UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10−Q/A


(Mark
One)




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




For the
quarterly period ended: September 30, 2009




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




For the
transition period from ____________ to _____________




Commission
File Number: 333-83375





CHINA NEW ENERGY GROUP
COMPANY


(Exact
Name of Registrant as Specified in Its Charter)





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





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


He
Ping District, Tianjin, 300042


People's
Republic of China


(Address
of principal executive offices, Zip Code)




(86 22) 5829
9778


(Registrant’s
telephone number, including area code)










(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 Nine Months Ended September 30, 2009







TABLE
OF CONTENTS





PART
      IFINANCIAL
      INFORMATIONITEM
      1.
                      FINANCIAL
      STATEMENTS
                      4ITEM
      2.
                      MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                      49ITEM
      3.
                      QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                      63ITEM
      4.
                      CONTROLS
      AND PROCEDURES
                      64PART
      IIOTHER
      INFORMATIONITEM
      1.
                      LEGAL
      PROCEEDINGS
                      65ITEM
      6.
                      EXHIBITS
                      65




2





EXPLANATORY
NOTE REGARDING RESTATEMENT





This
Amendment No. 1 ("Form 10-Q/A") to our Quarterly Report on Form 10-Q for the
three month period ended September 30, 2009 ("Form 10-Q"), which was filed with
the SEC on November 16, 2009, amends the Form 10-Q to reflect restated amounts
and revised disclosures of the Company's consolidated financial statements for
the three and nine month periods ended September 30, 2009.





A
detailed discussion of the restatement of the consolidated financial statements
for the nine months ended September 30, 2009 is included in note
20.


3





PART
I


FINANCIAL
INFORMATION




ITEM 1.
            FINANCIAL
      STATEMENTS.




CHINA
NEW ENERGY GROUP COMPANY





UNAUDITED
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE NINE MONTHS ENDED JUNE 30, 2009 AND 2008





Index to
unaudited condensed consolidated financial statements





PageUnaudited
      Condensed Consolidated Balance Sheets (Restated)
                5Uaudited
      Condensed Consolidated Statements of Operations and Comprehensive Income
      (Loss) (Restated)
                7Unaudited
      Condensed Consolidated Statements of Cash Flows (Restated)
                8Notes
      to Unaudited Condensed Consolidated Financial Statements
                9




4




CHINA
NEW ENERGY GROUP COMPANY


CONDENSED
CONSOLIDATED BALANCE SHEETS





September 30
                  
                  
                  December 312009
                  
                  
                  2008Restated(Unaudited)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                  
                  $
                  4,878,751
                  
                  
                  $
                  5,612,356Restricted
      cash
                  
                  
                  196,873
                  
                  
                  
                  221,152Accounts
      receivable, net of allowance for doubtful accounts of $- and
      $-
                  
                  
                  3,925,491
                  
                  
                  
                  2,183,087Inventories,
      net
                  
                  
                  288,799
                  
                  
                  
                  257,597Prepaid
      expenses
                  
                  
                  135,740
                  
                  
                  
                  133,614Other
      current assets
                  
                  
                  94,017
                  
                  
                  
                  3,340TOTAL
      CURRENT ASSETS
                  
                  
                  9,519,671
                  
                  
                  
                  8,411,146Property,
      plant and equipment, net
                  
                  
                  17,121,635
                  
                  
                  
                  13,470,468Intangible
      assets, net
                  
                  
                  1,286,758
                  
                  
                  
                  1,308,375Other
      receivables
                  
                  
                  2,075,390
                  
                  
                  
                  2,254,997Deposit
      paid for acquisition of long term assets
                  
                  
                  649,213
                  
                  
                  
                  1,424,747Goodwill
                  
                  
                  63,002
                  
                  
                  
                  63,014TOTAL
      ASSETS
                  
                  
                  30,715,669
                  
                  
                  
                  26,932,747




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


5


CHINA
NEW ENERGY GROUP COMPANY


CONDENSED
CONSOLIDATED BALANCE SHEETS





September 30
                                
                                
                                December 312009
                                
                                
                                2008Restated(Unaudited)LIABILITIES AND
      EQUITYCURRENT
      LIABILITIESAccounts
      payable
                                
                                $
                                351,750
                                
                                
                                $
                                874,542Accruals
      and other payables
                                
                                
                                243,648
                                
                                
                                
                                242,309Acquisition
      consideration payable
                                
                                
                                -
                                
                                
                                
                                1,838,946Registration
      rights penalties payable
                                
                                
                                1,728,000
                                
                                
                                
                                900,000Tax
      payable
                                
                                
                                523,770
                                
                                
                                
                                693,116Related
      party payables
                                
                                
                                498,491
                                
                                
                                
                                498,703Dividends
      payable on preferred stock
                                
                                
                                744,946
                                
                                
                                
                                194,000Derivative
      financial instruments - warrants
                                
                                
                                2,358,908
                                
                                
                                
                                5,506,143TOTAL
      CURRENT LIABILITIES
                                
                                
                                6,449,513
                                
                                
                                
                                10,747,759Commitment
      and contingencies (Note 18)Preferred
      Stock : 10,000,000 shares authorized, $0.001 par value Series A
      Convertible Preferred Stock:
                                
                                
                                7,031,818
                                
                                
                                
                                7,031,8182,098,918
      and 1,857,373 shares issued and outstanding, liquidation preference
      of $10,137,774 and $8,971,112, respectivelySeries
      B Convertible Preferred Stock:
                                
                                
                                2,153,307
                                
                                
                                
                                -1,116,388
      and 0 shares issued and outstanding, liquidation preference of
      $5,399,969 and $0CHINA
      NEW ENERGY'S STOCKHOLDERS' EQUITYCommon
      Stock: 500,000,000 shares authorized, $1 par value, 100,000,041 shares
      issued and outstanding
                                
                                
                                100,000
                                
                                
                                
                                100,000Additional
      paid in capital
                                
                                
                                9,720,473
                                
                                
                                
                                9,396,046Retained
      earnings/ (Accumulated deficit)
                                
                                
                                1,790,113
                                
                                
                                
                                (3,809,149
                                )Statutory
      surplus reserve fund
                                
                                
                                1,746,890
                                
                                
                                
                                1,746,890Accumulated
      other comprehensive income
                                
                                
                                1,580,509
                                
                                
                                
                                1,616,977TOTAL
      CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY
                                
                                
                                14,937,985
                                
                                
                                
                                9,050,764Non-controlling
      interest
                                
                                
                                143,046
                                
                                
                                
                                102,406TOTAL
      EQUITY
                                
                                
                                15,081,031
                                
                                
                                
                                9,153,170TOTAL
      LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
    EQUITY
                                
                                $
                                30,715,669
                                
                                
                                $
                                26,932,747





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




6


CHINA
NEW ENERGY GROUP COMPANY


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME





(Unaudited)
                          
                          
                          (Unaudited)For the Three months ended
                          
                          
                          For the nine months endedSeptember 30,
                          
                          
                          September 30,2009
                          
                          
                          2008
                          
                          
                          2009
                          
                          
                          2008Restated
                          
                          
                          
                          
                          
                          RestatedRevenues:Connection
      services
                          
                          $
                          2,659,930
                          
                          
                          $
                          2,092,445
                          
                          
                          $
                          5,433,912
                          
                          
                          $
                          3,846,773Natural
      gas
                          
                          
                          157,344
                          
                          
                          
                          161,413
                          
                          
                          
                          518,970
                          
                          
                          
                          390,2142,817,274
                          
                          
                          
                          2,253,858
                          
                          
                          
                          5,952,882
                          
                          
                          
                          4,236,987Cost
      of Sales:Connection
      services
                          
                          
                          742,925
                          
                          
                          
                          454,061
                          
                          
                          
                          1,548,040
                          
                          
                          
                          833,644Natural
      gas
                          
                          
                          157,863
                          
                          
                          
                          121,565
                          
                          
                          
                          517,745
                          
                          
                          
                          295,257900,788
                          
                          
                          
                          575,626
                          
                          
                          
                          2,065,785
                          
                          
                          
                          1,128,901Gross
      Profit
                          
                          
                          1,916,486
                          
                          
                          
                          1,678,232
                          
                          
                          
                          3,887,097
                          
                          
                          
                          3,108,086Operating
      Expenses:General
      and administrative expenses
                          
                          
                          909,061
                          
                          
                          
                          284,205
                          
                          
                          
                          1,772,908
                          
                          
                          
                          660,927Selling
      expenses
                          
                          
                          59,458
                          
                          
                          
                          61,889
                          
                          
                          
                          174,036
                          
                          
                          
                          153,047Registration
      rights penalties
                          
                          
                          378,000
                          
                          
                          
                          -
                          
                          
                          
                          828,000
                          
                          
                          
                          -Total
      operating expenses
                          
                          
                          1,346,519
                          
                          
                          
                          346,094
                          
                          
                          
                          2,774,944
                          
                          
                          
                          813,974Income
      from Operations
                          
                          
                          569,967
                          
                          
                          
                          1,332,138
                          
                          
                          
                          1,112,153
                          
                          
                          
                          2,294,112Other
      Income:Change
      in fair value of warrant liability
                          
                          
                          6,041,231
                          
                          
                          
                          -
                          
                          
                          
                          8,017,275
                          
                          
                          
                          -Interest
      income
                          
                          
                          10,680
                          
                          
                          
                          -
                          
                          
                          
                          20,307
                          
                          
                          
                          -Interest
      expense
                          
                          
                          (3,699
                          )
                          
                          
                          -
                          
                          
                          
                          (4,370
                          )
                          
                          
                          -Other
      Income
                          
                          
                          5,558
                          
                          
                          
                          3,702
                          
                          
                          
                          5,651
                          
                          
                          
                          9,974Total
      other income
                          
                          
                          6,053,770
                          
                          
                          
                          3,702
                          
                          
                          
                          8,038,863
                          
                          
                          
                          9,974Income
      From Continuing Operations, Before Income Tax
                          
                          
                          6,623,737
                          
                          
                          
                          1,335,840
                          
                          
                          
                          9,151,016
                          
                          
                          
                          2,304,086Income
      Tax
                          
                          
                          (461,013
                          )
                          
                          
                          (391,358
                          )
                          
                          
                          (828,800
                          )
                          
                          
                          (705,244
                          )Income
      From Continuing Operations, net of Income Tax
                          
                          
                          6,162,724
                          
                          
                          
                          944,482
                          
                          
                          
                          8,322,216
                          
                          
                          
                          1,598,842Income
      (Loss) From Discontinued Operations, net of Income Tax
                          
                          
                          -
                          
                          
                          
                          (7,116
                          )
                          
                          
                          -
                          
                          
                          
                          223,410Net
      Income
                          
                          
                          6,162,724
                          
                          
                          
                          937,366
                          
                          
                          
                          8,322,216
                          
                          
                          
                          1,822,252Net
      Income Attributable to Non-controlling Interest
                          
                          
                          (25,104
                          )
                          
                          
                          (37,009
                          )
                          
                          
                          (18,200
                          )
                          
                          
                          (46,277
                          )Net
      Income attributable to China New Energy Group
                          
                          
                          6,137,620
                          
                          
                          
                          900,357
                          
                          
                          
                          8,304,016
                          
                          
                          
                          1,775,975Dividend
      and Deemed Dividend on Preferred Stock
                          
                          
                          (204,000
                          )
                          
                          
                          -
                          
                          
                          
                          (2,074,753
                          )
                          
                          
                          -Net
      Income Attributable to Common Stockholders
                          
                          
                          5,933,620
                          
                          
                          
                          900,357
                          
                          
                          
                          6,229,263
                          
                          
                          
                          1,775,975Other
      Comprehensive IncomeNet
      Income
                          
                          
                          6,162,724
                          
                          
                          
                          937,366
                          
                          
                          
                          8,322,216
                          
                          
                          
                          1,822,252Foreign
      currency translation gain (loss)
                          
                          
                          (5,458
                          )
                          
                          
                          -
                          
                          
                          
                          (24,442
                          )
                          
                          
                          377,403Comprehensive
      income (loss) attributable to the Non-controlling interest
                          
                          
                          251
                          
                          
                          
                          -
                          
                          
                          
                          (12,026
                          )
                          
                          
                          -Comprehensive
      income attributable to the Company
                          
                          $
                          6,157,517
                          
                          
                          $
                          937,366
                          
                          
                          $
                          8,285,748
                          
                          
                          $
                          2,199,655Income
      (Loss) per share - BasicIncome
      (Loss) from continuing operations
                          
                          $
                          0.06
                          
                          
                          $
                          (0.06
                          )
                          
                          $
                          0.05
                          
                          
                          $
                          (0.05
                          )Loss
      from discontinued operations
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -Total
      income (loss) per share
                          
                          $
                          0.06
                          
                          
                          $
                          (0.06
                          )
                          
                          $
                          0.05
                          
                          
                          $
                          (0.05
                          )Income
      (Loss) per share - DilutedIncome
      from continuing operations
                          
                          $
                          0.03
                          
                          
                          $
                          (0.06
                          )
                          
                          $
                          0.04
                          
                          
                          $
                          (0.05
                          )Income
      (Loss) from discontinued operations
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -Total
      income(loss) per share
                          
                          $
                          0.03
                          
                          
                          $
                          (0.06
                          )
                          
                          $
                          0.04
                          
                          
                          $
                          (0.05
                          )Weighted
      average common shares outstandingBasic
                          
                          
                          100,000,041
                          
                          
                          
                          100,000,041
                          
                          
                          
                          100,000,041
                          
                          
                          
                          98,321,560Diluted
                          
                          
                          217,949,744
                          
                          
                          
                          150,677,768
                          
                          
                          
                          199,844,225
                          
                          
                          
                          116,245,214





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


7


CHINA
NEW ENERGY GROUP COMPANY


UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS





For The Nine Months EndedSeptember 302009
                        
                        
                        2008As RestatedCash
      flows from operating activities:Net
      Income
                        
                        $
                        8,322,216
                        
                        
                        $
                        1,822,252Net
      Income From Discontinued Operations
                        
                        
                        -
                        
                        
                        
                        223,410Net
      Income From Continuing Operations
                        
                        
                        8,322,216
                        
                        
                        
                        1,598,842Adjustments
      to reconcile net income to net cash used in operating
      activities:Depreciation
      and amortization
                        
                        
                        337,500
                        
                        
                        
                        129,982Change
      in fair value of warrant liability
                        
                        
                        (8,017,275
                        )
                        
                        
                        -Registration
      right payable
                        
                        
                        828,000
                        
                        
                        
                        -Changes
      in operating assets and liabilities:Accounts
      receivable
                        
                        
                        (1,741,568
                        )
                        
                        
                        (446,814
                        )Other
      receivables
                        
                        
                        205,909
                        
                        
                        
                        (646,372
                        )Inventories
                        
                        
                        (31,228
                        )
                        
                        
                        128,215Prepayment
                        
                        
                        (2,150
                        )
                        
                        
                        -Other
      current assets
                        
                        
                        (90,613
                        )
                        
                        
                        -Accounts
      payable
                        
                        
                        (598,522
                        )
                        
                        
                        (59,384
                        )Accruals
      and other payable-Third Party
                        
                        
                        41,716
                        
                        
                        
