEM, and AAG were organized in the United States and have incurred net operating losses for income tax purposes for the six months ended June 30, 2010.  The net operating loss carry forwards for United States income taxes amounted to $30,437,873 which may be available to reduce future years’ taxable income.  These carry forwards will expire, if not utilized, starting from 2027 through 2030.  Management believes that the realization of the benefits from these losses appears uncertain due to the Company’s limited operating history and continuing losses for United States income tax purposes.  Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit to reduce the asset to zero.  The net change in the valuation allowance for the six months ended June 30, 2010 was an increase of approximately $394,990. Management will review this valuation allowance periodically and make adjustments accordingly.

The Company has cumulative undistributed earnings of foreign subsidiaries of approximately $172,575,926 as of June 30, 2010, which is included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations.  Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings would 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.

 
14

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

VAT on sales and VAT on purchases amounted to $20,075,916 and $13,653,918 for the three months ended June 30, 2010, respectively.  VAT on sales and VAT on purchases amounted to $6,708,657 and $3,916,888 for the three months ended June 30, 2009, respectively. VAT on sales and VAT on purchases amounted to $38,059,087 and $24,967,631 for the six months ended June 30, 2010, respectively.  VAT on sales and VAT on purchases amounted to $12,695,403 and $7,586,458 for the six months ended June 30, 2009, respectively. Sales and purchases are recorded net of VAT collected and paid as the Company acts as an agent for the government.

Advertising costs

The Company expenses the cost of advertising as incurred in selling, general and administrative costs. The Company incurred $23,662 and $53,489 for the three months ended June 30, 2010 and 2009, respectively. The Company incurred $56,111 and $57,105 for the six months ended June 30, 2010 and 2009, respectively.

Research and development costs

Research and development costs are expensed as incurred.  The costs of material and equipment that are acquired or constructed for research and development activities and have alternative future uses are classified as plant and equipment and depreciated over their estimated useful lives.

Noncontrolling interest

The Company owns 100% of Simo Motor. The 0.04% of noncontrolling interest was indirectly from one of Simo Motor’s subsidiary Qishan Simo Moulding Co, Ltd.

Fair value of financial instruments

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

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

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

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

As of June 30, 2010, the outstanding principal on the Company’s 2012 Notes Payable, evaluated under these accounting standards, amounted to $5,083,486, net of discount.  Management concluded the carrying values are a reasonable estimate of fair value because of the short period of time between the origination of such instruments and their expected realization, and if applicable, their stated interest rate approximates current rates available.

 
15

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

Effective January 1, 2009, a total of 2,030,158 warrants previously treated as equity pursuant to the derivative treatment exemption is no longer afforded equity treatment because the strike price of the warrants is denominated in US dollar, a currency other than the Company’s functional currency, the Chinese RMB.  As a result, the warrants are not considered indexed to the Company’s own stock, and as such, all future changes in the fair value of these warrants will be recognized currently in earnings until such time as the warrants are exercised or expired. The Company reclassified the fair value of these warrants from equity to liability, as if these warrants were treated as a derivative liability since their issuance in August 2006. On January 1, 2009, the Company reclassified from additional paid-in capital, as a cumulative effect adjustment, $6.1 million to beginning retained earnings and $7.4 million to warrant liabilities to recognize the fair value of such warrants. As of June 30, 2010, the Company has 366,697 warrants outstanding. The fair value of the outstanding warrants was $3.2 million.  The Company recognized a total of $1.7 million gain from the change in fair value of the warrants for the three months ended June 30, 2010 and $1.4 million gain for the six months ended June 30, 2010.

