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: June 30, 2010




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




For the
transition period from ____________ to _____________




Commission
File Number: 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.)





Block
B1, 18/F,No. 85,Nanjing Road,


Tianjin
Emperor Place,Heping District,Tianjin, 300040


People's
Republic of China


(Address
of principal executive offices, Zip Code)




(86 22) 2321
0508


(Registrant’s
telephone number, including area code)




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


He
Ping District, Tianjin, China  300042




________________________________________________


(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 Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes  x  No   ̈





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





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See 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 stock, as of
August 10, 2010 is as follows:




Class
      of Securities
            
            Shares
      OutstandingCommon
      Stock, $0.001 par value
            
            107,070,281















Quarterly
Report on FORM 10-Q/A


Three and Six
Months Ended June 30, 2010




TABLE
OF CONTENTS





PART
      IFINANCIAL
      INFORMATIONITEM
      1.
            FINANCIAL
      STATEMENTS
            1ITEM
      2.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
            37ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            50ITEM
      4.
            CONTROLS
      AND PROCEDURES
            50PART
      IIOTHER
      INFORMATIONITEM
      1.
            LEGAL
      PROCEEDINGS
            51ITEM
      6.
            EXHIBITS
            52









PART
I


FINANCIAL
INFORMATION




ITEM
      1.
            FINANCIAL
      STATEMENTS.




CHINA
NEW ENERGY GROUP COMPANY





UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009





Index to
unaudited condensed consolidated financial statements





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





1




CHINA
NEW ENERGY GROUP COMPANY


CONDENSED
CONSOLIDATED BALANCE SHEETS





June
      30,
            
            
            December
      31,2010
            
            
            2009ASSETS
            
            (Unaudited)CURRENT
      ASSETSCash
      and cash equivalents
            
            $
            262,728
            
            
            $
            2,672,884Restricted
      cash
            
            
            131,930
            
            
            
            180,352Accounts
      receivable, net of allowance for doubtful accounts of $231,550 and
      $-
            
            
            4,555,133
            
            
            
            4,619,232Receivable
      from sale of a subsidiary
            
            
            3,260,582
            
            
            
            5,119,055Inventories,
      net
            
            
            286,595
            
            
            
            271,104Prepaid
      expenses
            
            
            205,024
            
            
            
            179,011Deemed
      receivable from former shareholders of subsidiaries acquired for
      settlement of certain liabilities
            
            
            1,384,073
            
            
            
            1,983,782Current
      assets held for sale
            
            
            1,407,538
            
            
            
            1,768,278NET
      CURRENT ASSETS
            
            
            11,493,603
            
            
            
            16,793,698Property,
      plant and equipment, net
            
            
            10,039,454
            
            
            
            8,000,069Other
      receivables
            
            
            1,940,197
            
            
            
            2,091,092Deposits
      for acquisitions of subsidiaries
            
            
            1,222,946
            
            
            
            197,696Intangible
      assets, net
            
            
            1,181,224
            
            
            
            1,186,272Deposits
      paid for acquisition of long term assets
            
            
            2,960,522
            
            
            
            1,972,162Goodwill
            
            
            225,430
            
            
            
            224,488Non-current
      assets held for sale
            
            
            9,970,525
            
            
            
            9,760,345TOTAL
      ASSETS
            
            $
            39,033,901
            
            
            $
            40,225,822LIABILITIES
      AND EQUITYCURRENT
      LIABILITIESAccounts
      payable
            
            $
            908,076
            
            
            $
            614,642Deposits
      receipt for disposal
            
            
            734,365
            
            
            
            -Accruals
      and other payable
            
            
            683,732
            
            
            
            187,904Acquisition
      consideration payable
            
            
            1,538,654
            
            
            
            1,651,888Tax
      payable
            
            
            621,980
            
            
            
            1,323,815Registration
      rights penalties payable
            
            
            2,160,000
            
            
            
            2,160,000Related
      party payables
            
            
            98,305
            
            
            
            97,893Dividends
      payable on preferred stock
            
            
            503,515
            
            
            
            509,381Derivative
      financial instruments – warrants
            
            
            6,476,070
            
            
            
            6,768,106Liabilities
      to be settled by former shareholders of subsidiaries
    acquired
            
            
            1,384,073
            
            
            
            1,983,782Current
      liabilities held for sale
            
            
            430,656
            
            
            
            548,832TOTAL
      CURRENT LIABILITIES
            
            
            15,539,426
            
            
            
            15,846,243Commitments
      and contingencies (Note 23)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 June 30, 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
      June 30, 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, 105,395,032 and
      101,788,199 shares issued and outstanding, respectively
            
            
            105,395
            
            
            
            101,788Additional
      paid in capital
            
            
            10,629,380
            
            
            
            10,152,971(Accumulated
      deficit)/ Retained earnings
            
            
            (98,061
            )
            
            
            1,423,523Statutory
      surplus reserve fund
            
            
            1,746,890
            
            
            
            1,746,890Accumulated
      other comprehensive income
            
            
            1,754,684
            
            
            
            1,600,941TOTAL
      CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY
            
            
            14,138,288
            
            
            
            15,026,113Non-controlling
      interest
            
            
            171,062
            
            
            
            168,341TOTAL
      EQUITY
            
            
            14,309,350
            
            
            
            15,194,454TOTAL
      LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
      AND EQUITY
            
            $
            39,033,901
            
            
            $
            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 ended
            
            
            For
      the six months endedJune
      30,
            
            
            June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Revenues:Connection
      services
            
            $
            663,179
            
            
            $
            505,106
            
            
            $
            2,354,541
            
            
            $
            651,858Natural
      gas
            
            
            28,452
            
            
            
            29,610
            
            
            
            46,902
            
            
            
            42,243691,631
            
            
            
            534,716
            
            
            
            2,401,443
            
            
            
            694,101Cost
      of Sales:Connection
      services
            
            
            140,102
            
            
            
            161,489
            
            
            
            571,678
            
            
            
            221,583Natural
      gas
            
            
            44,723
            
            
            
            35,136
            
            
            
            73,585
            
            
            
            58,417184,825
            
            
            
            196,625
            
            
            
            645,263
            
            
            
            280,000Gross
      Profit
            
            
            506,806
            
            
            
            338,091
            
            
            
            1,756,180
            
            
            
            414,101Operating
      Expenses:General
      and administrative expenses
            
            
            1,175,719
            
            
            
            485,146
            
            
            
            2,484,325
            
            
            
            772,298Selling
      expenses
            
            
            81,969
            
            
            
            48,541
            
            
            
            151,636
            
            
            
            86,602Registration
      right liabilities
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            450,000Total
      operating expenses
            
            
            1,257,688
            
            
            
            533,687
            
            
            
            2,635,961
            
            
            
            1,308,900Operating
      (Loss)
            
            
            (750,882
            )
            
            
            (195,596
            )
            
            
            (879,781
            )
            
            
            (894,799
            )Other
      Income (Expenses):Change
      in fair value of derivative financial instruments -
    warrants
            
            
            (107,680
            )
            
            
            13,688,558
            
            
            
            292,036
            
            
            
            1,976,044Interest
      income
            
            
            111
            
            
            
            25
            
            
            
            2,550
            
            
            
            2,234Interest
      expense
            
            
            (2,192
            )
            
            
            (2,401
            )
            
            
            (4,365
            )
            
            
            (3,010
            )Other
      income
            
            
            12,561
            
            
            
            -
            
            
            
            13,090
            
            
            
            93Total
      other income (expenses)
            
            
            (97,200
            )
            
            
            13,686,182
            
            
            
            303,311
            
            
            
            1,975,361(Loss)
      Income From continuing operations, Before Income Tax
            
            
            (848,082
            )
            
            
            13,490,586
            
            
            
            (576,470
            )
            
            
            1,080,562Income
      Tax
            
            
            92,674
            
            
            
            5,111
            
            
            
            382,597
            
            
            
            6,108(Loss)
      Income From continuing operations, net of Income Tax
            
            
            (940,756
            )
            
            
            13,485,475
            
            
            
            (959,067
            )
            
            
            1,074,454Discontinued
      Operations:(Loss)
      Income from discontinued operations, net of income tax
            