                        (789,882
                        )Taxes
      payable
                        
                        
                        (169,093
                        )
                        
                        
                        (276,093
                        )Cash
      used in operating activities-continuing operations
                        
                        
                        (915,108
                        )
                        
                        
                        (361,506
                        )Cash
      used in operating activities-discontinued operations
                        
                        
                        -
                        
                        
                        
                        (140,143
                        )Net
      cash used in operating activities
                        
                        
                        (915,108
                        )
                        
                        
                        (501,649
                        )Cash
      flows from investing activitiesAdditions
      to property, plant and equipments
                        
                        
                        (3,192,542
                        )
                        
                        
                        (933,657
                        )Payments
      made to acquire Chensheng
                        
                        
                        (1,838,946
                        )
                        
                        
                        -Proceeds
      from an associated company
                        
                        
                        -
                        
                        
                        
                        483,512Cash
      used in investing activities-continuing operations
                        
                        
                        (5,031,488
                        )
                        
                        
                        (450,145
                        )Cash
      used in investing activities-discontinued operations
                        
                        
                        -
                        
                        
                        
                        (124,410
                        )Net
      cash used in investing activities
                        
                        
                        (5,031,488
                        )
                        
                        
                        (574,555
                        )Cash
      flows from financing activitiesRepayment
      of cash advanced from director
                        
                        
                        -
                        
                        
                        
                        (210,711
                        )Proceeds
      from issuance of preferred stock
                        
                        
                        5,400,000
                        
                        
                        
                        9,000,000Payment
      of offering costs associated with preferred stock
                        
                        
                        (647,860
                        )
                        
                        
                        (1,507,144
                        )Contribution
      from former non-controlling interest
                        
                        
                        439,060
                        
                        
                        
                        -Change
      from restricted cash
                        
                        
                        24,279
                        
                        
                        
                        -Cash
      used in financing activities-continuing operations
                        
                        
                        5,215,479
                        
                        
                        
                        7,282,145Cash
      used in financing activities-discontinued operations
                        
                        
                        -
                        
                        
                        
                        -Net
      cash flows provided by financing activities
                        
                        
                        5,215,479
                        
                        
                        
                        7,282,145Effect
      of exchange rate changes in cash and cash equivalents
                        
                        
                        (2,488
                        )
                        
                        
                        (1,308,366
                        )Net
      (decrease) increase in cash and cash equivalents
                        
                        
                        (733,605
                        )
                        
                        
                        4,897,575Cash
      and cash equivalents - beginning of period
                        
                        
                        5,612,356
                        
                        
                        
                        2,311,028Cash
      and cash equivalents - end of period
                        
                        $
                        4,878,751
                        
                        
                        $
                        7,208,603Supplemental
      disclosure of cash flow information:Cash
      paid for interest
                        
                        
                        -
                        
                        
                        
                        -Cash
      paid for income tax
                        
                        
                        937,110
                        
                        
                        
                        -Supplemental
      disclosure of non cash investing and financing activities:Dividend
      and deemed dividend on preferred stock
                        
                        
                        2,704,753
                        
                        
                        
                        -





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




8





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





Restatement
of previously issued September 30, 2009 consolidated Financial
Statements





The Group
has restated its property, plant and equipment, intangible assets, registration
rights penalties payable and certain expenses for the nine months ended
September 30, 2009 and expanded the related footnote disclosures. These
adjustments resulted in an increase in the Group’s net income for the nine
months ended September 30, 2009 by $7,165,496 from the net income of $1,156,720
to $8,322,216 with a corresponding increase in accumulated deficit and equity at
September 30, 2009. A detailed discussion of the restatement of the consolidated
financial statements for the nine months ended September 30, 2009 originally
filed November 16, 2009 is included in note 20.





1.
            Basis
      of Presentation





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





The
interim condensed consolidated financial statements included herein, presented
in accordance with United States generally accepted accounting principles and
stated in US dollars, have been prepared by the Group, without audit, pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the Group
believes that the disclosures are adequate to make the information presented not
misleading. These statements reflect all adjustments, consisting of normal
recurring adjustments, which, in the opinion of management, are necessary for
fair presentation of the information contained therein. It is suggested that
these interim condensed consolidated financial statements be read in conjunction
with the financial statements of the Group for the year ended December 31, 2008
and notes thereto included in the Form 10KA 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.





9





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





2.
            Organization
      and Nature of Business





China New
Energy Group Company (“CNER” and the “Group”) 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.





Reverse
Acquisition


On March
28, 2008, the Company executed a share exchange agreement with Willsky
Development Ltd. (“Willsky”) whereby the Company issued to the stockholders of
Willsky 94,908,650 shares of the Company’s Common Stock in exchange for all of
the issued and outstanding capital stock of Willsky (the “Share Exchange”).
Prior to the Share Exchange, 7,091,391 shares of Common Stock were issued and
outstanding. Willsky thereby became our wholly-owned subsidiary and the former
shareholders of Willsky became our controlling stockholders.





Concurrently
with the Share Exchange, the two 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.





Simultaneous
with the consummation of the Share Exchange, the shareholder of Willsky, Eternal
International Holding Group Ltd, a Hong Kong corporation, distributed 85,417,785
shares of the Company’s Common Stock to its shareholders as a dividend.
Accordingly, following this distribution and the surrender of 2,000,000 shares
held by the existing shareholders, Eternal International beneficially owned
approximately 9.49% of the Company’s outstanding capital stock of 100,000,041
common shares.





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.





10





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





2.
Organization and Nature of Business-continued





Principal
activity





The
principal activity of the Group is the operation of natural gas distribution
network through its Chinese subsidiary companies. The Group’s operating
subsidiaries and branches (which together with the Company are collectively
referred to as the “Group”) and their principal activities as of September 30,
2009 are as follows:











Willsky Development Ltd.
(“Willsky”)





Willsky
Development Ltd. (“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.





11





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





2.
Organization and Nature of Business-continued





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 the Company purchased the remaining 51% of
Chensheng from 17 individuals, for an aggregate purchase price of approximately
$1,840,000 (RMB 12,560,000). As a result, the Company owns 51% of Chensheng and
our 99%-owned subsidiary Singocean owns 49% of Chensheng and thus the Group
ultimately owns 99.5% of Chensheng.





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





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





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





On
January 23, 2009, Yingkou Zhongneng was established in the PRC and operates a
natural gas distribution network in the city of Dashiqiao.





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





On June
26, 2009, Tianjin Binhai Zhongneng Gas Co., Ltd. (“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 another wholly owened subsidiary, Singocean
contributed $950,626 (RMB6,500,000) in assets representing 39.4% of the
shareholding of Binhai Zhongneng. As a result, the group hold 99.3% of the BinhaiZhongneng.





Operational Rights and Right
to Supply and Operate Gas Pipeline





The
Group, through Singocean, has signed an “Investment Agreement of Piped Gas
Project Construction in Dashiqiao City” which states that the Group is in charge
of operations and management of the piped gas project in Dashiqiao. On June 16,
2005, the Dashiqiao City Construction Bureau gave the Group a certificate which
confirmed that the Group has exclusive operational rights for thirty years in
Dashiqiao City. The Group receives a connection fee of $380 (RMB2,600) per
user.





On 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.





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




12





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





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)
Accounting Standards Codification





Effective
July 1, 2009, the Financial Accounting Standards Board’s (“FASB”) Accounting
Standards CodificationTM (“ASC”)
became the single official source of authoritative, non-governmental generally
accepted accounting principles (“GAAP”) in the United States. The historical
GAAP hierarchy was eliminated and the ASC became the only level of authoritative
GAAP, other than guidance issued by the Securities and Exchange Commission. Our
accounting policies were not affected by the introduction of the Codification
but we have updated our references to US GAAP to reflect the
Codification.





(e)
Cash and Cash Equivalents





The Group
considers all highly liquid investments with original maturities of three months
or less at the time of purchase to be cash equivalents. As of September 30, 2009
and 2008, the Group did not have any cash equivalents.





Deposits
in banks in the PRC are not insured by any government entity or agency, and are
consequently exposed to risk of loss. Management believes the probability of a
bank failure, causing loss to the Group, is remote.




13





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008




3.
Summary of Significant Accounting Policies-continued





(f)
Property, Plant and Equipment





Property,
plant and equipment are stated at cost. Expenditures for maintenance and
repairs, which do not improve or extend the expected useful life of the assets,
are expensed to operations but major repairs are capitalized. Depreciation is
provided principally by use of the straight-line method over the useful lives of
the related assets, as follows:





Computer
      equipment
            
            3
      yearsFurniture
      & fixtures
            
            5
      yearsOffice
      equipment
            
            5
      yearsMotor
      vehicles
            
            5
      yearsGas
      transportation vehicles
            
            5
      -20 yearsGas
      station
            
            20-25
      yearsUnderground
      gas pipelines
            
            20-30
      years





The gain
or loss on disposal of property, plant and equipment is the difference between
the net sales proceeds and the carrying amount of the relevant assets, and, if
any, is recognized in the statement of operations.





(g)
Intangible Assets





Intangible
assets are generally amortized on a straight line basis over their respective
estimated useful lives. The Company has no intangible assets with indefinite
useful lives. Intangible assets represent land use rights in the PRC. According
to Chinese regulations, land belongs to the nation. Land use rights refer to the
purchase from the government of the legal right to use the land for 50 years.
The land use rights are amortized using the straight-line method over their
estimated useful life of 50 years.





(h)
Inventories





Inventories,
including construction materials, integrated circuit cards, gas meters,
polyethylene valves and natural gas are stated at the lower of cost and net
realizable value. Cost is calculated using the weighted average method. Net
realizable value is based on estimated selling prices in the ordinary course of
business less estimated costs to completion and the estimated costs necessary to
make the sale.





(i)
Goodwill





Goodwill
represents the excess of the purchase price over the fair value of the net
tangible and identifiable intangible assets acquired in a business combination.
In accordance with FASB ASC 350 Intangibles - Goodwill and
Other, goodwill is no longer subject to amortization. Rather, goodwill is
subject to at least an annual assessment for impairment, applying a fair-value
based test. Fair value is generally determined using a discounted cash flow
analysis.





(j)
Impairment of Assets





In
accordance with FASB ASC 360 Property, Plant and
Equipment, the Company evaluates its long-lived assets to determine
whether events and circumstances warrant revised estimates of useful lives or a
reduction in carrying values due to impairment. If indicators of impairment
exist and if the value of the assets is impaired, an impairment loss would be
recognized. As of September 30, 2009 and 2008, no impairment loss has been
recognized.




14





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(k)
Income Taxes





The Group
accounts for income taxes under FASB ASC 740 Accounting for Income
Taxes.  Under FASB ASC 740, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases.  Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled.  Under FASB ASC 740, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.   FASB ASC 740-10-05 Accounting for Uncertainty in Income
Taxes prescribes a recognition threshold and a measurement attribute for
the financial statement recognition and measurement of tax positions taken or
expected to be taken in a tax return. For those benefits to be recognized, a tax
position must be more-likely-than-not to be sustained upon examination by taxing
authorities. The amount recognized is measured as the largest amount of benefit
that is greater than 50 percent likely of being realized upon ultimate
settlement. See Note 14 for a discussion of our income tax
provisions.





(l)
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.





For the
three and nine months ended September 30, 2009 and 2008, all the contracts for
connection services were started and completed in the same period.




15





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(l)
Revenue Recognition-continued





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.





(m)
Foreign Currency Translation and Transactions





The
Group’s functional currency is the Renminbi (“RMB”) and its reporting currency
is the U.S. dollar. The Group’s consolidated balance sheet accounts are
translated into U.S. dollars at the year-end exchange rates and all revenue and
expenses are translated into U.S. dollars at the average exchange rates
prevailing during the periods in which these items arise. Translation gains and
losses are deferred and accumulated as a component of other comprehensive income
in stockholders’ equity. Transaction gains and losses that arise from exchange
rate fluctuations from transactions denominated in a currency other than the
functional currency are included in the statement of operations as incurred. The
translation and transaction gains and losses were immaterial for the nine months
ended September 30, 2009 and 2008.





The PRC
government imposes significant exchange restrictions on fund transfers out of
the PRC that are not related to business operations. These restrictions have not
had a material impact on the Group because it has not engaged in any significant
transactions that are subject to the restrictions.





(n)
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:


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


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


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





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




16





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(o)
Derivative Financial Instruments





We do not
use derivative financial instruments to hedge exposures to cash-flow,
exchange-rate or market-risks that may affect the fair values of our financial
instruments. However, certain financial instruments, such as warrants, which are
indexed to our Common Stock, are classified as liabilities when either (a) the
holder possesses rights to net-cash settlement or physical or net-share
settlement is not within our control or (b) the instrument is not solely indexed
to our Common Stock. Derivative financial instruments are initially recorded,
and continuously carried, at fair value.





Determining
the fair value of these complex derivative financial instruments involves
judgment and the use of certain relevant assumptions including, but not limited
to, interest rates and stock price volatility.  The use of different
assumptions could have a material effect on the estimated fair value
amounts.





(p)
Basic and Diluted Earnings Per Share





The
Company reports basic earnings per share in accordance with FASB ASC 260 Earnings Per Share. Basic
earnings per share is computed by dividing net income attributable to common
shareholders of the Company by the weighted average number of shares outstanding
during the periods presented.





Diluted
earnings per share is based on the assumption that all dilutive convertible
preferred stock, options and warrants were converted or exercised as of the
beginning of the period or when issued, if later. Dilution is computed by
applying the treasury stock method. Under this method, options are assumed to be
exercised at the beginning of the period or the time of issuance, if later, and
as if the funds obtained thereby were used to re-purchase Common Stock at the
average market price during the period.





(q)
Accumulated Other Comprehensive Income





We report
comprehensive income in accordance with FASB ASC 220 Comprehensive
Income.  This statement requires the disclosure of accumulated
other comprehensive income or loss (excluding net income or loss) as a separate
component of shareholders’ equity. Accumulated other comprehensive income
represents the change in equity of the Group during the periods presented from
foreign currency translation adjustments.




(r)
Profit Appropriation





In
accordance with PRC regulations, the Group is required to make appropriations to
the statutory surplus reserve, based on after-tax net income determined in
accordance with PRC GAAP. Appropriation to the statutory surplus reserve should
be at 10% of the after-tax net income determined in accordance with PRC GAAP
until the reserve is equal to 50% of the entity’s registered capital. Statutory
surplus reserve is non-distributable other than in
liquidation.




17





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(s)
Accounts Receivable





Gas
connection fees are recognized on the percentage of completion method, measured
by reference to the value of work carried out during the year. The portion that
is not received in cash is recorded as accounts
receivable.





Trade
accounts receivable are stated at the amount management expects to collect from
balances outstanding at the period end. Outstanding account balances are
reviewed individually for collectability.  Account balances are charged off
against the allowance after all means of collection have been exhausted and the
potential for recovery is considered remote.  Over the last two years, we
have not experienced any bad debts from customers and, accordingly, did not have
a provision for uncollectible accounts at September 30, 2009 and December 31,
2008.





