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: June 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 Six
Months Ended June 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 June 30, 2009 ("Form 10-Q"), which was filed with the
SEC on August 19, 2009, amends the Form 10-Q to reflect restated amounts and
revised disclosures of the Company's consolidated financial statements for the
three and six month periods ended June 30, 2009.





The Group
has restated its property, plant and equipment, intangible assets, registration
rights penalties payable and certain expenses for the six months ended June 30,
2009 and expanded the related footnote disclosures. These adjustments resulted
in an increase in the our net income for the six months ended June 30, 2009 by
$1,519,082 from the net loss of $640,410 to net income of $2,159,492 with a
corresponding decrease in accumulated deficit and equity at June 30, 2009. A
detailed discussion of the restatement of the consolidated financial statements
for the six months ended June 30, 2009 originally filed May 20, 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 SIX MONTHS ENDED JUNE 30, 2009 AND 2008





Index to
unaudited condensed consolidated financial statements





PageUnaudited
      Condensed Consolidated Balance Sheets (Restated)
                
                
                5Unaudited
      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





June
      30,
                    
                    
                    December
      31,2009
                    
                    
                    2008Restated(unaudited)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                    
                    $
                    5,923,322
                    
                    
                    $
                    5,612,356Restricted
      cash
                    
                    
                    204,715
                    
                    
                    
                    221,152Accounts
      receivable, net of allowance for doubtful accounts of $- and
      $-
                    
                    
                    2,887,687
                    
                    
                    
                    2,183,087Inventories,
      net
                    
                    
                    248,736
                    
                    
                    
                    257,597Prepaid
      expenses
                    
                    
                    -
                    
                    
                    
                    133,614Other
      current assets
                    
                    
                    77,728
                    
                    
                    
                    3,340TOTAL
      CURRENT ASSETS
                    
                    
                    9,342,188
                    
                    
                    
                    8,411,146Property,
      plant and equipment, net
                    
                    
                    15,787,760
                    
                    
                    
                    13,470,468Intangible
      assets, net
                    
                    
                    1,294,960
                    
                    
                    
                    1,308,375Other
      receivables
                    
                    
                    1,929,741
                    
                    
                    
                    2,254,997Deposit
      paid for acquisition of long term assets
                    
                    
                    1,820,733
                    
                    
                    
                    1,424,747Goodwill
                    
                    
                    63,059
                    
                    
                    
                    63,014TOTAL
      ASSETS
                    
                    $
                    30,238,441
                    
                    
                    $
                    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





June
      30,
                            
                            
                            December
      31,2009
                            
                            
                            2008Restated(unaudited)LIABILITIES
      AND EQUITYCURRENT
      LIABILITIESAccounts
      payable
                            
                            $
                            419,815
                            
                            
                            $
                            874,542Accruals
      and other payables
                            
                            
                            14,637
                            
                            
                            
                            242,309Acquisition
      consideration payable
                            
                            
                            -
                            
                            
                            
                            1,838,946Registration
      rights penalties payable
                            
                            
                            1,350,000
                            
                            
                            
                            900,000Tax
      payable
                            
                            
                            688,629
                            
                            
                            
                            693,116Related
      party payables
                            
                            
                            499,105
                            
                            
                            
                            498,703Dividends
      payable on preferred stock
                            
                            
                            518,000
                            
                            
                            
                            194,000Derivative
      financial instruments – warrants
                            
                            
                            8,400,139
                            
                            
                            
                            5,506,143TOTAL
      CURRENT LIABILITIES
                            
                            
                            11,890,325
                            
                            
                            
                            10,747,759Commitment
      and contingencies (Note 17)Preferred
      Stock : 10,000,000 shares authorized, $0.001 par value
                            
                            
                            7,031,818
                            
                            
                            
                            7,031,818Series
      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, 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
                            
                            
                            9,720,475
                            
                            
                            
                            9,396,046Accumulated
      deficit
                            
                            
                            (4,120,562
                            )
                            
                            
                            (3,809,149
                            )Statutory
      surplus reserve fund
                            
                            
                            1,746,890
                            
                            
                            
                            1,746,890Accumulated
      other comprehensive income
                            
                            
                            1,597,994
                            
                            
                            
                            1,616,977TOTAL
      CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY
                            
                            
                            9,044,797
                            
                            
                            
                            9,050,764Non-controlling
      interest
                            
                            
                            118,194
                            
                            
                            
                            102,406TOTAL
      EQUITY
                            
                            
                            9,162,991
                            
                            
                            
                            9,153,170TOTAL
      LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
    EQUITY
                            
                            $
                            30,238,441
                            
                            
                            $
                            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
(LOSS)





(Unaudited)
                            
                            
                            (Unaudited)For
      the three months ended
                            
                            
                            For
      the six months endedJune 30,
                            
                            
                            June 30,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Restated
                            
                            
                            
                            
                            
                            RestatedRevenues:Connection
      services
                            
                            $
                            2,627,230
                            
                            
                            $
                            1,780,417
                            
                            
                            $
                            2,773,982
                            
                            
                            $
                            1,780,417Natural
      gas
                            
                            
                            183,360
                            
                            
                            