            
            (16
            )
            
            
            1,165,559
            
            
            
            (85,646
            )
            
            
            1,085,037(Loss)
      Income from discontinued operations, net of Income Tax
            
            
            (16
            )
            
            
            1,165,559
            
            
            
            (85,646
            )
            
            
            1,085,037Net
      (Loss) Income
            
            
            (940,772
            )
            
            
            14,651,034
            
            
            
            (1,044,713
            )
            
            
            2,159,491Net
      Loss (Income) attributable to Non-controlling Interest
            
            
            (996
            )
            
            
            (14,052
            )
            
            
            (2,721
            )
            
            
            6,903Net
      (Loss) Income attributable to China New Energy Group
            
            
            (941,768
            )
            
            
            14,636,982
            
            
            
            (1,047,434
            )
            
            
            2,166,394Dividend
      on Preferred Stock
            
            
            (258,975
            )
            
            
            (2,342,807
            )
            
            
            (474,150
            )
            
            
            (2,477,807
            )Net
      (Loss) Income attributable to China New Energy Group Common
      Stockholders
            
            
            (1,200,743
            )
            
            
            12,294,175
            
            
            
            (1,521,584
            )
            
            
            (311,413
            )Other
      Comprehensive Income:Net
      (Loss) Income
            
            
            (940,772
            )
            
            
            14,651,034
            
            
            
            (1,044,713
            )
            
            
            2,159,491Foreign
      currency translation loss
            
            
            (147,358
            )
            
            
            (10,679
            )
            
            
            (152,539
            )
            
            
            (10,679
            )Comprehensive
      Income attributable to Non-controlling interest
            
            
            -
            
            
            
            5,026
            
            
            
            -
            
            
            
            5,026Comprehensive
      (loss) income
            
            $
            (1,088,130
            )
            
            $
            14,645,381
            
            
            $
            (1,197,252
            )
            
            $
            2,153,838(Loss)
      Income per share – Basic(Loss)
      Income from continuing operations
            
            $
            (0.01
            )
            
            $
            0.10
            
            
            $
            (0.01
            )
            
            $
            (0.03
            )(Loss)
      Income from discontinued operations
            
            $
            (0.00
            )
            
            $
            0.01
            
            
            $
            (0.00
            )
            
            $
            0.01Total
      (loss) income per share
            
            $
            (0.01
            )
            
            $
            0.11
            
            
            $
            (0.01
            )
            
            $
            (0.02
            )(Loss)
      Income per share – Diluted(Loss) Income from
      continuing operations
            
            $
            (0.01
            )
            
            $
            0.10
            
            
            $
            (0.01
            )
            
            $
            (0.03
            )(Loss) Income from
      discontinued operations
            
            $
            (0.00
            )
            
            $
            0.01
            
            
            $
            (0.00
            )
            
            $
            0.01Total
      (loss) income per share
            
            $
            (0.01
            )
            
            $
            0.11
            
            
            $
            (0.01
            )
            
            $
            (0.02
            )Weighted
      average common shares outstandingBasic
            
            
            102,580,909
            
            
            
            100,000,041
            
            
            
            102,186,744
            
            
            
            100,000,041Diluted
            
            
            227,672,021
            
            
            
            144,433,653
            
            
            
            227,340,954
            
            
            
            142,264,680





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 Six Months EndedJune
      30,2010
            
            
            2009Cash
      flows from operating activities:Net
      (loss) income
            
            $
            (1,044,713
            )
            
            $
            2,159,491Net
      (income) loss from discontinued operations
            
            
            (85,646
            )
            
            
            1,085,037Net
      (loss) income from continuing operations
            
            $
            (959,067
            )
            
            $
            1,074,454Adjustments
      to reconcile net (loss) income to net cash used in operating
      activities:Change
      in fair value of derivative financial instruments –
    warrants
            
            
            (292,036
            )
            
            
            (1,976,044
            )Registration
      rights penalties
            
            
            -
            
            
            
            450,000Depreciation
      and amortization
            
            
            169,590
            
            
            
            88,702Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            83,183
            
            
            
            (1,502,292
            )Other
      receivables
            
            
            160,267
            
            
            
            385,321Inventories
            
            
            (14,297
            )
            
            
            21,316Prepayment
            
            
            (25,180
            )
            
            
            211,701Other
      current assets
            
            
            -
            
            
            
            (72,372
            )Accounts
      payable
            
            
            289,740
            
            
            
            (446,848
            )Accruals
      and other payables
            
            
            1,225,507
            
            
            
            (21,764
            )Tax
      payable
            
            
            (704,689
            )
            
            
            (241,029
            )Cash
      used in operating activities – continuing operations
            
            
            (66,982
            )
            
            
            (2,028,855
            )Cash
      provided by operating activities – discontinued operations
            
            
            171,811
            
            
            
            (410,215
            )Net
      cash provided by (used in) operating activities
            
            
            104,829
            
            
            
            (2,439,070
            )Cash
      flows from investing activitiesAcquisition
      of property, plant and equipment
            
            
            (2,157,702
            )
            
            
            (664,429
            )Deposit
      paid for property, plant and equipment
            
            
            (976,326
            )
            
            
            (395,017
            )Deposits
      paid for acquisitions of subsidiaries
            
            
            (1,025,250
            )
            
            
            -Payment
      made to acquire subsidiary – Chensheng
            
            
            -
            
            
            
            (1,838,946
            )Proceeds
      from sale of subsidiary
            
            
            1,872,782
            
            
            
            -Acquisition
      consideration payable
            
            
            (117,049
            )
            
            
            -Distribution
      from discontinued operation
            
            
            1,994
            
            
            
            -Cash
      used in investing activities-continuing operations
            
            
            (2,401,551
            )
            
            
            (2,898,392
            )Cash
      used in investing activities-discontinued operations
            
            
            (179,250
            )
            
            
            (1,849,891
            )Net
      cash used in investing activities
            
            
            (2,580,801
            )
            
            
            (4,748,283
            )Cash
      flows from financing activitiesChange
      from restricted cash
            
            
            48,422
            
            
            
            16,437Issued
      preferred stock
            
            
            -
            
            
            
            4,752,140Cash
      provided by financing activities-continuing operations
            
            
            48,422
            
            
            
            4,768,577Cash
      provided by financing activities-discontinued operations
            
            
            -
            
            
            
            439,060Net
      cash flows provided by financing activities
            
            
            48,422
            
            
            
            5,207,637Effect
      of exchange rate changes in cash and cash equivalents
            
            
            17,394
            
            
            
            1,392Net
      decrease in cash and cash equivalents
            
            
            (2,410,156
            )
            
            
            (1,978,324
            )Cash
      and cash equivalents - beginning of period
            
            
            2,672,884
            
            
            
            5,612,356Cash
      and cash equivalents - end of period
            
            $
            262,728
            
            
            $
            3,634,032Supplemental
      disclosure of cash flow information:Cash
      paid for interest
            
            $
            4,365
            
            
            $
            3,010Cash
      paid for income tax
            
            $
            1,036,534
            
            
            $
            372,556Supplemental
      disclosure of non-cash investing and financing activities:Preferred
      stock dividends payable
            
            $
            474,150
            
            
            $
            324,000




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




4


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  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 (which together with the
company are collectively referred to as 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 CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  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 June 30, 2010  and their principal
activities are as follows:









6


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  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 (RMB12,560,000). 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 CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  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 (RMB16,500,000).





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
(RMB6,000,000), 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 SingOcean 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 which was established in
Dashiqiao City at approximately $3,200,000 (RMB21,900,000).





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 15 and 16.





8




CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  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
period’s presentation.




9




CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  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 six months ended June 30, 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 the sale of gas represents the invoiced value of goods sold, net of
value-added tax (“VAT”). Revenue from the 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 CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


3.
Summary of Significant Accounting Policies-continued





(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 its 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.





(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 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 trouble 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.





For a
description of further accounting policies, please see the December 31, 2009
10K.




11




CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  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 (RMB21,900,000). 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 (RMB21,900,000). As of June 30, 2010, the Group received part of the
downpayment of $731,000 (RMB5,000,000). And the Group received a further part of
the downpayment of $297,000 (RMB2,000,000) on July 7, 2010.





