UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10−Q


(Mark
One)





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




For the
quarterly period ended: March 31, 2010




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




For the
transition period from ____________ to _____________




Commission
File Number: 333-83375





CHINA NEW ENERGY GROUP
COMPANY


(Exact
Name of Registrant as Specified in Its Charter)





Delaware
                  
                  65-0972647(State
      or other jurisdiction of
                    incorporation
      or organization)
                  
                  (I.R.S.
      Employer Identification
No.)





20/F,
Center Plaza, No.188 Jie Fang Road


He
Ping District, Tianjin, China  300042


(Address
of principal executive offices, Zip Code)




(86
22) 5829 9778


(Registrant’s
telephone number, including area code)




No.
1703 and 1704, A Building, No. 1, Hongji Apartment, Jin Wei Road


He Bei District, Tianjin,
China





(Former
name, former address and former fiscal year, if changed since last
report)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes  x  No   ̈





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





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 the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.





Large
      Accelerated Filer  ̈
            Accelerated
      Filer   ̈Non-Accelerated Filer  ̈(Do not check if a smaller reporting company)
            Smaller
      reporting company x





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





The
number of shares outstanding of each of the issuer’s classes of common equity,
as of May 10, 2010 is as follows:




Class
      of Securities
                  
                  Shares
      OutstandingCommon
      Stock, $0.001 par value
                  
                  101,788,199











Quarterly
Report on FORM 10-Q




Three
Months Ended March 31, 2010





Table
of Contents





PART
      IFINANCIAL
      INFORMATIONITEM
      1.
                FINANCIAL
      STATEMENTS.
                
                
                1ITEM
      2.
                MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.
                
                
                36ITEM
      3.
                QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
                
                
                48ITEM
      4T.
                CONTROLS
      AND PROCEDURES.
                
                
                48PART
      IIOTHER
      INFORMATIONITEM
      1.
                LEGAL
      PROCEEDINGS.
                
                
                49ITEM
      2.
                UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
                
                
                49ITEM
      3.
                DEFAULTS
      UPON SENIOR SECURITIES.
                
                
                49ITEM
      4.
                SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS.ITEM
      5.
                OTHER
      INFORMATION.
                
                
                49ITEM
      6.
                EXHIBITS.
                
                
                49





PART
I


FINANCIAL
INFORMATION




ITEM
      1.
            FINANCIAL
      STATEMENTS.





China
New Energy Group Company


Unaudited
Condensed Consolidated Financial Statements


Three
months ended March 31, 2010 and 2009





Index to
Unaudited Condensed Consolidated Financial Statements





PageUnaudited
      Condensed Consolidated Balance Sheets
                      
                      
                      2Unaudited
      Condensed Consolidated Statements of Operations and Comprehensive Income
      (Loss)
                      
                      
                      3Unaudited
      Condensed Consolidated Statements of Cash Flows
                      
                      
                      4Notes
      to Unaudited Consolidated Financial Statements
                      
                      
                      5


1


CHINA
NEW ENERGY GROUP COMPANY





CONDENSED
CONSOLIDATED BALANCE SHEETS





March
      31,
                          
                          
                          December
      31,2010
                          
                          
                          2009(Unaudited)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                          
                          $
                          514,127
                          
                          
                          $
                          2,672,884Restricted
      cash
                          
                          
                          180,352
                          
                          
                          
                          180,352Accounts
      receivable, net of allowance for doubtful accounts of $117,275 and
      $-
                          
                          
                          5,679,253
                          
                          
                          
                          4,619,232Receivable
      from sale of subsidiary
                          
                          
                          3,437,633
                          
                          
                          
                          5,119,055Inventories,
      net
                          
                          
                          296,918
                          
                          
                          
                          271,104Prepaid
      expenses
                          
                          
                          228,209
                          
                          
                          
                          179,011Deemed
      receivable from former shareholders of subsidiaries acquired for
      settlement of certain liabilities
                          
                          
                          1,984,101
                          
                          
                          
                          1,983,782Current
      assets held for sale
                          
                          
                          1,402,501
                          
                          
                          
                          1,768,278NET
      CURRENT ASSETS
                          
                          
                          13,723,094
                          
                          
                          
                          16,793,698Property,
      plant and equipment, net
                          
                          
                          9,546,014
                          
                          
                          
                          8,000,069Other
      receivables
                          
                          
                          1,933,489
                          
                          
                          
                          2,091,092Deposits
      for acquisition
                          
                          
                          1,222,946
                          
                          
                          
                          197,696Intangible
      assets, net
                          
                          
                          1,181,467
                          
                          
                          
                          1,186,272Deposits
      paid for acquisition of long term assets
                          
                          
                          2,642,480
                          
                          
                          
                          1,972,162Goodwill
                          
                          
                          224,524
                          
                          
                          
                          224,488Non-current
      assets held for sale
                          
                          
                          9,922,116
                          
                          
                          
                          9,760,345TOTAL
      ASSETS
                          
                          $
                          40,396,130
                          
                          
                          $
                          40,225,822LIABILITIES
      AND EQUITYCURRENT
      LIABILITIESAccounts
      payable
                          
                          $
                          985,927
                          
                          
                          $
                          614,642Accruals
      and other payable
                          
                          
                          384,561
                          
                          
                          
                          187,904Acquisition
      consideration payable
                          
                          
                          1,652,052
                          
                          
                          
                          1,651,888Tax
      payable
                          
                          
                          1,544,065
                          
                          
                          
                          1,323,815Registration
      rights penalties payable
                          
                          
                          2,160,000
                          
                          
                          
                          2,160,000Related
      party payables
                          
                          
                          97,909
                          
                          
                          
                          97,893Dividends
      payable on preferred stock
                          
                          
                          724,555
                          
                          
                          
                          509,381Derivative
      financial instruments – warrants
                          
                          
                          6,368,390
                          
                          
                          
                          6,768,106Liabilities
      to be settled by former shareholders of subsidiaries
    acquired
                          
                          
                          1,984,101
                          
                          
                          
                          1,983,782Current
      liabilities held for sale
                          
                          
                          428,924
                          
                          
                          
                          548,832TOTAL
      CURRENT LIABILITIES
                          
                          
                          16,330,484
                          
                          
                          
                          15,846,243Commitments
      and contingencies (Note 24)Preferred
      Stock : 10,000,000 shares authorized, $0.001 par value Series A
      Convertible Preferred Stock : 2,098,918 and 2,098,918 shares issued
      and outstanding, liquidation preference of $10,137,774 and $10,137,774 as
      of March 31, 2010 and December 31, 2009.
                          
                          
                          7,031,818
                          
                          
                          
                          7,031,818Series
      B Convertible Preferred Stock: 1,116,388 and 1,116,388 shares issued and
      outstanding, liquidation preference of $5,399,969 and $5,399,969 as of
      March 31, 2010 and December 31, 2009
                          
                          
                          2,153,307
                          
                          
                          
                          2,153,307CHINA
      NEW ENERGY'S STOCKHOLDERS' EQUITYCommon
      Stock: 500,000,000 shares authorized, $0.001 par value, 101,788,199 and
      101,788,199 shares issued and outstanding, respectively
                          
                          
                          101,788
                          
                          
                          
                          101,788Additional
      paid in capital
                          
                          
                          10,152,971
                          
                          
                          
                          10,152,971Retained
      earnings
                          
                          
                          1,102,682
                          
                          
                          
                          1,423,523Statutory
      surplus reserve fund
                          
                          
                          1,746,890
                          
                          
                          
                          1,746,890Accumulated
      other comprehensive income
                          
                          
                          1,606,124
                          
                          
                          
                          1,600,941TOTAL
      CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY
                          
                          
                          14,710,455
                          
                          
                          
                          15,026,113Non-controlling
      interest
                          
                          
                          170,066
                          
                          
                          
                          168,341TOTAL
      EQUITY
                          
                          
                          14,880,521
                          
                          
                          
                          15,194,454TOTAL
      LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
      AND EQUITY
                          
                          $
                          40,396,130
                          
                          
                          $
                          40,225,822





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


2


CHINA
NEW ENERGY GROUP COMPANY


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS AND


COMPREHENSIVE
INCOME (LOSS) – (UNAUDITED)





For
      the three months endedMarch
      312010
                                    
                                    
                                    2009Revenues:Connection
      services
                                    
                                    $
                                    1,691,362
                                    
                                    
                                    $
                                    146,752Natural
      gas
                                    
                                    
                                    18,450
                                    
                                    
                                    
                                    12,6331,709,812
                                    
                                    
                                    
                                    159,385Cost
      of Sales:Connection
      services
                                    
                                    
                                    431,576
                                    
                                    
                                    
                                    60,094Natural
      gas
                                    
                                    
                                    28,862
                                    
                                    
                                    
                                    23,281460,438
                                    
                                    
                                    
                                    83,375Gross
      Profit
                                    
                                    
                                    1,249,374
                                    
                                    
                                    
                                    76,010Operating
      Expenses:General
      and administrative expenses
                                    
                                    
                                    1,308,606
                                    
                                    
                                    
                                    287,152Selling
      expenses
                                    
                                    
                                    69,667
                                    
                                    
                                    
                                    38,061Registration
      right liabilities
                                    
                                    
                                    -
                                    
                                    
                                    
                                    450,000Total
      operating expenses
                                    
                                    
                                    1,378,273
                                    
                                    
                                    
                                    775,213Operating
      (Loss)
                                    
                                    
                                    (128,999
                                    )
                                    
                                    
                                    (699,203
                                    )Other
      Income (Expenses):Change
      in fair value of derivative financial instruments -
    warrants
                                    
                                    
                                    399,716
                                    
                                    
                                    
                                    (11,712,514
                                    )Interest
      income
                                    
                                    
                                    2,439
                                    
                                    
                                    
                                    2,212Interest
      expense
                                    
                                    
                                    (2,173
                                    )
                                    
                                    
                                    (612
                                    )Other
      income
                                    
                                    
                                    529
                                    
                                    
                                    
                                    93Total
      other income (expenses)
                                    
                                    
                                    400,511
                                    
                                    
                                    
                                    (11,710,821
                                    )Income
      (Loss) From Continuing Operations, Before Income Tax
                                    
                                    
                                    271,612
                                    
                                    
                                    
                                    (12,410,024
                                    )Income
      Tax
                                    
                                    
                                    289,923
                                    
                                    
                                    
                                    997Income
      (Loss) From Continuing Operations, net of Income Tax
                                    
                                    
                                    (18,311
                                    )
                                    
                                    
                                    (12,411,021
                                    )Discontinued
      Operations:(Loss)
      from discontinued operations, net of income tax
                                    
                                    
                                    (85,630
                                    )
                                    
                                    
                                    (80,522
                                    )(Loss)
      from Discontinued Operations, net of Income Tax
                                    
                                    
                                    (85,630
                                    )
                                    
                                    
                                    (80,522
                                    )Net
      (Loss)
                                    
                                    
                                    (103,941
                                    )
                                    
                                    
                                    (12,491,543
                                    )Net
      Loss Attributable to Non-controlling Interest
                                    
                                    
                                    (1,725
                                    )
                                    
                                    
                                    20,955Net
      (Loss) Attributable to China New Energy Group
                                    
                                    
                                    (105,666
                                    )
                                    
                                    
                                    (12,470,588
                                    )Dividend
      on Preferred Stock
                                    
                                    
                                    (215,175
                                    )
                                    
                                    
                                    (135,000
                                    )Net
      (Loss) Attributable to China New Energy Group Common
      Stockholders
                                    
                                    
                                    (320,841
                                    )
                                    
                                    
                                    (12,605,588
                                    )Other
      Comprehensive Income:Net
      (Loss)
                                    
                                    
                                    (103,941
                                    )
                                    
                                    
                                    (12,491,543
                                    )Foreign
      currency translation gain (loss)
                                    
                                    
                                    (5,183
                                    )
                                    
                                    
                                    (10,679
                                    )Comprehensive
      Loss Attributable to Non-controlling interest
                                    
                                    
                                    -
                                    
                                    
                                    
                                    5,026Comprehensive
      (Loss)
                                    
                                    $
                                    (109,124
                                    )
                                    
                                    $
                                    (12,497,196
                                    )




(Loss)
      per share – Basic(Loss)
      from continuing operations
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.13
                    )(Loss)
      from discontinued operations
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.00
                    )Total
      income (loss) per share
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.13
                    )Loss
      per share – Diluted(Loss) from
      continuing operations
                    
                    $
                    0.00
                    
                    
                    $
                    (0.13
                    )(Loss) from
      discontinued operations
                    
                    $
                    (0.00
                    )
                    
                    $
                    (0.00
                    )Total
      (loss) per share
                    
                    $
                    0.00
                    
                    
                    $
                    (0.13
                    )Weighted
      average common shares outstandingBasic
                    
                    
                    101,788,199
                    
                    
                    
                    100,000,041Diluted
                    
                    
                    101,788,199
                    
                    
                    
                    100,000,041





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





3





CHINA
NEW ENERGY GROUP COMPANY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS – (UNAUDITED)





For
      The Three Months EndedMarch
      31,2010
                            
                            
                            2009Cash
      flows from operating activities:Net
      (loss)
                            
                            $
                            (103,941
                            )
                            
                            $
                            (12,491,543
                            )Net
      loss from discontinued operations
                            
                            
                            85,650
                            
                            
                            
                            80,522Net
      income (loss) from continuing operations
                            
                            $
                            (18,311
                            )
                            
                            $
                            (12,411,021
                            )Adjustments
      to reconcile net (loss) to net cash used in operating
      activities:Change
      in fair value of derivative financial instruments –
    warrants
                            
                            
                            (399,716
                            )
                            
                            
                            11,712,514Registration
      rights penalties
                            
                            
                            -
                            
                            
                            
                            450,000Depreciation
      and amortization
                            
                            
                            79,125
                            
                            
                            
                            45,182Allowance
      for bad debts
                            
                            
                            117,275
                            
                            
                            
                            -Changes
      in operating assets and liabilities:Accounts
      receivable
                            
                            
                            (1,176,564
                            )
                            
                            
                            216,934Other
      receivables
                            
                            
                            157,942
                            
                            
                            
                            (7,786
                            )Inventories
                            
                            
                            (25,771
                            )
                            