                            125,662
                            
                            
                            
                            361,625
                            
                            
                            
                            227,4172,810,590
                            
                            
                            
                            1,906,079
                            
                            
                            
                            3,135,607
                            
                            
                            
                            2,007,834Cost
      of Sales:Connection
      services
                            
                            
                            711,160
                            
                            
                            
                            387,237
                            
                            
                            
                            805,115
                            
                            
                            
                            387,237Natural
      gas
                            
                            
                            178,147
                            
                            
                            
                            96,698
                            
                            
                            
                            359,882
                            
                            
                            
                            172,635889,307
                            
                            
                            
                            483,935
                            
                            
                            
                            1,164,997
                            
                            
                            
                            559,872Gross
      Profit
                            
                            
                            1,921,283
                            
                            
                            
                            1,422,144
                            
                            
                            
                            1,970,610
                            
                            
                            
                            1,447,962Operating
      Expenses:General
      and administrative expenses
                            
                            
                            529,209
                            
                            
                            
                            177,000
                            
                            
                            
                            863,847
                            
                            
                            
                            379,975Selling
      expenses
                            
                            
                            64,077
                            
                            
                            
                            47,714
                            
                            
                            
                            114,577
                            
                            
                            
                            91,158Registration
      right penalties
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            450,000
                            
                            
                            
                            -Total
      operating expenses
                            
                            
                            593,286
                            
                            
                            
                            224,714
                            
                            
                            
                            1,428,424
                            
                            
                            
                            471,133Operating
      income
                            
                            
                            1,327,997
                            
                            
                            
                            1,197,430
                            
                            
                            
                            542,186
                            
                            
                            
                            976,829Other
      Income (Expenses):Change
      in fair value of warrant liabilities
                            
                            
                            13,688,558
                            
                            
                            
                            (910,000
                            )
                            
                            
                            1,976,044
                            
                            
                            
                            (910,000
                            )Interest
      income
                            
                            
                            1,270
                            
                            
                            
                            6,539
                            
                            
                            
                            9,627
                            
                            
                            
                            6,415Interest
      expense
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (671
                            )
                            
                            
                            -Other
      Income
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            93
                            
                            
                            
                            -Total
      other income (expenses)
                            
                            
                            13,689,828
                            
                            
                            
                            (903,461
                            )
                            
                            
                            1,985,093
                            
                            
                            
                            (903,585
                            )Income
      From Continuing Operations, Before Income Tax
                            
                            
                            15,017,825
                            
                            
                            
                            293,969
                            
                            
                            
                            2,527,279
                            
                            
                            
                            73,244Income
      Tax
                            
                            
                            366,790
                            
                            
                            
                            318,047
                            
                            
                            
                            367,787
                            
                            
                            
                            318,047Income
      (Loss) From Continuing Operations, net of Income Tax
                            
                            
                            14,651,035
                            
                            
                            
                            (24,078
                            )
                            
                            
                            2,159,492
                            
                            
                            
                            (244,803
                            )Income
      From Discontinued Operations, net of Income Tax
                            
                            
                            -
                            
                            
                            
                            235,329
                            
                            
                            
                            -
                            
                            
                            
                            217,491Net
      Income (Loss)
                            
                            
                            14,651,035
                            
                            
                            
                            211,251
                            
                            
                            
                            2,159,492
                            
                            
                            
                            (27,312
                            )Net
      Income (loss) Attributable to Non-controlling Interest
                            
                            
                            (14,052
                            )
                            
                            
                            (8,237
                            )
                            
                            
                            6,903
                            
                            
                            
                            (7,071
                            )Net
      Income (Loss) Attributable to China New Energy Group
                            
                            $
                            14,636,983
                            
                            
                            $
                            203,014
                            
                            
                            $
                            2,166,395
                            
                            
                            $
                            (34,383
                            )Dividend
      and Deemed Dividend on Preferred Stock
                            
                            
                            (2,342,807
                            )
                            
                            
                            -
                            
                            
                            
                            (2,477,807
                            )
                            
                            
                            -Net
      Income (Loss) Attributable to Common Stockholders
                            
                            
                            12,294,176
                            
                            
                            
                            203,014
                            
                            
                            
                            (311,412
                            )
                            
                            
                            (34,383
                            )Other
      Comprehensive Income :Net
      Income (Loss)
                            
                            
                            14,651,035
                            
                            
                            
                            211,251
                            
                            
                            
                            2,159,492
                            
                            
                            
                            (27,312
                            )Foreign
      currency translation
                            
                            
                            (24,636
                            )
                            
                            
                            (127,843
                            )
                            
                            
                            (18,983
                            )
                            
                            
                            -Comprehensive
      Income Attributable to the Non-controlling Interest
                            
                            
                            (8,678
                            )
                            
                            
                            (1,291
                            )
                            
                            
                            (12,277
                            )
                            
                            
                            -Comprehensive
      income (loss) attributable to the Company
                            
                            $
                            14,617,721
                            
                            
                            $
                            82,117
                            
                            
                            $
                            2,128,232
                            
                            
                            $
                            (27,312
                            )Income
      (Loss) per share – BasicIncome
      (Loss) from continuing operations
                            