As of
June 30, 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 operating activity of Yingkou was recorded
under the discontinued operations for the six months ended June 30, 2010 and
2009.





The
following table displays summarized operating activity for the discontinued
operations of Yingkou for the six and three months ended June 30, 2010, and
Yingkou and Acheng for the six and three months ended June 30,
2009.








For
      the three months ended
            
            
            For
      the six months endedJune
      30,
            
            
            June,
      302010
            
            
            2009
            
            
            2010
            
            
            2009Revenue
            
            $
            -
            
            
            $
            2,275,875
            
            
            $
            201,159
            
            
            $
            2,441,507Operating
      (loss) profit
            
            $
            (16
            )
            
            $
            1,526,133
            
            
            $
            (108,698
            )
            
            $
            1,439,525(Loss)
      Profit before income taxes
            
            $
            (16
            )
            
            $
            1,527,238
            
            
            $
            (85,646
            )
            
            $
            1,446,716Income
      tax expense
            
            $
            -
            
            
            $
            361,679
            
            
            $
            -
            
            
            $
            361,679(Loss)
      Profit from discontinued operations, net of tax
            
            $
            (16
            )
            
            $
            1,165,559
            
            
            $
            (85,646
            )
            
            $
            1,085,037





12





CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


5.
Restricted cash





At June
30, 2010 and December 31, 2009, restricted cash of $131,930 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:





June
      30,
              2010
            
            
            December
      31,
              2009Due
      from Tianjin East Ocean Gas Company Limited
            
            $
            1,460,832
            
            
            $
            1,454,721Other
      receivables
            
            
            479,365
            
            
            
            636,371Total
            
            $
            1,940,197
            
            
            $
            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 June 30, 2010 and December 31, 2009 of $286,595 and $271,104, respectively,
consist of raw materials and do not include any work in progress or finished
goods.




8.
Property, Plant and Equipment, net





Property,
plant and equipment consist of the following:




June
      30,
              2010
            
            
            December
      31,
              2009Cost:Leasehold
      improvements
            
            $
            75,991
            
            
            $
            75,673Building
            
            
            79,936
            
            
            
            79,603Office
      Equipment
            
            
            135,210
            
            
            
            112,987Motor
      Vehicles
            
            
            324,258
            
            
            
            304,359Gas
      Transportation Vehicles
            
            
            190,984
            
            
            
            190,099Gas
      Station
            
            
            182,396
            
            
            
            181,511Machinery
            
            
            137,412
            
            
            
            134,484Underground
      Gas Pipelines
            
            
            3,719,386
            
            
            
            2,388,733$
            4,845,573
            
            
            $
            3,467,449Less:
      Accumulated depreciation
            
            
            (486,280
            )
            
            
            (324,706
            )$
            4,359,293
            
            
            $
            3,142,743Construction-in-progress
            
            
            5,680,161
            
            
            
            4,857,326$
            10,039,454
            
            
            $
            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.




13


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


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 June 30, 2010, depreciation expense amounted to $85,468,
of which $51,387 and $34,081 was recorded as cost of sales and as general and
administrative expenses, respectively.





During
the six months ended June 30, 2010, depreciation expense amounted to $159,597,
of which $92,341 and $67,256 was recorded as cost of sales and as general and
administrative expenses, respectively.





During
the three months ended June 30, 2009, depreciation expense amounted to $38,520,
of which $31,555 and $6,965 was recorded as cost of sales and as general and
administrative expenses, respectively.





During
the six months ended June 30, 2009, depreciation expense amounted to $78,705, of
which $63,080 and $15,625 was recorded as cost of sales and as general and
administrative expenses, respectively.




14




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




9.
Intangibles Assets, net





Intangible
assets consist of the following:




June
      30,
              2010
            
            
            December
      31,
              2009Land
      use rights
            
            $
            1,216,338
            
            
            $
            1,211,250Less:
      accumulated amortization
            
            
            (35,114
            )
            
            
            (24,978
            )$
            1,181,224
            
            
            $
            1,186,272





Amortization
expense for the three months ended June 30, 2010 and 2009 was $4,997 and $5,000,
respectively.





Amortization
expense for the six months ended June 30, 2010 and 2009 was $9,993 and $9,997,
respectively.





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




Remainder
      of 2010
            
            $
            14,1832011
            
            
            28,3672012
            
            
            28,3672013
            
            
            28,3672014
            
            
            28,367Thereafter
            
            
            1,053,573Total
            
            $
            1,181,224




15




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




10.
Acquisition Consideration Payable




June
      30,
              2010
            
            
            December
      31,
              2009Acquisition
      consideration payable relating to the purchase of Zhanhua
      Jiutai
            
            $
            901,804
            
            
            $
            1,015,038Acquisition
      consideration payable relating to the purchase of Wuyuan
            
            
            636,850
            
            
            
            636,850Total
            
            $
            1,538,654
            
            
            $
            1,651,888





The
acquisition consideration payable as of June 30, 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 & 15). This amount will be due
according to the payment terms under Equity Interest Purchase
Agreement.





11.
Related Party Payables





Related
party payables consist of the following:




June
      30,
              2010
            
            
            December
      31,
              2009Tianjin
      Huan Long Trading Ltd.
              (non-controlling
      shareholder of a subsidiary)
            
            $
            98,305
            
            
            $
            97,893




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




16


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


12.
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 June
30, 2010 and December 31, 2009, 105,395,032 and 101,788,199 shares of Common
Stock were issued and outstanding, respectively.





Series
A Convertible Preferred Stock





In
connection with the August 20, 2008 private placement described in Note 13,
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”),.





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 June 30, 2010
and December 31, 2009, 2,098,918 shares of Series A Preferred Stock were issued
and outstanding.




17




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




12.
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.





18




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




12.
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.





19





CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


12.
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 13. 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 June 30, 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.





20


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


12.
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.




21




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009





13.
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 12
and the warrants are further described in Note 14.





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 14, 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 June
30, 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 June 30, 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.





22


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


14.
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 June
30, 2010 and December 31, 2009, the fair value of the warrants was $6,476,070
and $6,768,106, respectively, based on the following assumptions:




June
      30, 2010
            
            
            December
      31, 2009Warrants
      outstanding
            
            
            31,224,489
            
            
            
            31,224,489Exercise
      price
            
            $
            0.187
            
            
            $
            0.187Annual
      dividend yield
            
            
            0
            %
            
            
            0
            %Expected
      life (years)
            
            
            3.14-3.83
            
            
            
            3.64-4.33Risk-free
      interest rate
            
            
            1.06%-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 loss of $107,680 from the change in fair value of
these warrants for the three months ended June 30, 2010 and a gain of
$13,688,558 from the change in fair value for the three months ended June
30, 2009. The Company recognized a gain of $292,036 from the change in fair
value of these warrants for the six months ended June 30, 2010 and a gain
of $1,976,044 from the change in fair value for the six months ended June
30, 2009.




23




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




15.
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 100% 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
(RMB16,500,000).




Below set
forth the payment terms of the acquisition consideration payable under the
Equity Interest Purchase Agreements.
 
 1)The amount of the
first installment is 58% of the total transfer price, Renminbi 9,500,000 Yuan
(approximately $1.40 million). The Transferee (CNER) shall make the first
installment payment to the Transferors (former shareholders) within 13 working
days as of the effective day of the Equity Transfer Agreement.
 
 2)The amount of the
second installment payment is 36% of the total transferred price, that is,
Renminbi 6,000,000 Yuan (approximately $0.87 million). And the second
installment payment is completed within the sixth month as of the date of the
first installment payment. The Parties agree that, all the debts owed by Zhanhua
Jiutai, including but not limited to the amount owed to the original
shareholders, the amount payable to suppliers and construction teams, salaries
and benefits payable to employees, taxes payable to tax bureau and so on should
have been paid up by the Transferors at its own cost. Otherwise, the Transferee
shall have the right to refuse to make the second installment
payment.
  3)The amount of the
third installment payments is 6% of the total transfer price, that is, Renminbi
1,000,000 Yuan (approximately $0.14 million) will be paid to the Transferors on
December 31, 2010 on the condition that the Transferor are free of any
liabilities.