                            
                            (3,343
                            )Prepaid
      expenses
                            
                            
                            (49,177
                            )
                            
                            
                            (57,077
                            )Accounts
      payable
                            
                            
                            371,191
                            
                            
                            
                            86,657Accruals
      and other payables
                            
                            
                            196,637
                            
                            
                            
                            (6,064
                            )Tax
      payable
                            
                            
                            220,039
                            
                            
                            
                            223,330Cash
      provided by (used in) operating activities – continuing
      operations
                            
                            
                            (527,330
                            )
                            
                            
                            249,326Cash
      provided by (used in) operating activities – discontinued
      operations
                            
                            
                            179,452
                            
                            
                            
                            (622,055
                            )Net
      cash used in operating activities
                            
                            
                            (347,878
                            )
                            
                            
                            (372,729
                            )Cash
      flows from investing activitiesAcquisition
      of property, plant and equipment
                            
                            
                            (1,618,804
                            )
                            
                            
                            (169,089
                            )Deposit
      paid for property, plant and equipment
                            
                            
                            (670,008
                            )
                            
                            
                            -Deposits
      paid for acquisitions of subsidiaries
                            
                            
                            (1,025,250
                            )
                            
                            
                            -Payment
      made to acquire subsidiary – Chensheng
                            
                            
                            -
                            
                            
                            
                            (1,838,946
                            )Proceeds
      from disposal of subsidiaries
                            
                            
                            1,682,263
                            
                            
                            
                            -Cash
      used in investing activities-continuing operations
                            
                            
                            (1,631,799
                            )
                            
                            
                            (2,008,035
                            )Cash
      used in investing activities-discontinued operations
                            
                            
                            (179,217
                            )
                            
                            
                            (32,050
                            )Net
      cash used in investing activities
                            
                            
                            (1,811,016
                            )
                            
                            
                            (2,040,085
                            )Cash
      flows from financing activitiesChange
      from restricted cash
                            
                            
                            -
                            
                            
                            
                            415Cash
      provided by financing activities-continuing operations
                            
                            
                            -
                            
                            
                            
                            415Cash
      provided by financing activities-discontinued operations
                            
                            
                            -
                            
                            
                            
                            438,852Net
      cash flows provided by financing activities
                            
                            
                            -
                            
                            
                            
                            439,267Effect
      of exchange rate changes in cash and cash equivalents
                            
                            
                            137
                            
                            
                            
                            (4,777
                            )Net
      (decrease) in cash and cash equivalents
                            
                            
                            (2,158,757
                            )
                            
                            
                            (1,978,324
                            )Cash
      and cash equivalents - beginning of period
                            
                            
                            2,672,884
                            
                            
                            
                            5,612,356Cash
      and cash equivalents - end of period
                            
                            $
                            514,127
                            
                            
                            $
                            3,634,032Supplemental
      disclosure of cash flow information:Cash
      paid for income tax
                            
                            $
                            1,302,664
                            
                            
                            $
                            371,384Supplemental
      disclosure of non-cash investing and financing activities:Preferred
      stock dividends payable
                            
                            $
                            215,175
                            
                            
                            $
                            135,000Registration
      rights payable
                            
                            $
                            -
                            
                            
                            $
                            450,000





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


4


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





1.
            Basis
      of Presentation





The
financial statements are prepared in accordance with the accounting principles
generally accepted in the United States of America (“US GAAP”).  This
basis differs from that used in the statutory accounts of our subsidiaries in
China, which were prepared in accordance with the accounting principles and
relevant financial regulations applicable to enterprises in the
PRC.  All necessary adjustments have been made to present the
financial statements in accordance with US GAAP.





The
interim condensed consolidated financial statements included herein, presented
in accordance with United States generally accepted accounting principles and
stated in US dollars, have been prepared by the Group, without audit, pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the Group
believes that the disclosures are adequate to make the information presented not
misleading. These statements reflect all adjustments, consisting of normal
recurring adjustments, which, in the opinion of management, are necessary for
fair presentation of the information contained therein. It is suggested that
these interim condensed consolidated financial statements be read in conjunction
with the financial statements of the Group for the year ended December 31, 2009
and notes thereto included in the Form 10K of China New Energy Group Company
filed on April 15, 2010. The Group follows the same accounting policies in the
preparation of interim reports.





Results
of operations for the interim periods are not indicative of annual
results.





2.           Organization
and description of business





China New
Energy Group Company (“CNER”, the “Company”, “we”, “us” or “our”) was
incorporated on March 28, 2008 in the state of Delaware USA, under the name of
Travel Hunt Holdings, Inc. (“Travel Hunt”). On May 27, 2008, Travel Hunt changed
its name to China New Energy Group Company in connection with a share exchange
transaction.




5


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





2.           Organization
and description of business-continued





Principal
activity




The
principal activity of the Company is the operation of a natural gas distribution
network through its Chinese subsidiary companies. The Company’s operating
subsidiaries and branches at March 31, 2010 (which together with the company are
collectively referred to as the “Group”) and their principal activities are as
follows:







6


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





2.           Organization
and description of business-continued





Willsky Development Ltd.
(“Willsky”)




Willsky
was incorporated on May 31, 2005 under the laws of the British Virgin
Islands.





Tianjin Sing Ocean Public
Utility Development Co., Ltd. (“SingOcean”)





In 2005,
Willsky acquired a 99% shareholding in SingOcean, which was formed in the PRC as
an equity joint venture to be operated for a period of 50 years until January
18, 2054, with registered capital of $4,500,000 (RMB31,897,000). SingOcean set
up a branch division in Acheng, Tianjin, called Tianjin Sing Ocean Public
Utility Development Co., Ltd. – Acheng Division (“SingOcean – Acheng Division”)
which is to be operated for a period of five years until December 28, 2010, but
the Acheng Division was sold in 2009.





Qinhuangdao Chensheng Gas
Company Limited (“Chensheng”)





On
September 16, 2008, our SingOcean subsidiary entered into an Equity Swap
Agreement with Mr. Xiu Hai Tian, whereby we acquired from Mr. Xiu
a 49% ownership interest in Chensheng, in exchange for our 99%
ownership in Hunchun Sing Ocean.  The parties to the Equity Swap
Agreement determined that the value of the 49% interest in Chensheng and the 99%
interest in Hunchun Sing Ocean were approximately equal and therefore there was
no cash or other consideration exchanged.





On
December 10, 2008, we entered into an Agreement for Equity Transfer with the
holders of the remaining 51% ownership interest in Chensheng. The Agreement was
consummated on December 30, 2008 and CNER purchased the remaining 51% of
Chensheng from 17 individuals, for an aggregate purchase price of approximately
$1,840,000 (RMB 12,560,000). As a result, the Company owns 51% of Chensheng and
our 99%-owned subsidiary SingOcean owns 49% of Chensheng and thus the Group
ultimately owns 99.5% of Chensheng.





China New Energy (Tianjin)
Investment & Consulting Co., Ltd. (“Tianjin Investment”)





On
January 12, 2009, Tianjin Investment was established in the PRC and is engaged
in the business of investment holding and CNER owns 100% of Tianjin
Investment.





Yingkou Zhongneng Gas
Development Co., Ltd. (“Yingkou Zhongneng”)





On
January 23, 2009, Yingkou Zhongneng was established in the PRC through our 99%
owned subsidiary,  SingOcean and operates a natural gas distribution
network in the city of Dashiqiao. As described in Note 4, on March 17, 2010, we
entered into an agreement to sell our interest in Yingkou
Zhongneng.




Tianjin Binhai Zhongneng Gas
Co., Ltd. (“Binhai Zhongneng”)





On June
26, 2009, Binhai Zhongneng was established in the PRC by SingOcean and
Chengsheng. Through our 99.5%-owned subsidiary, Chensheng, SingOcean invested
$1,462,501 (RMB10,000,000) in cash for a 60.6% interest in Binhai Zhongneng, and
through our wholly-owned subsidiary, SingOcean, transferred $950,626
(RMB6,500,000) in assets for a 39.4% interest in Binhai Zhongneng. As a result,
the Group holds a 100% interest in Binhai Zhongneng.


7


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





2.           Organization
and description of business-continued





Zhanhua Jiutai Gas Co.Ltd.
(“Zhanhua Jiutai”)




On
December 12, 2009, ChenSheng entered into an Equity Interest Purchase Agreement
to acquire all of the equity interests in Zhanhua Jiutai, a PRC company, from
the five shareholders of Zhanhua Jiutai, for a total purchase price of
$2,413,259 (RMB 16,500,000).





Wuyuan County Zhongran Gas
Ltd. (“Wuyuan”)




On
December 16, 2009,  Willsky entered into an Equity Interest Purchase
Agreement to acquire all of the equity interests in Wuyuan, a PRC company, from
Flying Dragon Investment Management Limited, for a total purchase price of
$877,552 (RMB 6,000,000), based on an appraised value of Wuyuan as of September
30, 2009.




Operational Rights and Right
to Supply and Operate Gas Pipeline




The
Group, through SingOcean, has signed an “Investment Agreement of Piped Gas
Project Construction in Dashiqiao City” which states that the Group is in charge
of operations and management of the piped gas project in Dashiqiao. On June 16,
2005, the Dashiqiao City Construction Bureau gave the Group a certificate which
confirmed that the Group has exclusive operational rights for thirty years in
Dashiqiao City. The Group receives a connection fee of $380 (RMB2,600) per
user. On March 17, 2010, SingOcean entered into an agreement to sell our
interest in Yingkou Zhongneng at approximately $3,200,000 (RMB
21,900,000).





On June
10, 2005, the Group, through SingOcean, signed an “Investment Agreement of Piped
Gas Project Construction in Acheng City” which states that the Group has the
exclusive right to invest in and operate the gas pipeline system in Acheng City
for thirty years. The Group receives a connection fee of $293 (RMB2,000) per
user. This SingOcean - Acheng division was sold in the third quarter of
2009.





On
October 8, 2005, Chengsheng signed an “Investment Agreement of Piped Gas Project
Construction in Qinhuangdao” which states that Chengsheng has the exclusive
right to invest in and operate the gas pipeline system in Qinhuangdao for
twenty-five years. The Group acquired Chengsheng in the fourth quarter of 2008
to have the above operation rights. The Group receives a connection fee of $351
(RMB2,400) per user.





2010
Acquisitions




In 2010,
we have entered into various agreements to acquire additional subsidiaries, as
described in Note 16.


8


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





3.
Summary of Significant Accounting Policies





(a)
Basis of Presentation




The
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America (“US GAAP”).  This
basis differs from that used in the statutory accounts of our subsidiaries in
China, which were prepared in accordance with the accounting principles and
relevant financial regulations applicable to enterprises in the
PRC.  All necessary adjustments have been made to present the
financial statements in accordance with US GAAP.





(b)
Use of Estimates




In
preparing consolidated financial statements in conformity with US GAAP,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reported periods. Actual results could differ from those
estimates.





Significant
Estimates





These
consolidated financial statements include some amounts that are based on
management's best estimates and judgments. The most significant estimates relate
to revenue recognition of gas connection contracts, depreciation of property,
plant and equipment, the valuation allowance for deferred taxes, impairment
testing of intangible assets, the fair value of derivative instrument
liabilities and various contingent liabilities. It is reasonably possible that
the above-mentioned estimates and others may be adjusted as more current
information becomes available, and any adjustment could be significant in future
reporting periods.





(c)
Principles of Consolidation





The
consolidated financial statements include the accounts of the Company and all of
its subsidiaries. All significant intercompany transactions and accounts have
been eliminated in consolidation.




(d)
Reclassification





Certain
amounts in the prior year have been reclassified to conform to the current
year’s presentation.


9


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





3.
Summary of Significant Accounting Policies-continued





(e) Revenue
Recognition




Among the
accounting policies adopted by the Group, the most critical one is the policy
regarding revenue recognition of the Group’s major sources of income from gas
connection services and sales of gases. In accordance with FASB ASC 650-10-S99
Revenue Recognition,
all of the following criteria must be met in order for us to recognize
revenue:





1.
            Persuasive
      evidence of an arrangement exists;




2.
            Delivery
      has occurred or services have been
rendered;




3.
            The
      seller's price to the buyer is fixed or determinable;
  and




4.
            Collectibility
      is reasonably assured.





Gas
connection revenue




Gas
connection revenue is recognized when the outcome of a contract can be estimated
reliably and the stage of completion at the balance sheet date can be measured
reliably.





Revenue
from gas connection contracts is recognized on the percentage of completion
method, measured by reference to the value of work carried out during the year.
When the outcome of a gas connection contract cannot be estimated reliably,
revenue is recognized only to the extent of contract costs incurred that it is
probable will be recoverable.





When the
outcome of a gas connection contract can be estimated reliably and the stage of
contract completion at the balance sheet date can be measured reliably, contract
costs are charged to the income statement by reference to the stage of
completion of the contract activity at the balance sheet date on the same basis
as revenue from the gas connection contract is recognized.





When the
outcome of a gas connection contract cannot be estimated reliably, contract
costs are recognized as expenses in the period in which they are incurred. When
it is probable that total contract costs will exceed contract revenue, the
expected loss is recognized as an expense immediately.





Where
contract costs incurred to date plus recognized profits less recognized losses
exceed progress billings, the surplus is shown as an amount due from customers
for contract work. For contracts where progress billings exceed contract costs
incurred to date plus recognized profits less recognized losses, the surplus is
shown as an amount due to customers for contract work. Amounts received before
the related work is performed are included in the consolidated balance sheet, as
a liability, as advances received. Amounts billed for work performed but not yet
paid by the customer are included in the consolidated balance sheet under trade
and other receivables.





During
the three months ended March 31, 2010 and 2009, all the contracts for connection
services were started and completed in the same period.





Revenue
from sale of gas




Sales
revenue from sale of gas represents the invoiced value of goods sold, net of
value-added tax (“VAT”). Revenue from sale of gas is recognized when the goods
are delivered and title has passed.





All of
the Company’s products that are sold in the PRC are subject to Chinese
value-added tax of 3% 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.