                            $
                            0.12
                            
                            
                            $
                            -
                            
                            
                            $
                            (0.01
                            )
                            
                            $
                            -Loss
      from discontinued operations
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -Total
      income (loss) per share
                            
                            $
                            0.12
                            
                            
                            $
                            -
                            
                            
                            $
                            (0.01
                            )
                            
                            $
                            -Income(Loss)
      per share – DilutedIncome
      (Loss) from continuing operations
                            
                            $
                            0.10
                            
                            
                            $
                            -
                            
                            
                            $
                            (0.01
                            )
                            
                            $
                            -Income(Loss)
      from discontinued operations
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -Total
      income (Loss) per share
                            
                            $
                            0.10
                            
                            
                            $
                            -
                            
                            
                            $
                            (0.01
                            )
                            
                            $
                            -Weighted
      average common shares outstandingBasic
                            
                            
                            100,000,041
                            
                            
                            
                            100,000,041
                            
                            
                            
                            100,000,041
                            
                            
                            
                            49,736,567Diluted
                            
                            
                            144,433,652
                            
                            
                            
                            100,000,041
                            
                            
                            
                            142,264,680
                            
                            
                            
                            49,736,567





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 Six Months EndedJune
      302009
                        
                        
                        2008As RestatedCash
      flows from operating activitiesNet
      income (loss)
                        
                        $
                        2,159,492
                        
                        
                        $
                        (244,803
                        )Net
      income from discontinued operations
                        
                        
                        -
                        
                        
                        
                        217,491Net
      income (loss) from continuing operations
                        
                        
                        2,159,492
                        
                        
                        
                        (27,312
                        )Adjustments
      to reconcile net income(Loss) to net cash used in operating
      activities:Depreciation
      and amortization
                        
                        
                        220,260
                        
                        
                        
                        84,171Change
      in fair value of warrant liabilities
                        
                        
                        (1,976,044
                        )
                        
                        
                        910,000Registration
      rights penalties
                        
                        
                        450,000
                        
                        
                        
                        -Changes
      in operating assets and liabilities:Accounts
      receivable
                        
                        
                        (703,104
                        )
                        
                        
                        (151,962
                        )Other
      receivables
                        
                        
                        353,535
                        
                        
                        
                        7,434Inventories
                        
                        
                        9,024
                        
                        
                        
                        143,319Prepayment
                        
                        
                        133,683
                        
                        
                        
                        -Other
      current assets
                        
                        
                        (74,377
                        )
                        
                        
                        -Accounts
      payable
                        
                        
                        (442,524
                        )
                        
                        
                        391,588Accrued
      expense
                        
                        
                        74,772
                        
                        
                        
                        -Accruals
      and other payable-Third party
                        
                        
                        (349,562
                        )
                        
                        
                        (874,295
                        )Tax
      payable
                        
                        
                        (4,933
                        )
                        
                        
                        (611,744
                        )Cash
      provided by (used in) operating activities-continuing
      operations
                        
                        
                        (149,778
                        )
                        
                        
                        (128,801
                        )Cash
      used in operating activities-discontinued operations
                        
                        
                        -
                        
                        
                        
                        (331,721
                        )Net
      cash (used in) operating activities
                        
                        
                        (149,778
                        )
                        
                        
                        (460,522
                        )Cash
      flows from investing activitiesAddition
      to property, plant and equipment
                        
                        
                        (2,909,337
                        )
                        
                        
                        (1,465,608
                        )Increase
      in short-term loan
                        
                        
                        -
                        
                        
                        
                        660,000Payments
      made to acquire Chensheng
                        
                        
                        (1,838,946
                        )
                        
                        
                        -Cash
      used in investing activities-discontinued operations
                        
                        
                        -
                        
                        
                        
                        -Net
      cash used in investing activities
                        
                        
                        (4,748,283
                        )
                        
                        
                        (805,608
                        )Cash
      flows from financing activitiesIssued
      preferred stock
                        
                        
                        4,752,140
                        
                        
                        
                        -Contribution
      from non-controlling interest
                        
                        
                        439,060
                        
                        
                        
                        -Fund
      deposit as restricted cash
                        
                        
                        16,437
                        
                        
                        
                        -Loan
      from related parties
                        
                        
                        -
                        
                        
                        
                        252,064Cash
      used in financing activities-continuing operations
                        
                        
                        5,207,637
                        
                        
                        
                        252,064Cash
      used in financing activities-discontinued operations
                        
                        
                        -
                        
                        
                        
                        -Net
      cash flows provided by financing activities:
                        
                        
                        5,207,637
                        
                        
                        
                        252,064Effect
      of exchange rate changes in cash and cash equivalents
                        
                        
                        1,390
                        
                        
                        
                        (11,869
                        )Net
      increase (decrease) in cash and cash equivalents
                        
                        
                        310,966
                        
                        
                        
                        (1,025,935
                        )Cash
      and cash equivalents - beginning of period
                        
                        
                        5,612,356
                        
                        
                        