Allowances
for doubtful accounts receivable balances are recorded when circumstances
indicate that collection is doubtful for particular accounts receivable or as a
general reserve for all accounts receivable.  Management estimates
such allowances based on historical evidence such as amounts that are subject to
risk.  Accounts receivable are written off if reasonable collection
efforts are not successful.





Based on
management’s evaluation of historical experience, the following policy for
allowance of doubtful accounts is established:





Trade and other receivables due:
                  
                  % of BalanceBetween
      91 and 180 days:
                  
                  
                  5
                  %Between
      181 and 360 days:
                  
                  
                  20
                  %Between
      361 and 720 days:
                  
                  
                  50
                  %Over
      721 days:
                  
                  
                  100
                  %





(t)
Non-controlling interests





As of
September 30, 2009, Tianjin Huan Long Trading Ltd. directly held a 1%
non-controlling interest in Tianjin Singocean and indirectly held a 0.5%
non-controlling interest in Chengsheng, Binhai Zhongneng, and Yingkou
Zhongneng.





As of
December 31, 2008, Tianjin Huan Long Trading Ltd. directly held a 1%
non-controlling interest in Tianjin Singocean and indirectly held a 0.5%
non-controlling interest in Chengsheng.





(u)
Advertising and promotion costs





Costs
incurred in direct-response advertising are capitalized and amortized on a
straight-line basis over the duration of the advertising campaign. As of
September 30, 2009 and December 31, 2008, there was no capitalized
direct-response advertising. All other advertising costs are expensed as
incurred. During the three months and nine months ended September 30, 2009 and
2008, advertising and promotion costs were nil.





(v)
Post-retirement and post-employment benefits





The
Company’s subsidiaries contribute to a state pension plan in respect of their
PRC employees. Other than the above, neither the Company nor its subsidiaries
provide any other post-retirement or post-employment benefits.





(w)
Shipping and handling costs





Shipping
and handling costs related to delivery of finished goods are included in selling
expenses. During the three months and nine months ended September 30, 2009 and
2008, shipping and handling costs were nil.





(x)
Seasonality





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




18





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(y)
New accounting pronouncements





In
December 2007, the FASB amended its guidance on accounting for business
combinations. The new accounting guidance resulted in a change in our accounting
policy effective January 1, 2009, and is being applied prospectively to all
business combinations subsequent to the effective date. Among other things, the
new guidance amends the principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any non-controlling interest in the acquiree
and the goodwill acquired. It also establishes new disclosure requirements to
enable the evaluation of the nature and financial effects of the business
combination. The adoption of this new accounting policy, which has no effect in
these consolidated financial statements.





In
December 2007, the FASB issued new accounting and disclosure guidance related to
non-controlling interests in subsidiaries (previously referred to as minority
interests), which resulted in a change in our accounting policy effective
January 1, 2009. Among other things, the new guidance requires that a
non-controlling interest in a subsidiary be accounted for as a component of
equity separate from the parent's equity, rather than as a liability. The new
guidance is being applied prospectively, except for the presentation and
disclosure requirements, which have been applied retrospectively. The adoption
of this new accounting policy affects the presentation and disclosure of
non-controlling interests in our consolidated financial statements.





The
following Accounting Standards Codification Updates have been issued, or will
become effective, after the end of the period covered by these financial
statements:





Pronouncement
                    
                    Issued
                    
                    TitleASU
      No. 2009-13
                    
                    October
      2009
                    
                    Revenue
      Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements – a
      consensus of the FASB Emerging Issues Task ForceASU
      No. 2009-14
                    
                    October
      2009
                    
                    Software
      (Topic 985): Certain Revenue Arrangements That Include
      Software Elements—a consensus of the FASB Emerging Issues Task
      ForceASU
      No. 2009-15
                    
                    October
      2009
                    
                    Accounting
      for Own-Share Lending Arrangements in Contemplation of Convertible
      Debt Issuance or Other FinancingASU
      No. 2009-16
                    
                    December
      2009
                    
                    Transfers
      and Servicing (Topic 860): Accounting for Transfers and
      Financial AssetsASU
      No. 2009-17
                    
                    December
      2009
                    
                    Consolidations
      (Topic 810): Improvements to Financial Reporting by Enterprises
      Involved with Variable Interest EntitiesASU
      No. 2010-01
                    
                    January
      2010
                    
                    Equity
      (Topic 505): Accounting for Distributions to Shareholders
      with Components of Stock and Cash – a consensus of the FASB Emerging
      Issues Task ForceASU
      No. 2010-02
                    
                    January
      2010
                    
                    Consolidations
      (Topic 810): Accounting and Reporting for Decreases in Ownership
      of a Subsidiary – a Scope ClarificationASU
      No. 2010-03
                    
                    January
      2010
                    
                    Extractive
      Activities – Oil and Gas (Topic 932): Oil and Gas Reserve Estimation
      and DisclosuresASU
      No. 2010-04
                    
                    January
      2010
                    
                    Accounting
      for Various Topics: Technical Corrections to SEC
  ParagraphsASU
      No. 2010-05
                    
                    January
      2010
                    
                    Compensation
      - Stock Compensation (Topic718): Escrowed Share Arrangements and the
      Presumption of CompensationASU
      No. 2010-06
                    
                    January
      2010
                    
                    Fair
      Value Measurements and Disclosures (Topic 820): Improving
      Disclosures about Fair Value MeasurementsASU
      No. 2010-07
                    
                    January
      2010
                    
                    Not-for-Profit
      Entities (Topic 958): Not-for-Profit Entities - Mergers
      and AcquisitionsASU
      No. 2010-08
                    
                    February
      2010
                    
                    Technical
      Corrections to Various TopicsASU
      No. 2010-09
                    
                    February
      2010
                    
                    Subsequent
      Events (Topic 855): Amendments to Certain Recognition and Disclosure
      RequirementsASU
      No. 2010-10
                    
                    February
      2010
                    
                    Consolidation
      (Topic 810): Amendments for Certain Investment FundsASU
      No. 2010-11
                    
                    March
      2010
                    
                    Derivatives
      and Hedging (Topic 815): Scope Exception Related to Embedded Credit
      Derivatives





To the
extent appropriate, the guidance in the above Accounting Standards Codification
Updates is already reflected in our consolidated financial statements and
management does not anticipate that these accounting pronouncements will have
any future effect on our consolidated financial statements.





19





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





4.
Restricted cash





At
September 30, 2009 and December 31, 2008, restricted cash of $196,873 and
$221,152 respectively represented the cash held by Escrow agent for the expenses
relating to investor and public relations.





5.
Other Receivables





Other
receivables consist of the following:





September 30
                        2009
                      
                      
                      December 31
                        2008RestatedDue
      from Tianjin East Ocean Gas Company Limited
                      
                      $
                      1,454,636
                      
                      
                      $
                      1,416,707Other
      receivables
                      
                      
                      620,754
                      
                      
                      
                      838,290Total
                      
                      $
                      2,075,390
                      
                      
                      $
                      2,254,997





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 during September 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.




6.
Inventories





Inventories
at September 30, 2009 and December 31, 2008 of $288,799 and $257,597,
respectively, consist of raw materials and do not include any work in progress
or finished goods.




20





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





7.
Property, plant and Equipment, net





Property,
plant and equipment consist of the following:


September 30,
                      2009
                    
                    
                    December 31
                      2008RestatedAt
      CostOffice
      Equipment
                    
                    $
                    101,126
                    
                    
                    $
                    33,660Motor
      Vehicles
                    
                    
                    263,988
                    
                    
                    
                    171,175Gas
      Transportation Vehicles
                    
                    
                    721,670
                    
                    
                    
                    652,910Gas
      Station
                    
                    
                    891,121
                    
                    
                    
                    891,291Machinery
                    
                    
                    241,234
                    
                    
                    
                    141,725Underground
      Gas Pipelines
                    
                    
                    7,411,842
                    
                    
                    
                    6,630,8979,630,981
                    
                    
                    
                    8,521,658Less:
      Accumulated depreciation
                    
                    
                    (956,991
                    )
                    
                    
                    (640,741
                    )$
                    8,673,990
                    
                    
                    $
                    7,880,917Construction-in-progress
                    
                    
                    8,447,645
                    
                    
                    
                    5,589,551$
                    17,121,635
                    
                    
                    $
                    13,470,468





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 September 30, 2009, depreciation expenses amounted to
$109,069, of which $96,468 and $12,601 was recorded as cost of sales and other
selling, general administrative expenses, respectively.





During
the three months ended September 30, 2008, depreciation expenses amounted to
$43,639, of which $37,811 and $5,828 was recorded as cost of sales and other
selling, general administrative expenses, respectively.





During
the nine months ended September 30, 2009, depreciation expenses amounted to
$315,073, of which $285,692 and $29,381 was recorded as cost of sales and other
selling, general administrative expenses, respectively.





During
the nine months ended September 30, 2008, depreciation expenses amounted to
$123,553, of which $111,637 and $11,916 was recorded as cost of sales and other
selling, general administrative expenses, respectively.




21





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





8.
Intangible Asset, net





Intangible
asset consist of the following:


September 30,
                        2009
                      
                      
                      December 31
                        2008RestatedLand
      use rights
                      
                      $
                      1,348,659
                      
                      
                      $
                      1,348,915Less:
      accumulated amortization
                      
                      
                      (61,901
                      )
                      
                      
                      (40,540
                      )$
                      1,286,758
                      
                      
                      $
                      1,308,375





Amortization
expense for the three months ended September 30, 2009 and 2008 was $8,171 and
$2,172, respectively





Amortization
expense for the nine months ended September 30, 2009 and 2008 was $22,427 and
$6,429, respectively.





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





Remainder
      of 2009
                      
                      $
                      6,3452010
                      
                      
                      28,7722011
                      
                      
                      28,7722012
                      
                      
                      28,7722013
                      
                      
                      28,772Thereafter
                      
                      
                      1,165,325Total
                      
                      $
                      1,286,758




22





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





9.
Acquisition Consideration Payable




September 30
                      2009
                    
                    
                    December 31
                      2008RestatedAcquisition
      consideration payable relating to the purchase of
Chensheng
                    
                    $
                    -
                    
                    
                    $
                    1,838,946Total
                    
                    $
                    -
                    
                    
                    $
                    1,838,946





The
acquisition consideration payable as of December 31, 2008 represents the amount
due for acquiring the remaining 51% interest in Chensheng in December, 2008 (see
Note 2).  This amount was paid on January 20, 2009.





10.
Related Party Payable





As of
September 30, 2009 and December 31, 2008, the Group has the following balances
payable to related parties:





September 30,
                      2009
                    
                    
                    December 31
                      2008RestatedEternal
      International Holding Group Ltd, shareholder of the
Company
                    
                    $
                    400,522
                    
                    
                    $
                    400,797Tianjin
      Huanlong Commercial and Trading Company, non-controlling shareholder of
      the a subsidiary
                    
                    $
                    97,969
                    
                    
                    $
                    97,906$
                    498,491
                    
                    
                    $
                    498,703


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




23





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





11.
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
September 30, 2009 and December 31, 2008, 100,000,041 shares of Common Stock
were issued and outstanding.





Series A Convertible
Preferred Stock





In
connection with the August 20, 2008 private placement described in Note 12,
the Company filed a Certificate of Designations of Preferences, Rights and
Limitations of Series A Convertible Preferred Stock with the Secretary of State
of the State of Delaware (the "Certificate").  The Company’s Certificate of
Incorporation authorizes it to issue 10,000,000 shares of Preferred Stock and by
the filing, 5,500,000 shares were designated as Series A Convertible Preferred
Stock ("Series A Preferred Stock").  On August 20, 2008, the Company
issued 1,857,373 shares of Series A Preferred Stock to China Hand Fund I,
LLC (“China Hand”), as described in Note 12.





As
described in Note 12, 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 September 30, 2009 and December 31, 2008, there were 2,098,918
shares and 1,857,373 shares, respectively, of Series A Preferred Stock issued
and outstanding.




24





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





11.
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.




25





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





11.
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.




26





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





11.
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 12. 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 September 30, 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.




27





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





11.
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.




28





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





12.
Private Placement of Series A and B Convertible Preferred Stock and
Warrants





August
20, 2008 Private Placement





On August
20, 2008, the Company entered into a Securities Purchase Agreement with China
Hand Fund I, LLC (“China Hand”), an accredited investor. Pursuant to the
Agreement, the Company issued to China Hand 1,857,373 shares of the Company’s
Series A Convertible Preferred Stock and 13,001,608 warrants to purchase
Common Stock, for aggregate gross proceeds of $9,000,000. 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 A Preferred Stock are described in Note 11 and
the warrants are further described in Note 13.





Kuhns
Brothers Securities Corporation (“Kuhns Brothers”) acted as placement agent in
connection with the private placement. As compensation for its services, Kuhns
Brothers received a cash fee of $900,000, representing 10% of the gross proceeds
received from the private placement, as well as warrants to purchase 6,500,804
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 A
Preferred Stock.





As
discussed in Note 13, on August 20, 2008, the fair value of the 13,001,608
warrants issued to China Hand with the Series A Convertible Preferred Stock was
$1,968,182 and the fair value of the 6,500,804 warrants issued to Kuhns Brothers
was $984,091.





After
deducting the placement agent cash fees and other costs of $1,023,698, the
Company received net cash proceeds of $7,076,302.





Registration Rights
Agreement





In
connection with the private placement, the Company and China Hand entered into
a Registration Rights Agreement dated August 20, 2008, in which the Company
agreed to register all of the shares of Common Stock underlying the securities
issued to China Hand, within a defined period. As discussed and described below,
in connection with the May 1, 2009 private placement with China Hand, the
Registration Rights Agreement was subsequently amended and
restated.





Make Good
Provision





The
Agreement also provided for a make good provision that initially required the
Company to issue to China Hand up to an aggregate of 1,114,442 additional shares
of Series A Preferred Stock (557,221 shares for each of 2008 and 2009) if the
Company did not achieve defined after-tax net income and earnings per share
targets for 2008 and 2009. The 2008 after tax net income and earnings per share
targets were $4,300,000 and $0.0261 per share on a fully-diluted basis,
respectively. The 2009 after tax net income and earnings per share targets were
$6,000,000 and $0.0294 per share on a fully diluted basis, respectively. These
targets were subsequently amended in connection with the May 1, 2009 private
placement with China Hand.





As
amended, the Company agreed to issue to China Hand 241,545 shares of Series A
Preferred Stock because the Company did not meet the 2008 earnings target. These
additional shares were issued to China Hand on May 1, 2009.  For 2009,
the number of shares and the earnings target was amended so that China Hand
would be entitled to receive up to an additional 241,545 shares if the Company’s
2009 after tax net income was less than $5,000,000. In the event that the 2009
earnings were equal to or greater than 85% of the $5,000,000 target, no shares
would be issued to China Hand; in the event that 2009 earnings were less than
50% of the target, all 241,545 shares would be issued to China Hand; and in the
event that the 2009 earnings were between 50% and 85% of the target, a pro-rata
portion of the 241,545 additional shares would be issued to China Hand. The 2009
earnings target was not met but the target income is greater than 85% of the
$5,000,000 target and, accordingly, no further shares were issued.