10


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009




(f)
Fair Value of Financial Instruments




The Group
records and discloses certain financial and non-financial assets and liabilities
at their fair value. The fair value of an asset is the price at which the asset
could be sold in an orderly transaction between unrelated, knowledgeable and
willing parties able to engage in the transaction. A liability’s fair value is
defined as the amount that would be paid to transfer the liability to a new
obligor in a transaction between such parties, not the amount that would be paid
to settle the liability with the creditor.





Assets
and liabilities recorded at fair value are measured using a three-tier fair
value hierarchy, which prioritizes the inputs used in measuring fair value.
These tiers include:




Level
      1, defined as observable inputs such as quoted prices in active
      markets;




Level
      2, defined as inputs other than quoted prices in active markets that are
      either directly or indirectly observable;
and




Level
      3, defined as unobservable inputs in which little or no market data
      exists, therefore requiring the Group to develop our own
      assumptions.





Our
derivative instrument liabilities are recorded at fair value. Our financial
instruments that are recorded at cost include cash and cash equivalents,
restricted cash, accounts receivable, receivables related to subsidiaries sold,
deposits for acquisitions, accounts payable, accrued expenses, dividends
payable, and other current liabilities. We believe the carrying values of these
financial instruments approximate their fair values due to their short-term
nature.




11




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





3.
Summary of Significant Accounting Policies-continued





(g)
New accounting pronouncements




Fair
Value Measurements


In
January 2010, the FASB issued guidance to amend the disclosure requirements
related to recurring and nonrecurring fair value measurements. The guidance
requires disclosure of transfers of assets and liabilities between Level 1 and
Level 2 of the fair value measurement hierarchy, including the reasons and the
timing of the transfers and information on purchases, sales, issuance, and
settlements on a gross basis in the reconciliation of the assets and liabilities
measured under Level 3 of the fair value measurement hierarchy. The guidance is
effective for annual and interim reporting periods beginning after December 15,
2009, except for Level 3 reconciliation disclosures which are effective for
annual and interim periods beginning after December 15, 2010. The Company
adopted this guidance at the January 1, 2010, except for the Level 3
reconciliation disclosures on the rollforward activities, which it will adopt at
the beginning of January 1, 2011. Adoption did not have a material impact on our
consolidated financial statements.





Receivables


In April
2010, the FASB issued ASU 2010-18, Receivables (Topic 310), Effect of a
Loan Modification When the Loan is Part of A Pool That Is Accounted for as a
Single Asset. ASU2010-18 provides that
modifications of loans that are accounted for within a pool under Subtopic
310-30 do not result in the removal of those loans from the pool even if the
modification of those loans would otherwise be considered a troubled debt
restructuring. An entity will continue to be required to consider whether the
pool of assets in which the loans are included is impaired if expected cash
flows for the pool change. This guidance is effective prospectively for the
first interim and annual period ending on or after July 15, 2010. Early
adoption is permitted. The Company adopted this guidance without a material
impact on its consolidated financial statements.








12


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





4.
Discontinued Operations




Disposal of Yingkou
Zhongneng Gas Development Co.,Ltd in 2010 – completed in
2010




On March
17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On March 31, 2010, the agreement was
terminated.




On April
2, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Changsha Yuedu Steel Co.,Ltd(. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On April 9, 2010 and the Group received part of the
downpaymnet of $731,000 (RBM5,000,000).





As of
March 31, 2010, the control of Yingkou still remains in the Group and therefore,
the Group recorded all the assets and liabilities of Yingkou under the caption
of “Current Assets Held for Sale”, “Non-current Assets Held for Sale” and
“Liabilities Held for Sale”. The operations activity of Yingkou was recorded
under the discontinued operations for the three months ended March 31, 2010 and
2009.





The
following table displays summarized operating activity for the discontinued
operations of Yingkou for the three months ended March 31, 2010 and Yingkou and
Acheng for the three months ended March 31, 2009.





For
      the three months ended2010
                    
                    
                    2009Revenue
                    
                    $
                    201,159
                    
                    
                    $
                    165,632Operating
      loss
                    
                    $
                    (92,501
                    )
                    
                    $
                    (86,608
                    )Loss
      before income taxes
                    
                    $
                    (85,630
                    )
                    
                    $
                    (80,522
                    )Income
      tax expense
                    
                    $
                    -
                    
                    
                    $
                    -Loss
      from discontinued operations, net of tax
                    
                    $
                    (85,630
                    )
                    
                    $
                    (80,522
                    )


13


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





5.
Restricted cash





At March
31, 2010 and December 31, 2009, restricted cash of $180,352 and $180,352
represented the cash held by an escrow agent for expenses relating to investor
and public relations.




6.
Other Receivables





Other
receivables consist of the following:





March
      31,
                      2010
                    
                    
                    December
      31,
                      2009Due
      from Tianjin East Ocean Gas Company Limited
                    
                    $
                    1,454,955
                    
                    
                    $
                    1,454,721Other
      receivables
                    
                    
                    478,534
                    
                    
                    
                    636,371Total
                    
                    $
                    1,933,489
                    
                    
                    $
                    2,091,092





The
balance due from Tianjin East Ocean Gas Company Limited (“East Ocean”)
represents the amount due from Hunchun to the Group which was assigned to East
Ocean when East Ocean obtained 99% ownership of Hunchun by the exchange of a 49%
ownership interest in Chensheng in 2008.





Other
receivables, which are unsecured, interest free, and have no fixed repayment
date, are mainly comprised of an amount due from the Dashiqiao City Construction
Bureau relating to various construction projects.  These deposits will
be refunded to us once certain construction milestones are
completed.




7.
Inventories





Inventories
at March 31, 2010 and December 31, 2009 of $296,918 and $271,104, respectively,
consist of raw materials and do not include any work in progress or finished
goods.


14


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





8.
Property, Plant and Equipment, net





Property,
plant and equipment consist of the following:





March
      31,
                                2010
                              
                              
                              December
      31,
                                2009Cost:Leasehold
      improvements
                              
                              $
                              75,685
                              
                              
                              $
                              75,673Building
                              
                              
                              79,615
                              
                              
                              
                              79,603Office
      Equipment
                              
                              
                              132,428
                              
                              
                              
                              112,987Motor
      Vehicles
                              
                              
                              322,954
                              
                              
                              
                              304,359Gas
      Transportation Vehicles
                              
                              
                              190,216
                              
                              
                              
                              190,099Gas
      Station
                              
                              
                              181,662
                              
                              
                              
                              181,511Machinery
                              
                              
                              136,859
                              
                              
                              
                              134,484Underground
      Gas Pipelines
                              
                              
                              3,704,423
                              
                              
                              
                              2,388,733$
                              4,823,842
                              
                              
                              $
                              3,467,449Less:
      Accumulated depreciation
                              
                              
                              (398,888
                              )
                              
                              
                              (324,706
                              )$
                              4,424,954
                              
                              
                              $
                              3,142,743Construction-in-progress
                              
                              
                              5,121,060
                              
                              
                              
                              4,857,326$
                              9,546,014
                              
                              
                              $
                              8,000,069





Construction-in-progress
represents labor costs, materials, and capitalized interest incurred in
connection with the construction of pipelines and networks. No depreciation is
provided for construction-in-progress until it is completed and placed into
service. Most construction-in-progress we purchased with cash and in general the
assembling process can be done in less than 12 weeks. Therefore, no interest
expense was capitalized as the capitalized interest was not
significant.





The gas
pipelines, gas station, and other constructed assets belong to the Group, not to
the municipalities or other units that contract with the Group to provide the
hookups and the gas distribution to the households. Depreciation is provided for
these assets as they are used in operations.





During
the three months ended March 31, 2010, depreciation expense amounted to $74,129,
of which $40,954 and $33,175 was recorded as cost of revenue and as general and
administrative expenses, respectively.





During
the three months ended March 31, 2009, depreciation expense amounted to $40,185,
of which $31,525 and $8,660 was recorded as cost of revenue and as general and
administrative expenses, respectively.


15


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





9.
Intangible Assets, net





Intangible
asset consist of the following:





March
      31,
                          2010
                        
                        
                        December
      31,
                          2009Land
      use rights
                        
                        $
                        1,211,445
                        
                        
                        $
                        1,211,250Less:
      accumulated amortization
                        
                        
                        (29,978
                        )
                        
                        
                        (24,978
                        )$
                        1,181,467
                        
                        
                        $
                        1,186,272





Amortization
expense for the three months ended March 31, 2010 and 2009 was $4,996 and
$4,997, respectively.





Estimated
amortization for the next five years and thereafter is as follows:





Remainder
      of 2010
                  
                  $
                  14,9882011
                  
                  
                  19,9842012
                  
                  
                  19,9842013
                  
                  
                  19,9842014
                  
                  
                  19,984Thereafter
                  
                  
                  1,086,543Total
                  
                  $
                  1,181,467





10.
Deposits for acquisition





March
      31,
                            2010
                          
                          
                          December
      31,
                            2009Deposit
      relating to the purchase of Lean Zhongran
                          
                          $
                          197,696
                          
                          
                          
                          197,696Deposit
      relating to the purchase of Fuzhou Zhongran
                          
                          
                          1,025,250
                          
                          
                          
                          -Total
                          
                          $
                          1,222,946
                          
                          
                          
                          197,696


16


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





11.
Acquisition Consideration Payable




March
      31,
                          2010
                        
                        
                        December
      31,
                          2009Acquisition
      consideration payable relating to the purchase of Zhanhua
      Jiutai
                        
                        $
                        1,015,202
                        
                        
                        $
                        1,015,038Acquisition
      consideration payable relating to the purchase of Wuyuan
                        
                        
                        636,850
                        
                        
                        
                        636,850Total
                        
                        $
                        1,652,052
                        
                        
                        $
                        1,651,888





The
acquisition consideration payable as of March 31, 2010 represents the remaining
amounts due as of that date in connection with the December 2009 acquisitions of
Zhanhua Jiutai and Wuyuan (see Note 2 & 16). This amount will be due
according to the payment terms under Equity Interest Purchase
Agreement.





12.
Related Party Payables





Related
party payables consist of the following:





March
      31,
                      2010
                    
                    
                    December
      31,
                      2009Tianjin
      Huan Long Trading Ltd.
                      (non-controlling
      shareholder of a subsidiary)
                    
                    $
                    97,909
                    
                    
                    $
                    97,893





The balances have
no stated terms for repayment and are not interest bearing.





17





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





13.
Capital Stock





Common
Stock





We are
authorized to issue 500,000,000 shares of Common Stock, $0.001 par value.
Holders of Common Stock are entitled to one vote for each share held of record
on each matter submitted to a vote of shareholders. Subject to the prior rights
of any class or series of preferred stock which may from time to time be
outstanding, if any, holders of Common Stock are entitled to receive ratably,
dividends when, as, and if declared by our Board of Directors out of funds
legally available for that purpose and, upon our liquidation, dissolution, or
winding up, are entitled to share ratably in all assets remaining after payment
of liabilities and payment of accrued dividends and liquidation preferences on
the preferred stock, if any. As long as any shares of our Series A and Series B
Preferred Stock are outstanding, the terms of those instruments prohibit us from
paying dividends on the Common Stock. Holders of Common Stock have no preemptive
rights and have no rights to convert their Common Stock into any other
securities.  The outstanding Common Stock is duly authorized and
validly issued, fully-paid, and non-assessable.





Except as
otherwise required by Delaware law, and subject to the rights of the holders of
preferred stock, all stockholder action is taken by the vote of a majority of
the outstanding shares of Common Stock present at a meeting of stockholders at
which a quorum consisting of a majority of the outstanding shares of Common
Stock is present in person or by proxy. However, for so long as the number of
outstanding shares of Series B Preferred Stock is at least 30% of the total
number of shares of Series B Preferred Stock originally issued, the holders of
Series B Preferred Stock vote together as a single class with the holders of the
Company’s Common Stock, and the holders of any other class or series of shares
entitled to vote with the Common Stock, with the holders of Series B Preferred
Stock being entitled to 70% of the total votes on all such matters regardless of
the actual number of shares of Series B Preferred Stock then outstanding, and
the holders of Series A Preferred Stock and Common Stock being entitled to their
proportional share of the remaining 30% of the total votes based on their
respective voting power.





At March
31, 2010 and December 31, 2009, 101,788,199 shares of Common Stock were issued
and outstanding





Series
A Convertible Preferred Stock





In
connection with the August 20, 2008 private placement, the Company filed a
Certificate of Designations of Preferences, Rights and Limitations of Series A
Convertible Preferred Stock with the Secretary of State of the State of Delaware
(the "Certificate").  The Company’s Certificate of Incorporation authorizes
it to issue 10,000,000 shares of Preferred Stock and by the filing, 5,500,000
shares were designated as Series A Convertible Preferred Stock ("Series A
Preferred Stock").  On August 20, 2008, the Company issued 1,857,373 shares
of Series A Preferred Stock to China Hand Fund I, LLC (“China Hand”), as
described in Note 14.





On May 1,
2009, the Company issued an additional 241,545 shares of Series A Preferred
Stock to China Hand in connection with a make-good provision. At March 31, 2010
and December 31, 2009, 2,098,918 shares of Series A Preferred Stock issued and
outstanding.


18


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





13.
Capital Stock-continued





Dividends




The
holders of the Series A Preferred Stock are entitled to cumulative
dividends at a rate of 6% per annum of the stated price paid per share of $4.83,
compounded daily and payable semi-annually on June 1 and December
1. Dividends are payable in shares of Common Stock or, at the option of the
Company, in cash. If paid in shares of Common Stock, the number of shares to be
issued is determined by dividing the dividend payable by 90% of the
volume-weighted average price for the 20 days preceding the dividend payment
date of June 1 or December 1. As long as any shares of Series A Preferred Stock
are outstanding, the Company may not declare or pay dividends with respect to
the Common Stock.