As of
June 30, 2010, the total outstanding on the acquisition of Zhanhua Jiutai is
$901,804 which is recorded under the Acquisition consideration payable (see Note
10).





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
Group’s 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





Zhanhua
Jiutai did not commence business up to the acquisition date, and therefore, the
pro forma financial information for the six months ended June 30, 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 June
30, 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 June 30, 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
            
            $
            611,574Other
      payables
            
            
            4,307Salary
      payables
            
            
            459,824Liabilities
      to be settled by former shareholders
            
            $
            1,075,705Deemed
      receivable from former shareholdersfor
      settlement of certain liabilities
            
            $
            1,075,705





24


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009





15.
Acquisitions of Subsidiaries - 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 (RMB6,000,000), which purchase price was based on an appraised value of
Wuyaun as of September 30, 2009.




Below set
forth the payment terms of the acquisition consideration payable under the
Equity Interest Purchase Agreements.
 
 1)The amount of the
first installment is 27.5% of the Consideration, namely Renminbi 1,650,000 Yuan
(approximately $0.24 million). The Transferee shall make the first installment
payment to the Transferor before December 20, 2009.
 
 2)The amount of the
second installment is 52.5% of the Consideration, namely Renminbi 3,150,000 Yuan
(approximately $0.46 million) shall be paid on April 30, 2010. The Parties agree
that, all the debts owed by Wuyuan, including but not limited to the amount owed
to the original shareholders, the amount payable to suppliers and construction
teams, salaries and benefits payable to employees, taxes payable to tax bureau
and so on should have been paid up by the Transferors at its own cost.
Otherwise, the Transferee shall have the right to refuse to make the second
installment payment
 
 3)The amount of the
third installment is 20% of the Consideration, namely Renminbi 1,200,000 Yuan
(approximately $0.18 million) shall be considered as deposit of this transaction
and will be paid to the Transferor on August 31, 2010 on the condition that the
Transferor are free of any liabilities.




As of
June 30, 2010, the total outstanding on the acquisition of Wuyuan is $636,850
which is recorded under the Acquisition consideration payable (see Note
10).





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 of Wuyuan 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





Wuyuan
did not commence business up to the acquisition date, and therefore, the pro
forma financial information for the six months ended June 30, 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 June
30, 2010 includes certain liabilities of Wuyuan assumed by the former
shareholder of Wuyuan in 2009, as the Group consolidates Wuyuan.





The
following table summarizes the liabilities to be settled by the former
shareholder but which are included in our balance sheet as of June 30, 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
            
            $
            105,769Other
      current liabilities
            
            
            202,563Liabilities
      to be settled by former shareholder
            
            $
            308,332Deemed
      receivable from former shareholder
              for
      settlement of certain liabilities
            
            $
            308,332




25


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


16.
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 (RMB4,800,000). 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 Flying Dragon
Zhongran Gas Inc. (“Fuzhou Zhongran”)




On
January 5, 2010, Willsky entered into an Equity Interest Purchase Agreement, to
acquire all of the outstanding equity interests in Fuzhou Flying Dragon Gas
Inc., a PRC company (“Fuzhou  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
(RMB26,000,000).  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
June 30, 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.





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





Deposits
for acquisition of Lena Zhongran and Fuzhou Zhongran





June
      30,
              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





26


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009





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





Deemed
receivable from former shareholders of subsidiaries acquired for settlement of
certain liabilities of $1,384,073 and $1,983,782 as of June 30, 2010 and
December 31, 2009, represents the liabilities of Zhanhua Jiutai and Wuyuan which
are to be settled by the former shareholders of Zhanhua Jiutai and Wuyuan, as
disclosed in Note 14. These amounts will be due in future financial reporting
periods.





18.
Non-controlling Interests in Subsidiaries





As of
June 30, 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 June 30, 2010
was $171,062 and their share of net income for the six months ended June 30,
2010 was $2,721.





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 December 31,
2009 was $168,341 and their share of net loss for the six months ended June 30,
2009 was $6,903.




27


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009





19.
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 June 30, 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 SingOcean, Chensheng and Yingkou for fiscal years 2010 and 2009.
Chensheng was taxed at 1% of revenues from January to June 2009.  From
July 2009 onwards, Chensheng is taxed at 25% of net income.




The
current year tax provision was $382,597 and $6,108 for the six months ended June
30, 2010 and 2009, respectively.  The Group has recorded no deferred
tax assets or liabilities as of June 30, 2010 and December 31, 2009, because all
significant differences in tax basis and financial statement amounts are
permanent differences.





For
      the three months ended
              June
      30,
            
            
            For
      the six months ended
              June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Income
      Tax Expense:Current
      tax
            
            $
            92,674
            
            
            $
            5,111
            
            
            $
            382,597
            
            
            $
            6,108Change
      in deferred tax assets – Net operating loss
            
            
            294,849
            
            
            
            3,304,353
            
            
            
            476,885
            
            
            
            199,513Change
      in valuation allowance
            
            
            (294,849
            )
            
            
            (3,304,353
            )
            
            
            (476,885
            )
            
            
            (199,513
            )Total
            
            $
            92,674
            
            
            $
            5,111
            
            
            $
            382,597
            
            
            $
            6,108





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 June 30,
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 six months June 30, 2010 and
2009.





28




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




19.
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 and six months ended
June 30, 2010 and 2009 for the followings reasons:





For
      the three months ended
              June
      30,
            
            
            For
      the six months ended
              June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009(Loss)
      Income from continuing operations before income taxes
            
            $
            (848,082
            )
            
            $
            13,490,586
            
            
            $
            (576,470
            )
            
            $
            1,080,562Computed
      “expected” income tax expense at 25% in 2010 and 2009, except on the net
      income of Chensheng of $2,931 in 2009
            
            $
            (212,021
            )
            
            $
            3,375,577
            
            
            $
            (144,117
            )
            
            $
            270,140Income
      tax expense of Chensheng - charged at 0.8% of gross sales of $694,109 in
      2009
            
            
            -
            
            
            
            (66,113
            )
            
            
            -
            
            
            
            (64,519
            )Tax
      effect of net taxable permanent differences
            
            
            39,164
            
            
            
            -
            
            
            
            49,829
            
            
            
            -Effect
      of cumulative tax losses
            
            
            265,531
            
            
            
            (3,304,353
            )
            
            
            476,885
            
            
            
            (199,513
            )$
            92,674
            
            
            $
            5,111
            
            
            $
            382,597
            
            
            $
            6,108





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 six months ended June 30, 2010 and 2009.




29


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


20.
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
            
            
            For
      The Six months EndedJune
      30,
            
            
            June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009BASICNumerator
      for basic (loss) earnings per share from continuing operations
      attributable to China New Energy Group’s common
    stockholders:Net
      (loss) Income From Continuing Operations
            
            $
            (941,768
            )
            
            $
            14,636,982
            
            
            $
            (1,047,434
            )
            
            $
            2,166,394Deemed
      dividend on preferred stock issued
            
            
            -
            
            
            
            (2,350,829
            )
            
            
            -
            
            
            
            (2,350,829
            )Dividend
      on preferred stock
            
            
            (258,975
            )
            
            
            (2,342,807
            )
            
            
            (474,150
            )
            
            
            (2,477,807
            )(Loss)
      Income From Continuing Operations used in computing basic (loss) earnings
      per share
            
            
            (1,200,743
            )
            
            
            9,943,346
            
            
            
            (1,521,584
            )
            
            
            (2,662,242
            )Basic
      (loss) earnings per share from continuing operations
            
            
            (0.01
            )
            
            
            0.10
            
            
            
            (0.01
            )
            
            
            (0.03
            )Numerator
      for basic (loss) earnings per share from discontinued
      operationsNet
      (loss) Income from Discontinued Operations
            
            
            (16
            )
            
            
            1,165,559
            
            
            
            (85,646
            )
            
            
            1,085,037(Loss)
      Income from Discontinued Operations used in computing basis (loss)
      earnings per share
            
            
            (16
            )
            