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:

   
June 30, 2010
   
January 1, 2009
 
   
(Unaudited)
   
(Unaudited)
 
Annual dividend yield
   
-
     
-
 
Expected life (years)
   
2.17
     
3.67
 
Risk-free interest rate
   
0.70
%
   
1.20
%
Expected volatility
   
69
%
   
66
%

Expected volatility is based primarily on historical volatility. Historical volatility was computed using daily price 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
June 30,
2010
   
Fair Value Measurements at June 30, 2010 Using
Fair Value Hierarchy
 
   
(Unaudited)
   
Level 1
   
Level 2
   
Level 3
 
                         
Fair value of warrant liabilities
  $ 3,200,179             $ 3,200,179          

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

Recent Accounting Pronouncements

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

 
16

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

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

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

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

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

 
17

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

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

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications have no effect on net income or cash flows.

Note 3 – Disposal of subdivisions

Effective April 1, 2010, Simo Motor, a PRC subsidiary of the Company, sold its equity interests in its three subsidiaries, Tianjin Simo, Science and Technology, and Imports and Exports, to certain shareholders of these three subsidiaries.  As a result of the above dispositions, Simo Motor will no longer own any of the outstanding equity of these three subsidiaries.  The Company evaluates the impact of the disposal of the above entities, which results in the Company failing the test in ASC 205-20-45. The failure of this test therefore does not require the classification of the disposal of the above entities as a discontinued operation. The aggregate sales price for the equity interests in Tianjin Simo, Science and Technology, and Imports and Exports is RMB12.55 million (US$1.84 million). A net loss of $623,158 was recorded in loss from disposal of subdivisions, net of income taxes in the Company’s Consolidated Statements of Operations.

Note 4 – Acquisition of the noncontrolling interests

Effective April 1, 2010, Simo Motor, a PRC subsidiary of the Company, acquired all of the equity interests in its four subsidiaries, Lamination, A’Da Motor, Moulds, and Transportation.  As a result of the above acquisitions, Simo Motor will now own 100% of the outstanding equity of these four subsidiaries.  The aggregate purchase price for the equity interests in these four subsidiaries is $27.60 million, of which $26.55 million was received in June with the remaining $1.1 million received in July 2010.

The effects of changes in the Company’s ownership interest in its subsidiaries:

   
For the six months ended June 30
 
   
2010
 
2009
 
     
(Unaudited)
 
Net income attributable to controlling interest
 
$
46,228,492
   
$
3,234,970
 
Transfer (to) from the noncontrolling interest
               
Decrease in Paid-in Capital for purchase of noncontrolling interests
   
(5,387,208
)
   
-
 
Change from net income attributable to controlling interest and transfers (to) noncontrolling interest
 
$
40,841,284
   
$
3,234,970
 

 
18

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

Note 5 – Supplemental disclosure of cash flows

The Company prepares its statements of cash flows using the indirect method as defined under the ASC Topic 230. The following information relates to non-cash investing and financing activities for the six months ended June 30, 2010 and 2009.

Total interest paid amounted to $1,513,782 and $1,807,095 for the six months ended June 30, 2010 and 2009, respectively.

Total income tax paid amounted to $7,089,794 and $2,312,075 for the six months ended June 30, 2010 and 2009, respectively.

For the six months ended June 30, 2010, equipment in the amount of $322,027 was transferred as payment to accounts payable for $171,279 and as payment to other payables for the amount of $150,748.

Note 6 – Accounts receivable

Accounts receivable consisted of the following:

   
June 30,
   
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
       
Accounts receivable
  $ 99,438,034     $ 97,302,153  
Less: allowance for bad debts
    (3,953,599 )     (3,979,268 )
Accounts receivable, net
  $ 95,484,435     $ 93,322,885  

The following table consists of allowance for bad debts:

Allowance for bad debts at January 1, 2009
  $ 153,155  
Provision for bad debts
    647,729  
Accounts receivable write off
    -  
Effect of foreign currency translation
    (519 )
Allowance for bad debts at June 30, 2009 (Unaudited)
    800,365  
Recovery of accounts receivable
    (1,082,929 )
Increase in allowance from acquisition of Simo Motor
    4,263,411  
Effect of foreign currency translation
    (1,579 )
Allowance for bad debts at December 31, 2009
    3,979,268  
Recovery of accounts receivable
    (29,116 )
Accounts receivable write off
    -  
Effect of foreign currency translation
    3,447  
Allowance for bad debts at June 30, 2010 (Unaudited)
  $ 3,953,599  