Voting
Rights




In
addition to the right to vote as a separate class of securities, the holders of
the Preferred Stock are entitled to vote together with the holders of the
Company’s Common Stock, with each such holder of Series A Preferred Stock
entitled to the number of votes equal to the number of shares of the Company’s
Common Stock in to which such Series A Preferred Stock would be converted if
converted on the record date for the taking of a vote. However, for so long as
the number of outstanding shares of Series B Preferred Stock is at least 30% of
the total number of shares of Series B Preferred Stock originally issued, the
holders of Series B Preferred Stock vote together as a single class with the
holders of the Company’s Common Stock and the holders of any other class or
series of shares entitled to vote with the Common Stock, including the Series A
Preferred Stock, with the holders of Series B Preferred Stock being entitled to
70% of the total votes on all such matters regardless of the actual number of
shares of Series B Preferred Stock then outstanding, and the holders of Series A
Preferred Stock and Common Stock being entitled to their proportional share of
the remaining 30% of the total votes based on their respective voting
power.




Liquidation




Upon any
liquidation, dissolution or winding-up of the Company, whether voluntary or
involuntary (each, a “Liquidation Event”), the holders of the Series A
Preferred Stock are entitled to receive out of the assets of the Company,
whether such assets are capital or surplus, for each share of Series A Preferred
Stock an amount equal to $4.83, plus any accumulated but unpaid dividends
thereon (the “Liquidation Value”), before any distribution or payment is made to
the holders of any securities which are junior to the Series A Preferred Stock
upon the occurrence of a Liquidation Event and after any distributions or
payments made to holders of any class or series of securities which are senior
to the Series A Preferred Stock upon the occurrence of a Liquidation Event. If
the assets of the Company are insufficient to pay in full such amounts, then the
entire assets to be distributed to the Series A Holders will be distributed
among the Series A Holders ratably in accordance with the respective amounts
that would be payable on such shares if all amounts payable thereon were paid in
full. In the event the assets of the Company available for distribution to the
holders of shares of Series A Preferred Stock upon the occurrence of a
Liquidation Event are insufficient to pay in full all amounts to which such
holders are entitled, no such distribution shall be made on account of any
shares of any other class or series of capital stock of the Company ranking on a
parity with the shares of Series A Preferred Stock upon the occurrence of such
Liquidation Event unless proportionate distributive amounts are paid on account
of the shares of Series A Preferred Stock, ratably, in proportion to the full
distributable amounts for which holders of all such parity shares are
respectively entitled upon the occurrence of such Liquidation
Event.


19


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





13.
Capital Stock-continued





Conversion




Each
share of Series A Preferred Stock is initially convertible, at any time at the
option of the holder, into 35 shares of the Company’s Common Stock, subject to
future adjustments as provided for in the Certificate. The Series A Preferred
Stock will automatically convert into shares of the Company’s Common Stock
immediately prior to any transaction resulting in a Change in Control of the
Company. Further, provided there is an effective registration statement covering
the shares to be received on conversion, the Company may require conversion of
the Series A Preferred Stock if the volume-weighted average price for at least
20 trading days in any consecutive 30 day period equals or exceeds twice the
conversion price and the trading volume on each day in the 30 day period has
equaled or exceeded 100,000 shares.





The
conversion price of the Series A Preferred Stock will be adjusted for standard
anti-dilution events, including stock dividends or stock splits or
reclassification of shares of the Common Stock. For as long as any shares of
Series A Preferred Stock remain outstanding, the Company may not enter into any
Variable Rate Transactions or Most Favored Nation transactions. If the Company
does enter into a Variable Rate Transaction, in which it issues debt or equity
securities that are convertible into shares of Common Stock at a conversion or
exercise price that is based upon or varies with the trading price for shares of
the Common Stock or enters into a Most Favored Nation transaction in which the
Company issues any securities in a capital raising transaction or series of
transactions on terms more favorable than those granted to the holders of the
Series A Preferred Stock, the holders of the Series A Preferred Stock are
entitled to adjustment of the conversion price and to receive additional shares
or other rights. Furthermore, if the Company issues (except in an underwritten
public offering approved by holders of the Series A Preferred Stock in which the
gross proceeds to the Company are not less than $20 million) any shares of
Common Stock or securities convertible into shares of Common Stock at a price
which is less than the conversion price then in effect, the conversion price
will be reduced to that lower price.





As long
as 20% of the shares of Series A Preferred Stock remain outstanding, the Company
may not issue any other preferred stock (except for the issuance of Series A
Preferred Stock and Series B Preferred Stock issued pursuant to the agreements
under which those Series were originally issued) or any convertible debt
convertible into Common Stock, without the consent of the holders of outstanding
shares of Series A Preferred Stock.


20


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





13.
Capital Stock-continued





Series
B Convertible Preferred Stock





On April
30, 2009, the Company entered into a Series B Convertible Preferred Stock
Securities Purchase Agreement with China Hand, as described in Note 14. In
connection with this private placement, the Company filed a Certificate of
Designations of Preferences, Rights and Limitations of Series B Convertible
Preferred Stock with the Secretary of State of the State of Delaware,
designating 2,000,000 shares as Series B Preferred Stock. At March 31, 2010 and
December 31, 2009, there were 1,116,388 shares of Series B Preferred Stock
issued and outstanding.





Dividends




The
holders of the Series B Preferred Stock are entitled to cumulative dividends at
a rate of 6% per annum of the stated price paid per share of $4.837, compounded
daily and payable semi-annually in arrears on June 1 and December 1 of each
year. Dividends are payable in shares of Common Stock or, at the option of the
Company, in cash. If paid in shares of Common Stock, the number of shares to be
issued is determined by dividing the dividend payable by 90% of the
volume-weighted average price for the 20 days preceding the dividend payment
date of June 1 or December 1. As long as any shares of Series B Preferred Stock
are outstanding, the Company may not declare or pay dividends with respect to
the Common Stock.





Voting
Rights




In
addition to the right to vote as a separate class of securities, the holders of
the Preferred Stock are entitled to vote together with the holders of the
Company’s Common Stock, with each such holder of Preferred Stock entitled to the
number of votes equal to the number of shares of the Company’s Common Stock in
to which such Preferred Stock would be converted if converted on the record date
for the taking of a vote. For so long as the number of outstanding shares of
Series B Preferred Stock is at least 30% of the total number of shares of Series
B Preferred Stock issued under the Securities Purchase Agreement, the holders of
Series B Preferred Stock shall vote together as a single class with the holders
of the Company’s Common Stock, and the holders of any other class or series of
shares entitled to vote with the Common Stock, with the holders of Series B
Preferred Stock issued under the Securities Purchase Agreement being entitled to
70% of the total votes on all such matters regardless of the actual number of
shares of Series B Preferred Stock then outstanding, and the holders of Series A
Preferred Stock and Common Stock being entitled to their proportional share of
the remaining 30% of the total votes based on their respective voting
power.


21


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





13.
Capital Stock-continued





Liquidation




Upon any
liquidation, dissolution or winding-up of the Company, whether voluntary or
involuntary (each, a “Liquidation Event”), the Series B Holders shall be
entitled to receive out of the assets of the Company, whether such assets are
capital or surplus, for each share of Series B Preferred Stock an amount equal
to the Original Purchase Price, which is $4.837 per share, plus any accumulated
but unpaid dividends thereon (the “Series B Liquidation Value”), before any
distribution or payment shall be made to the holders of any securities which are
junior to the Series B Preferred Stock upon the occurrence of a Liquidation
Event and after any distributions or payments made to holders of any class or
series of securities which are senior to the Series B Preferred Stock upon the
occurrence of a Liquidation Event. Upon the occurrence of a Liquidation Event,
the right of the Series B Holders to receive Liquidation Value hereunder shall
rank pari passu with that of the holders of Series A Preferred Stock (the
“Series A Holders”). If the assets of the Company shall be insufficient to pay
in full such amounts, then the entire assets to be distributed to the Series B
Holders shall be distributed among the Series B Holders and the Series A Holders
ratably in accordance with the respective amounts that would be payable on such
shares if all amounts payable thereon were paid in full. In the event the assets
of the Company available for distribution to the holders of shares of Series B
Preferred Stock upon the occurrence of a Liquidation Event shall be insufficient
to pay in full all amounts to which such holders are entitled, no distribution
shall be made on account of any shares of any other class or series of capital
stock of the Company ranking on a parity with the shares of Series B Preferred
Stock upon the occurrence of such Liquidation Event unless proportionate
distributive amounts shall be paid on account of the shares of Series B
Preferred Stock, ratably, in proportion to the full distributable amounts for
which holders of all such parity shares are respectively entitled upon the
occurrence of such Liquidation Event.





Conversion




Each
share of Series B Preferred Stock is initially convertible, at any time at the
sole option of the holder of such Preferred Stock, at a conversion price of
$0.1382 per share, into 35 shares of the Company’s Common Stock, subject to
future adjustments as provided for in the Certificate. The Series B Preferred
Stock will automatically convert into shares of the Company’s Common Stock
immediately prior to any transaction resulting in a change in control of the
Company.





The
conversion price of the Series B Preferred Stock will be adjusted for standard
anti-dilution events, including stock dividends or stock splits or
reclassification of shares of the Common Stock. For as long as any shares of
Series B Preferred Stock remain outstanding, the Company may not enter into any
Variable Rate Transactions or Most Favored Nation transactions. If the Company
does enter into a Variable Rate Transaction, in which it issues debt or equity
securities that are convertible into shares of Common Stock at a conversion or
exercise price that is based upon or varies with the trading price for shares of
the Common Stock or enters into a Most Favored Nation transaction in which the
Company issues any securities in a capital raising transaction or series of
transactions on terms more favorable than those granted to the holders of the
Series B Preferred Stock, the holders of the Series B Preferred Stock are
entitled to adjustment of the conversion price and to receive additional shares
or other rights. Furthermore, if the Company issues (except in an underwritten
public offering approved by holders of the Series A Preferred Stock in which the
gross proceeds to the Company are not less than $20 million) any shares of
Common Stock or securities convertible into shares of Common Stock at a price
which is less than the conversion price then in effect, the conversion price
will be reduced to that lower price.





As long
as 20% of the shares of Series B Preferred Stock remain outstanding, the Company
may not issue any other preferred stock (except for the issuance of Series A
Preferred Stock and Series B Preferred Stock issued pursuant to the agreements
under which those Series were originally issued) or any convertible debt
convertible into Common Stock, without the consent of 75% of the holders of
outstanding shares of Series B Preferred Stock.


22




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





14.
Private Placement of Series A and B Convertible Preferred Stock and
Warrants





May
1, 2009 Private Placement





On April
30, 2009, the Company entered into a second Securities Purchase Agreement with
China Hand and on May 1, 2009, the Company issued to China Hand 1,116,388 shares
of the Company’s Series B Convertible Preferred Stock and 7,814,719
warrants to purchase Common Stock, for aggregate gross proceeds of $5,400,000.
The warrants are exercisable at any time at an initial exercise price of $0.187
per share (subject to adjustment) for a period of five years following the date
of issuance The terms of the Series B Preferred Stock are described in Note 13
and the warrants are further described in Note 15.





Kuhns
Brothers acted as placement agent in connection with the second private
placement. As compensation for its services, Kuhns Brothers received a cash fee
of $540,000, representing 10% of the gross proceeds received from the private
placement, as well as warrants to purchase 3,907,358 shares of the Company’s
Common Stock, representing 10% of the aggregate number of shares of Common Stock
issuable to China Hand on conversion of the Series B Preferred
Stock.





As
discussed in Note 15, on May 1, 2009, the fair value of the 7,814,719 warrants
issued to China Hand with the Series B Convertible Preferred Stock was
$3,246,693 and the fair value of the 3,907,358 warrants issued to Kuhns Brothers
was $1,623,346.





After
deducting the placement agent cash fees and other costs of $130,528, the Company
received net cash proceeds of $4,729,472.





Amendment and Restatement of
Certain Registration Rights




In
connection with the second private placement, the Company and China Hand amended
and restated the Registration Rights Agreement dated August 20, 2008 and
China Hand waived any registration delay payments that may have accrued under
that Registration Rights Agreement up to the date of the Amended
Agreement.  Pursuant to the Amended and Restated Registration Rights
Agreement, the Company agreed to register all of the shares of Common Stock
underlying the securities issued to China Hand in the August 20, 2008 and May 1,
2009 private placements and to file a Registration Statement covering the resale
of the shares by May 31, 2009. The Company is subject to registration delay
payments if it is unable to file the Registration Statement, cause it to become
effective or maintain its effectiveness as required by the Amended and Restated
Registration Rights Agreement.  Registration delay payments accrue at
a rate of 1% per month of the aggregate investment amount paid by the holder
applicable to each securities purchase agreement or $144,000 per month, provided
that the maximum aggregate amount of the registration delay payments will be
$2,160,000, or 15% of the gross proceeds of the private placements. As of March
31, 2010, the Company has not filed the required Registration
Statement.





Management
expects to file the required Registration Statement and use its best efforts to
have it effective by August, 2010. In accordance with the guidance in FASB ASC
815-40-05 Accounting for
Registration Payment Arrangements (formerly FSP EITF 00-19-2), the
Company has accrued the $144,000 per month registration delay payments for the
period from June 1, 2009 to August 31, 2010. As of March 31, 2010 and December
31, 2009, the Company has accrued $2,160,000 (which is the maximum amount of the
registration delay payments) for these registration delay payments.




23




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





15.
Derivative financial instruments - warrants





In
connection with the sale of its Series A and Series B Convertible Preferred
Stock to China Hand, an accredited investor, the Company issued Common Stock
warrants to China Hand and to the Company’s placement agent.





Effective
January 1, 2009, the Company adopted the provisions of FASB ASC 815-40-15-5
Derivatives and Hedging
(formerly EITF Issue 07-5). Because the warrants are denominated in U.S. dollars
whereas the Company’s functional currency is the Renminbi, the warrants are not
considered to be indexed only to the Company’s Common Stock. Furthermore, the
warrants contain full ratchet anti-dilution protection requiring the exercise
price of the warrants to be reduced in the event that the Company issues
securities in the future at a lower price. Accordingly, the warrants do not
qualify for the exemption from being accounted for as derivative financial
instruments provided by FASB ASC 815-10-15-74. In addition, because the warrants
contain a provision requiring the Company to re-purchase the warrants from the
investor in certain circumstances, the Company has concluded that the warrants
issued in 2008 should be accounted for as derivative financial instruments from
the time they were originally issued.





Derivative
instruments are recorded at fair value and marked-to-market each period until
they are exercised or expire, with any change in the fair value charged or
credited to income each period. Because these warrants do not trade in an active
securities market, we estimate their fair value using the Cox-Ross-Rubinstein
(“CRR”) binomial model.