Management
Incentive





China
Hand agreed to place in escrow 46,434 shares of Series A Preferred Stock, to be
issued to certain members of the Company’s management as a performance incentive
if the 2008 and 2009 earnings targets were met. The 2008 earnings target was not
met and the shares were returned to China Hand. In connection with the May 1,
2009 private placement with China Hand, the number of shares to be provided as
an incentive for 2009 was revised to 22,328 shares of Series B Preferred Stock,
as discussed below.




29




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





12.
Private Placement of Series A and B Convertible Preferred Stock and
Warrants-continued





Accounting





In
accordance with the guidance in ASC 815-15-25 Derivatives and Hedging –
Recognition, the Series A Preferred Stock is considered to be an equity
instrument and, accordingly, the embedded conversion option has not been
separated and accounted for as a derivative financial instrument. After
allocating $1,968,182 to the initial fair value of the warrants issued to China
Hand, the remaining proceeds received from China Hand of $7,031,818 were
allocated to the carrying value of the Series A Preferred Stock. As required by
ASC 470-20-30 Beneficial
Conversion Features, the Company recognized a beneficial conversion
feature as of the date of issuance of the Series A Preferred Stock. The amount
of the beneficial conversion feature exceeded the proceeds allocated to the
carrying value of the Series A Preferred Stock and, accordingly, the beneficial
conversion feature recorded was limited to the allocated proceeds. Because the
holders of the Series A Preferred Stock may convert their shares at any time,
the beneficial conversion feature recorded of $7,031,818 was immediately
recognized as a deemed dividend to those holders.





As
discussed above, the Company was obligated to issue additional shares of Series
A Preferred Stock to China Hand if the Company did not meet prescribed earnings
targets for 2008 and 2009.  This obligation represents a contingent
beneficial conversion feature, which would be accounted for at the date the
contingency is resolved. Because all of the proceeds allocated to the Series A
Preferred Stock were recognized at inception as a beneficial conversion feature,
no further recognition of any beneficial conversion feature is permitted and the
241,545 additional shares issued to China Hand because the 2008 earnings target
was not met have been recorded at their value.





Because
the Series A Preferred Stock has conditions for its redemption that may be
outside our control, including the right of the holders to request redemption at
the liquidation value in the event of a Fundamental Transaction or a Change in
Control, in accordance with FASB ASC 480-10-S99 Distinguishing Liabilities from
Equity, the Series A Preferred Stock has been classified outside of
Stockholders’ Equity in our consolidated balance sheet. Because the Company
believes that it is not probable that the Series A Preferred Stock will become
redeemable, the carrying value of the Series A Preferred Stock is not being
adjusted to its redemption value.




30





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





12.
Private Placement of Series A and B Convertible Preferred Stock and
Warrants-continued





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 11
and the warrants are further described in Note 13.





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 13, 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  September 30,, 2009, 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 May, 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 May 31, 2010. As of September 30, 2009 and December
31, 2008, the Company has accrued $1,728,000 and $900,000 for these registration
delay payments, respectively.





Waiver
Agreement





On April
30, 2009, in connection with the second private placement, the Company signed a
waiver agreement with China Hand. As described above, China Hand agreed to (a)
waive any registration delay payments that may have accrued as of the date of
the waiver, (b) accept 241,545 additional shares of Series A Preferred Stock in
satisfaction of the Company’s obligation for failure to meet the required 2008
earnings target and (c) modify the 2009 earnings target.




31





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





12.
Private Placement of Series A and B Convertible Preferred Stock and
Warrants-continued





Exchange
Listing





In the
second Securities Purchase Agreement, the Company agreed to list and trade its
shares of Common Stock on the Nasdaq Capital Market or the Nasdaq Global Market
or the American Stock Exchange and to include in the listing the shares
underlying the Series B Preferred Stock and the Warrants issued to China
Hand.  In the event the required listing was not completed by January
31, 2010, the Company was obligated to issue to China Hand an additional 27,910
shares of Series B Preferred Stock. The Company’s Common Stock is traded on the
Over-The-Counter Bulletin Board but has not yet been listed on a national
securities exchange, as required by the agreement with China Hand. Accordingly,
the Company expects to issue an additional 27,910 shares of Series B Preferred
Stock to China Hand.





Management
Incentive





China
Hand agreed to place in escrow 22,328 shares of Series B Preferred Stock, to be
issued to certain members of the Company’s management as a performance incentive
if the 2009 earnings target was met. The earnings target was not met and the
Company did not distribute any shares to members of the Company’s
management.





Accounting





In
accordance with the guidance in ASC 815-15-25 Derivatives and Hedging –
Recognition, the Series B Preferred Stock is considered to be an equity
instrument and, accordingly, the embedded conversion option has not been
separated and accounted for as a derivative financial instrument. After
allocating $3,246,693 to the initial fair value of the warrants issued to China
Hand, the remaining proceeds received from China Hand of $2,153,807 were
allocated to the carrying value of the Series B Preferred Stock. As required by
ASC 470-20-30 Beneficial
Conversion Features, the Company recognized a beneficial conversion
feature as of the date of issuance of the Series B Preferred Stock. The amount
of the beneficial conversion feature exceeded the proceeds allocated to the
carrying value of the Series B Preferred Stock and, accordingly, the beneficial
conversion feature recorded was limited to the allocated proceeds. Because the
holders of the Series B Preferred Stock may convert their shares at any time,
the beneficial conversion feature recorded of $2,153,807 was immediately
recognized as a deemed dividend to those holders.





As
discussed above, the Company is obligated to issue additional shares of Series B
Preferred Stock to China Hand because the Company did not meet its obligation to
list its Common Stock on a national stock exchange no later than January 31,
2010. This obligation represents a contingent beneficial conversion feature,
which would be accounted for at the date the contingency is resolved. Because
all of the proceeds allocated to the Series B Preferred Stock were recognized at
inception as a beneficial conversion feature, no further recognition of any
beneficial conversion feature is permitted and the 27,910 additional shares to
be issued to China Hand, because the required listing has not yet been obtained,
will be recorded at their value.





Because
the Series B Preferred Stock has conditions for its redemption that may be
outside our control, including the right of the holders to request redemption at
the liquidation value in the event of a Fundamental Transaction or a Change in
Control, in accordance with FASB ASC 480-10-S99 Distinguishing Liabilities from
Equity, the Series B Preferred Stock has been classified outside of
Stockholders’ Equity in our consolidated balance sheet. Because the Company
believes that it is not probable that the Series B Preferred Stock will become
redeemable, the carrying value of the Series B Preferred Stock is not being
adjusted to its redemption value.




32





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





13.
Derivative financial instruments - warrants





As
discussed in Note 12, 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. Accordingly, the Company has restated its
2008 financial statements to account for those warrants as derivative
instruments from the time they were 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 $3,246,694 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
September 30, 2009 and 2008, the fair value of the warrants was $2,358,908 and
$5,506,143, respectively, based on the following assumptions:


September 30, 2009
              
              December 31, 2008Warrants
      outstanding
              
              31,224,489
              
              19,502,412Exercise
      price
              
              $0.187
              
              $0.187Annual
      dividend yield
              
              0%
              
              0%Expected
      life (years)
              
              3.91
      – 4.58
              
              4.64Risk-free
      interest rate
              
              1.51%
      - 2.47%
              
              1.45%Expected
      volatility
              
              90%
              
              66%





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





The
Company recognized a gain of $6,041,231 and $8,017,275 from the change in fair
value of these warrants during the three months and nine months ended
September 30, 2009.





33





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





14.
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 Company 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 September 30, 2009.





BVI





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





PRC





Pursuant
to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income
tax is 25% for Singocean, Acheng, and Daishiquiao for fiscal year 2009 and 2008,
whereas Chensheng is being taxed on 1% of sales figure from January to June 2009
and 25% on net income from July to December 2009 and 0.8% of its annual sales
for fiscal year of 2008.




The
Company had no material adjustments to its liabilities for unrecognized income
tax benefits according to the provisions of FASB ASC 740.  The income
tax expenses were $828,800 and $461,013 for the nine months ended September 30,
2009 and 2008, respectively.  The Company has recorded no deferred tax
assets or liabilities as of September 30, 2009 and 2008, since nearly all
differences in tax basis and financial statement carrying values are permanent
differences.




34




CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008




14.
Income Taxes -continued





Our
policy for recording interest and penalties associated with audits is to record
such items as a component of income tax expenses. There were no interest and
penalties recorded for the three months and nine months ended September 30,
2009.





For The Three Months Ended
                  
                  
                  For The Nine Months EndedSeptember 30,
                  
                  
                  September 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Restated
                  
                  
                  
                  
                  
                  RestatedIncome
      Tax ExpensesCurrent
      tax
                  
                  $
                  461,013
                  
                  
                  $
                  391,358
                  
                  
                  $
                  828,800
                  
                  
                  $
                  705,244Change
      in deferred tax assets – NOL
                  
                  
                  1,437,684
                  
                  
                  
                  57,398
                  
                  
                  
                  1,681,432
                  
                  
                  
                  129,223Change
      in valuation allowance
                  
                  
                  (1,437,684
                  )
                  
                  
                  (57,398
                  )
                  
                  
                  (1,681,432
                  )
                  
                  
                  (129,223
                  )Total
                  
                  $
                  461,013
                  
                  
                  $
                  391,358
                  
                  
                  $
                  828,800
                  
                  
                  $
                  705,244





All of
the Company’s income (loss) before income taxes is from PRC sources. Actual
income tax expenses reported in the consolidated statements of income and
comprehensive income differ from the amounts computed by applying the PRC
statutory income tax rate of 25% for the three and nine months ended September
30, 2009 and 2008 respectively to income (loss) before income taxes for the
three and nine months ended September 30, 2009 and 2008 for the following
reasons:





For The Three Months Ended
                  
                  
                  For The Nine Months EndedSeptember 30
                  
                  
                  September 302009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Restated
                  
                  
                  
                  
                  
                  RestatedProfit
      before income taxes
                  
                  $
                  6,623,737
                  
                  
                  $
                  1,335,840
                  
                  
                  $
                  9,151,016
                  
                  
                  $
                  2,304,086Computed
      “expected” income tax expense at 25% in 2009 and 2008, except on the net
      income of Chensheng Gas of $70,627 in 2009 and $- in 2008
                  
                  
                  1,655,934
                  
                  
                  
                  557,710
                  
                  
                  
                  2,270,097
                  
                  
                  
                  576,021Income
      tax expense of “Chensheng Gas” - charged at 0.8% of gross sales of $64,519
      and $- in 2008
                  
                  
                  71,460
                  
                  
                  
                  -
                  
                  
                  
                  6,941
                  
                  
                  
                  -Tax
      effect of net taxable permanent differences
                  
                  
                  171,303
                  
                  
                  
                  33,048
                  
                  
                  
                  233,194
                  
                  
                  
                  28,889Effect
      of cumulative tax losses
                  
                  
                  (1,437,684
                  )
                  
                  
                  (199,400
                  )
                  
                  
                  (1,681,432
                  )
                  
                  
                  100,334$
                  461,013
                  
                  
                  $
                  391,358
                  
                  
                  $
                  828,800
                  
                  
                  $
                  705,244





Our
policy for recording interest and penalties associated with audits is to record
such items as a component of income tax expense. There were no interest and
penalties recorded for the three and six months ended June 30, 2009 and
2008.





35





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





15.
Earnings Per Share





Basic
earnings per share (EPS) is computed by dividing the earnings for the periods by
the weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution of securities by including
other potential common stock, including 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 EPS are presented in the following table:





Components
of basic and diluted earnings per share were as follows:





For The Three Months Ended
                  
                  
                  For The Nine Months EndedSeptember 30
                  
                  
                  September 302009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Restated
                  
                  
                  
                  
                  
                  RestatedBASICNumerator
      for basic and diluted EPS:Net
      income from continuing operations attributable to China New Energy Group’s
      Common Stockholders
                  
                  $
                  6,137,620
                  
                  
                  $
                  900,357
                  
                  
                  
                  8,304,016
                  
                  
                  $
                  1,775,975Deemed
      dividend on preferred stock issued
                  
                  
                  -
                  
                  
                  
                  (7,031,818
                  )
                  
                  
                  (2,350,829
                  )
                  
                  
                  (7,031,818
                  )Dividend
      on preferred stock
                  
                  
                  (226,946
                  )
                  
                  
                  (59,000
                  )
                  
                  
                  (550,946
                  )
                  
                  
                  (59,000
                  )Income
      (loss) from continuing operations used in computing basic
    EPS
                  
                  
                  5,910,674
                  
                  
                  
                  (6,190,461
                  )
                  
                  
                  5,402,241
                  
                  
                  
                  (5,314,843
                  )Basic
      EPS per share from continuing operations
                  
                  
                  0.06
                  
                  
                  
                  (0.06
                  )
                  
                  
                  0.05
                  
                  
                  
                  (0.05
                  )Numerator
      for basic and diluted EPS:Net
      income (loss) from discontinued operations
                  
                  $
                  -
                  
                  
                  $
                  (7,116
                  )
                  
                  $
                  -
                  
                  
                  $
                  223,410Deemed
      dividend on preferred stock issued
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Dividend
      on preferred stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Income
      (loss) from discontinued operations used in computing basis
      EPS
                  
                  
                  -
                  
                  
                  
                  (7,116
                  )
                  
                  
                  -
                  
                  
                  
                  223,410Basic
      EPS per share from discontinued operations
                  
                  
                  -
                  
                  
                  
                  (0.00
                  )
                  
                  
                  -
                  
                  
                  
                  0.00




36




CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


15.
Earnings Per Share – Continued





DILUTEDNet
      income (loss) from continuing operations attributable to China New Energy
      Group’s Common stockholders
                  
                  $
                  5,910,674
                  
                  
                  $
                  (6,190,461
                  )
                  
                  
                  5,402,241
                  
                  
                  $
                  (5,314,843
                  )Deemed
      dividend on preferred stock issued
                  
                  
                  -
                  
                  
                  
                  7,031,818
                  
                  
                  
                  2,350,829
                  
                  
                  
                  7,031,818Dividend
      on preferred stock
                  
                  
                  226,946
                  
                  
                  
                  59,000
                  
                  
                  
                  550,946
                  
                  
                  
                  59,000Income
      (loss) from continuing operations used in computing diluted
      EPS
                  
                  
                  6,137,620
                  
                  
                  
                  900,357
                  
                  
                  
                  8,304,016
                  
                  
                  
                  1,775,975Diluted
      EPS per share from continuing operations
                  
                  
                  0.03
                  
                  
                  
                  (0.06
                  )
                  
                  
                  0.04
                  
                  
                  
                  (0.05
                  )Net
      income (loss) from discontinued operations
                  
                  $
                  -
                  
                  
                  $
                  (7,116
                  )
                  
                  $
                  -
                  
                  
                  $
                  (223,410
                  )Deemed
      dividend on preferred stock issued
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Dividend
      on preferred stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Income
      (loss) from discontinued operations used in computing diluted
      EPS
                  
                  
                  -
                  
                  
                  
                  (7,116
                  )
                  
                  
                  -
                  
                  
                  
                  (223,410
                  )Diluted
      EPS per share from discontinued operations
                  