                        2,311,028Cash
      and cash equivalents - end of period
                        
                        $
                        5,923,322
                        
                        
                        $
                        1,285,093Supplemental
      disclosure of cash flow informationCash
      paid for interest
                        
                        $
                        -
                        
                        
                        $
                        -Cash
      paid for income tax
                        
                        $
                        372,556
                        
                        
                        $
                        -Supplemental
      disclosure of non cash investing and financing activities:Dividend
      and Deemed Dividend on Preferred Stock
                        
                        $
                        324,000
                        
                        
                        $
                        -





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 SIX MONTHS ENDED JUNE 30, 2009 AND 2008





Restatement
of previously issued June 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 six months ended June 30,
2009 and expanded the related footnote disclosures. These adjustments resulted
in an increase in the Group’s net income for the six months ended June 30, 2009
by $1,519,082 from the net loss of $640,410 to net income of $2,159,492 with a
corresponding decrease in accumulated deficit and equity at June 30, 2009. A
detailed discussion of the restatement of the consolidated financial statements
for the six months ended June 30, 2009 originally filed May 20, 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 SIX MONTHS ENDED JUNE 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 SIX MONTHS ENDED JUNE 30, 2009 AND 2008





2. 
         Organization and Nature of
Business-continued





Principal
activity





The
principal activity of the Company is the operation of natural gas distribution
network through its Chinese subsidiary companies. The Company’s operating
subsidiaries and branches (which together with the Company are collectively
referred to as the “Group”) and their principal activities as of June 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 SIX MONTHS ENDED JUNE 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, 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,
Singocean, 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.





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 SIX MONTHS ENDED JUNE 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)
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 June 30, 2009 and
December 31, 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.





(e)
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.


13




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


(f)
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 of the legal right to use land from the government. The term of the
land use rights is 50 years. The land use rights are amortized using the
straight-line method over their estimated useful life of 50 years.





(g)
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.





(h)
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 Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill” and Other Intangible Assets”, 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.





(i)
Impairment of Assets





In
accordance with SFAS No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets", the Company evaluates its long-lived assets to determine
whether later events and circumstances warrant revised estimates of useful lives
or a reduction in carrying value 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 June 30, 2009 and December 31, 2008, no impairment loss has
been recognized.





(j)
Income Taxes





The Group
accounts for income taxes under SFAS No. 109, “Accounting for Income
Taxes”.  Under SFAS No. 109, 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 SFAS No. 109, 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.  Also, the Group did not have any liabilities
for unrecognized income tax benefits according to the provisions of FIN
48.


14


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(k)
Revenue Recognition





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





1.
            Persuasive
      evidence of an arrangement exists;


2.
            Delivery
      has occurred or services have been
rendered;


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


4.
            Collectibility
      is reasonably assured.





Gas
connection revenue





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





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





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





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





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





During
the six months ended June 30, 2009 and 2008, all the contracts for connection
services were started and completed in the same period.





Revenue
from sale of gas





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





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


15


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





3. Summary of Significant Accounting
Policies-continued





(l)
Foreign Currency Translation and Transactions





The
Group’s functional currency is the Renminbi (“RMB”) and its reporting currency
is U.S. dollars. 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 six months
ended June 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.





(m)
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:


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


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


Ÿ
            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.





(n)
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.


16


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(o)
Basic and diluted earnings per share





The Group
reports basic earnings per share in accordance with SFAS No. 128, “Earnings Per
Share”. Basic earnings per share is computed using the weighted average number
of shares outstanding during the periods presented. The weighted average number
of shares of the Group represents the common stock outstanding during the
reporting periods.





Diluted
earnings per share is based on the assumption that all dilutive options 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.





(p)
Accumulated Other Comprehensive Income





Accumulated
other comprehensive income represents the change in equity of the Group during
the periods presented from foreign currency translation
adjustments.




(q)
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 the 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.





(r)
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 June 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
                  %


17


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(s)
Non-controlling interests





As of
June 30, 2009 , Tianjin Huan Long Trading Ltd. is the 1% non-controlling
interest in Tianjin Singocean. held a 0.5% non-controlling interest interest in
Qinhuangdao Chengsheng Gas Co., Ltd.





(t)
Discontinued Operations





Effective
September 26, 2008, the Group entered into an asset swap in which it disposed of
our former subsidiary Hunchun.





In
accordance with SFAS No. 144, “Accounting for the Impairment of
Long-Lived Assets”, Hunchun 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.





(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 June
30, 2009 and 2008, there was no capitalized direct-response advertising. All
other advertising costs are expensed as incurred. Advertising and promotion
costs were nil for the six months ended June 30, 2009 and 2008.





(v)
Post-retirement and post-employment benefits





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





(w)
Shipping and handling cost





Shipping
and handling costs related to delivery of finished goods are included in other
selling, general and administrative expenses. During the six months ended June
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 SIX MONTHS ENDED JUNE 30, 2009 AND 2008





3.
Summary of Significant Accounting Policies-continued





(y)
New accounting pronouncements





Effective
July 1, 2009, the Financial Accounting Standards Board’s (“FASB”) Accounting
Standards Codification (“ASC”) became the single official source of
authoritative, nongovernmental 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 conversion to ASC.