Note 7 – Inventories

The following is a summary of inventories by major category:

   
June 30,
   
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
       
Raw and packing materials
  $ 13,680,851     $ 11,826,804  
Work in process
    26,158,585       28,434,522  
Finished goods
    32,003,242       25,471,544  
Finished goods - consignment
    17,516,405       18,077,870  
Inventory valuation allowance
    (8,493,792 )     (8,896,863 )
Total inventories, net
  $ 80,865,291     $ 74,913,877  

 
19

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

As of June 30, 2010 and December 31, 2009, total inventory valuation allowance amounted to $8,493,792 and $8,896,863.  All inventory valuation allowance is from the subsidiary Simo Motor acquired on October 2, 2009.

Allowance for inventory valuation at January 1, 2009
  $ -  
Additional reserves
    -  
Recovery of reserves
    -  
Effect of foreign currency translation
    -  
Allowance for inventory valuation at June 30, 2009 (Unaudited)
    -  
Additional reserves
    710,466  
Recovery of reserves
    -  
Increase in allowance from acquisition of Simo Motor
    8,186,252  
Effect of foreign currency translation
    145  
Allowance for inventory valuation at December 31, 2009
    8,896,863  
Additional reserves
    998,749  
Recovery of inventory reserves
    (1,385,949 )
Effect of foreign currency translation
    (15,871 )
Allowance for inventory valuation at June 30, 2010 (Unaudited)
  $ 8,493,792  

Note 8 – Advances on inventory purchases

The Company makes advances to certain vendors for inventory purchases.  The advances on inventory purchases were $13,255,272 and $11,718,544 as of June 30, 2010 and December 31, 2009, respectively.

Note 9 – Plant and equipment

The following table presents details of our property and equipment:

   
June 30,
   
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
       
Buildings
  $ 87,607,192     $ 88,081,895  
Office equipment
    2,481,373       1,437,761  
Production equipment
    29,203,327       28,801,414  
Vehicles
    2,848,332       3,633,367  
Construction in progress
    69,095,265       40,504,272  
Total
    191,235,489       162,458,709  
Less: accumulated depreciation
    (9,086,930 )     (6,094,161 )
Property and equipment, net
  $ 182,148,559     $ 156,364,548  

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

 
20

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

Depreciation expense for the three months ended June 30, 2010 and 2009 amounted to $1,941,073 and $619,730, respectively. Depreciation expense for the six months ended June 30, 2010 and 2009 amounted to $3,829,181 and $1,287,510, respectively.

For the six months ended June 30, 2010 and 2009, a total of $127,751 and $2,092,580 of interest were capitalized into construction in progress, respectively.

Note 10 – Advances on non-current assets

Advances on non-current assets consisted of advance for intangible assets and advanced payment to certain vendors for equipment and construction project, as follows:

   
June 30,
   
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
       
Advance for intangible assets
  $ 3,146,328     $ 3,133,512  
Advance for equipments and constructions
    21,021,101       10,532,902  
Total advances on non-current assets
  $ 24,167,429     $ 13,666,414  

Advance for intangible assets

The advances for intangible assets consisted of land use right prepayment. On September 8, 2006, HTFE entered into an agreement ("Land Use Agreement") with Shanghai Lingang Investment and Development Company Limited ("Shanghai Lingang") with respect to HTFE’s use of 40,800 square meters of State-owned land in the Shanghai Zhuqiao Airport Industrial Zone (the "Site").  The size of the land used by HTFE was later revised to a total of approximately 53,000 square meters. The term of the land use agreement is 50 years and the aggregate amount HTFE shall pay to Shanghai Lingang is approximately $6.28 million (RMB 42,840,000) ("Fee"), approximately 96.8% or $6.08 million (RMB 41,452,020) has been paid, as of June 30, 2010. HTFE shall register a Sino-foreign joint venture company at the location of Shanghai Lingang, with taxes payable at the same location. HTFE has agreed to compensate Shanghai Lingang for certain local taxes due to the local tax authority in connection with applicable tax generation requirements.