                  
                  -
                  
                  
                  
                  (0.00
                  )
                  
                  
                  -
                  
                  
                  
                  (0.00
                  )Weighted
      average outstanding shares of common stock
                  
                  
                  100,000,041
                  
                  
                  
                  100,000,041
                  
                  
                  
                  100,000,041
                  
                  
                  
                  98,321,560Weighted
      average shares of convertible preferred stock outstanding
                  
                  
                  112,535,710
                  
                  
                  
                  47,515,529
                  
                  
                  
                  91,644,433
                  
                  
                  
                  15,954,119Warrants
      and contingently issuable shares
                  
                  
                  5,413,993
                  
                  
                  
                  3,162,198
                  
                  
                  
                  8,199,751
                  
                  
                  
                  1,969,535Shares
      used in computing diluted net income (loss) per share
                  
                  
                  217,949,744
                  
                  
                  
                  150,677,768
                  
                  
                  
                  199,844,225
                  
                  
                  
                  116,245,214Total
      Earnings (Loss) per share:Basic
                  
                  $
                  0.06
                  
                  
                  $
                  (0.06
                  )
                  
                  $
                  0.05
                  
                  
                  $
                  (0.05
                  )Diluted
                  
                  $
                  0.03
                  
                  
                  $
                  (0.06
                  )
                  
                  $
                  0.04
                  
                  
                  $
                  (0.05
                  )




37




CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


16.  Business
and geographical segments





The
Company’s operations are classified into two principal reportable segments which
are provision of gas pipe connection services and 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
                    September 30, 2009
                  
                  
                  For the three months ended
                    September 30, 2008
                  
                  
                  For the three months ended September 30Connection
                  
                  
                  
                  
                  
                  
                  
                  
                  Connection
                  
                  
                  
                  
                  
                  
                  
                  
                  2009
                  
                  
                  2008services
                  
                  
                  Natural gas
                  
                  
                  Corporate
                  
                  
                  services
                  
                  
                  Natural gas
                  
                  
                  Corporate
                  
                  
                  Total
                  
                  
                  TotalExternal
      revenue
                  
                  $
                  2,659,930
                  
                  
                  
                  157,344
                  
                  
                  
                  -
                  
                  
                  
                  2,,092.445
                  
                  
                  
                  161,413
                  
                  
                  
                  -
                  
                  
                  
                  2,817,274
                  
                  
                  
                  2,253,858Interest
      income
                  
                  
                  10,680
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  10,680
                  
                  
                  
                  -Interest
      expense
                  
                  
                  (3,699
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,699
                  )
                  
                  
                  -Depreciation
      and amortization
                  
                  
                  59,858
                  
                  
                  
                  36,610
                  
                  
                  
                  20,772
                  
                  
                  
                  24,708
                  
                  
                  
                  13,103
                  
                  
                  
                  8,000
                  
                  
                  
                  117,240
                  
                  
                  
                  45,811Income
      tax
                  
                  
                  461,013
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  391,358
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  461,013
                  
                  
                  
                  391,358Net
      income/(loss) after income tax
                  
                  
                  1,923,987
                  
                  
                  
                  (521
                  )
                  
                  
                  4,239,258
                  
                  
                  
                  1,012,278
                  
                  
                  
                  (116,817
                  )
                  
                  
                  41,905
                  
                  
                  
                  6,162,724
                  
                  
                  
                  937,366Expenditures
      for long-lived assets
                  
                  
                  121,197
                  
                  
                  
                  152,338
                  
                  
                  
                  9,670
                  
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  283,205




38





CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008





16.           Business
and geographical segments





Reportable
Segments





For the nine months ended
                          September 30, 2009
                        
                        
                        For the nine months ended
                          September 30, 2008
                        
                        
                        For the nine months ended September 30Connection
                        
                        
                        
                        
                        
                        
                        
                        
                        Connection
                        
                        
                        
                        
                        
                        
                        
                        
                        2009
                        
                        
                        2008services
                        
                        
                        Natural gas
                        
                        
                        Corporate
                        
                        
                        services
                        
                        
                        Natural gas
                        
                        
                        Corporate
                        
                        
                        Total
                        
                        
                        TotalExternal
      revenue
                        
                        $
                        5,433,912
                        
                        
                        
                        518,970
                        
                        
                        
                        -
                        
                        
                        
                        3,846,773
                        
                        
                        
                        390,214
                        
                        
                        
                        -
                        
                        
                        
                        5,952,882
                        
                        
                        
                        4,236,987Interest
      income
                        
                        
                        20,307
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        20,307
                        
                        
                        
                        -Interest
      expense
                        
                        
                        (4,370
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (4,370
                        )
                        
                        
                        -Depreciation
      and amortization
                        
                        
                        171,410
                        
                        
                        
                        114,282
                        
                        
                        
                        51,808
                        
                        
                        
                        74,729
                        
                        
                        
                        36,908
                        
                        
                        
                        18,345
                        
                        
                        
                        337,500
                        
                        
                        
                        129,982Income
      tax
                        
                        
                        828,494
                        
                        
                        
                        306
                        
                        
                        
                        -
                        
                        
                        
                        705,244
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        828,800
                        
                        
                        
                        705,244Net
      income/(loss) after income tax
                        
                        
                        3,901,810
                        
                        
                        
                        1,223
                        
                        
                        
                        4,419,183
                        
                        
                        
                        3,059,407
                        
                        
                        
                        (37,064
                        )
                        
                        
                        (1,200,091
                        )
                        
                        
                        8,322,216
                        
                        
                        
                        1,822,252Expenditures
      for long-lived assets
                        
                        
                        2,860,140
                        
                        
                        
                        172,203
                        
                        
                        
                        160,199
                        
                        
                        
                        933,657
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        3,192,542
                        
                        
                        
                        933,657As
      at September 30, 2009
                        
                        
                        As
      at December 31, 2008
                        
                        
                        As
      at September 30,
                        
                        
                        As
      at December 31,Connection
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        Connection
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2009
                        
                        
                        2008services
                        
                        
                        Natural
      gas
                        
                        
                        Corporate
                        
                        
                        services
                        
                        
                        Natural
      gas
                        
                        
                        Corporate
                        
                        
                        Total
                        
                        
                        TotalAssets
                        
                        
                        16,725,017
                        
                        
                        
                        8,975,356
                        
                        
                        
                        5,015,296
                        
                        
                        
                        16,542,520
                        
                        
                        
                        2,520,108
                        
                        
                        
                        7,870,119
                        
                        
                        
                        30,715,669
                        
                        
                        
                        26,932,747








The
Company’s operations are located in the PRC. All revenue is from customers in
the PRC. All of the company’s assets are located in the PRC. Accordingly, no
analysis of the Company’s sales and assets by geographical market is
presented.




39





17.
Concentrations and Credit Risk





Cash -
Cash includes cash on hand and demand deposits in accounts maintained with state
owned banks within the PRC. The Company 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 September 30,
2009 and December 31, 2008 amounted to $4,878,751 and $5,612,356, respectively,
of which no deposits were covered by insurance. Also, as of September 30, 2009
and December 31, 2008, the Company held $196,873 and $221,152, respectively in
restricted cash in a corporate legal counsel’s trust account, in accordance with
an agreement with investors for the restricted use of preferred stock dividend
and investor relation related expenses. Nonperformance by these institutions
could expose the Company to losses not covered by insurance. Management reviews
the financial condition of these institutions on a periodic
basis.  The Company has not incurred any losses on these accounts from
nonperformance by the aforementioned institutions.





Major
customers – For the three months ended September 30, 2009, four customers
accounted for approximately 62% of the Company’s sales. For the nine months
ended September 30, 2009, one customer accounted for approximately 12% of the
Company’s sales and three customers accounted for approximately 40% of the
Company’s accounts receivable as of September 30, 2009.





For the
three months ended September 30, 2008, three customers accounted for
approximately 93% of the Company’s sales. For the nine months ended September
30, 2008, three customers accounted for approximately 84% of the Company’s sales
and three customers accounted for approximately 100% of the Company’s accounts
receivable as of September 30, 2008.





Major
suppliers – For the three months ended September 30, 2009, two suppliers
accounted for approximately 47% of the Company’s purchases. For the nine months
ended September 30, 2009, one supplier accounted for approximately 11% of the
Company’s purchases and four suppliers accounted for approximately 71% of the
Company’s accounts payable as of September 30, 2009.





For the
three months ended September 30, 2008, two suppliers accounted for approximately
67% of the Company’s purchases. For the nine months ended September 30, 2008,
two suppliers accounted for approximately 45% of the Company’s purchases and two
suppliers accounted for approximately 61% of the Company’s accounts payable as
of September 30, 2008.





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





40




18.
Commitments and Contingencies





Operating
Leases - In the normal course of business, the Company leases the land for hen
house under operating lease agreements. The Company rents land, primarily for
the office rental. The operating lease agreements generally contain renewal
options that may be exercised at the Company’s discretion after the completion
of the base rental terms. The Company was obligated under operating leases
requiring minimum rentals as follows:





As
      of December 31,Remainder
      of 2009
                    
                    $
                    43,3292010
                    
                    
                    141,6782011
                    
                    
                    -2012
                    
                    
                    -2013
                    
                    
                    -Thereafter
                    
                    
                    -Total
      minimum lease payments
                    
                    $
                    185,007





During
the nine months ended September 30, 2009 and 2008, rental expenses included in
general and administrative expenses were $102,409 and $8,214,
respectively.





During
the three months ended September 30, 2009 and 2008, rental expenses included in
general and administrative expenses were $39,816 and $0,
respectively.





As of
September 30, 2009, the Company did not have any contingent
liabilities.





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





Deposits
in banks in the PRC are not insured by any government entity or agency, and are
consequently exposed to risk of loss. Management believes the probability of a
bank failure, causing loss to the Company, is remote.





19.           Subsequent
Events





The
Company evaluated subsequent events through the time of filing this Quarterly
Report on Form 10-Q on November 16, 2009. 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.




41





20.           Restatement
and reclassification of financial statements





The
Restatement results from our management’s determination subsequent to the
issuance of our financial statements for the nine months ended September 30,
2009 that was originally filed on November 16, 2009. The Group has also
reflected the corrections of the following errors and reclassifications in its
consolidated financial statements as of and for the nine months ended September
30, 2009. For Note 1 to Note 3 are the errors reflected in the restated
financial statements for the year ended December 31, 2008 which brings the same
effects to the financial statements for the period ended September 30,
2009.





No. 1 to
No.3 are the same restatement adjustments included in the Form 10KA of China New
Energy Group Company filed on April 15, 2010, which brought forward to these
financial statements for the nine months ended September 30, 2009.





1)
            There
      were errors in the recording of the fair value of the assets acquired
      during the acquisition of Chensheng. Therefore, the Group has recorded the
      increase to the fair value from the book value of several assets,
      including $1,036,655 of Property, plant and equipment, $757,550 of
      Intangible assets (ie Land use right) and $3,012 of Inventories, and the
      decrease in $1,200,477 of Goodwill. Consequently, we recalculated the
      $96,489 of the depreciation for such increment of those assets and
      minority interest in Chensheng, which caused a decrease to the minority
      interest by $77,647 in the consolidated balance sheet and a decrease to
      the minority interest’s share of net income by $414,763 in the
      consolidated statement of operations and comprehensive
    income.





2)
            There
      was an error in the elimination of its intercompany accounts. Therefore,
      the Group has recorded a decrease in the Related party receivable balances
      by $84,120 and an increase in the General and administrative expenses by
      $54,196 and the comprehensive income of
$29,924.





3)
            The
      Group reassessed the nature of the Preferred stock together with warrants
      and the Group reclassified $1,857 and $7,029,961 (total amounting to
      $7,031,818) from Preferred stock and Additional paid in capital of
      Stockholders’ Equity to the mezzanine section as of December 31, 2008.
      Also, the Group reclassified warrant liabilities of $2,952,273 from
      additional paid in capital and recognized a $2,553,870 loss from the
      change in fair value of the warrant liabilities in the income statement
      and the total amount of the warrant liabilities was $5,506,143 as of
      December 31, 2008. Besides, the Group has accrued $900,000 registration
      right liabilities as of December 31,
2008.





4)
            The
      adjustments further made for this quarter owing to the effect on the above
      3 brought forward restatement adjustments from the 2008K/A
      are:





Ÿ
            The
      Group further provided the depreciation and amortization of $50,485 in the
      income statement which brought a decrease of $341 in exchange effects to
      accumulated other comprehensive income for the increment of the fair value
      of the assets which decreased $38,894 and $11,932 of the property, plant
      and equipment and intangible assets respectively for the nine months ended
      September 30, 2009. The Group decreased the goodwill of $39 by the
      exchange rate effects.


Ÿ
            The
      Group further provided the depreciation and amortization of $16,817 in the
      income statement for the increment of the fair value of the assets for the
      three months ended September 30,
2009.


Ÿ
            The
      Group corrected the Related party receivable by $84,120 and decrease in
      the General and administrative expenses by $26,706 and the comprehensive
      income of $57,414.


Ÿ
            The
      Group has further accrued $378,000 and $828,000 registration right
      liabilities for the three and nine ended September 30, 2009 and it
      resulted in a total of $1,728,000 as of September 30,
  2009.


Ÿ
            The
      Group decreased the deemed dividend of $197,020 from $2,350,327 to
      $2,153,307 as the beneficial conversion feature further for the nine
      months ended September 30, 2009.


Ÿ
            The
      Group has recorded an increase in the derivative financial instruments –
      warrants and the expense for change in fair value of warrant liabilities
      by $8,017,275 and $6,041,231 for the nine and three months ended September
      30, 2009, respectively.




42





20.
Restatement and reclassification of financial statements -
continued





5)
            The
      Group has reflected the following
  reclassifications.





Ÿ
            The
      Group reclassified $2,075,390 of other receivable from current assets to
      long term assets.


Ÿ
            The
      Group reclassified $649,213 from prepayment to deposits paid for
      acquisition of long term assets.


Ÿ
            The
      Group reclassified accrued expenses of $277,271 to related party
      payable.


Ÿ
            The
      group reclassified $207,556 and $75,633 from other payable to accounts
      payable and related party payable
respectively.


Ÿ
            The
      Group reclassified $84,224 from related payable to other
      receivable.


Ÿ
            The
      Group reclassified $347,202 from additional paid-in capital and $156,144
      from statutory surplus reserve fund to accumulated other comprehensive
      income of $503,347.


Ÿ
            The
      Group reclassified $131,877 and $39,533 of depreciation from general and
      administrative expenses and cost of sales of natural gas, respectively, to
      cost of sales of connection services for the nine months ended September
      30, 2009.


Ÿ
            The
      Group reclassified $174,036 of depreciation from general and
      administrative expenses to connection services for the nine months ended
      September 30, 2009.


Ÿ
            The
      Group reclassified $209,548 of depreciation from cost of sales of natural
      gas to cost of sales to connection services, general and administrative
      expenses and selling expenses of $59,857, $90,233 and $59,458
      ,respectively, for the three months ended September 30,
    2009.


Ÿ
            The
      Group has the above reclassifications which brought the same
      reclassification effect into the cashflow statements for the nine months
      ended September 30, 2009.