            
            1,165,559
            
            
            
            (85,646
            )
            
            
            1,085,037Basic
      (loss) earnings per share from discontinued operations
            
            
            (0.00
            )
            
            
            0.01
            
            
            
            (0.00
            )
            
            
            0.01Weighted
      average outstanding shares of common stock
            
            
            102,580,909
            
            
            
            100,000,041
            
            
            
            102,186,744
            
            
            
            100,000,041




30




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




20.
Earnings Per Share – continued





For
      The Three months Ended
            
            
            For
      The Six months EndedJune
      30,
            
            
            June
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009DILUTEDNumerator
      for diluted (loss) earnings per share from continuing operations
      attributable to China New Energy Group’s common
    stockholders:Net
      (loss) Income From Continuing Operations
            
            $
            (1,200,743
            )
            
            $
            9,943,346
            
            
            $
            (1,521,584
            )
            
            $
            (2,662,242
            )Deemed
      dividend on preferred stock issued
            
            
            -
            
            
            
            2,350,829
            
            
            
            -
            
            
            
            2,350,829Dividend
      on preferred stock
            
            
            258,975
            
            
            
            2,342,807
            
            
            
            474,150
            
            
            
            2,477,807(Loss)
      Income From Continuing Operations used in computing diluted (loss)
      earnings per share
            
            
            (941,768
            )
            
            
            14,636,982
            
            
            
            (1,047,434
            )
            
            
            2,166,394Diluted
      (loss) earnings per share from continuing operations
            
            
            (0.01
            )
            
            
            0.10
            
            
            
            (0.01
            )
            
            
            (0.03
            )Numerator
      for diluted (loss) earnings per share from discontinued
      operationsNet
      (loss) Income From Discontinued Operations
            
            
            (16
            )
            
            
            1,165,559
            
            
            
            (85,646
            )
            
            
            1,085,037(Loss)
      Income From Discontinued Operations used in computing diluted (loss)
      earnings per share
            
            
            (16
            )
            
            
            1,165,559
            
            
            
            (85,646
            )
            
            
            1,085,037Diluted
      (loss) earnings per share from discontinued operations
            
            
            (0.00
            )
            
            
            0.01
            
            
            
            (0.00
            )
            
            
            0.01Weighted
      average outstanding shares of common stock
            
            
            102,580,909
            
            
            
            100,000,041
            
            
            
            102,186,744
            
            
            
            100,000,041Weighted
      average shares of convertible preferred stock outstanding
            
            
            112,535,710
            
            
            
            20,980,665
            
            
            
            112,535,710
            
            
            
            18,811,693Warrants
      and contingently issuable shares
            
            
            12,555,402
            
            
            
            23,452,947
            
            
            
            12,618,500
            
            
            
            23,452,946Common
      stock and common stock equivalents
            
            
            227,672,021
            
            
            
            144,433,653
            
            
            
            227,340,954
            
            
            
            142,264,680(Loss)
      earnings per share:Basic
            
            $
            (0.01
            )
            
            $
            0.11
            
            
            $
            (0.01
            )
            
            $
            (0.02
            )Diluted
            
            $
            (0.01
            )
            
            $
            0.11
            
            
            $
            (0.01
            )
            
            $
            (0.02
            )Potential
      common shares outstanding as of June 30,:Series A Convertible Preferred
      Stock
            
            
            7,031,818
            
            
            
            -
            
            
            
            7,031,818
            
            
            
            7,031,818Series B Convertible Preferred
      Stock
            
            
            2,153,307
            
            
            
            -
            
            
            
            2,153,307
            
            
            
            -Warrant
    outstanding
            
            
            31,224,489
            
            
            
            -
            
            
            
            31,224,489
            
            
            
            19,502,41240,409,614
            
            
            
            -
            
            
            
            40,409,614
            
            
            
            26,534,230


For the
three months ended June 30, 2010, six months ended June 30, 2010 and 2009, the
number of securities totaled was 40,409,614, 40,409,614 and 26,534,230
respectively not included in the diluted EPS because the effect would have been
anti-dilutive.




31


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


21.
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 June 30, 2010
                
                
                For
      the three months ended June 30, 2009Connection
                
                
                
                
                
                
                
                
                
                
                
                Connectionservices
                
                
                Natural
      gas
                
                
                Corporate
                
                
                Total
                
                
                services
                
                
                Natural
      gas
                
                
                Corporate
                
                
                TotalExternal
      revenue

                    For
      the three months ended June 30, 2009
                
                $
                663,179
                
                
                
                28,452
                
                
                
                -
                
                
                
                691,631
                
                
                $
                505,106
                
                
                
                29,610
                
                
                
                -
                
                
                
                534,716Interest
      income
                
                
                111
                
                
                
                -
                
                
                
                -
                
                
                
                111
                
                
                
                25
                
                
                
                -
                
                
                
                -
                
                
                
                25Interest
      expense
                
                
                (2,192
                )
                
                
                -
                
                
                
                -
                
                
                
                (2,192
                )
                
                
                -
                
                
                
                -
                
                
                
                (2,401
                )
                
                
                (2,401
                )Depreciation
      and amortization
                
                
                39,580
                
                
                
                11,807
                
                
                
                39,078
                
                
                
                90,465
                
                
                
                19,711
                
                
                
                11,844
                
                
                
                11,965
                
                
                
                43,520Income
      tax
                
                
                92,674
                
                
                
                -
                
                
                
                -
                
                
                
                92,674
                
                
                
                5,111
                
                
                
                -
                
                
                
                -
                
                
                
                5,111Net
      income (loss)
                
                
                682,005
                
                
                
                (16,271
                )
                
                
                (1,606,506
                )
                
                
                (940,772
                )
                
                
                271,645
                
                
                
                (59,536
                )
                
                
                14,438,925
                
                
                
                14,651,034Expenditures
      for long-lived assets
                
                
                478,542
                
                
                
                -
                
                
                
                60,356
                
                
                
                538,898
                
                
                
                453,321
                
                
                
                42,019
                
                
                
                -
                
                
                
                495,340As
      of June 30, 2010
                
                
                
                As
      of December 31, 2009Total
      Assets
                
                $
                13,409,165
                
                
                
                2,418,303
                
                
                
                23,206,433
                
                
                
                39,033,901
                
                
                $
                23,608,532
                
                
                
                2,820,280
                
                
                
                13,797,010
                
                
                
                40,225,822


32




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009




21.
Business and Geographical Segments – continued





Reportable
Segments





For
      the six months ended June 30, 2010
            
            
            For
      the six months ended June 30, 2009Connection
            
            
            
            
            
            
            
            
            
            
            
            Connectionservices
            
            
            Natural
      gas
            
            
            Corporate
            
            
            Total
            
            
            services
            
            
            Natural
      gas
            
            
            Corporate
            
            
            TotalExternal
      revenue
            
            $
            2,354,541
            
            
            
            46,902
            
            
            
            -
            
            
            
            2,401,443
            
            
            $
            651,858
            
            
            
            42,243
            
            
            
            -
            
            
            
            694,101Interest
      income
            
            
            2,550
            
            
            
            -
            
            
            
            -
            
            
            
            2,550
            
            
            
            2,234
            
            
            
            -
            
            
            
            -
            
            
            
            2,234Interest
      expense
            
            
            (4,365
            )
            
            
            -
            
            
            
            -
            
            
            
            (4,365
            )
            
            
            (259
            )
            
            
            -
            
            
            
            (2,751
            )
            
            
            (3,010
            )Depreciation
      and amortization
            
            
            68,733
            
            
            
            23,609
            
            
            
            77,248
            
            
            
            169,590
            
            
            
            39,416
            
            
            
            23,664
            
            
            
            25,622
            
            
            
            88,702Income
      tax
            
            
            382,597
            
            
            
            -
            
            
            
            -
            
            
            
            382,597
            
            
            
            6,108
            
            
            
            -
            
            
            
            -
            
            
            
            6,108Net
      income (loss)
            
            
            1,781,049
            
            
            
            (26,683
            )
            
            
            (2,799,079
            )
            
            
            (1,044,713
            )
            
            
            360,113
            
            
            
            (70,183
            )
            
            
            1,869,561
            
            
            
            2,159,491Expenditures
      for long-lived assets
            
            
            2,097,346
            
            
            
            -
            
            
            
            60,356
            
            
            
            2,157,702
            
            
            
            514,142
            
            
            
            150,287
            
            
            
            -
            
            
            
            664,429




33


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009


22.
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 June 30, 2010 and
December 31, 2009 amounted to $262,728 and $2,672,884, respectively, of which no
deposits were covered by insurance. Also, as of both June 30, 2010 and December
31, 2009, the Group held $131,930 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 June 30, 2010, four customers accounted
for approximately 99% of the Company’s sales. For the six months ended June 30,
2010, four customers accounted for approximately 62% of the Company’s sales and
two customers accounted for approximately 27% of the Company’s accounts
receivable as of June 30, 2010.