Note 11 – Goodwill and other intangible assets

Net intangible assets consist of the following at:

   
June 30,
2010
   
December 31,
2009
 
   
(Unaudited)
       
Goodwill on 2008 Acquisition of Weihai
  $ 12,273,778     $ 12,273,778  
Goodwill on 2009 Acquisition of Simo Motor
     40,835,817        41,799,976  
Total goodwill
    53,109,595       54,073,754  
Land use rights
    17,795,814       17,481,972  
Patents
    6,733,782       6,702,983  
Software
     233,786        95,110  
Total goodwill and other intangible assets
    77,872,977       78,353,819  
Less: accumulated amortization
    (4,199,236 )     (2,807,594 )
Intangible assets, net
  $ 73,673,741     $ 75,546,225  

Amortization expense for the three months ended June 30, 2010 and 2009 amounted to $387,916 and $232,033, respectively. Amortization expense for the six months ended June 30, 2010 and 2009 amounted to $753,764 and $524,960, respectively.

 
21

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

The Company uses the purchase method of accounting for business combinations. Annual testing for impairment of goodwill is performed during the fourth quarter of each year unless events or circumstances indicate earlier impairment testing is required. No impairment loss was recognized for the three months and six months ended June 30, 2010 and 2009. As a result of the disposition of the three subdivisions, effective April 1, 2010, Simo Motor would no longer own any of the outstanding equity of Tianjin Simo, Science and Technology, and Imports and Exports (see Note 3 for more discussion).  Goodwill of these three subdivisions in the amount of $964,159 was included in the carrying amount of the reporting unit in determining the gain or loss on disposal.

Goodwill, at the date of the acquisition of Simo Motor, (audited)
  $ 41,799,976  
Goodwill, disposed subsidiaries
    (964,159 )
Goodwill, as of June 30, 2010 (unaudited)
  $ 40,835,817  

Note 12 – Taxes payable

Taxes payable consisted of the following:
   
June 30,
2010
   
December 31,
2009
 
   
(Unaudited)
       
VAT tax payable
  $ 3,161,276     $ 3,473,092  
Individual income tax withholding payable
    79,597       71,563  
Corporation income tax payable
    3,400,750       2,825,545  
Others miscellaneous tax payable
      2,371,184        1,863,662  
Total
  $ 9,012,807     $ 8,233,862  

Note 13 – Financing

On August 29, 2006, the Company, Citadel Equity Fund Ltd. (“Citadel”) and Merrill Lynch International (“Merrill Lynch” and, together with Citadel, the “Investors”) entered into a purchase agreement (the “Purchase Agreement”) relating to the purchase and sale of (a) $50 million aggregate principal amount of the Company's Guaranteed Senior Secured Floating Rate Notes (collectively, the “Notes”) and (b) fully detachable warrants (the “Warrants”) to purchase an aggregate of 3,487,368 shares of our common stock. The transaction closed on August 30, 2006.