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 noncontrolling 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 affects our acquisitions
made during 2009.





In
December 2007, the FASB issued new accounting and disclosure guidance related to
noncontrolling 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
noncontrolling 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
noncontrolling interests on our consolidated financial statements.





In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. This ASU is effective for the
first reporting period, including interim periods, beginning after the issuance
of this ASU. The adoption of this ASU did not have a material impact on the
Company’s consolidated financial statements.





In
January 2010, the FASB issued an accounting standard update to address the
accounting for distributions to shareholders with components of stock and cash
(A Consensus of the FASB Emerging Issues Task Force). This amendment to Topic
505 clarifies the stock portion of a distribution to shareholders that allows
them to elect to receive cash or stock with a limit on the amount of cash that
will be distributed is not a stock dividend for purposes of applying Topics 505
and 260 for interim and annual periods ending on or after December 15, 2009, and
should be applied on a retrospective basis. The Company does not expect the
provisions of this ASU to have a material effect on the financial position,
results of operations, or cash flows of the Company.


19


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





4.
Restricted cash





At June
30, 2009 and December 31, 2008, restricted cash of $204,715 and $221,152
represented the cash held by an escrow agent for expenses relating to investor
and public relations.





5.
Other Receivables





Other
receivables consist of the following:


June
      30
                      2009
                    
                    
                    December
      31
                      2008RestatedDue
      from Tianjin East Ocean Gas Company Limited
                    
                    $
                    1,417,863
                    
                    
                    $
                    1,416,707Other
      receivables
                    
                    
                    511,878
                    
                    
                    
                    838,290Total
                    
                    $
                    1,929,741
                    
                    
                    $
                    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 June 30, 2009 and December 31, 2008 of $248,736 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 SIX MONTHS ENDED JUNE 30, 2009 AND 2008





7.
Property, Plant and Equipment, net





Property,
plant and equipment consist of the following:


June
      30
                    2009
                  
                  
                  December
      31
                    2008RestatedAt
      CostOffice
      Equipment
                  
                  $
                  91,307
                  
                  
                  $
                  33,660Motor
      Vehicles
                  
                  
                  264,208
                  
                  
                  
                  171,175Gas
      Transportation Vehicles
                  
                  
                  653,331
                  
                  
                  
                  652,910Gas
      Station
                  
                  
                  891,864
                  
                  
                  
                  891,291Machinery
                  
                  
                  141,816
                  
                  
                  
                  141,725Underground
      Gas Pipelines
                  
                  
                  6,635,169
                  
                  
                  
                  6,630,8978,677,695
                  
                  
                  
                  8,521,658Less:
      Accumulated depreciation
                  
                  
                  (847,183
                  )
                  
                  
                  (640,741
                  )$
                  7,830,512
                  
                  
                  $
                  7,880,917Construction-in-progress
                  
                  
                  7,957,248
                  
                  
                  
                  5,589,551$
                  15,787,760
                  
                  
                  $
                  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 six months ended June 30, 2009, depreciation expenses amounted to $206,004,
of which $189,224 and $16,780 was recorded as cost of sales and other selling,
general administrative expenses, respectively.





During
the six months ended June 30, 2008, depreciation expenses amounted to $79,914,
of which $73,826 and $6,088 was recorded as cost of sales and other selling,
general administrative expenses, respectively.





During
the three months ended June 30, 2009, depreciation expenses amounted to
$102,266, of which $94,753 and $7,513 was recorded as cost of sales and other
selling, general administrative expenses, respectively.





During
the three months ended June 30, 2008, depreciation expenses amounted to $40,061,
of which $36,224 and $3,837 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 SIX MONTHS ENDED JUNE 30, 2009 AND 2008





8.
Intangible Asset, net





Intangible
asset consist of the following:


June
      30
                    2009
                  
                  
                  December
      31
                    2008RestatedLand
      use rights
                  
                  $
                  1,349,784
                  
                  
                  $
                  1,348,915Less:
      accumulated amortization
                  
                  
                  (54,824
                  )
                  
                  
                  (40,540
                  )$
                  1,294,960
                  
                  
                  $
                  1,308,375





Amortization
expense for the three months ended June 30, 2009 and 2008 was $7,131 and $2,213,
respectively.





Amortization
expense for the six months ended June 30, 2009 and 2008 was $14,256 and $4,257,
respectively.





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





Remainder
      of 2009
                  
                  $
                  16,3922010
                  
                  
                  30,6482011
                  
                  
                  30,6482012
                  
                  
                  30,6482013
                  
                  
                  30,648Thereafter
                  
                  
                  1,155,976Total
                  
                  $
                  1,294,960


22


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





9.
Acquisition Consideration Payable




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





June
      30
                    2009
                  
                  
                  December
      31
                    2008RestatedEternal
      International Holding Group Ltd, shareholder of the
Company
                  
                  $
                  401,136
                  
                  
                  $
                  400,797Tianjin
      Huanlong Commercial and Trading Company, non-controlling shareholder of
      the a subsidiary
                  
                  
                  97,969
                  
                  
                  
                  97,906$
                  499,105
                  
                  
                  $
                  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 SIX MONTHS ENDED JUNE 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 June
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 June 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 SIX MONTHS ENDED JUNE 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 SIX MONTHS ENDED JUNE 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 SIX MONTHS ENDED JUNE 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 June 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 SIX MONTHS ENDED JUNE 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 SIX MONTHS ENDED JUNE 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.