On August
20, 2008, the fair value of the 13,001,608 warrants issued to China Hand in
connection with the Series A Convertible Preferred Stock was $1,968,182 and the
fair value of the 6,500,804 warrants issued to the placement agent was $984,091.
The fair values were based on the five year life of the warrants, the exercise
price of $0.187, estimated volatility of 66%, a risk free interest rate of 3%
and an assumed dividend rate of 0%.





On May 1,
2009, the fair value of the 7,814,719 warrants issued to China Hand in
connection with the Series B Convertible Preferred Stock was $3,246,693 and the
fair value of the 3,907,358 warrants issued to the placement agent was
$1,623,346. The fair values were computed using the CRR model, based on the five
year life of the warrants, the exercise price of $0.187, estimated volatility of
90%, a risk free interest rate of 2.03% and an assumed dividend rate of
0%.





At March
31, 2010 and December 31, 2009, the fair value of the warrants was $6,368,390
and $6,768,106, respectively, based on the following assumptions:





March
      31, 2010
                
                
                December
      31, 2009Warrants
      outstanding
                
                
                31,224,489
                
                
                
                31,224,489Exercise
      price
                
                $
                0.187
                
                
                $
                0.187Annual
      dividend yield
                
                
                0
                %
                
                
                0
                %Expected
      life (years)
                
                
                3.39-4.08
                
                
                
                3.64-4.33Risk-free
      interest rate
                
                
                1.45%-3
                %
                
                
                2.02%
      - 2.36
                %Expected
      volatility
                
                
                90
                %
                
                
                90
                %





Because
of the limited trading history of the Company’s Common Stock, expected
volatility is based on the historical volatility of a similar U.S. public
company with a longer trading history. The Company has no reason to believe that
the future volatility of its Common Stock over the remaining life of these
warrants will differ materially from this estimate. The expected life of the
warrants is based on their remaining term. Risk-free interest rates are based on
published rates for U.S. Treasury securities for the remaining term of the
warrants. The expected dividend yield is based on the Company’s current and
expected dividend policy.





The
Company recognized a gain of $399,716 from the change in fair value of
these warrants for the three months ended March 31, 2010 and a loss of
$11,712,514 from the change in fair value for the three months ended March
31, 2009.


24


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





16.
Acquisitions of Subsidiaries





ZhanhuaJiutaiGas Co.Ltd. (“Zhanhua
Jiutai”)




On
December 12, 2009, Chensheng, our indirect wholly-owned subsidiary, entered into
an Equity Interest Purchase Agreement to acquire all of the outstanding equity
interests of Zhanhua Jiutai, a PRC company, from the five shareholders of
Zhanhua Jiutai, for a total purchase price of $2,413,269 (RMB
16,500,000).





As of
March 31, 2010, the total outstanding on the acquisition of Zhanhua Jiutai is
$1,015,202 which is recorded under the Acquisition consideration payable (see
note 11).





The
acquisition of Zhanhua Jiutai was accounted for as a business combination, in
accordance with FASB ASC 805 Business
Combinations.  The results of Zhanhua Jiutai and the estimated
fair market values of the assets and liabilities have been included in the
consolidated financial statements from the date of acquisition. The assets
acquired and liabilities assumed of Zhanhua Jiutai were recorded based on their
fair values, as follows:





Other
      receivables
                  
                  $
                  2,925Inventories
                  
                  
                  82,939Property,
      plant and equipment
                  
                  
                  139,014Construction
      in progress
                  
                  
                  2,218,043Advance
      accounts
                  
                  
                  (254,140
                  )Goodwill
                  
                  
                  224,488Purchase
      price
                  
                  $
                  2,413,269





As of the
acquisition date, Zhanhua Jiutai did not commence business since acquisition,
and therefore, the pro forma financial information for the three months ended
March 31, 2009 is the same as the actual figure shown in the statement of
Condensed Consolidated Statements of Operations and Comprehensive
Income.





In
accordance with FASB 810-10-5, the condensed consolidated balance sheet at March
31, 2010 includes certain liabilities of Zhanhua Jiutai assumed by the five
former shareholders of Zhanhua Jiutai in 2009, as the Group consolidates Zhanhua
Jiutai.





The
following table summarizes the liabilities to be settled by the former
shareholders, but which are included in our balance sheet as of March 31, 2010.
In accordance with the Agreement, these liabilities were not assumed by
Chensheng and will be settled by the five former shareholders of Zhanhua Jiutai
in 2010.





Accounts
      payable
                  
                  $
                  711,512Other
      payables
                  
                  
                  4,290Salary
      payables
                  
                  
                  961,207Liabilities
      to be settled by former shareholders
                  
                  $
                  1,677,009Deemed
      receivable from former shareholders for settlement of certain
      liabilities
                  
                  $
                  1,677,009


25


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





16.
Acquisitions of Subsidiary - continued





Wuyuan County Zhongran Gas
Ltd. (“Wuyuan”)




On
December 16, 2009, Willsky entered into an Equity Interest Purchase Agreement to
acquire 100% of the outstanding equity interests in Wuyuan, a PRC company, from
Flying Dragon Investment Management Limited, for a total purchase price of
$877,552 (RMB 6,000,000), which purchase price was based on an appraised value
of Wuyaun as of September 30, 2009.





As of
March 31, 2010, the total outstanding on the acquisition of Wuyuan is $636,850
which is recorded under the Acquisition consideration payable (see note
11).





The
acquisition of Wuyuan was accounted for as a business combination, in accordance
with FASB ASC 805 Business
Combinations. The results of Wuyuan and the estimated fair market values
of the assets and liabilities have been included in the Group’s consolidated
financial statements from the date of acquisition. The purchase price of
$877,552 was less than the fair value of the assets acquired and liabilities
assumed on the date of the acquisition December 16, 2009 and, accordingly, we
recognized a gain related to the acquisition, as follows:





Prepaid
      expenses
                    
                    $
                    650,120Other
      receivables
                    
                    
                    89,598Inventories
                    
                    
                    67Construction
      in progress
                    
                    
                    203,742Intangible
      assets
                    
                    
                    244,000Assets
      acquired
                    
                    $
                    1,187,527Less:
      Purchase consideration (net of $3,081 cash received)
                    
                    
                    (874,471
                    )Gain
      on acquisition of Wuyuan
                    
                    $
                    313,056





As of the
acquisition date, Wuyuan did not commence business up to third quarter of 2009,
and therefore, the pro forma financial information for the three months ended
March 31, 2009 is the same as the actual figure shown in the statement of
Condensed Consolidated Statements of Operations and Comprehensive
Income.





The
following table summarizes the liabilities to be settled by the former
shareholders but which are included in our balance sheet as of March 31, 2010.
In accordance with the Agreement, these liabilities were not assumed by the
Company and will be settled by the former shareholder of Wuyuan in
2010.





Accounts
      payable
                    
                    $
                    105,344Other
      current liabilities
                    
                    
                    201,748Liabilities
      to be settled by former shareholder
                    
                    $
                    307,092Deemed
      receivable from former shareholder for settlement of certain
      liabilities
                    
                    $
                    307,092


26


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





17.
Deposits for Acquisitions of Subsidiaries





Fuzhou City Lean Zhongran
Gas Inc. a PRC company (“Lean Zhongran”)




On
December 16, 2009,  Willsky entered into an Equity Interest Purchase
Agreement to acquire all of the outstanding equity interests in Lean Zhongran, a
PRC company, from Flying Dragon Resource Development Limited, for a total
purchase price of approximately $702,782 (RMB 4,800,000). The purchase price is
based on an appraised value of Lean Zhongran as of September 30, 2009 and will
be adjusted to reflect the appraised value of the assets as of the closing date.
The closing of the transaction is subject to approval by our Board of
Directors.





Fuzhou Zhongran - Dongxiang
Project




On
January 5, 2010,  Willsky entered into an Equity Interest Purchase
Agreement, to acquire all of the outstanding equity interests in Stockholder
Flying Dragon Gas Inc., a PRC company (“Stockholder Zhongran”) from Flying
Dragon Resource Development Limited and Flying Dragon Investment Management
Limited. The effectiveness of the Agreement was subject to the approval of our
Board of Directors, which approval was granted on December 2, 2009.





Under the
Agreement, Willsky will purchase 100% of the outstanding equity interests in
Fuzhou Zhongran for a total purchase price of approximately $3,800,000 (RMB
26,000,000).  The purchase price is based on an appraised value of
Fuzhou Zhongran as of September 30, 2009 and will be adjusted to reflect the
appraised value of the assets as of the closing date. The closing of the
transaction is subject to Board approval.





As of
March 31, 2010, the transfers of the ownership of Lean Zhonran and Fuzhou
Zhongran were not completed and the Group paid $1,222,946 as deposits and
recorded it under the caption of Deposits for acquisition. (See note
10).





The
stockholder of Lean Zhongran, Flying Dragon Resources Investment Management
Limited and Flying Dragon Resource Development Limited are two different
companies but controlled by the same person.


27


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





18.  Deemed
Receivable From Former Shareholders Of Subsidiaries Acquired For Settlement Of
Certain Liabilities





Deemed
receivable from former shareholders for settlement of certain liabilities of
$1,984,101 as of March 31, 2010, represents $1,677,009 of the liabilities of
Zhanhua Jiutai which are to be settled by the five former shareholders of
Zhanhua Jiutai and $307,092 of the liabilities of Wuyuan which are to be settled
by the former shareholders of Wuyuan, as disclosed in Note 16. These amounts
will be due in future financial reporting periods.





19.
Non-controlling Interests in Subsidiaries





As of
March 31, 2010, Tianjin Huan Long Trading directly held a 1% non-controlling
interest in our subsidiary SingOcean and indirectly held a 0.5% non-controlling
interest in Chengsheng and Zhanhua Jiutai and a 0.3% non-controlling interest in
Binhai Zhongneng. The total of these non-controlling interests at March 31, 2010
was $170,066 and their share of net income for the three months ended March 31,
2010 was $1,725.





As of
December 31, 2009, Tianjin Huan Long Trading directly held a 1% non-controlling
interest in our subsidiary SingOcean and indirectly held a 0.5% non-controlling
interest in Chengsheng and Zhanhua Jiutai and a 0.3% non-controlling interest in
Binhai Zhongneng. The total of these non-controlling interests at March 31, 2010
was $168,341 and their share of net loss for the three months ended March 31,
2009 was $20,955.


28


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





20.
Income Taxes





USA




The
Company and its subsidiary and branch divisions are subject to income taxes on
an entity basis on income arising in, or derived, from the tax jurisdiction in
which they operate. As the Group had no income generated in the United States,
there was no tax expense or tax liability due to the Internal Revenue Service of
the United States as of March 31, 2010 and December 31, 2009.





BVI




Willsky
is incorporated under the International Business Companies Act of the British
Virgin Islands and accordingly, is exempted from payment of British Virgin
Island’s income taxes.





PRC




Pursuant
to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income
tax is 25% for all subsidiaries in the PRC for fiscal years 2010 and 2009.
Chensheng was taxed at 1% of revenues from January to June 2009.  From
July 2009 on, Chensheng is taxed at 25% of net income.




The
current year tax provision was $289,923 and $997 for the three months ended
March 2010 and 2009, respectively.  The Group has recorded no deferred
tax assets or liabilities as of March 31, 2010 and December 31, 2009, because
all significant differences in tax basis and financial statement amounts are
permanent differences, and a full valuation allowance has been provided against
temporary differences.





For
      the three months ended March 31,2010
                    
                    
                    2009Income
      Tax Expense:Current
      tax
                    
                    $
                    289,923
                    
                    
                    $
                    997Change
      in deferred tax assets – NOL
                    
                    
                    211,355
                    
                    
                    
                    3,104,840Change
      in valuation allowance
                    
                    
                    (211,355
                    )
                    
                    
                    (3,104,840
                    )Total
                    
                    $
                    289,923
                    
                    
                    $
                    997





We follow
the guidance in FASB ASC 740 Accounting for Uncertainty in Income
Taxes.  We have not taken any uncertain tax positions on any of
our open income tax returns filed through the period ended March 31,
2010.  Our methods of accounting are based on established income tax
principles and are properly calculated and reflected within our income tax
returns.  In addition, we have timely filed extension of income tax
returns in all applicable jurisdictions in which we believe we are required to
make an income tax return filing.





We
re-assess the validity of our conclusions regarding uncertain tax positions on a
quarterly basis to determine if facts or circumstances have arisen that might
cause us to change our judgment regarding the likelihood of a tax position’s
sustainability under audit.  We have determined that there were no
uncertain tax positions for the three months March 31, 2010 and
2009.


29


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





20.
Income Taxes - continued





All of
the Group’s income before income taxes is from PRC sources. Actual income tax
expense reported in the consolidated statements of operations and comprehensive
income differ from the amounts computed by applying the PRC statutory income tax
rate of 25% to income before income taxes for the three months ended March 31,
2010 and 2009 for the followings reasons:





For
      the three months ended March 31,2010
                      
                      
                      2009Income
      (loss) from continuing operations before income taxes
                      
                      $
                      271,612
                      
                      
                      $
                      (12,410,024
                      )Computed
      “expected” income tax expense at 25% in 2010 and 2009, except on the net
      income of Chensheng of $2,931 in 2009
                      
                      $
                      67,903
                      
                      
                      $
                      (3,105,437
                      )Income
      tax expense of Chensheng - charged at 0.8% of gross sales of $199,250 in
      2009
                      
                      
                      -
                      
                      
                      
                      1,594Tax
      effect of net taxable permanent differences
                      
                      
                      10,665
                      
                      
                      
                      -Effect
      of cumulative tax losses
                      
                      
                      211,355
                      
                      
                      
                      3,104,840$
                      289,923
                      
                      
                      $
                      997





Our
policy for recording interest and penalties associated with audits is to record
such items as a component of income tax expense. There were no interest and
penalties recorded for the three months ended March 31, 2010 and
2009.