For the
three months ended June 30, 2009, two customers accounted for approximately 24%
of the Company’s sales. For the six months ended June 30, 2009, one customer
accounted for approximately 12% of the Company’s sales and two customers
accounted for approximately 30% of the Company’s accounts receivable as of June
30, 2009.





Major
suppliers – For the three months ended June 30, 2010, three suppliers accounted
for approximately 95% of the Company’s purchase’s. For the six months ended June
30, 2010, five suppliers accounted for approximately 87% of the Company’s
purchase’s and two suppliers accounted for approximately 67% of the Company’s
accounts payable as of June 30, 2010.





For the
three months ended June 30, 2009, four suppliers accounted for approximately 53%
of the Company’s purchase’s. For the six months ended June 30, 2009, three
suppliers accounted for approximately 34% of the Company’s purchase’s and three
suppliers accounted for approximately 52% of the Company’s accounts payable as
of June 30, 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.




34




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009





23.
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:





Remainder
      of 2010
            
            $
            166,6982011
            
            
            136,1402012
            
            
            45,380Thereafter
            
            
            -Total
      minimum lease payments
            
            $
            348,218





During
the three months ended June 30, 2010 and 2009, rental expenses included in
general and administrative expenses were $71,440 and $25,818,
respectively.





During
the six months ended June 30, 2010 and 2009, rental expenses included in general
and administrative expenses were $159,838 and $59,947,
respectively.





As of
June 30, 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 is expected to grow with any increase in gas users. The Group has
selected three qualified gas resource suppliers to ensure stable operations in
meeting its obligations.





35




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE SIX MONTHS ENDED JUNE 30,  2010 AND 2009





24.
Subsequent events





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.





36





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; 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.





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;




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




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




37




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




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




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





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
USA, 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(Willsky Development
Ltd) 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 (Fountainhead Capital Management Limited)
and La Pergola (La Pergola Investments Limited), the previously 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.





After the
reverse acquisition, the total common stock issued and outstanding of the
Company as of December 31, 2008 was 100,000,041 shares.




38





This
transaction has been accounted for as a reverse acquisition and recapitalization
of the Company whereby Willsky is deemed to be the accounting acquirer (legal
acquiree) and the Company the accounting acquiree (legal acquirer). The
historical financial statements for periods prior to March 28, 2008 are those of
Willsky, except that the equity section and earnings per share have been
retroactively restated to reflect the reverse acquisition.





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.




39





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:





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 and six months ended June 30, 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
six months ended June 30, 2010, we had sales revenue of $2.40 million of
which $2.35 million, or 98%, was from connection services while $0.05
million, or 2%, was from gas sales.





Our
revenue for the six months ended June 30, 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.





Second
Quarter Financial Performance Highlights





The
following are some financial highlights for the second quarter of 2010 (MM
represents million):





Revenues: Our
revenues were $0.69 MM for the second quarter of 2010, an increase of 29%
from the same period of 2009.





Gross
Margin: Gross margin was 73% for the second quarter of 2010 compared
to gross margin of 63% for the second quarter of 2009, representing a
percentage increase of 10%.





Operating
Expenses: Operating expenses (including selling, general
and administrative expenses) were $1.26 MM for the second quarter of 2010,
an increase of 136% from the same period of 2009.





Net Income /
(Loss): A net loss of $0.94 MM resulted for the second quarter of
2010, while the net income for the same period of 2009 was $14.64 MM. The
decrease of net income was mainly due to: (1) an increase of operating expenses
by $0.72 MM; (2) a change in fair value of warrant liabilities which
resulted in other expenses of $0.11 MM while it resulted in other income of
$13.69 MM for the same period of 2009; and (3) a decrease in income from
discontinued operations by 1.17 MM.





Fully diluted net
income per share: Fully diluted net loss per share was $0.01 for the
second quarter of 2010, as compared to net income per share of $0.09 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 six months ended June 30, 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 six months ended June 30, 2010 and
2009 as Willsky did not have reportable taxable income for the
period.




41





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




Prior to
2009 Chensheng was 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.





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





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





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





On April
22, 2009, the State Administration of Taxation issued the Notice Concerning
Relevant Issues Regarding Cognizance of Chinese Investment Controlled
Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria
of de facto Management Bodies, or the Notice, further interpreting the
application of the New EIT Law and its implementation with respect to
non-Chinese enterprises or group controlled offshore entities. Pursuant to the
Notice, an enterprise incorporated in an offshore jurisdiction and controlled by
a Chinese enterprise or group will be classified as a “non-domestically
incorporated resident enterprise” if (i) its senior management in charge of
daily operations reside or perform their duties mainly in China; (ii) its
financial or personnel decisions are made or approved by bodies or persons in
China; (iii) its main properties, accounting books, corporate seal, board and
shareholder minutes are kept in China; and (iv) directors with voting rights or
senior management often reside in China.  Such resident enterprise
would be subject to an EIT rate of 25% on its worldwide income and must pay a
withholding tax at a rate of 10% when paying dividends to its non-PRC
shareholders. However, it remains unclear as to whether the Notice is applicable
to an offshore enterprise incorporated by a Chinese natural
person.  Nor are detailed measures available on the imposition of tax
on non-domestically incorporated resident enterprises. Therefore, it is unclear
how tax authorities will determine tax residency based on the facts of each
case.





However,
as our case substantially meets the foregoing criteria, there is a likelihood
that we are deemed to be a resident enterprise by Chinese tax authorities. If
the PRC tax authorities determine that we are a “resident enterprise” for PRC
enterprise income tax purposes, a number of unfavorable PRC tax consequences
could follow. First, we may be subject to the enterprise income tax at a rate of
25% on our worldwide taxable income as well as subject to PRC enterprise income
tax reporting obligations. In our case, this would mean that income such as
interest on financing proceeds and non-China source income would be subject to
PRC enterprise income tax at a rate of 25%. Second, although under the New EIT
Law and its Implementing Rules dividends paid to us from our PRC subsidiaries
would qualify as “tax-exempt income,” we cannot guarantee that such dividends
will not be subject to a 10% withholding tax, as the PRC foreign exchange
control authorities, which enforce the withholding tax, have not yet issued
guidance with respect to the processing of outbound remittances to entities that
are treated as resident enterprises for PRC enterprise income tax purposes.
Finally, it is possible that future guidance issued with respect to the new
“resident enterprise” classification could result in a situation in which a 10%
withholding tax is imposed on dividends we pay to our non-PRC stockholders and
with respect to gains derived by our non-PRC stockholders from transferring our
shares. We are actively monitoring the possibility of “resident enterprise”
treatment and are evaluating appropriate organizational changes to avoid this
treatment, to the extent possible.