29


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





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





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.





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 SIX MONTHS ENDED JUNE 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 June
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 February, 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 February 28, 2010. As of June 30, 2009 and December
31,2008, the Company has accrued $1,350,000 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 SIX MONTHS ENDED JUNE 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 SIX MONTHS ENDED JUNE 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 June
30, 2009 and December 31,2008, the fair value of the warrants was $8,400,139 and
$5,506,143, respectively, based on the following assumptions:





June
      30, 2009
                  
                  
                  December
      31, 2008Warrants
      outstanding
                  
                  
                  31,224,489
                  
                  
                  
                  19,502,412Exercise
      price
                  
                  $
                  0.187
                  
                  
                  $
                  0.187Annual
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %Expected
      life (years)
                  
                  
                  3.64
      – 4.33
                  
                  
                  
                  4.64Risk-free
      interest rate
                  
                  
                  1.51
                  %
                  
                  
                  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 $13,688,558 and $1,976,044 from the change in fair
value of these warrants during the six months and three months June 30,
2009.


33


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 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 June 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 FIN 48.  The income tax
expenses was $367,787 and $318,047 for the six months ended June 30, 2009 and
2008, respectively.  The Company has recorded no deferred tax assets
or liabilities as of June 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 SIX MONTHS ENDED JUNE 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 six months ended June 30,
2009.





For The Three Months Ended
                    
                    
                    For The Six Months EndedJune 30,
                    
                    
                    June 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Restated
                    
                    
                    
                    
                    
                    RestatedIncome
      Tax ExpensesCurrent
      tax
                    
                    $
                    366,790
                    
                    
                    $
                    318,047
                    
                    
                    $
                    367,787
                    
                    
                    $
                    318,047Change
      in deferred tax assets – NOL
                    
                    
                    (2,988,422
                    )
                    
                    
                    
                    
                    
                    
                    136,548Change
      in deferred tax assets
                    
                    
                    2,988,422
                    
                    
                    
                    
                    
                    
                    
                    (136,548
                    )Change
      in valuation allowance
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Total
                    
                    $
                    366,790
                    
                    
                    $
                    318,047
                    
                    
                    $
                    367,787
                    
                    
                    $
                    318,047





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 six months ended June 30,
2009 and 2008 respectively to income (loss) before income taxes for the three
and six months ended June 30, 2009 and 2008 for the following
reasons:





For The Three Months Ended
                    
                    
                    For The Six Months EndedJune 30,
                    
                    
                    June 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Restated
                    
                    
                    
                    
                    
                    RestatedProfit
      before income taxes
                    
                    $
                    15,017,825
                    
                    
                    $
                    293,969
                    
                    
                    $
                    2,527,279
                    
                    
                    $
                    73,244Computed
      “expected” income tax expense at 25% in 2009 and 2008, except on the net
      income of Chensheng of $70,627 in 2009
                    
                    
                    3,369,195
                    
                    
                    
                    73,492
                    
                    
                    
                    243,628
                    
                    
                    
                    18,311Income
      tax expense of “Chensheng” - charged at 1.0% of gross sales of $
      694,109
                    
                    
                    (66,113
                    )
                    
                    
                    
                    
                    
                    
                    (64,519
                    )Tax
      effect of net taxable permanent differences
                    
                    
                    52,130
                    
                    
                    
                    -
                    
                    
                    
                    52,130
                    
                    
                    
                    -Effect
      of cumulative tax losses
                    
                    
                    (2,988,422
                    )
                    
                    
                    244,555
                    
                    
                    
                    136,548
                    
                    
                    
                    299,736$
                    366,790
                    
                    
                    $
                    318,047
                    
                    
                    $
                    367,787
                    
                    
                    $
                    318,047





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 SIX MONTHS ENDED JUNE 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 six months endedJune 30
                    
                    
                    June 302009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Restated
                    
                    
                    
                    
                    
                    RestatedBASICNumerator
      for basic and diluted EPS:Net
      income (loss) from continuing operations attributable toChina New Energy
      Croup’s Common Stockholders
                    
                    $
                    14,636,983
                    
                    
                    $
                    203,014
                    
                    
                    $
                    2,166,395
                    
                    
                    $
                    (34,383
                    )Deemed
      dividend on preferred stock issued
                    
                    
                    (2,350,829
                    )
                    
                    
                    -
                    
                    
                    
                    (2,350,829
                    )
                    
                    
                    -Dividend
      on preferred stock
                    
                    
                    (189,000
                    )
                    
                    
                    -
                    
                    
                    
                    (324,000
                    )
                    
                    
                    -Income
      (loss) from continuing operations used in computing basic
    EPS
                    
                    
                    12,097,154
                    
                    
                    
                    203,014
                    
                    
                    
                    (508,434
                    )
                    