30


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





21.
Earnings Per Share





Basic
earnings per share is computed by dividing net income attributable to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflects the potential dilution of
securities by including other potential common stock, including convertible
preferred stock, stock options and warrants, in the weighted average number of
common shares outstanding for a period, if dilutive.  The numerators
and denominators used in the computations of basic and dilutive earnings per
share are presented in the following table:




For
      the three months ended March 31,2010
                            
                            
                            2009Numerator
      for basic (loss) per share from continuing operations attributable to
      China New Energy Group’s common stockholders:Net
      (loss) from continuing operations
                            
                            $
                            (105,666
                            )
                            
                            $
                            (12,470,588
                            )Dividend
      on preferred stocks
                            
                            
                            (215,175
                            )
                            
                            
                            (135,000
                            )Loss
      from continuing operations used in computing basic loss per
      share
                            
                            $
                            (320,841
                            )
                            
                            $
                            (12,605,588
                            )Basic
      (loss) per share from continuing operations
                            
                            $
                            (0.00
                            )
                            
                            $
                            (0.13
                            )Numerator
      for basic (loss) per share from discontinued operationsNet
      loss from discontinued operations
                            
                            $
                            (85,630
                            )
                            
                            $
                            (80,522
                            )Loss
      from discontinued operations used in computing basic earnings per
      share
                            
                            $
                            (85,630
                            )
                            
                            $
                            (80,522
                            )Basic
      loss per share from discontinued operations
                            
                            $
                            (0.00
                            )
                            
                            $
                            (0.00
                            )Numerator
      for diluted (loss) per share from continuing operations attributable to
      China New Energy Group’s common stockholders:Net
      loss from continuing operations
                            
                            $
                            (320,841
                            )
                            
                            $
                            (12,605,588
                            )Dividend
      on preferred stocks
                            
                            
                            215,175
                            
                            
                            
                            135,000(Loss)
      from continuing operations used in computing diluted earnings per
      share
                            
                            $
                            (105,666
                            )
                            
                            $
                            (12,470,588
                            )Diluted
      (loss) per share from continuing operations
                            
                            $
                            (0.00
                            )
                            
                            $
                            (0.13
                            )Numerator
      for diluted loss per share from discontinued operationsNet
      loss from discontinued operations
                            
                            $
                            (85,630
                            )
                            
                            $
                            (80,522
                            )Loss
      from discontinued operations used in computing diluted earnings per
      share
                            
                            $
                            (85,630
                            )
                            
                            $
                            (80,522
                            )Diluted
      loss per share from discontinued operations
                            
                            $
                            (0.00
                            )
                            
                            $
                            (0.00
                            )Denominator
      for basic and diluted earnings per shareWeighted
      average shares of Common Stock outstanding
                            
                            
                            101,788,199
                            
                            
                            
                            100,000,041Shares
      used in computing diluted net income (loss) per share
                            
                            
                            101,788,199
                            
                            
                            
                            100,000,041Total
      loss per share:Basic
                            
                            $
                            (0.00
                            )
                            
                            $
                            (0.13
                            )Diluted
                            
                            $
                            (0.00
                            )
                            
                            $
                            (0.13
                            )Potential
      common shares outstanding as of March 31,:Series
      A Convertible Preferred Stock
                            
                            
                            7,031,818
                            
                            
                            
                            7,031,818Series
      B Convertible Preferred Stock
                            
                            
                            2,153,307
                            
                            
                            
                            -Warrant
      outstanding
                            
                            
                            31,224,489
                            
                            
                            
                            19,502,412





For the
three months ended March 31, 2010 and 2009, the number of securities totaled
40,409,614 and 26,534,230, respectively, which are not included in the diluted
EPS because the effect would have been anti-dilutive.


31


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





22.
Business and Geographical Segments





The
Group’s operations are classified into two principal reportable segments which
are the provision of gas pipe connection services and the provision of natural
gas. Separate management of each segment is required because each business
unit is subject to different production and technology strategies.





Reportable
Segments




For
      the three months ended March 31, 2010
                            
                            
                            For
      the three months ended March 31, 2009
                            
                            
                            For
      the three months ended March 31,Connection
                            
                            
                            
                            
                            
                            
                            
                            
                            Connection
                            
                            
                            
                            
                            
                            
                            
                            
                            2010
                            
                            
                            2009services
                            
                            
                            Natural
      gas
                            
                            
                            Corporate
                            
                            
                            services
                            
                            
                            Natural
      gas
                            
                            
                            Corporate
                            
                            
                            Total
                            
                            
                            TotalExternal
      revenue
                            
                            $
                            1,691,362
                            
                            
                            
                            18,450
                            
                            
                            
                            -
                            
                            
                            $
                            146,752
                            
                            
                            $
                            12,633
                            
                            
                            $
                            -
                            
                            
                            $
                            1,709,812
                            
                            
                            $
                            159,385Interest
      income
                            
                            
                            2,439
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            2,212
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            2,439
                            
                            
                            
                            2,212Interest
      expense
                            
                            
                            (2,173
                            )
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (401
                            )
                            
                            
                            -
                            
                            
                            
                            (211
                            )
                            
                            
                            (2,173
                            )
                            
                            
                            (612
                            )Depreciation
      and amortization
                            
                            
                            29,152
                            
                            
                            
                            11,802
                            
                            
                            
                            38,171
                            
                            
                            
                            19,705
                            
                            
                            
                            11,820
                            
                            
                            
                            13,657
                            
                            
                            
                            79,125
                            
                            
                            
                            45,182Income
      tax
                            
                            
                            289,923
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            997
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            289,923
                            
                            
                            
                            997Net
      income (loss)
                            
                            
                            1,099,044
                            
                            
                            
                            (10,412
                            )
                            
                            
                            (1,192,573
                            )
                            
                            
                            88,469
                            
                            
                            
                            (10,647
                            )
                            
                            
                            (12,569,365
                            )
                            
                            
                            (103,941
                            )
                            
                            
                            (12,491,543
                            )Expenditures
      for long-lived assets
                            
                            
                            1,618,804
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            60,821
                            
                            
                            
                            108,268
                            
                            
                            
                            -
                            
                            
                            
                            1,618,804
                            
                            
                            
                            169,089As
      at March 31, 2010
                            
                            
                            As
      at December 31, 2009
                            
                            
                            As
      at March 31,
                              2010
                            
                            
                            As
      at December
                              31,
      2009Total
      Assets
                            
                            $
                            13,944,794
                            
                            
                            
                            2,413,055
                            
                            
                            
                            24,038,281
                            
                            
                            $
                            23,608,532
                            
                            
                            $
                            2,820,280
                            
                            
                            $
                            13,797,010
                            
                            
                            $
                            40,396,130
                            
                            
                            $
                            40,225,822


32


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





23.
Concentrations and Credit Risk





Cash -
Cash includes cash on hand and demand deposits in accounts maintained with state
owned banks within the PRC. The Group considers all highly liquid instruments
purchased with original maturities of three months or less, and money market
accounts, to be cash equivalents. Total cash in these banks at March 31, 2010
and December 31, 2009 amounted to $514,127 and $2,672,884, respectively, of
which no deposits were covered by insurance. Also, as of both March 31, 2010 and
December 31, 2009, the Group held $180,352 in restricted cash in a corporate
legal counsel’s trust account, in accordance with an agreement with investors to
restrict use of the funds to pay preferred stock dividends and investor relation
expenses. Nonperformance by these institutions could expose the Group to losses
not covered by insurance. Management reviews the financial condition of these
institutions on a periodic basis.  The Group has not incurred any
losses on these accounts from nonperformance by the aforementioned
institutions.





Major
customers – For the three months ended March 31, 2010, four customers accounted
for approximately 76% of the Group’s revenues and three customers accounted
for approximately 52% of the Group’s accounts receivable as of March 31, 2010.
For the three months ended March 31, 2009, one customer accounted for
approximately 100% of the Group’s revenues and five customers accounted for
approximately 98% of the Group’s accounts receivable as of March 31,
2009.





Major
suppliers – For the three months ended March 31, 2010, four suppliers accounted
for approximately 93% of the Group’s purchases and two suppliers accounted for
approximately 73% of the Group’s accounts payable as of March 31, 2010. For the
three months ended March 31, 2009, one supplier accounted for approximately 100%
of the Group’s purchases and three suppliers accounted for approximately 96% of
the Group’s accounts payable as of March 31, 2009.





Political
and economic risks - The Group's operations are carried out in the PRC.
Accordingly, the Group'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 Group's
operations in the PRC are subject to specific considerations and significant
risks not typically associated with companies in North America and Western
Europe. These include risks associated with, among others, the political,
economic, and legal environments, and foreign currency exchange. The Group'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
others.





The Group
does not require collateral to support financial instruments that are subject to
credit risk.





Environmental
Matters - The Group does not anticipate any material future cash requirements
related to environmental issues. If circumstances change, the Group will record
the estimated charges necessary to return sites to their original
condition.


33


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





24.
Commitments and Contingencies





Operating
Leases - In the normal course of business, the Group leases office space under
operating lease agreements. The operating lease agreements generally contain
renewal options that may be exercised at the Company’s discretion after the
completion of the base rental term. The Company is obligated under operating
leases requiring minimum rentals as follows:





Year
      ending December 31:Remainder
      of 2010
                      
                      $
                      130,6162011
                      
                      
                      1192012
                      
                      
                      -2013
                      
                      
                      -2014
                      
                      
                      -Thereafter
                      
                      
                      -Total
      minimum lease payments
                      
                      $
                      130,735





During
the three months ended March 31, 2010 and 2009, rental expenses included in
general and administrative expenses were $88,398 and $34,129,
respectively.





As of
March 31, 2010 and 2009, the Group did not have any contingent
liabilities.





The Group
is obligated to provide uninterrupted piped gas to connected users and to ensure
safety in the process of piped gas operations. The volume of gas to be supplied
by the Group will grow with the increase in gas users. The Group has selected
three qualified gas resource suppliers to ensure stable operations in meeting
its obligations.


34


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009





25.
Subsequent  events





Acquisition of Beijing
Century Dadi Gas Engineering Co., Ltd.(“Century Dadi”) and its affiliated
companies including Beijing Dadi Gas Engineering Co. Ltd. (“Dadi
Gas”)





On March
17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On March 31, 2010, the agreement was
terminated.




On April
2, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Changsha Yuedu Steel Co.,Ltd(. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On April 9, 2010 and the Group received part of the
downpayment of $731,000 (RBM5,000,000).





On March
8, 2010, the Company entered into an Equity Transfer Agreement with Mr. Tang
Zhixiang, to acquire from Mr. Tang a 70% equity interest in Century Dadi, a PRC
company and a 70% equity interest in its affiliated companies including Dadi
Gas.





Century
Dadi, Dadi Gas and their respective affiliated companies are primarily engaged
in the business of the supply of natural gas and construction and development of
a gas pipeline network in urban areas. The total purchase price has not yet been
determined but will be based on a multiple of the net profits of Century Dadi
and its consolidated subsidiaries for the year ended December 31, 2009, as
determined in accordance with US GAAP consistently applied, capped at
approximately $57,500,000 (RMB392,150,000). The purchase price is payable in
three installments. Each payment is subject to satisfaction of certain
preconditions.





Under the
terms of the Agreement, the parties will open a mutually managed account and we
will deposit approximately $1,466,000 (RMB10,000,000) into that account, to be
applied towards the purchase price.





The
Company paid part of the installment of $731,000 (RBM5,000,000) on April 9, 2010
as deposit to acquire Dadi Gas.





The
Company evaluated subsequent events through the time of filing this Quarterly
Report on Form 10-Q. No significant events occurred subsequent to the balance
sheet date but prior to the filing of this report that would have a material
impact on our Condensed Consolidated Financial Statements.


35





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





Special
Note Regarding Forward Looking Statements





This
Quarterly Report on Form 10-Q, including the following “Management’s Discussion
and Analysis of Financial Condition and Results of Operations,” contains
forward-looking statements that are based on the beliefs of our management, and
involve risks and uncertainties, as well as assumptions, that, if they ever
materialize or prove incorrect, could cause actual results to differ materially
from those expressed or implied by such forward-looking statements. The words
“believe,” “expect,” “anticipate,” “project,” “targets,” “optimistic,” “intend,”
“aim,” “will” or similar expressions are intended to identify forward-looking
statements.  All statements, other than statements of historical fact,
are statements that could be deemed forward-looking statements, including
statements regarding new and existing products, technologies and opportunities;
statements regarding market and industry segment growth and demand and
acceptance of new and existing products; any projections of sales, earnings,
revenue, margins or other financial items; any statements of the plans,
strategies and objectives of management for future operations; any statements
regarding future economic conditions or performance; uncertainties related to
conducting business in China; any statements of belief or intention; any of the
factors and risks mentioned in the “Risk Factors” sections of our Annual Report
on Form 10-K filed with the Securities and Exchange Commission on April 15,
2010, and any statements of assumptions underlying any of the foregoing. All
forward-looking statements included in this report are based on information
available to us on the date of this report. We assume no obligation and do not
intend to update these forward-looking statements, except as required by
law.





Certain
Terms





In this
report, unless indicated otherwise, references to:





·
            “China New Energy,” “the
      company,” “we,” “us,” or “our,” are references to the combined business of
      China New Energy Group Company and its wholly-owned subsidiaries, Willsky,
      Wuyuan,Tianjin Investment, SingOcean, Chensheng  and Yingkou
      Zhongneng, Zhanhua Jiutai, Binhai Zhongneng, but do not include the
      stockholders of China New
Energy;




·
            “Willsky” are references to
      Willsky Development, Ltd.





·
            “Wuyuan” are references to Wuyuan
      County Zhongran Gas Limited.





·
            “Tianjin Investment” are
      references to China New Energy(Tianjin) Investment & Consulting
      Co.,Ltd.





·
            “SingOcean” are references to
      Tianjin SingOcean Public Utility Development Co.,
    Ltd.





·
            “Chensheng” are references to
      Qinhuangdao Chensheng Gas Co.
Ltd.





·
            “Yingkou Zhongneng” are reference
      to Yingkou Zhongneng Gas Development Company
    Limited.





·
            “Zhanhua Jiutai” are reference to
      Zhanhua Jiutai Gas Co.
Limited.





·
            “Binhai Zhongneng” are reference
      to Tianjin Binhai Zhongneng Gas Company
  Limited.