The net
effect of the correction of errors was to:





Ÿ
            Increase
      the Group’s reported total assets as of September 30, 2009 by $461,651
      from $30,254,018 to $30,715,669.


Ÿ
            Decrease
      the Group’s reported non-controlling interest as of September 30, 2009 by
      $77,647 from $220,693 to $143,046.


Ÿ
            Decrease
      the Group’s reported accumulated deficit as of September 30, 2009 by
      $4,172,726 from accumulated deficit of $(2,382,613) to retained earnings
      of $1,790,113.


Ÿ
            Increase
      the Group’s reported accumulated other comprehensive income as of
      September 30, 2009 by $886,570 from $693,939 to
  $1,580,509.


Ÿ
            Increase
      the Group’s reported net income by $5,646,414 and $7,165,496 for the three
      and nine months ended September 30, 2009 from $516,310 to $6,162,724 and
      $1,156,720 to $8,322,216,
respectively.


Ÿ
            Increase
      the Group’s reported net income attributable to China New Energy Group by
      $7,165,496 for the nine months ended September 30, 2009 from $1,156,720 to
      $8,322,216.


Ÿ
            Increase
      the Group’s reported comprehensive income attributable to China New Energy
      Group by $5,683,115 and $7,182,908 for the three months and nine months
      ended September 30, 2009, from $474,402 to $6,157,517 and from $1,102,840
      to 8,285,748 respectively.


Ÿ
            Decrease
      the basic net income(loss) per share from continuing operations by $0.06
      from $0.00 to $0.06 and $0.07 from $(0.02) to $0.05 for the three and nine
      months ended September 30, 2009.


Ÿ
            Decrease
      the dilutive net income(loss) per share from continuing operations by
      $0.03 from $0.00 to $0.03 and $0.06from $(0.02) to $0.04for the three and
      nine months ended September 30,
2009





43





20.
Restatement and reclassification of financial statements -
continued





Condensed
Consolidated Balance Sheet as at September 30, 2009





September 30
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            September 302009
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            2009(Reported)
                            
                            
                            Note1
                            
                            
                            Note2
                            
                            
                            Note3
                            
                            
                            Note 4
                            
                            
                            Note 5
                            
                            
                            RestatedASSETSCURRENT
      ASSETSCash
      and cash equivalents
                            
                            $
                            4,878,751
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            4,878,751Restricted
      cash
                            
                            
                            196,873
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            196,873Accounts
      receivable
                            
                            
                            3,925,491
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            3,925,491(84,224
                            )Other
      receivables
                            
                            
                            2,159,614
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (2,075,390
                            )
                            
                            
                            -Related
      party receivable
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            (84,120
                            )
                            
                            
                            
                            
                            
                            84,120
                            
                            
                            
                            
                            
                            
                            
                            -Inventories,
      net
                            
                            
                            285,787
                            
                            
                            
                            3,012
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            288,799Prepaid
      expenses
                            
                            
                            784,953
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (649,213
                            )
                            
                            
                            135,740Other
      current assets
                            
                            
                            94,017
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            94,017TOTAL
      CURRENT ASSETS
                            
                            
                            12,325,486
                            
                            
                            
                            3,012
                            
                            
                            
                            (84,120
                            )
                            
                            
                            -
                            
                            
                            
                            84,120
                            
                            
                            
                            (2,808,827
                            )
                            
                            
                            9,519,671Property,
      plant and equipment, net
                            
                            
                            16,123,874
                            
                            
                            
                            1,036,655
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (38,894
                            )
                            
                            
                            
                            
                            
                            
                            17,121,635Intangible
      assets, net
                            
                            
                            541,140
                            
                            
                            
                            757,550
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (11,932
                            )
                            
                            
                            
                            
                            
                            
                            1,286,758Other
      receivables
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            2,075,390
                            
                            
                            
                            2,075,390Deposits
      paid for acquisition of long term assets
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            649,213
                            
                            
                            
                            649,213Goodwill
                            
                            
                            1,263,518
                            
                            
                            
                            (1,200,477
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (39
                            )
                            
                            
                            
                            
                            
                            
                            63,002TOTAL
      ASSETS
                            
                            $
                            30,254,018
                            
                            
                            
                            596,740
                            
                            
                            
                            (84,120
                            )
                            
                            
                            -
                            
                            
                            
                            33,255
                            
                            
                            
                            (84,224
                            )
                            
                            
                            30,715,669LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIESAccounts
      payable
                            
                            $
                            276,117
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            75,633
                            
                            
                            
                            351,750Accrued
      expenses
                            
                            
                            277,271
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (277,271
                            )
                            
                            
                            -(207,556
                            )Accrual
      and other payables
                            
                            
                            526,837
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (75,633
                            )
                            
                            
                            243,648Registration
      right penalties payable
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            900,000
                            
                            
                            
                            828,000
                            
                            
                            
                            
                            
                            
                            
                            1,728,000Tax
      payable
                            
                            
                            523,770
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            523,770277,271207,556Related
      party payable
                            
                            
                            97,888
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (84,224
                            )
                            
                            
                            498,491Dividend
      payable on preferred stock
                            
                            
                            744,946
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            744,946Derivative
      financial instruments - warrants
                            
                            
                            -
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            5,506,143
                            
                            
                            
                            (3,147,235
                            )
                            
                            
                            
                            
                            
                            
                            2,358,908TOTAL
      CURRENT LIABILITIES
                            
                            
                            2,446,829
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            6,406,143
                            
                            
                            
                            (2,319,235
                            )
                            
                            
                            (84,224
                            )
                            
                            
                            6,449,513Commitment
      and contingencies (Note 12)





44





20.
Restatement and reclassification of financial statements -
continued





Preferred
      Stock : 10,000,000 shares authorized, $0.001 par value
                          Series
      A Convertible Preferred Stock:
                          2,098,918
      and 1,857,373 shares issued and outstanding, liquidation preference of
      $10,137,774 and $8,971,112, respectively
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,031,818
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,031,818Series
      B Convertible Preferred Stock:
                          1,116,388
      and 0 shares issued and outstanding, liquidation preference of
      $5,399,969 and $0
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2,153,307
                        
                        
                        
                        
                        
                        
                        2,153,307CHINA
      NEW ENERGY'S STOCKHOLDERS' EQUITYCommon
      stock: (500,000,000 shares authorized, $0.001 par value, 100,000,041
      shares issued and outstanding) as of September 30, 2009
                        
                        
                        100,000
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        100,000Preferred
      shares: (10,000,000 shares authorized, 1,857,373 shares issued and
      outstanding)
                        
                        
                        2,973
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,857
                        )
                        
                        
                        (1,116
                        )
                        
                        
                        
                        
                        
                        -(7,029,961
                        )
                        
                        
                        (197,022
                        )Additional
      paid in capital
                        
                        
                        27,269,163
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (2,952,273
                        )
                        
                        
                        (7,022,231
                        )
                        
                        
                        (347,203
                        )
                        
                        
                        9,720,4738,017,275(828,000
                        )414,763
                        
                        
                        
                        
                        
                        
                        (900,000
                        )
                        
                        
                        (23,779
                        )Retained
      earnings/ (Accumulated deficit)
                        
                        
                        (2,382,613
                        )
                        
                        
                        (96,489
                        )
                        
                        
                        (54,196
                        )
                        
                        
                        (2,553,870
                        )
                        
                        
                        197,022
                        
                        
                        
                        
                        
                        
                        
                        1,790,113Statutory
      surplus reserve fund
                        
                        
                        1,903,034
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (156,144
                        )
                        
                        
                        1,746,8906,169Accumulated
      other comprehensive income
                        
                        
                        693,939
                        
                        
                        
                        356,113
                        
                        
                        
                        (29,924
                        )
                        
                        
                        
                        
                        
                        
                        50,865
                        
                        
                        
                        503,347
                        
                        
                        
                        1,580,509TOTAL
      CHINA NEW ENERGY'S STOCKHOLDERS EQUITY
                        
                        
                        27,586,496
                        
                        
                        
                        674,387
                        
                        
                        
                        (84,120
                        )
                        
                        
                        (13,437,961
                        )
                        
                        
                        199,183
                        
                        
                        
                        -
                        
                        
                        
                        14,937,985Non-controlling
      interest
                        
                        
                        220,693
                        
                        
                        
                        (77,647
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        143,046TOTAL
      EQUITY
                        
                        
                        27,807,189
                        
                        
                        
                        596,740
                        
                        
                        
                        (84,120
                        )
                        
                        
                        (13,437,961
                        )
                        
                        
                        199,183
                        
                        
                        
                        -
                        
                        
                        
                        15,081,031TOTAL
      LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’
      EQUITY
                        
                        $
                        30,254,018
                        
                        
                        
                        596,740
                        
                        
                        
                        (84,120
                        )
                        
                        
                        -
                        
                        
                        
                        33,255
                        
                        
                        
                        (84,224
                        )
                        
                        
                        30,715,669




45





20.
Restatement and reclassification of financial statements -
continued


Condensed
Consolidated Statements of Operations And Comprehensive Loss for the Nine Months
Ended September 30, 2009





Nine months
                                              ended
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            Nine months
                                              endedSeptember 30
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            September 302009
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2009As
      reported
                                            
                                            
                                            Note
    1
                                            
                                            
                                            Note
    2
                                            
                                            
                                            Note
    3
                                            
                                            
                                            Note
    4
                                            
                                            
                                            Note
    5
                                            
                                            
                                            RestatedRevenue:Connection
      services
                                            
                                            
                                            5,433,912
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            5,433,912Natural
      gas
                                            
                                            
                                            518,970
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            518,9705,952,882
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,952,882Cost
      of Sales:39,533Connection
      services
                                            
                                            
                                            1,376,630
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            131,877
                                            
                                            
                                            
                                            1,548,040Natural
      gas
                                            
                                            
                                            649,622
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (131,877
                                            )
                                            
                                            
                                            517,7452,026,252
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            39,533
                                            
                                            
                                            
                                            2,065,785Gross
      Profit(Loss)
                                            
                                            
                                            3,926,630
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (39,533
                                            )
                                            
                                            
                                            3,887,097Operating
      Expenses:(26,706
                                            )
                                            
                                            
                                            (174,036
                                            )General
      and administrative expenses
                                            
                                            
                                            1,962,698
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            50,485
                                            
                                            
                                            
                                            (39,533
                                            )
                                            
                                            
                                            1,772,908Selling
      expenses
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            174,036
                                            
                                            
                                            
                                            174,036Registration
      rights penalties
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            828,000
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            828,000Total
      operating expenses
                                            
                                            
                                            1,962,698
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            851,779
                                            
                                            
                                            
                                            (39,533
                                            )
                                            
                                            
                                            2,774,944Income (Loss)
      from Operations
                                            
                                            
                                            1,963,932
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (851,779
                                            )
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1,112,153Other
      Income (Expenses):Change
      in fair value of warrant liabilities
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            8,017,275
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            8,017,275Interest
      income
                                            
                                            
                                            20,307
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            20,307Interest
      expense
                                            
                                            
                                            (4,370
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (4,370
                                            )Other
      Income
                                            
                                            
                                            5,651
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            5,651Total
      other income (expense)
                                            
                                            
                                            21,588
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            8,017,275
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            8,038,863Income
      From Continuing Operations, Before Income Tax
                                            
                                            
                                            1,985,520
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            7,165,496
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            9,151,016Income
      Tax
                                            
                                            
                                            (828,800
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (828,800
                                            )Income
      From Continuing Operations, net of Income Tax
                                            
                                            
                                            1,156,720
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            7,165,496
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            8,322,216Income
      From Discontinued Operations, net of Income Tax
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Net
      Income
                                            
                                            
                                            1,156,720
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            7,165,496
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            8,322,216Less:
      Net Income Attributable to Non-controlling Interest
                                            
                                            
                                            (18,200
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (18,200
                                            )Net
      Income Attributable to China New Energy Group
                                            
                                            
                                            1,138,520
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            7,165,496
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            8,304,016Dividend
      and Deemed Dividend on Preferred Stock
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (2,074,753
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (2,074,753
                                            )Net
      Income Attributable to Common Stockholders
                                            
                                            
                                            1,138,520
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,090,743
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,229,263Other
      Comprehensive IncomeNet
      Income
                                            
                                            
                                            1,156,720
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            7,165,496
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            8,322,216Foreign
      currency translation gain(loss)
                                            
                                            
                                            (41,854
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            17,412
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (24,442
                                            )Comprehensive
      Income Attributable to Non-controlling Interest
                                            
                                            
                                            (12,026
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (12,026
                                            )Comprehensive
      income attributable to the Company
                                            
                                            
                                            1,102,840
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            7,182,908
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            8,285,748Income
      (Loss) per share - BasicIncome
      (Loss) from continuing operations
                                            
                                            
                                            (0.02
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.07
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.05Income
      (Loss) from discontinued operations
                                            
                                            
                                            0.00
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.00Total
      Income (Loss) per share
                                            
                                            
                                            (0.02
                                            )
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.07
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.05Income
      (Loss) per share - DilutedIncome
      (Loss) from continuing operations
                                            
                                            
                                            (0.02
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.06
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.04Income
      (Loss) from discontinued operations
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.00Total
      Income (Loss) per share
                                            
                                            
                                            (0.02
                                            )
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.06
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.04Weighted
      average common shares outstandingBasic
                                            
                                            
                                            100,000,041
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            100,000,041Diluted
                                            
                                            
                                            199,844,225
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            199,844,225




46





20.
Restatement and reclassification of financial statements -
continued


Condensed
Consolidated Statements of Operations And Comprehensive Loss for the Three
Months Ended September 30, 2009





Three months
                                              ended
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            Three months
                                              endedSeptember 30,
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            September 30,2009
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2009As
      reported
                                            
                                            
                                            Note
    1
                                            
                                            
                                            Note
    2
                                            
                                            
                                            Note
    3
                                            
                                            
                                            Note
    4
                                            
                                            
                                            Note
    5
                                            
                                            
                                            RestatedRevenue:Connection
      services
                                            
                                            
                                            2,659,930
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,659,930Natural
      gas
                                            
                                            
                                            157,344
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            157,3442,817,274
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            2,817,274Cost
      of Sales:Connection
      services
                                            
                                            
                                            683,068
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            59,857
                                            
                                            
                                            
                                            742,925Natural
      gas
                                            
                                            
                                            367,411
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (209,548
                                            )
                                            
                                            
                                            157,8631,050,479
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (149,691
                                            )
                                            
                                            
                                            900,788Gross
      Profit
                                            
                                            
                                            1,766,795
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            149,691
                                            
                                            
                                            
                                            1,916,486Operating
      Expenses:General
      and administrative expenses
                                            
                                            
                                            802,011
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            16,817
                                            
                                            
                                            
                                            90,233
                                            
                                            
                                            
                                            909,061Selling
      expenses
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            59,458
                                            
                                            
                                            
                                            59,458Registration
      rights penalties
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            378,000
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            378,000Total
      operating expenses
                                            
                                            
                                            802,011
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            394,817
                                            
                                            
                                            
                                            149,691
                                            
                                            
                                            