                    
                    (34,383
                    )Basic
      EPS per share from continuing operations
                    
                    
                    0.12
                    
                    
                    
                    -
                    
                    
                    
                    (0.01
                    )
                    
                    
                    -Numerator
      for basic and diluted EPS:Net
      income from discontinued operations
                    
                    $
                    -
                    
                    
                    $
                    235,329
                    
                    
                    $
                    -
                    
                    
                    $
                    217,491Deemed
      dividend on preferred stock issued
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Dividend
      on preferred stock
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Income
      (loss) from discontinued operations used in computing basis
      EPS
                    
                    
                    -
                    
                    
                    
                    235,329
                    
                    
                    
                    -
                    
                    
                    
                    217,491Basic
      EPS per share from discontinued operations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -


36


CHINA
NEW ENERGY GROUP COMPANY
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008
 
 15.
Earnings Per Share – Continued





DILUTEDNet
      income (Loss) from continuing operations attributable to China New Energy
      Group’s Common Stockholders
                    
                    $
                    12,097,154
                    
                    
                    $
                    203,014
                    
                    
                    $
                    (508,434
                    )
                    
                    $
                    (34,383
                    )Deemed
      dividend on preferred stock issued
                    
                    
                    2,350,829
                    
                    
                    
                    -
                    
                    
                    
                    2,350,829
                    
                    
                    
                    -Dividend
      on preferred stock
                    
                    
                    189,000
                    
                    
                    
                    -
                    
                    
                    
                    324,000
                    
                    
                    
                    -Income
      (loss) from continuing operations used in computing diluted
      EPS
                    
                    
                    14,636,983
                    
                    
                    
                    203,014
                    
                    
                    
                    2,166,395
                    
                    
                    
                    (34,383
                    )Diluted
      EPS per share from continuing operations
                    
                    
                    0.10
                    
                    
                    
                    -
                    
                    
                    
                    (0.01
                    )
                    
                    
                    -Net
      income from discontinued operations
                    
                    $
                    -
                    
                    
                    $
                    235,329
                    
                    
                    $
                    -
                    
                    
                    $
                    217,491Deemed
      dividend on preferred stock issued
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Dividend
      on preferred stock
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Income
      (loss) from discontinued operations used in computing diluted
      EPS
                    
                    
                    -
                    
                    
                    
                    235,329
                    
                    
                    
                    -
                    
                    
                    
                    217,491Diluted
      EPS per share from discontinued operations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Weighted
      average outstanding shares of common stock
                    
                    
                    100,000,041
                    
                    
                    
                    100,000,041
                    
                    
                    
                    100,000,041
                    
                    
                    
                    49,736,566Weighted
      average shares of convertible preferred stock outstanding
                    
                    
                    20,980,665
                    
                    
                    
                    -
                    
                    
                    
                    18,811,693
                    
                    
                    
                    -Warrants
      and contingently issuable shares
                    
                    
                    23,452,946
                    
                    
                    
                    -
                    
                    
                    
                    23,452,946
                    
                    
                    
                    -Shares
      used in computing diluted net income (loss) per share
                    
                    
                    144,433,652
                    
                    
                    
                    100,000,041
                    
                    
                    
                    142,264,680
                    
                    
                    
                    49,736,566Total
      Earnings (Loss) per share:Basic
                    
                    $
                    0.12
                    
                    
                    $
                    -
                    
                    
                    $
                    (0.01
                    )
                    
                    $
                    -Diluted
                    
                    $
                    0.10
                    
                    
                    $
                    -
                    
                    
                    $
                    (0.01
                    )
                    
                    $
                    -


37


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


16.
Business and geographical segments





The
Group’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
                    June 30, 2009
                  
                  
                  For the three months ended
                    June 30, 2008
                  
                  
                  For the three months ended
                    June 30Connection
                  
                  
                  
                  
                  
                  
                  
                  
                  Connection
                  
                  
                  
                  
                  
                  
                  
                  
                  2009
                  
                  
                  2008services
                  
                  
                  Natural gas
                  
                  
                  Corporate
                  
                  
                  services
                  
                  
                  Natural gas
                  
                  
                  Corporate
                  
                  
                  Total
                  
                  
                  TotalExternal
      revenue
                  
                  $
                  2,627,230
                  
                  
                  
                  183,360
                  
                  
                  
                  -
                  
                  
                  
                  1,780,417
                  
                  
                  
                  125,662
                  
                  
                  
                  -
                  
                  
                  
                  2,810,590
                  
                  
                  
                  1,906,079Interest
      income
                  
                  
                  1,270
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  6,539
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,270
                  
                  
                  
                  6,539Interest
      expense
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Depreciation
      and amortization
                  
                  
                  57,986
                  
                  
                  
                  36,767
                  
                  
                  
                  14,644
                  
                  
                  
                  23,849
                  
                  
                  
                  12,375
                  
                  
                  
                  6,050
                  
                  
                  
                  109,397
                  
                  
                  
                  42,274Income
      tax
                  
                  
                  366,786
                  
                  
                  
                  4
                  
                  
                  
                  -
                  
                  
                  
                  298,109
                  
                  
                  
                  19,938
                  
                  
                  