·
            “China,” “Chinese” and “PRC,” are
      references to the People’s Republic of
  China;


36


·
            “BVI” are references to the
      British Virgin Islands;





·
            “RMB” refer to Renminbi, the
      legal currency of China;





·
            “U.S. dollar,” “$” and “US$” are
      to the legal currency of the United
  States;





·
            “SEC” means the Securities and
      Exchange Commission; and





·
            “Securities Act” mean the
      Securities Act of 1933, as amended, and “Exchange Act” mean the Securities
      Exchange Act of 1934, as
amended.


37





Overview
of Our Business





We are a
natural gas company engaged in the development of natural gas distribution
networks, and the distribution of natural gas to residential, industrial and
commercial customers in small and medium sized cities in China.





We
currently own the exclusive rights to develop distribution networks to provide
natural gas to industrial, commercial and residential consumers in the cities of
Nandaihe,Zhanhua and Shangrao. Currently, these distribution networks provide
natural gas to an aggregate of approximately 26,000 consumers in these
cities.





We
procure our natural gas by purchasing natural gas from third-party suppliers.
Once natural gas is extracted by the supplier, all water content and impurities
are removed.  Natural gas is then delivered by truck to either (1) our
natural gas supply stations, where the gas is either depressurized and then
delivered to households through pipelines or delivered directly to customers in
pressurized tanks, or (2) to gas stations where the gas is sold for use in motor
vehicles.





Our major
business activities include development and construction of local gas
distribution networks, transportation of natural gas from suppliers to our
storage facilities in a given operational location, and operating and
maintaining the gas distribution networks.





Our
Current Organizational Structure





China New
Energy Group Company was incorporated on March 28, 2008 in the state of
Delaware, under the name of Travel Hunt Holdings, Inc.  On May 27,
2008, Travel Hunt changed its name to China New Energy Group Company in
connection with a share exchange transaction as described below.





Willsky
was incorporated on May 31, 2005 in the British Virgin Islands. On March 28,
2008, Travel Hunt Holdings, Inc. completed a reverse acquisition transaction
with Willsky whereby Travel Hunt Holdings, Inc. issued to the shareholder of
Willsky 94,908,650 shares of its common stock in exchange for all of the issued
and outstanding capital stock of Willsky. Simultaneous with the consummation of
the share exchange, the shareholder of Willsky, Eternal International Holding
Group Ltd, a Hong Kong corporation, or Eternal International, distributed
85,417,785 shares of Travel Hunt Holdings, Inc. common stock as a dividend.
Accordingly, following this distribution, Eternal International beneficially
owns approximately 9.49% of Travel Hunt Holdings, Inc. outstanding capital
stock. Willsky thereby became Travel Hunt Holdings, Inc.’s wholly-owned
subsidiary and the former shareholders of Willsky became Travel Hunt Holdings,
Inc. controlling stockholders.





Concurrently
with the reverse merger, Fountainhead and La Pergola, the existing shareholders
of Travel Hunt, surrendered to the Company a total of 2,000,000 shares of the
common stock of the Company for cancellation in exchange for $660,000 payable
through the delivery of a six month Convertible Promissory Note. After
surrender, the existing shareholders retained 5,091,391 shares of our common
stock.




38


In 2005,
Willsky acquired 99% of the equity of SingOcean which was formed in the PRC as
an equity joint venture to be operated for a period of 50 years until January
18, 2054 with registered capital of $4.5 million (RMB31,897,000).





On
September 16, 2008, we, through our 99%-owned subsidiary SingOcean,
entered into an Equity Swap Agreement with Mr. Xiu Hai Tian, whereby we
acquired fromMr. Xiu a 49%
ownership interest in Chensheng, in exchange for our 99% ownership in
Hunchun SingOcean.  The parties to the Equity Swap Agreement
determined that the value of the 49% interest in Chensheng and the 99% interest
in Hunchun Sing Ocean were approximately equal and therefore there was no cash
or other consideration involved in the transaction from either
party.





On
December 10, 2008, the Company entered into an Agreement for Equity Transfer
with the holders of the remaining 51% outstanding equity in
Chensheng.  Pursuant to the Agreement for Equity Transfer, the Company
agreed to purchase the remaining 51% of the outstanding equity of Chensheng from
17 individuals for an aggregate purchase price of RMB 12.56 million
(approximately $1.84 million).  The transaction was consummated on
December 30, 2008, following which the Company now owns 51% of the equity of
Chensheng, and Tianjin Sing Ocean now owns 49% of the equity of
Chensheng.





On
January 12, 2009, Tianjin Investment was established in the PRC and engaged in
the business of investment holding.





On
January 23, 2009, Yingkou Zhongneng was established in the PRC and operates a
natural gas distribution network in the city of Dashiqiao. On March 17, 2010, we
entered into an agreement to sell our interest in Yingkou
Zhongneng.





On June
26, 2009, Binhai Zhongneng was established. Through our 99.5%-owned subsidiary,
Chensheng contributed $1,462,501 (RMB10,000,000) in cash representing 60.6% of
the shareholding of Binhai Zhongneng and, through our wholly-owned subsidiary,
SingOcean contributed $950,626 (RMB6,500,000) in assets representing 39.4% of
the shareholding of Binhai Zhongneng. As a result, the group holds 100% of
Binhai Zhongneng.





On
December 12, 2009, Chensheng, our indirect wholly-owned subsidiary, entered into
an Equity Interest Purchase Agreement to acquire all of the outstanding equity
interest of Zhanhua Jiutai  from the 5 shareholders of Zhanhua Jiutai.
Under this Agreement, Chensheng agreed to purchase 100% of the outstanding
equity interest of Zhanhua Jiutai from the Zhanhua Jiutai Shareholders for a
total purchase price of $2,413,259 (RMB 16,500,000).





On
December 16, 2009, the Company entered into an Equity Interest Purchase
Agreement, to acquire all of the outstanding equity interest of Wuyuan, from
Flying Dragon Investment Management Limited. Under this Agreement, the Company
agreed to purchase 100% of the outstanding equity interest of Wuyuan for a total
purchase price of $877,552 (RMB 6,000,000) which purchase price is based on an
appraised value of Wuyuan as of September 30, 2009.





Critical Accounting
Policies





Accounting
policies discussed in this section are those that we consider to be most
critical to an understanding of our financial statements because they inherently
involve significant judgment and uncertainties.  For all of these
estimates, we caution that future events rarely develop exactly as forecast, and
the best estimates routinely require adjustment.





Revenue
Recognition





Among the
accounting policies adopted by the Group, the most critical one is the policy
regarding revenue recognition of the Group’s major sources of income, namely,
gas connection services and sales of gases. In accordance with the SEC's Staff
Accounting Bulletin ("SAB") No. 104, under this policy, all of the following
criteria must be met in order for us to recognize revenue:


39


1.       Persuasive evidence of an arrangement
exists;


2.       Delivery has occurred or services have
been rendered;


3.       The seller's price to the buyer is fixed
or determinable; and


4.       Collectibility is reasonably
assured.





Gas
connection revenue





Gas
connection revenue is recognized when the outcome of a contract can be estimated
reliably and the stage of completion at the balance sheet date can be measured
reliably.





Revenue
from gas connection contracts is recognized on the percentage of completion
method, measured by reference to the value of work carried out during the year.
When the outcome of a gas connection contract cannot be estimated reliably,
revenue is recognized only to the extent of contract costs incurred that it is
probable will be recoverable.





When the
outcome of a gas connection contract can be estimated reliably and the stage of
contract completion at the balance sheet date can be measured reliably, contract
costs are charged to the income statement by reference to the stage of
completion of the contract activity at the balance sheet date on the same basis
as revenue from the gas connection contract is recognized.





When the
outcome of a gas connection contract cannot be estimated reliably, contract
costs are recognized as expenses in the period in which they are incurred. When
it is probable that total contract costs will exceed contract revenue, the
expected loss is recognized as an expense immediately.





Where
contract costs incurred to date plus recognized profits less recognized losses
exceed progress billings, the surplus is shown as an amount due from customers
for contract work. For contracts where progress billings exceed contract costs
incurred to date plus recognized profits less recognized losses, the surplus is
shown as an amount due to customers for contract work. Amounts received before
the related work is performed are included in the consolidated balance sheet, as
a liability, as advances received. Amounts billed for work performed but not yet
paid by the customer are included in the consolidated balance sheet under trade
and other receivables.





During
the three months ended March 31, 2010 and 2009, all the contracts for connection
services were started and completed .





Revenue
from sale of gas





Sales
revenue from sale of gas represents the invoiced value of goods sold, net of
value-added tax (“VAT”). Revenue from sale of gas is recognized when the goods
are delivered and title has passed.





All of
the Company’s products that are sold in the PRC are subject to Chinese
value-added tax of 3% 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.





Use
of Estimates





In
preparing consolidated financial statements in conformity with US GAAP,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reported periods. Actual results could differ from those
estimates


40


Significant
Estimates





These
consolidated financial statements include some amounts that are based on
management's best estimates and judgments. The most significant estimates relate
to revenue recognition of gas connection contracts, depreciation of property,
plant and equipment, the valuation allowance for deferred taxes, impairment
testing of intangible assets and various contingent liabilities. It is
reasonably possible that the above-mentioned estimates and others may be
adjusted as more current information becomes available, and any adjustment could
be significant in future reporting periods.





Reportable
Operating Segments





For the
three months ended March 31, 2010, we had sales revenue of $1.71 million of
which $1.69 million,   or 98.83%, was from connection services
while $0.02 million, or 1.17%, was derived from gas sales.





Our
revenue for the three months ended March 31, 2010 was mainly contributed by the
connection services segment as we concentrate our efforts to provide our
services to property developers.  Thus, the gas consumption will begin
when the properties are sold in the market.  Currently, the volume of
gas sales to connected households is not high.  This phenomenon does
affect our revenue structure.




First
Quarter Financial Performance Highlights





The
following are some financial highlights for the three months ended March 31,
2010:





Revenues:Our revenues were $1.71
million for the three months ended March 31, 2010, an increase of 975% from the
same period of 2009.





Gross
Margin:  Gross margin was
73% for the three months ended March 31, 2010 compared to gross margin of 48%
for the three months ended March 31, 2009, representing a percentage
increase of 25%.





Total Operating
Expenses:  Operating expenses (including selling, general
and administrative expenses) were $1.38 million for the three months ended
March 31, 2010, an increase of 78% from the same period of 2009.





NetLoss:  Net loss
was $0.11 million for the three months ended March 31, 2010. It was mainly due
to: (1) an increase of revenue by $1.55 million, and (2) a change in fair value
of warrant liabilities which resulted in other income of $0.40 million, which
was offset by the increase in operating expenses of $0.49 million.





Fully diluted net
income per share: Fully diluted net income per share was $0.00 for the
three months ended March 31, 2010, as compared to a net loss per share of $0.13
for the same period of 2009.





Taxation





As a
Delaware company, the Company is subject to United States taxation, but no
provision for income taxes was made for the three months ended March 31, 2010
and 2009 as the Company did not have reportable taxable income for the
period.





Willsky,
a wholly-owned subsidiary of the Company, is subject to BVI taxation, but no
provision for income taxes was made for the three months ended March 31, 2010
and 2009 as Willsky did not have reportable taxable income for the
period.





SingOcean
is subject to the tax laws of the PRC at the prevailing statutory rate
of enterprise income tax of 25%.


41


Chensheng
is subject to the tax laws of the PRC being taxed on 0.8% of annual
sales. Starting from January 1, 2009, the tax rate was changed to 1% on
sales.  On July 1, 2009, the tax rate was changed to 25% on net income. For
the three months ended March 31, 2010 and 2009, the amount of income tax was
$0.18 MM and $0.001 MM, respectively.





Binhai
Zhongneng is subject to the tax laws of the PRC at  the
prevailing statutory rate of enterprise income tax of 25%. For the three months
ended March 31, 2010, the amount of income tax was nil.





Zhanhua
is subject to the tax laws of the PRC at the prevailing statutory rate
of enterprise income tax of 25%. For the three months ended March 31, 2010, the
amount of income tax was $0.04 MM.





Wuyuan is
subject to the tax laws of the PRC at the prevailing statutory rate of
enterprise income tax of 25%. For the three months ended March 31, 2010, the
amount of income tax was $0.06 MM.


42


Results
of Operations





Comparison
of Three Months Ended March 31, 2010 and 2009





The
following table summarizes the results of our operations during the three months
ended March 31, 2010 and 2009:





(All
amounts, other than percentages, in thousands of U.S. dollars)





For
      the three months endedMarch 312010
                      
                      
                      2009
                      
                      
                      Change
                      
                      
                      Change%Revenues:
                      
                      $
                      1,710
                      
                      
                      $
                      159
                      
                      
                      $
                      1,551
                      
                      
                      
                      975
                      %Cost
      of Sales:
                      
                      
                      460
                      
                      
                      
                      83
                      
                      
                      
                      377
                      
                      
                      
                      454
                      %Gross
      Profit
                      
                      
                      1,250
                      
                      
                      
                      76
                      
                      
                      
                      1,174
                      
                      
                      
                      1545
                      %Total
      operating expenses
                      
                      
                      1,378
                      
                      
                      
                      775
                      
                      
                      
                      603
                      
                      
                      
                      78
                      %Loss
      from operations
                      
                      
                      (128
                      )
                      
                      
                      (699
                      )
                      
                      
                      571
                      
                      
                      
                      82
                      %Other
      Income (Expenses):Change
      in fair value of derivative financial instruments -
    warrants
                      
                      
                      400
                      
                      
                      
                      (11,713
                      )
                      
                      
                      12,112
                      
                      
                      
                      103
                      %Interest
      income (expense)
                      
                      
                      -
                      
                      
                      
                      2
                      
                      
                      
                      (2
                      )
                      
                      
                      -100
                      %Income
      (loss) From Continuing Operations, Before Income Tax
                      
                      
                      272
                      
                      
                      
                      (12,410
                      )
                      
                      
                      12,682
                      
                      
                      
                      102
                      %Income
      Tax
                      
                      
                      290
                      
                      
                      
                      1
                      
                      
                      
                      289
                      
                      
                      
                      28900
                      %(Loss)
      from Discontinued Operations, net of Income Tax
                      
                      
                      (86
                      )
                      
                      
                      (81
                      )
                      
                      
                      (5
                      )
                      
                      
                      -6
                      %Non-controlling
      Interest
                      
                      
                      (2
                      )
                      
                      
                      21
                      
                      
                      
                      (23
                      )
                      
                      
                      -110
                      %Net
      (Loss)
                      
                      
                      (106
                      )
                      
                      
                      (12,471
                      )
                      
                      
                      12,365
                      
                      
                      
                      99
                      %





Revenues.  
Revenues are derived primarily from connection fees and sales of natural
gas.  Revenues increased $1.55 MM, or 975%, to $1.71 MM for the three
months ended March 31, 2010 from $0.16 MM for the same period in 2009. This
increase was mainly attributable to an increase in number of connection
households. Connection households increased by 3,989 to4,407 which provided by
Zhanhua Jiutai, Wuyuan and Chensheng for the three months ended March 31, 2010
and from 418 which provided by Chensheng for the same period in
2009.