42





Results
of Operations





Comparison
of Three Months Ended June 30, 2010 and 2009





The
following table summarizes the results of our operations during the three-month
periods ended June 30, 2010 and 2009:





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





For
      the three months endedJune
      302010
              
              
              2009
              
              
              Change
              
              
              Change%Revenues:
              
              $
              692
              
              
              $
              535
              
              
              
              157
              
              
              
              29
              %Cost
      of Sales:
              
              
              185
              
              
              
              197
              
              
              
              (12
              )
              
              
              -6
              %Gross
      Profit
              
              
              507
              
              
              
              338
              
              
              
              169
              
              
              
              50
              %Total
      operating expenses
              
              
              1,258
              
              
              
              534
              
              
              
              724
              
              
              
              136
              %Loss
      from operations
              
              
              (751
              )
              
              
              (196
              )
              
              
              (555
              )
              
              
              283
              %Other
      Income (Expenses):Change
      in fair value of derivative financial instruments -
    warrants
              
              
              (108
              )
              
              
              13,689
              
              
              
              (13,797
              )
              
              
              -101
              %Interest
      income(expense)
              
              
              (2
              )
              
              
              (2
              )
              
              
              0Other
      income
              
              
              13
              
              
              
              0
              
              
              
              13(Loss)
      Income from Continuing Operations, Before IncomeTax
              
              
              (848
              )
              
              
              13,491
              
              
              
              (14,339
              )
              
              
              -106
              %Income
      Tax
              
              
              93
              
              
              
              5
              
              
              
              88
              
              
              
              1760
              %(Loss)
      Income from Discontinued Operations, net of Income Tax
              
              
              0
              
              
              
              1,166
              
              
              
              (1,166
              )
              
              
              -100
              %Non-controlling
      Interest
              
              
              (1
              )
              
              
              (14
              )
              
              
              13
              
              
              
              -93
              %Net
      (Loss) Income
              
              
              (942
              )
              
              
              14,637
              
              
              
              (15,579
              )
              
              
              -106
              %





Revenues.  Revenues
are derived primarily from connection fees and sales of natural
gas.  Revenues increased $0.15 MM, or 29%, to $0.69 MM for the three
months ended June 30, 2010 from $0.54 MM for the same period in 2009. This
increase was mainly attributable to an increase in connection services for an
industry customer.





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 decreased by $0.01 MM, or 6%, to $0.19 MM for the three months ended
June 30, 2010 from $0.20 MM during the same period in 2009. Such decrease in
cost while increase in revenues was mainly attributable to increase in an
industry customer which the gross margin is 99%. .




43





Gross
Profit.Our
gross profit increased by $0.17 MM, or 50%, to $0.51 MM for the three months
ended June 30, 2010 from $0.34 MM during the same period in 2009. Gross profit
as a percentage of revenues or gross profit margin, was 73% for the three months
ended June 30, 2010.  The gross profit margin during the same period
in 2009 was 63%. Such increase in gross profit margin was mainly due to an
increase of the industry connection services.





Total Operating ExpensesThe
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 June 30, 2010, the total
operating expenses were $1.26 MM while the amount was $0.53 MM for the same
period of 2009, or increased by 136%.  This increase was mainly due to
the fact that we are expanding our company. Management believes that the
relatively high SG&A expenses will continue as we endeavor to expand
our business.





Loss from operationsOur loss from operations
increased by $0.56 MM, or 283%, to $0.75 MM for the three months ended June 30,
2010 from $0.19 MM during the same period in 2009. This increase  was
mainly due to an increase in operating expenses.





Other
Income (Expenses)





Change In Fair Value of Warrant
Liability:For the three months ended June 30, 2010, the change in fair
value of warrant liability was recorded as other expenses of $0.11 MM while the
one incurred in the same period of 2009 was recorded as other income of $13.69
MM.





The
Company adopted a FASB accounting standard, which defines determining whether an
instrument (or embedded feature) is indexed to an entity’s own
stock.  This accounting standard specifies that a contract that would
otherwise meet the definition of a derivative but is both (a) indexed to the
Company’s own stock and (b) classified in stockholders’ equity in the statement
of financial position would not be considered a derivative financial
instrument.  This FASB accounting standard provides a new
two-step model to be applied in determining whether a financial instrument or an
embedded feature is indexed to an issuer’s own stock and thus able to qualify
for the scope exception.





As a
result of adopting this FASB accounting standard, warrants previously treated as
equity pursuant to the derivative treatment exemption are no longer afforded
equity treatment because the warrants have a downward ratchet provision on the
exercise price. As a result, the warrants are not considered indexed to the
Company’s own stock, and as such, all future changes in the fair value of these
warrants will be recognized currently in earnings until such time as the
warrants are exercised or expired.





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 June 30, 2010, the fair value of the Series A and B Convertible
Preferred Stock was $6.48 MM.  Therefore, the Company recognized a $0.11 MM
loss from the change in fair value for the three months ended June 30, 2010
and a $13.69 MM gain from the change in fair value during the same period
in 2009.





Income (loss)From Continuing Operations, Before
Income Tax.Our loss from continuing
operations before income tax increased by $14.34 MM, to $0.85 MM for the
three months ended June 30, 2010 from an income of $13.49 MM during the same
period in 2009.  Such increase was mainly due to the fact that the
company recorded a $13.69 MM income from the change in fair value of the
warrants during the period in 2009 according to EITF 07-05.




44





Income
(Loss) From Discontinued Operation





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 (RMB21,900,000). 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 (RMB21,900,000). As of June 30, 2010, the Group received part of the
downpayment of $731,000 (RMB5,000,000). And the Group received a further part of
the downpayment of $297,000 (RMB2,000,000) on July 7, 2010.





As of
June 30, 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 operating activity of Yingkou was recorded
under the discontinued operations for the six months ended June 30, 2010 and
2009.





The
following table displays summarized operating activity for the discontinued
operations of Yingkou for the three months ended June 30, 2010, and Yingkou and
Acheng for the three months ended June 30, 2009.





For
      the three months ended2010
            
            
            2009Revenue
            
            $
            
            
            
            $
            2,275,875Operating
      loss
            
            $
            (16
            )
            
            $
            1,526,133Loss
      before income taxes
            
            $
            (16
            )
            
            $
            1,527,238Income
      tax expense
            
            $
            -
            
            
            $
            361,679Loss
      from discontinued operations, net of tax
            
            $
            (16
            )
            
            $
            1,165,559





NetIncome(loss).
Net loss increased by $15.58 MM, to a net loss of $0.94 MM for the three
months ended June 30, 2010, from net income of $14.64 MM for the same period of
2009, which is mainly due to: (1) an increase in operating expenses by
$0.72 MM; and (2) an increase in the loss from the change in fair value of the
warrants $13.80 MM.




45





Comparison
of Six Months Ended June 30, 2010 and 2009





The
following table summarizes the results of our operations during the six-months
ended June 30, 2010 and 2009:





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





June
      30,2010
              
              
              2009
              
              
              Change
              
              
              Change%Revenues:
              
              
              2,401
              
              
              
              694
              
              
              
              1,707
              
              
              
              246
              %Cost
      of Sales:
              
              
              645
              
              
              
              280
              
              
              
              365
              
              
              
              130
              %Gross
      Profit
              
              
              1,756
              
              
              
              414
              
              
              
              1,342
              
              
              
              324
              %Total
      operating expenses
              
              
              2,636
              
              
              
              1,309
              
              
              
              1,327
              
              
              
              101
              %Loss
      from operations
              
              
              (880
              )
              
              
              (895
              )
              
              
              15
              
              
              
              -2
              %Other
      Income (Expenses):Change
      in fair value of derivative financial instruments -
    warrants
              
              
              292
              
              
              
              1,976
              
              
              
              (1,684
              )
              
              
              -85
              %Interest
      income(expense)
              
              
              (2
              )
              
              
              (1
              )
              
              
              (1
              )
              
              
              100
              %Other
      income
              
              
              13
              
              
              
              0
              
              
              
              13(Loss)
      Income from Continuing Operations, Before IncomeTax
              
              
              (576
              )
              
              
              1,081
              
              
              
              (1,657
              )
              
              
              -153
              %Income
      Tax
              
              
              383
              
              
              
              6
              
              
              
              377
              
              
              
              6283
              %(Loss)
      Income from Discontinued Operations, net of Income Tax
              
              
              (86
              )
              
              
              1,085
              
              
              
              (1,171
              )
              
              
              -108
              %Non-controlling
      Interest
              
              
              (3
              )
              
              
              7
              
              
              
              (10
              )
              
              
              -143
              %Net
      (Loss) Income
              
              
              (1,047
              )
              
              
              2,166
              
              
              
              (3,213
              )
              
              
              -148
              %





Revenues.  Revenues
are derived primarily from connection fees and sales of natural
gas.  Revenues increased $1.71 MM, or 246%, to $2.40 MM for
the six months ended June 30, 2010 from $0.69 MM for the same period
in 2009. This increase was mainly attributable to an increase in number of
connection households for an industry customer.