                                            1,346,519Income (Loss)
      from Operations
                                            
                                            
                                            964,784
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (394,817
                                            )
                                            
                                            
                                            -
                                            
                                            
                                            
                                            569,967Other
      Income (Expenses):Change
      in fair value of warrant liabilities
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            6,041,231
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            6,041,231Interest
      income
                                            
                                            
                                            10,680
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            10,680Interest
      expense
                                            
                                            
                                            (3,699
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (3,699
                                            )Other
      Income
                                            
                                            
                                            5,558
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            5,558Total
      other income (expense)
                                            
                                            
                                            12,539
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,041,231
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,053,770Income
      From Continuing Operations, Before Income Tax
                                            
                                            
                                            977,323
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,646,414
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,623,737Income
      Tax
                                            
                                            
                                            (461,013
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (461,013
                                            )Income
      From Continuing Operations, net of Income Tax
                                            
                                            
                                            516,310
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,646,414
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,162,724Income
      From Discontinued Operations, net of Income Tax
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            -Net
      Income
                                            
                                            
                                            516,310
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,646,414
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,162,724Less:
      Net Income Attributable to Non-controlling Interest
                                            
                                            
                                            (25,104
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (25,104
                                            )Net
      Income Attributable to China New Energy Group
                                            
                                            
                                            491,206
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,646,414
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,137,620Dividend
      and Deemed Dividend on Preferred Stock
                                            
                                            
                                            -
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (204,000
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            (204,000
                                            )Net
      Income Attributable to Common Stockholders
                                            
                                            
                                            468,260
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,442,414
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,933,620Other
      Comprehensive IncomeNet
      Income
                                            
                                            
                                            516,310
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            5,646,414
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            6,162,724Foreign
      currency translation gain (loss)
                                            
                                            
                                            (42,159
                                            )
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            36,701
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            (5,458
                                            )Comprehensive
      Income Attributable to Non-controlling Interest
                                            
                                            
                                            251
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            251Comprehensive
      Income attributable to the Company
                                            
                                            
                                            474,402
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,683,115
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,157,517Income
      per share - BasicIncome
      from continuing operations
                                            
                                            
                                            0.00
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.06
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.06Income
      from discontinued operations
                                            
                                            
                                            0.00
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.00Total
      Income per share
                                            
                                            
                                            0.00
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.06
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.06Income
      per share - DilutedIncome
      from continuing operations
                                            
                                            
                                            0.00
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.03
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.03Income
      from discontinued operations
                                            
                                            
                                            0.00
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            0.00Total
      Income per share
                                            
                                            
                                            0.00
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.03
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.03Weighted
      average common shares outstandingBasic
                                            
                                            
                                            100,000,041
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            100,000,041Diluted
                                            
                                            
                                            209,495,669
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            217,949,744








47





20.
Restatement and reclassification of financial statements -
continued





2009
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          2009(Unaudited)
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (Unaudited)As reported
                          
                          
                          Note 1
                          
                          
                          Note 2
                          
                          
                          Note 3
                          
                          
                          Note 4
                          
                          
                          Note 5
                          
                          
                          RestatedCash
      flows from operating activities:Net
      income Attributable to China New Energy Group Company
                          
                          $
                          1,138,520
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          7,183,696
                          
                          
                          
                          
                          
                          
                          8,322,216Income
      Attributable to Non-controlling Interest
                          
                          
                          18,200
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (18,200
                          )
                          
                          
                          
                          
                          
                          -Adjustments
      to reconcile net income to net cash used in operating
      activities:
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          -
                          
                          
                          
                          
                          
                          
                          -Depreciation
      and amortization
                          
                          
                          287,048
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          50,452
                          
                          
                          
                          
                          
                          
                          337,500Change
      in fair value of warrant liabilities
                          
                          
                          -
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (8,017,275
                          )
                          
                          
                          
                          
                          
                          (8,017,275
                          )Registration
      right liabilities
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          828,000
                          
                          
                          
                          
                          
                          
                          828,000Changes
      in operating assets and liabilities:Accounts
      receivable
                          
                          
                          (1,741,568
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (1,741,568
                          )Other
      receivables
                          
                          
                          205,909
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          205,909Inventories
                          
                          
                          (31,228
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (31,228
                          )Prepayment
                          
                          
                          772,557
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (774,707
                          )
                          
                          
                          (2,150
                          )Other
      current assets
                          
                          
                          (90,613
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (90,613
                          )Accounts
      payable
                          
                          
                          164,360
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (762,882
                          )
                          
                          
                          (598,522
                          )Accrued
      expenses
                          
                          
                          21,251
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (21,251
                          )
                          
                          
                          -Other
      payables
                          
                          
                          (710,835
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          752,551
                          
                          
                          
                          41,716Tax
      payable
                          
                          
                          (169,093
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (169,093
                          )Net
      cash used in operating activities
                          
                          
                          (135,492
                          )
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          26,673
                          
                          
                          
                          (806,289
                          )
                          
                          
                          (915,108
                          )Cash
      flows from investing activitiesAddition
      to property plant and equipment
                          
                          
                          (3,967,253
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          774,711
                          
                          
                          
                          (3,192,542
                          )Payments
      made to acquire Chensheng
                          
                          
                          (1,838,946
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (1,838,946
                          )Net
      cash used in investing activities
                          
                          
                          (5,806,199
                          )
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          774,711
                          
                          
                          
                          (5,031,488
                          )Cash
      flows from financing activitiesRepayment
      of cash advanced from director
                          
                          
                          -Proceeds
      from issuance of preferred stock
                          
                          
                          5,400,000
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          5,400,000Payment
      of offering costs associated with preferred stock
                          
                          
                          (647,860
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (647,860
                          )Contribution
      from former non-controlling interest
                          
                          
                          439,060
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          439,060Change
      from restricted cash
                          
                          
                          24,279
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          24,279Net
      cash provided by financing activities
                          
                          
                          5,215,479
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          5,215,479Effect
      of exchange rate changes in cash and cash equivalents
                          
                          
                          (7,393
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          36,483
                          
                          
                          
                          (31,578
                          )
                          
                          
                          (2,488
                          )Net
      (decrease) in cash and cash equivalents
                          
                          
                          (733,605
                          )
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (733,605
                          )Cash
      and cash equivalents - beginning of period
                          
                          
                          5,612,356
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          5,612,356Cash
      and cash equivalents - end of period
                          
                          $
                          4,878,751
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          4,878,751




48




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/A, 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;




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




49




·
            “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.




50




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
Dashiqiao, Nandaihe and Zhanhua. Currently, these distribution networks provide
natural gas to an aggregate of approximately 64,000 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
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-
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 Travel Hunt Holdings, Inc. common stock in exchange
for all of the issued and outstanding capital stock of Willsky Development.
Simultaneous with the consummation of the share exchange agreement, 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's 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.





For
accounting purposes, the acquisition was accounted for as a recapitalization
effected by a share exchange, and the transaction treated as a reverse
acquisition with Willsky as the acquirer and Travel Hunt Holdings, Inc. as the
acquired party. The assets and liabilities of the acquired entity (Willsky) were
brought forward at their book value and no goodwill was recognized.





In 2005,
Willsky acquired 99% shareholding of Tianjin Sing Ocean Public Utility
Development Co., Ltd. (“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). Singocean has two
branch divisions, namely Acheng SingOcean and Dashiqiao SingOcean, and
established in the PRC to be operated for a period of 5 years until December 28,
2010 and 50 years until January 18, 2054, respectively.





ChenSheng
- 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 from Mr. Tian 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 Gas 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.





51




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 Gas
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 engaged in
the business of natural gas distribution network in the city of
Dashiqiao.





On June
26, 2009, Binhai Zhongneng was established in the PRC. Through our 99.5%-owned
subsidiary, Chensheng, we paid $1,462,501 (RMB10,000,000) in cash for a 60.6%
interest in Binhai Zhongneng, and through our wholly-owned subsidiary, Sing
Ocean, paid $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.





Critical Accounting
Policies





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





Revenue
Recognition





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





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.





52




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 nine months ended September 30, 2009 and 2008, 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.





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 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
nine months ended September 30, 2009, we had sales revenue of $5.95
million of which $5.43 million, or 91%, was from connection services
while $0.52 million, or 9%, was from gas sales.





Our
revenue for the nine months ended September 30, 2009 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.





Third
Quarter Financial Performance Highlights





The
following are some financial highlights for the third quarter of 2009 (MM
represents million):





Revenues:
Our revenues were $2.82 MM for the third quarter of 2009, an increase of
25% from the same period of 2008.





Gross
Margin: Gross margin was 68% for the third quarter of 2009 compared
to gross margin of 74% for the third quarter of 2008, representing a
percentage decrease of 6%.





53




Operating
Expenses: Operating expenses (including selling, general
and administrative expenses) were $1.35 MM for the third quarter of 2009,
an increase of 289% from the same period of 2008.





Net Income /
(Loss): A net income of $6.14 MM resulted for the third
quarter of 2009, while the net income for the same period of 2008 was
$0.90 MM, The increment of net income was mainly due to changes in fair value of
warrant liabilities of $6.04 MM for the third quarter of
2009.





Fully diluted net
income per share: Fully diluted net income per share was $0.03 for the
third quarter of 2009, as compared to net loss per share of ($0.06) for the
same period of 2008.





Taxation





As a
Delaware company, the Company is subject to United States taxation, but no
provision for income taxes was made for the nine months ended September 30, 2009
and 2008 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 nine months ended September 30, 2009
and 2008 as Willsky did not have reportable taxable income for the
period.





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





Acheng is
a division of SingOcean; thus, it is not
subject to separate statutory income tax.





Yingkou
Zhongneng was funded as an independent legal entity in January 2009 from a
division of SingOcean which is subject to the tax laws of the PRC
at  the prevailing statutory rate of enterprise income tax of
25%.





Chensheng
is subject to the tax laws of the PRC being taxed on 0.8% of annual
sales. Starting from January 1, 2009, the tax rate was changed to 1% on
sales.  On July 1, 2009, the tax rate was changed to 25% on net
income.





Binhai
Zhongneng 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.




54





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.





Results
of Operations





Comparison
of Three Months Ended September 30, 2009 and 2008





The
following table summarizes the results of our operations during the three-month
periods ended September 30, 2009 and 2008:





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





55




For the three months endedSeptember 30,2009
                  
                  
                  2008
                  
                  
                  Change
                  
                  
                  Change%RestatedRevenues:
                  
                  $
                  2,817
                  
                  
                  $
                  2,254
                  
                  
                  $
                  563
                  
                  
                  
                  25
                  %Cost
      of Sales:
                  
                  
                  901
                  
                  
                  
                  576
                  
                  
                  
                  325
                  
                  
                  
                  56
                  %Gross
      Profit
                  
                  
                  1,916
                  
                  
                  
                  1,678
                  
                  
                  
                  238
                  
                  
                  
                  14
                  %Total
      operating expenses
                  
                  
                  1,347
                  
                  
                  
                  346
                  
                  
                  
                  1,001
                  
                  
                  
                  289
                  %Income
      from Operations
                  
                  
                  570
                  
                  
                  
                  1,332
                  
                  
                  
                  (762
                  )
                  
                  
                  -57
                  %Other
      Income:Change
      in fair value of warrant liability
                  
                  
                  6,041
                  
                  
                  
                  -
                  
                  
                  
                  6,041
                  
                  
                  
                  100
                  %Interest
      income
                  
                  
                  11
                  
                  
                  
                  -
                  
                  
                  
                  11
                  
                  
                  
                  100
                  %Interest
      expenses
                  
                  
                  -4
                  
                  
                  
                  -
                  
                  
                  
                  -4
                  
                  
                  
                  -100
                  %Other
      Income
                  
                  
                  6
                  
                  
                  
                  4
                  
                  
                  
                  2
                  
                  
                  
                  50
                  %Income
      From Continuing Operations, Before Income Tax
                  
                  
                  6,624
                  
                  
                  
                  1,336
                  
                  
                  
                  5,288
                  
                  
                  
                  396
                  %Income
      Tax
                  
                  
                  (461
                  )
                  
                  
                  (391
                  )
                  
                  
                  -70
                  
                  
                  
                  -18
                  %Income
      from Discontinued Operations, net of Income Tax
                  
                  
                  -
                  
                  
                  
                  (7
                  )
                  
                  
                  7
                  
                  
                  
                  100
                  %Non-controlling
      Interest
                  
                  
                  (25
                  )
                  
                  
                  (37
                  )
                  
                  
                  12
                  
                  
                  
                  -32
                  %Net
      Income attributable to China New Energy Group
                  
                  
                  6,138
                  
                  
                  
                  900
                  
                  
                  
                  5,238
                  
                  
                  
                  582
                  %




Revenues.  Revenues
are derived primarily from connection fees and sales of natural
gas.  Revenues increased $0.57 MM, or 25%, to $2.82 MM for the three
months ended September 30, 2009 from $2.25 MM for the same period in 2008. This
increase was mainly attributable to an increase in number of connection
households.





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 $0.32 MM, or 56%, to $0.90 MM for the three months ended
September 30, 2009 from $0.58 MM during the same period in 2008. Such increase
was mainly attributable to a increase in the number of households connected to
our distribution network.





Gross
Profit.Our
gross profit increased by $0.24 MM, or 14%, to $1.92 MM for the three months
ended September 30, 2009 from $1.68 MM during the same period in
2008.  Gross profit as a percentage of revenues or gross profit
margin, was 68% for the three months ended September 30, 2009.  The
gross profit margin during the same period in 2008 was 74%. Such decrease in
gross profit margin was mainly due to an increase of operating assets and thus
increased the cost allocation of depreciation.




56




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
September 30, 2009, the total operating expenses were $1.35 MM while the amount
was $0.35 MM for the same period of 2008, or increased by 289%.  This
increase was mainly due to the fact that: (1) we are expanding our company; and
(2) recognized $0.38 MM of registration rights penalties in the third quarter of
2009. Management believes that the relatively high SG&A expenses will
continue as we endeavor to expand our business.





Income from OperationsOur income from
operation decreased by $0.76 MM, or 57%, to $0.57 MM for the three months ended
September 30, 2009 from $1.33 MM during the same period in 2008. This
decrease in income from operations was mainly due to increase in operating
expenses.





Other
Income (Expenses)





Change In
Fair Value of Warrant Liability: For the three months ended September 30, 2009,
the change in fair value of warrant liability was recorded as other income of
$6.04 MM while the one incurred in the same period of 2008 was nil.





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
September 30, 2009, the fair value of the Series A and B Convertible Preferred
Stock were $2.36 MM.  Therefore, the Company recognized a $6.04 MM gain
from the change in fair value for the three months ended September 30, 2009
during the same period of 2008 gain from the change in fair value was
nil.




IncomeFrom Continuing Operations, Before
Income TaxOur income from continuing operations, before income tax
increased by $5.29 MM, to $6.62 MM for the three months ended September 30,
2009 from $1.33 MM during the same period in 2008.  Such increase
was mainly due to the fact that the company recorded a $6.04 MM income from the
change in fair value of the warrants which put through according to
EITF 07-05.