On June 1, 2009, the Company and Citadel entered into a Letter Agreement (the “Citadel Agreement”). Pursuant to the Citadel Agreement, the Company was granted the option to repurchase, all (but not part), of the $26.5 million 2012 Notes held by Citadel before August 31, 2009 (“the Proposed 2012 Notes Repurchase”).  On August 4, 2009, the Company notified Citadel that pursuant to the Citadel Agreement (i) the Company was exercising its option to consummate the Proposed 2012 Notes Repurchase and (ii) the Proposed 2012 Notes Repurchase shall be consummated on August 11, 2009 (the “Citadel Repurchase Date”) at an aggregate Citadel Repurchase Price of $23,131,997 to be paid in cash, which Repurchase Price shall be comprised of $22,525,000 representing 85% of the $26,500,000 aggregate principal amount of the 2012 Notes held by Citadel (the “Citadel Notes”) plus $606,997 representing accrued and unpaid interest on the Citadel Notes to but excluding the Repurchase Date. On August 11, 2009, the Company made cash payment in accordance with terms of the Citadel Agreement and recorded a gain of $3,975,000 from the repurchase transaction.  After principal payment of $2,400,000 made in September 2009 and $3,800,000 made in March 2010, the 2012 Notes balance as of June 30, 2010 amounted to $5,083,486 (net of debt discount of $216,514), or a total of $5,300,000 which will be fully paid off in September 2010.

 
22

 

HARBIN ELECTRIC, INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(UNAUDITED)

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

The following table disclosed the combined aggregate amounts of maturities for all the notes payable discussed above for each of the five years following June 30, 2010:

Contractual Obligations
 
2012 Notes
   
Total
 
2010
  $ 5,300,000     $ 5,300,000  
Thereafter
     -        -  
Total
  $ 5,300,000     $ 5,300,000  

The Warrants are governed by a warrant agreement, dated August 30, 2006, between AEM and The Bank of New York, as warrant agent. The Warrants consist of (i) six-year warrants to purchase an aggregate of 2,192,308 shares of our common stock, at an exercise price of $7.80 per share (the “First Tranche 2012 Warrants”), (ii) six-year warrants to purchase an aggregate of 525,830 shares of our common stock at an exercise price of $10.84 per share (the “Second Tranche 2012 Warrants”) and (iii) three-year warrants to purchase an aggregate of 769,230 shares of our common stock at an exercise price of $7.80 per share (the “2009 Warrants”).

The First Tranche 2012 Warrants and the Second Tranche 2012 Warrants were issued to Citadel, and the 2009 Warrants were issued to Merrill Lynch. Each Warrant is exercisable at the option of the Warrant holder at any time through the maturity date of such Warrant. The warrant agreements contain a cashless exercise provision.  During the three months and six months ended June 30, 2010, no warrants were exercised.

The fair value of the warrants upon issuance totaled $22,921,113, was treated as a discount on the carrying value of the debt, and is being amortized over the life of the loan using the effective interest method. $312,741 and $885,034 were amortized to interest expense for the three months ended June 30, 2010 and 2009, respectively.  $1,223,276 and $2,007,648 were amortized to interest expense for the six months ended June 30, 2010 and 2009, respectively.  As of June 30, 2010 and December 31, 2009, the unamortized discounts totaled $216,514 and $1,439,790, respectively.

Debt issuance costs, initially $2,954,625, are carried in other assets and are amortized over the life of the loan using the effective interest method.  A total of $140,968 and $135,610 was amortized to interest expense for the three months ended June 30, 2010 and 2009, respectively. A total of $281,936 and $271,220 was amortized to interest expense for the six months ended June 30, 2010 and 2009, respectively. As of June 30, 2010 and December 31, 2009, unamortized debt issuance costs totaled $77,319, and $359,255, respectively.

Note 14 -Short term loans

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

   
June 30, 2010
   
December 31, 2009
 
   
(Unaudited)
       
Short term loan – bank  
  $ 40,068,546     $ 38,291,634  
Short term loan – noncontrolling shareholders  
    -       918,342  
Short term loan – others
    5,545,525       5,229,653  
Short term loan – officers and employees
     536,172        -  
Total short term loans  
  $ 46,150,243     $ 44,439,629  

 
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HARBIN ELECTRIC, INC. AND SUBSIDIARIES