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 $0.37 MM, or 130%, to $0.65 MM for the six months
ended June 30, 2010 from $0.28 MM during the same period in 2009. Such
increase was mainly attributable to an increase in the number of households
connected to our distribution network.





Gross
Profit.Our gross profit
increased by $1.35 MM, or 324%, to $1.76 MM for the six months
ended June 30, 2010 from $0.41 MM during the same period in
2009.  Gross profit as a percentage of revenues or gross profit
margin, was 73% for the six months ended June 30, 2010.  The
gross profit margin during the same period in 2009 was 60%. Such increase in
gross margin was mainly due to 98% of sales revenue was derived from connection
services while 94% of sales revenue was derived from connection services during
the same period in 2009, the gross margin of connection services was higher than
that of gas sales..




46





Total Operating ExpensesThe
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 six months ended June 30, 2010, the
total operating expenses were $2.64 MM while the amount was $1.31 MM for the
same period of 2009, or increased by 101%.  This increase was mainly
due to the fact that we are expanding our
company.    Management believes that the relatively high
SG&A expenses will continue as we endeavor to expand our
business.





Loss from operationsOur loss
from operations decreased by $0.02 MM, or 2%, to $0.88 MM for the six
months ended June 30, 2010 from $0.90 MM during the same period in
2009.  This decrease in loss from operations was mainly due to an
increase in gross profit which was offset by the increase in operating expenses
of $1.33 MM.





Total
Other Income (Expenses)





Change In Fair Value of Warrant Liability:For
the six months ended June 30, 2010, the change in fair value of warrant
liability was recorded as other income of $0.29 MM while the one incurred in the
same period of 2009 was $1.98 MM.





The
Company adopted a FASB accounting standard, which defines determining whether an
instrument (or embedded feature) is indexed to an entity’s own
stock.  This accounting standard specifies that a contract that would
otherwise meet the definition of a derivative but is both (a) indexed to the
Company’s own stock and (b) classified in stockholders’ equity in the statement
of financial position would not be considered a derivative financial
instrument.  This FASB accounting standard provides a new two-step
model to be applied in determining whether a financial instrument or an embedded
feature is indexed to an issuer’s own stock and thus able to qualify for the
scope exception.





As a
result of adopting this FASB accounting standard, warrants previously treated as
equity pursuant to the derivative treatment exemption are no longer afforded
equity treatment because the warrants have a downward ratchet provision on the
exercise price. As a result, the warrants are not considered indexed to the
Company’s own stock, and as such, all future changes in the fair value of
these warrants will be recognized currently in earnings until such time as the
warrants are exercised or expired.





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 June 30, 2010, the fair value of the Series A and B Convertible
Preferred Stock was $6.48 MM.  Therefore, the Company recognized a $0.29 MM
gain from the change in fair value for the six months ended June 30, 2010
and a $1.98 MM gain from the change in fair value during the same period in
2009.





Income (loss)From Continuing Operations, Before
Income Tax.Our loss from continuing operations before income
tax increased by $1.66 MM to $0.58MM for the six months ended June 30,
2010 from a gain of $1.08 MM during the same period in
2009.  Such increase was mainly due to an increase by $1.33 in
operating expenses and a decrease by $1.68 MM in income from the change in
fair value of the warrants according to EITF 07-05.




47





Income
(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 (RMB21,900,000). 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 (RMB21,900,000). As of June 30, 2010, the Group received part of the
downpayment of $731,000 (RMB5,000,000). And the Group received a further part of
the downpayment of $297,000 (RMB2,000,000) on July 7, 2010.





As of
June 30, 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 operating activity of Yingkou was recorded
under the discontinued operations for the six months ended June 30, 2010 and
2009.





The
following table displays summarized operating activity for the discontinued
operations of Yingkou for the six ended June 30, 2010, and Yingkou and Acheng
for the six ended June 30, 2009.





For
      the six months ended2010
            
            
            2009Revenue
            
            $
            201,159
            
            
            $
            2,441,507Operating
      loss
            
            $
            (108,698
            )
            
            $
            1,439,525Loss
      before income taxes
            
            $
            (85,646
            )
            
            $
            1,446,716Income
      tax expense
            
            $
            -
            
            
            $
            361,679Loss
      from discontinued operations, net of tax
            
            $
            (85,646
            )
            
            $
            1,085,037





NetIncome
(Loss). Net loss increased by $3.22 MM to a net loss of $1.05 MM for
the six months ended June 30, 2010, from net income of $2.17 MM for
the same period of 2009, which is mainly due to: (1) a decrease in the gain
from the change in fair value of the warrants by $1.68 MM; and (2) an
increase of operating expenses by $1.33 MM.




48





Liquidity
and Capital Resources





As of
June 30, 2010, we had cash and cash equivalents of approximately $0.26 million.
 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 Six Months EndedJune
      302010
              
              
              2009Net
      cash provided by (used in)  operating activities
              
              $
              105
              
              
              $
              (2,439
              )Net
      cash used in investing activities
              
              
              (2,581
              )
              
              
              (4,748
              )Net
      cash provided by financing activities:
              
              
              48
              
              
              
              5,208Effect
      of exchange rate changes in cash and cash equivalents
              
              
              17
              
              
              
              1Net
      decrease in cash and cash equivalents
              
              $
              (2,410
              )
              
              $
              (1,978
              )





Operating
Activities





Net cash
provided by operating activities was $0.11 MM for the six months ended June 30,
2010, compared to net cash used in operating activities of $2.44 MM during the
same period of 2009. This increase in funds provided by our operating activities
was primarily due to a decrease in accounts receivable and an increase in
accruals and other payables.





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 six months ended June 30, 2010 was $2.58 MM
which was a decrease of $2.17 MM from $4.75 MM for the same
period of 2009.  This decrease was mainly due to the decrease in
the investing activities-discontinued operations..





Financing
Activities





Our debt
(included warrant liabilities) to equity ratio (total debt/total
equity) was 109% as of June 30, 2010.  Net cash provided by
financing activities for the six months ended June 30, 2010 was $0.05 MM, which
is a decrease of $5.16 MM from $5.21 MM during the same period of 2009.
This decrease was mainly due to the contribution from the private
placement consummated on May 1, 2009.





On May 1,
2009, we issued and sold to China Hand 1,116,388 shares of our Series B
Convertible Preferred Stock and warrants to purchase 7,814,719 shares of our
common stock at an initial exercise price of $0.187 per share (subject to
adjustments) exercisable for a period of five (5) years following the date of
issuance for a purchase price of $5,400,000.




49





Capital
Expenditures, Contractual Obligations, Commitments and Contingences





For the
six months ended June 30, 2010, the company spent about $3.13 MM in capital
expenditures which was mainly for the construction of gas pipelines, gas station
and acquisition. The company settled the payments according to the terms of the
contract and fulfilled its contractual obligations.  Other than the
operating leases stated in Note 23 to Unaudited Condensed Consolidated Financial
Statements, we have no other commitments and contingencies. As disclosed in Note
3, the Company is obligated under operating leases to pay minimum lease payments
of approximately $0.35 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). The agreement was completed in April 9, 2010 and
the Group received part of the installment 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.





50




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 June 30, 2010.  Based on that
evaluation, Mr. Chong and Mr. Yu concluded that as of June 30, 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




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 believe 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.




51





ITEM
      6.
            EXHIBITS.





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





Exhibit
      No.
            
            Description31.1
            
            Certifications
      of Principal Executive Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
            
            Certifications
      of Principal Financial Officer filed pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
            
            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.





52




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.




Date:
      August 16, 2010
            CHINA
      NEW ENERGY GROUP COMPANYBy:
            /s/
      Yangkan ChongYangkan
      Chong, Chief Executive Officer(Principal
      Executive Officer)




By:
            /s/ Eric
      YuEric
      Yu, Chief Financial Officer(Principal
      Financial Officer and Principal
              Accounting
      Officer)




53