57




Income
(Loss) From Discontinued Operations





The
income (loss) from the discontinued operation was due to the fact that, on
September 26, 2008, the Company entered into an asset swap in which it disposed
of the subsidiary Hunchun, including substantially (99%) of the net assets, for
a 49% ownership in Qinhuangdao Chensheng Gas Co. Ltd.





In
accordance with SFAS No. 144, “Accounting for the Impairment of
Long-Lived Assets”, Hunchun Singocean operation is being accounted for as
discontinued operations and, accordingly, its operating results are segregated
and reported as discontinued operations in the accompanying consolidated
statement of operations in 2008. There were no assets or liabilities of Hunchun
in the consolidated balance sheet as of September 30, 2008.





Disposal
of Hunchun in 2008





The
following table displays summarized activity in the Company's consolidated
statements of operations for discontinued operations of Hunchun during the three
months ended September 30, 2008.





2009 (MM)
                                
                                
                                2008 (MM)Revenue
                                
                                $
                                
                                
                                
                                $Operating
      income
                                
                                $
                                
                                
                                
                                $
                                (0.01
                                )Income
      before income taxes
                                
                                $
                                
                                
                                
                                $
                                (0.01
                                )Income
      tax expense
                                
                                $
                                
                                
                                
                                $Income
      from discontinued operations, net of tax
                                
                                $
                                
                                
                                
                                $
                                (0.01
                                )





NetIncome
attributable to China New Energy Group Net income increased by $5.24 MM, to
a net income of $6.14 MM for the three months ended September 30, 2009,
from net income of $0.90 MM for the same period of 2008, which is mainly due to:
(1) an increase in gross profit by $0.24 MM; and (2) income from the change in
fair value of the warrants, $6.04MM.





58




Comparison
of Nine Months Ended September 30, 2009 and 2008





The
following table summarizes the results of our operations during the nine-months
ended September 30, 2009 and 2008:





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




(Unaudited)For the nine months endedSeptember 30,2009
                  
                  
                  2008
                  
                  
                  Change
                  
                  
                  Change%RestatedRevenues:
                  
                  $
                  5,953
                  
                  
                  $
                  4,237
                  
                  
                  
                  1,716
                  
                  
                  
                  40
                  %Cost
      of Sales:
                  
                  
                  2,066
                  
                  
                  
                  1,129
                  
                  
                  
                  937
                  
                  
                  
                  83
                  %Gross
      Profit
                  
                  
                  3,887
                  
                  
                  
                  3,108
                  
                  
                  
                  779
                  
                  
                  
                  25
                  %Total
      operating expenses
                  
                  
                  2,775
                  
                  
                  
                  814
                  
                  
                  
                  1,961
                  
                  
                  
                  241
                  %Income
      from Operations
                  
                  
                  1,112
                  
                  
                  
                  2,294
                  
                  
                  
                  (1,182
                  )
                  
                  
                  -52
                  %Other
      Income:Change
      in fair value of warrant liability
                  
                  
                  8,017
                  
                  
                  
                  -
                  
                  
                  
                  8,017
                  
                  
                  
                  100
                  %Interest
      income
                  
                  
                  20
                  
                  
                  
                  -
                  
                  
                  
                  20
                  
                  
                  
                  100
                  %Interest
      expenses
                  
                  
                  -4
                  
                  
                  
                  -
                  
                  
                  
                  -4
                  
                  
                  
                  -100
                  %Other
      Income
                  
                  
                  6
                  
                  
                  
                  10
                  
                  
                  
                  (4
                  )
                  
                  
                  -40
                  %Income
      From Continuing Operations, Before Income Tax
                  
                  
                  9,151
                  
                  
                  
                  2,304
                  
                  
                  
                  6,847
                  
                  
                  
                  297
                  %Income
      Tax
                  
                  
                  (829
                  )
                  
                  
                  (705
                  )
                  
                  
                  -124
                  
                  
                  
                  -18
                  %Income
      from Discontinued Operations, net of Income Tax
                  
                  
                  -
                  
                  
                  
                  223
                  
                  
                  
                  -223
                  
                  
                  
                  -100
                  %Non-controlling
      Interest
                  
                  
                  (18
                  )
                  
                  
                  (46
                  )
                  
                  
                  28
                  
                  
                  
                  -61
                  %Net
      Income attributalbe to China New Energy Group
                  
                  
                  8,304
                  
                  
                  
                  1,776
                  
                  
                  
                  6,528
                  
                  
                  
                  368
                  %




Revenues.  Revenues
are derived primarily from connection fees and sales of natural
gas.  Revenues increased $1.71 MM, or 40%, to $5.95 MM for
the nine months ended September 30, 2009 from $4.24 MM for the same
period in 2008. This increase was mainly attributable to an increase in number
of connection households.





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





59




Our cost
of sales increased by $0.94 MM, or 83%, to $2.07 MM for the nine
months ended September 30, 2009 from $1.13 MM during the same period in
2008. 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 0.78 MM, or 25%, to $3.89 MM for the nine months
ended September 30, 2009 from $3.11 MM during the same period in
2008.  Gross profit as a percentage of revenues or gross profit
margin, was 65% for nine months ended September 30, 2009.  The
gross profit margin during the same period in 2008 was 73%. Such decrease in
gross profit margin was mainly due to an increase of operating assets and thus
increased the cost allocation of depreciation.





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 nine months
ended September 30, 2009, the total operating expenses were $2.78 MM while
the amount was $0.81 MM for the same period of 2008, or increased by
241%.  This increase was mainly due to the fact that: (1) we are
expanding our company; and (2) recognized $0.83 MM of registration rights
penalties during the nine months ended September 30,
2009.   Management believes that the relatively high SG&A
expenses will continue as we endeavor to expand our business.





Income from OperationsOur income from
operations decreased by $1.18 MM, or 52%, to $1.11 MM for the nine
months ended September 30, 2009 from $2.29 MM during the same period in
2008.  This decrease in operating income was mainly due to an increase
in registration rights penalties.





Total
Other Income (Expenses)





Change In
Fair Value of Warrant Liability: For the nine months ended September 30, 2009,
the change in fair value of warrant liability was recorded as other income of
$8.02 MM while the one incurred in the same period of 2008 was nil.





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
September 30, 2009, the fair value of the Series A and B Convertible Preferred
Stock were $2.36MM.  Therefore, the Company recognized an $8.02 MM gain
from the change in fair value for the nine months ended September 30, 2009
during the same period of 2008 loss from the change in fair value was
nil.





60




IncomeFrom Continuing Operations, Before
Income Tax.Our income from continuing operations, before
income tax increased by $6.85 MM, to $9.15 MM for the nine months
ended September 30, 2009 from $2.30 MM during the same period in
2008.  Such increase was mainly due to the fact that the company
recorded a $8.02 MM income from the change in fair value of the warrants which
put through according to EITF 07-05.





Income
(Loss) From Discontinued Operations





The
income (loss) from the discontinued operation was due to the fact that, on
September 26, 2008, the Company entered into an asset swap in which it disposed
of the subsidiary Hunchun, including substantially (99%) of the net assets, for
a 49% ownership in Qinhuangdao Chensheng Gas Co. Ltd.





In
accordance with SFAS No. 144, “Accounting for the Impairment of
Long-Lived Assets”, Hunchun Singocean operation is being accounted for as
discontinued operations and, accordingly, its operating results are segregated
and reported as discontinued operations in the accompanying consolidated
statement of operations in 2008. There were no assets or liabilities of Hunchun
in the consolidated balance sheet as of September 30, 2008.





Disposal
of Hunchun in 2008





The
following table displays summarized activity in the Company's consolidated
statements of operations for discontinued operations of Hunchun during the nine
months ended September 30, 2008.




2009 (MM)
                                  
                                  
                                  2008 (MM)Revenue
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  0.46Operating
      income
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  0.30Income
      before income taxes
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  0.30Income
      tax expense
                                  
                                  $
                                  
                                  
                                  
                                  $Income
      from discontinued operations, net of tax
                                  
                                  $
                                  
                                  
                                  
                                  $
                                  0.30





NetIncome.
attributable to China New Energy Group Net income increased by $6.52 MM, to
a net income of $8.30 MM for the nine months ended September 30, 2009,
from a net income of $1.78 MM for the same period of 2008, which is mainly due
to: (1) an increase in gross profit by $0.78 MM; and (2) income from the change
in fair value of the warrants, $8.02 MM.





61




Liquidity
and Capital Resources





As of
September 30, 2009, we had cash and cash equivalents of approximately $4.88
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 Nine Months EndedSeptember 302009
                    
                    
                    2008RestatedNet
      cash used in operating activities
                    
                    $
                    (915
                    )
                    
                    $
                    (502
                    )Net
      cash used in investing activities
                    
                    
                    (5,031
                    )
                    
                    
                    (575
                    )Net
      cash flows provided by financing activities
                    
                    
                    5,215
                    
                    
                    
                    7,282Effect
      of exchange rate changes in cash and cash equivalents
                    
                    
                    (2
                    )
                    
                    
                    (1,308
                    )Net
      increase (decrease) in cash and cash equivalents
                    
                    $
                    (734
                    )
                    
                    $
                    4,898




Operating
Activities





Net cash
used in operating activities was $0.92 MM for the nine months ended September
30, 2009, compared to net cash used in operating activities of $0.50 MM during
the same period of 2008. This increase in funds used in our operating activities
was primarily due to an increase in accounts receivable.





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 nine months ended September 30, 2009 was
$5.03 MM which was an increase of $4.45 MM from $0.58 MM for the
same period of 2008.  This increase was due to payments made for
the increased construction in progress and fixed assets.





Financing
Activities





Our debt
(included warrant liabilities) to equity ratio (total debt/total
equity) was 104% as of September 30, 2009.  Net cash provided by
financing activities for the nine months ended September 30, 2009 was $5.22 MM,
which is a decrease of $2.06 MM from $7.28 MM during the same period of 2008.
This decrease was mainly attributable to issue less preferred stock in
2009.





On August
20, 2008, we completed a private placement in which we sold to China Hand Fund
I, LLC, or China Hand, and its designees 1,857,373 shares of our Series A
Preferred Stock and warrants to purchase 13,001,608 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 $9,000,000.





62




Subsequently,
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.





Additionally,
we agreed to certain make good provisions that will require us to issue to China
Hand up to 334,916 additional shares of our Series B Preferred Stock if we do
not achieve audited after-tax net income of $5.0 million for the year ending
December 31, 2009.  If we are successful in achieving this income
target, China Hand will transfer 22,327 shares of its Series B Preferred Stock
to certain members of our management.  We also agreed to issue to China
Hand 27,910 shares of our Series B Preferred Stock if our common stock is not
listed for trading on a national securities exchange on or before January
31, 2010.





Kuhns
Brothers Securities Corporation, or Kuhns Brothers, acted as placement agent in
connection with the August 20, 2008 and May, 1, 2009 private placements. In each
case, as compensation for its services, Kuhns Brothers received a cash fee equal
to 10% of the gross proceeds received from each private placement, as well as
warrants to purchase 10% of the aggregate number of shares of our common stock
issuable to China Hand in each private placement upon conversion of the Series A
and Series B Preferred Stock.  Accordingly, Kuhns Brothers received
cash fees of $900,000 and $540,000, and warrants to purchase 6,500,804 and
3,907,358 shares of our common stock, in connection with the August 20, 2008 and
May 1, 2009 private placements, respectively.





Capital
Expenditures, Contractual Obligations, Commitments and Contingences





For the
nine months ended September 30, 2009, the company spent about $5.03 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 of its contractual obligations.  Other
than the operating leases stated in Note 18 to Unaudited Condensed Consolidated
Financial Statements, we have no other commitments and contingencies. As
disclosed in Note 18, the Company is obligated under operating leases to pay
minimum lease payments of approximately $0.19 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





We do not
have any off balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity or capital
expenditures or capital resources that is material to an investor in our
securities.




ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.





Not
Applicable.





63




ITEM
      4.
            CONTROLS
      AND PROCEDURES.





Disclosure
Controls and Procedures.





As
required by Rule 13a-15 under the Exchange Act, we carried out an evaluation of
the effectiveness of the design and operation of our disclosure controls and
procedures, as of September 30, 2009.  This evaluation was carried out
under the supervision and with the participation of our management, including
our Chief Executive Officer and our Chief Financial Officer.  Based
upon that evaluation, management concluded that our disclosure controls and
procedures were not effective.   Our conclusion that our
disclosure controls and procedures were not effective was based on the fact
that, as more fully disclosed in our Current Report on Form 8-K filed on April
15, 2010, as amended on Form 8K/A filed on April 26 2010, we identified a number
of “significant deficiencies” in the process of preparing our financial
statements for the fiscal year ended December 31, 2008, which deficiencies have
not yet been completely remedied.   On April 9, 2010, the Chief
Executive Officer and Chief Financial Officer of China New Energy
Group,  Inc. (the “Company or “we”) concluded that the previously
issued audited financial statements for the fiscal year ended December 31,
2008 included in the Company’s Annual Report on Form 10-K filed on April, 15,
2009 (the “2008 10-K”) and the unaudited financial statements for the three
months ended March 31, 2009, June 30, 2009 and September 30, 2009 included in
its Quarterly Reports on Form 10-Q filed on May 15, 2009, August 14, 2009 and
November 16, 2009 (collectively, the “2009 10-Qs”) should no longer be relied
upon and that disclosure should be made and action should be taken to prevent
future reliance.





On April
26, 2010, the Company filed an amendment to the 2008 10-K, which filing contains
restated financial statements for the fiscal year ended December 31,
2008.   The Company is filing amendments to the 2009 10-Qs on
August 17, 2010.





Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC’s rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in our
reports filed under the Exchange Act is accumulated and communicated to
management, including the Company’s Chief Executive and acting Chief Financial
Officer as appropriate, to allow timely decisions regarding required
disclosure.




Changes
in Internal Control Over  Financial Reporting.





Because
our current accounting department is relatively new to U.S. GAAP and the related
internal control procedures required of U.S. public companies, our management
has determined that they require additional training and assistance in U.S. GAAP
matters.  Management has determined that our internal audit function
is also significantly deficient due to insufficient qualified resources to
perform internal audit functions.




In order
to correct the foregoing significant deficiencies, we have taken or are taking
the following remediation measures:





            We
      have hired a new chief executive
officer,





            We
      established an audit committee





            We
      are in the process of arranging necessary training for our accounting
      department staff;





            We
      have engaged external professional accounting or consultancy firms to
      assist us in the preparation of the US GAAP
  accounts;




64





            We
      have committed to the establishment of effective internal audit functions;
      however, due to the scarcity of qualified candidates with extensive
      experience in U.S. GAAP reporting and accounting in the region, we were
      not able to hire sufficient internal audit resources before the end of our
      reporting period. However, we will increase our search for qualified
      candidates with assistance from recruiters and through
      referrals;





            In
      addition, we have allocated significant financial and human resources to
      strengthen the internal control structure. As part of our efforts to
      comply with Section 404 of the Sarbanes-Oxley Act for fiscal year 2010, 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 remediate the significant deficiency
identified above, and we will continue to monitor the effectiveness of these
steps and make any changes that our management deems appropriate.




As
described above we are taking certain remediation measures that have materially
affected, or is 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.





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.




65




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 17, 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)




66