43


Cost of
Sales.Cost of sales
consists primarily of connection costs and purchase of natural gas from our
suppliers and depreciation.





Our cost
of sales increased by $0.38 million, or 454%, to $0.46 million, for the three
months ended March 31, 2010 from $0.08 million during the same period in 2009.
Such increase was mainly attributable to a corresponding increase in the number
of households.





Gross
Profit. Our gross profit increased by $1.17 million to $1.25 million
for the three months ended March 31, 2010 from $0.08 million during the same
period in 2009. Gross profit as a percentage of revenues, or gross profit
margin, was 73% for the three months ended March 31, 2010.  The gross
profit margin during the same period in 2009 was 48%. Such increase in gross
margin was mainly due to 99% of revenues were derived from connection fees while
during the same period in 2009 was 92%, and the gross margin of connection fees
was higher than that of gas sales.




Total Operating Expenses.The
total operating expenses consist of two components, the first one is
registration right penalties and the other is general and administrative
expenses (“SG&A”). For the three months ended March 31, 2010, the total
operating expenses were $1.38 million while the amount was $0.78 million for the
same period of 2009, or increased by 78%.  This increase was mainly
due to the fact that we are preparing to expand our company. Management
believes that the relatively high SG&A expenses will continue as we
endeavor to expand our business.





Loss from Operations.Our
loss from operations decreased by $0.57 million, or 82%, to $0.13 million for
the three months ended March 31, 2010 from $0.70 million during the same period
in 2009. Such decrease in loss from operations is due to an increase of revenues
generated.





Other
Income (Expenses).





Change In Fair Value of Warrant
Liability: For the three months ended March 31, 2010, the change in fair
value of warrant liability was recorded as other income of $0.40 million while
the one incurred in the same period for 2009 was recorded as other expenses of
$11.71 million.





On August
20, 2008, the fair value of the 13,001,608 warrants issued with the Series A
Convertible Preferred Stock to China Hand was $1.97 MM and the fair value of
6,500,804 warrants issued to Kuhns Brothers was $0.98 MM. The fair value was
computed using the Cox-Ross-Rubinstein (“CRR”) Binomial Model under the
following assumptions: (1) expected life of 5 years, (2) volatility of 90%, (3)
risk free interest rate of 3% and dividend rate of 0%.





On May 1,
2009, the fair value of the 7,814,719 warrants issued with the Series B
Convertible Preferred Stock to China Hand was $3.25 MM and the fair value of
3,907,358 warrants issued to Kuhns Brothers was $1.62 MM. The fair value was
computed using the Cox-Ross-Rubinstein (“CRR”) Binomial Model under the
following assumptions: (1) expected life of 5 years, (2) volatility of 90%, (3)
risk free interest rate of 2.03% and dividend rate of 0%.





As of
March 31, 2010 and the year ended December 31, 2009, the fair value of the
warrants was $6.37 MM and $6.77 MM, respectively.  Therefore, the Company
recognized a $0.40 MM gain from the change in fair value for the three
months ended March 31, 2010 and a $11.71 MM loss from the change in fair
value for the three months ended March 31, 2009.





Incomefrom Continuing Operations, Before
Income Tax.Our
income from continuing operations, before income tax increased by $12.68 MM to
$0.27 MM for the three months ended March 31, 2010 from a loss of $12.41 MM
during the same period in 2009.  Such variance was mainly due to: (1)
an increase in revenue; and (2) a gain $0.40 MM of the change in fair value of
warrant liability recognized in the three months of 2010, while a loss $11.71 MM
was recorded in the same period of 2009.


44


Loss From Discontinued Operations.




Disposal of Yingkou
Zhongneng Gas Development Co.,Ltd in 2010 – completed in
2010




On March
17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On March 31, 2010, the agreement was
terminated.




On April
2, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Changsha Yuedu Steel Co.,Ltd(. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On April 9, 2010 and the Group received part of the
downpaymnet of $731,000 (RBM5,000,000).





As of
March 31, 2010, the control of Yingkou still remains in the Group, and
therefore, the Group recorded all the assets and liabilities of Yingkou under
the caption of “Current Assets Held for Sale”, “Non-current Assets Held for
Sale” and “Liabilities Held for Sale”. The operations activity of Yingkou was
recorded under the discontinued operations for the three months ended March 31,
2010 and 2009.





The
following table displays summarized operating activity for the discontinued
operations of Yingkou for the three months ended March 31 2010 and Yingkou and
Acheng for the three months ended March 31, 2009.





For
      the three months ended2010
                    
                    
                    2009Revenue
                    
                    $
                    201,159
                    
                    
                    $
                    165,632Operating
      loss
                    
                    $
                    (92,501
                    )
                    
                    $
                    (86,608
                    )Loss
      before income taxes
                    
                    $
                    (85,630
                    )
                    
                    $
                    (80,522
                    )Income
      tax expense
                    
                    $
                    -
                    
                    
                    $
                    -Loss
      from discontinued operations, net of tax
                    
                    $
                    (85,630
                    )
                    
                    $
                    (80,522
                    )


45


Net Loss.
Net loss decreased by $12.36 MM to a net loss of $0.11 MM for the
three months ended March 31, 2010, from a net loss of $12.47 MM for the same
period of 2009, which is mainly due to: (1) an increase in revenue of $1.55MM;
and (2) a gain $0.40 MM of the change in fair value of warrant liability
recognized in the three months of 2010, while a loss $11.71 MM was recorded in
the same period of 2009.





Liquidity
and Capital Resources





As of
March 31, 2010, we had cash and cash equivalents of approximately $0.51 MM.
 The following table provides detailed information about our net cash flow
for all financial statement periods presented in this report.





Cash
Flow


(All
amounts in thousands of U.S. dollars)


For
      The Three Months EndedMarch 31,2010
                  
                  
                  2009Net
      cash used in operating activities
                  
                  $
                  (348
                  )
                  
                  $
                  (373
                  )Net
      cash used in investing activities
                  
                  
                  (1,811
                  )
                  
                  
                  (2,040
                  )Net
      cash provided by financing activities
                  
                  
                  -
                  
                  
                  
                  439Effect
      of exchange rate changes in cash and cash equivalents
                  
                  
                  -
                  
                  
                  
                  (4
                  )Net
      decrease in cash and cash equivalents
                  
                  $
                  (2,159
                  )
                  
                  $
                  (1,978
                  )





Operating
Activities





Net cash
used in operating activities was $0.35 MM for the three months ended March 31,
2010, compared to net cash used in operating activities of $0.37 MM during the
same period of 2009. It was approximately equal.





Investing
Activities





Our main
use of cash in investing activities was mainly for the construction of gas
pipelines and acquisition of assets.





Net cash
used in investing activities for the three months ended March 31, 2010 was $1.81
MM, which was a decrease of $0.23 MM from $2.04 MM for the same
period of 2009.  This decrease was due to a payment made for the
acquisition of Dongxiang $1.03 MM in the three months ended March 31, 2010,
while for the acquisition of Chengsheng $1.84 MM in the same period of
2009.





Financing
Activities





Our debt
(included in the warrant liabilities) to equity ratio was 171% as of March
31, 2010.  Net cash provided by financing activities for the three
months ended March 31, 2010 was nil and $0.44 provided by discontinued
operations for the same period.


46


Capital
Expenditures, Contractual Obligations, Commitments and Contingences





For the
three months ended March 31, 2010, the company spent about $2.29 MM in capital
expenditures which was mainly for the construction of gas pipelines and gas
station. The company settled the payments according to the terms of the contract
and fulfilled of its contractual obligations.  Other than the
operating leases stated in Note 24 to Audited Condensed Consolidated Financial
Statements, we have no other commitments and contingencies. As disclosed in Note
24, the Company is obligated under operating leases to pay minimum lease
payments of approximately $0.13 MM.




Seasonality





Our
pipeline distribution networks are primarily located in northeastern China,
which is extremely cold during the winter months. Additionally, gas consumption
by residential customers is higher in the winter months for heating purposes,
and there is a corresponding increase in usage during winter. However, due to
the cold weather we are unable to construct primary gas pipelines.  If
a primary pipeline is already in place, we are able to connect new customers to
our distribution network during this time.





Effects
of Inflation





Our
business, revenues and operating results have not been affected in any material
way by inflation.





Off
Balance Sheet Arrangements





On March
17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On March 31, 2010, the agreement was
terminated.




On April
2, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity
Transfer Agreement, with Changsha Yuedu Steel Co.,Ltd(. (the “Purchaser”).
Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100%
equity interest in Yingkou Zhongneng, for a cash purchase price of approximately
$3,200,000 (RMB 21,900,000). On April 9, 2010 and the Group received part of the
downpayment of $731,000 (RBM5,000,000).





On March
8, 2010, the Company entered into an Equity Transfer Agreement with Mr. Tang
Zhixiang to acquire from Mr. Tang a 70% equity interest in Century Dadi, a PRC
company, and a 70% equity interest in its affiliated companies including Dadi
Gas.





Century
Dadi, Dadi Gas and their respective affiliated companies are primarily engaged
in the business of the supply of natural gas and construction and development of
a gas pipeline network in urban areas. The total purchase price has not yet been
determined but will be based on a multiple of the net profits of Century Dadi
and its consolidated subsidiaries for the year ended December 31, 2009, as
determined in accordance with US GAAP consistently applied, capped at
approximately $57,500,000 (RMB392,150,000). The purchase price is payable in
three installments. Each payment is subject to satisfaction of certain
preconditions.





Under the
terms of the Agreement, the parties will open a mutually managed account and we
will deposit approximately $1,466,000 (RMB10,000,000) into that account to be
applied towards the purchase price.





The
Company paid part of the installment of $731,000 (RBM5,000,000) on April 9, 2010
on the acquisition of Dadi Gas.





The
Company evaluated subsequent events through the time of filing this Quarterly
Report on Form 10-Q. No significant events occurred subsequent to the balance
sheet date but prior to the filing of this report that would have a material
impact on our Condensed Consolidated Financial Statements.


47





ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not
Applicable.





ITEM
      4.
            CONTROLS
      AND PROCEDURES.





Evaluation of
Disclosure Controls and Procedures.





We
maintain “disclosure controls and procedures” (as defined in Rule 13a-15(e)
under the Exchange Act) that are designed to ensure that information that would
be required to be disclosed in Exchange Act reports is recorded, processed,
summarized and reported within the time period specified in the SEC’s rules and
forms, and that such information is accumulated and communicated to our
management, including to our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.




As
required by Rule 13a-15 under the Exchange Act, our management, including Mr.
Yangkan Chong, our Chief Executive Officer and Mr. Eric Yu, our Chief Financial
Officer, evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of March 31, 2010.  Based on
that evaluation, Mr. Chong and Mr. Yu concluded that as of March 31, 2010, and
as of the date that the evaluation of the effectiveness of our disclosure
controls and procedures was completed, our disclosure controls and procedures
were effective and the following measurements have been
deployed.


·
              We
      continue to arrange necessary training for our accounting department
      staff;
  ·
              We
      continue to engage external professional accounting or consultancy firms
      to assist us in the preparation of the US GAAP
  accounts;
  ·
              We have established
      an effective internal audit function; through allocating
      financial and human resources to strengthen the internal control structure
      and we have been actively working with external consultants to assess our
      data collection, financial reporting, and control procedures and to
      strengthen our internal controls over financial
      reporting.
  We
believe that the foregoing steps will strengthen our disclosure controls and
procedures, and we will continue to monitor the effectiveness of these steps and
make any changes that our management deems appropriate.
  Changes
in Internal Controls.
  Except as
described abovethere
were no changes in our internal control over financial reporting that occurred
during the fiscal quarter covered by this report that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.


48


PART
II





OTHER
INFORMATION





ITEM
      1.
            LEGAL
      PROCEEDINGS.





From time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business.  We are currently not aware
of any such legal proceedings or claims that we expect will have a material
adverse affect on our business, financial condition or operating
results.  However, litigation is subject to inherent uncertainties,
and an adverse result in these or other matters may arise from time to time that
may harm our business.





ITEM
      2.
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS.





None.





ITEM
      3.
            DEFAULTS
      ON SENIOR SECURITIES.





None.





ITEM
      5.
            OTHER
      INFORMATION.





None.





ITEM
      6.
            EXHIBITS.





The
following exhibits are filed as part of this report or incorporated by
reference:





Exhibit No.
                  
                  Description31.1
                  
                  Certification
      of Principal Executive Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                  
                  Certification
      of Principal Financial Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32
                  
                  Certification
      of Principal Executive Officer and Principal Financial Officer furnished
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of
2002.


49


SIGNATURES





In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





Dated:
May 24, 2009





CHINA NEW ENERGY GROUP
      COMPANYBy:
                  /s/
      Yangkan ChongYangkan
      ChongChief
      Executive Officer(Principal
      Executive Officer)By:
                  /s/
      Eric YuEric
      YuChief
      Financial Officer(Principal
      Financial and Accounting
Officer)


50


EXHIBIT
INDEX





Exhibit No.
                  
                  Description31.1
                  
                  Certification
      of Principal Executive Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                  
                  Certification
      of Principal Financial Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32
                  
                  Certifications
      of Principal Executive Officer and Principal Financial Officer furnished
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of
2002.


51