                  -
                  
                  
                  
                  366,790
                  
                  
                  
                  318,047Net
      income (loss) after income tax
                  
                  
                  1,917,339
                  
                  
                  
                  5,214
                  
                  
                  
                  12,728,482
                  
                  
                  
                  1,152,768
                  
                  
                  
                  300,478
                  
                  
                  
                  (1,241,995
                  )
                  
                  
                  14,651,035
                  
                  
                  
                  211,251Expenditures
      for long-lived assets
                  
                  
                  2,601,777
                  
                  
                  
                  -
                  
                  
                  
                  106,421
                  
                  
                  
                  1,281,235
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,708,198
                  
                  
                  
                  1,281,235


38


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





16.
Business and geographical segments





Reportable
Segments




For the six months ended
                          June 30, 2009
                        
                        
                        For the six months ended
                          June 30, 2008
                        
                        
                        For the six months ended
                          June 30Connection
                        
                        
                        
                        
                        
                        
                        
                        
                        Connection
                        
                        
                        
                        
                        
                        
                        
                        
                        2009
                        
                        
                        2008services
                        
                        
                        Natural gas
                        
                        
                        Corporate
                        
                        
                        services
                        
                        
                        Natural gas
                        
                        
                        Corporate
                        
                        
                        Total
                        
                        
                        TotalExternal
      revenue
                        
                        $
                        2,773,982
                        
                        
                        
                        361,625
                        
                        
                        
                        -
                        
                        
                        
                        1,780,417
                        
                        
                        
                        227,417
                        
                        
                        
                        -
                        
                        
                        
                        3,135,607
                        
                        
                        
                        2,007,834Interest
      income
                        
                        
                        9,627
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        6,415
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        9,627
                        
                        
                        
                        6,415Interest
      expense
                        
                        
                        (211
                        )
                        
                        
                        -
                        
                        
                        
                        (460
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (671
                        )
                        
                        
                        -Depreciation
      and amortization
                        
                        
                        111,552
                        
                        
                        
                        77,672
                        
                        
                        
                        31,036
                        
                        
                        
                        50,021
                        
                        
                        
                        23,805
                        
                        
                        
                        10,345
                        
                        
                        
                        220,260
                        
                        
                        
                        84,171Income
      tax
                        
                        
                        367,783
                        
                        
                        
                        4
                        
                        
                        
                        
                        
                        
                        
                        298,109
                        
                        
                        
                        19,938
                        
                        
                        
                        -
                        
                        
                        
                        367,787
                        
                        
                        
                        318,047Net
      income (loss) after income tax
                        
                        
                        1,977,823
                        
                        
                        
                        1,744
                        
                        
                        
                        179,925
                        
                        
                        
                        1,134,931
                        
                        
                        
                        79,753
                        
                        
                        
                        (1,241,996
                        )
                        
                        
                        2,159,492
                        
                        
                        
                        (27,312
                        )Expenditures
      for long-lived assets
                        
                        
                        2,738,943
                        
                        
                        
                        19,865
                        
                        
                        
                        150,529
                        
                        
                        
                        1,465,608
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,909,337
                        
                        
                        
                        1,465,608As
      at June 30, 2009
                        
                        
                        As
      at December 31, 2008
                        
                        
                        As
      at
                          June
      30,
                          2009
                        
                        
                        As at
                          December 31,
                          2008Assets16,057,478
                        
                        
                        
                        8,113,967
                        
                        
                        
                        6,066,996
                        
                        
                        
                        16,542,520
                        
                        
                        
                        2,520,108
                        
                        
                        
                        7,870,119
                        
                        
                        
                        30,238,441
                        
                        
                        
                        26,932,747


39


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


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 June 30, 2009 and
December 31, 2008 amounted to $5,923,322 and $5,612,356, respectively, of which
no deposits were covered by insurance. Also, as of June 30, 2009 and December
31, 2008, the Company held $204,715 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 June 30, 2009, two customers accounted
for approximately 24% of the Company’s sales. For the six months ended June 30,
2009, one customer accounted for approximately 12% of the Company’s sales and
two customers accounted for approximately 30% of the Company’s accounts
receivable as of June 30, 2009.





For the
three months ended June 30, 2008, two customers accounted for approximately 76%
of the Company’s sales. For the six months ended June 30, 2008, two customers
accounted for approximately 72% of the Company’s sales and three customers
accounted for approximately 94% of the Company’s accounts receivable as of June
30, 2008.





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





For the
three months ended June 30, 2008, two suppliers accounted for approximately 59%
of the Company’s purchases. For the six months ended June 30, 2008, one supplier
accounted for approximately 42% of the Company’s purchases and three suppliers
accounted for approximately 72% of the Company’s accounts payable as of June 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


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





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
                
                $
                64,6242010
                
                
                114,7432011
                
                
                -2012
                
                
                -2013
                
                
                -Thereafter
                
                
                -Total
      minimum lease payments
                
                $
                179,367





During
the three months ended June 30, 2009 and 2008, rental expenses included in
general and administrative expenses were $30,114 and $251,
respectively.





During
the six months ended June 30, 2009 and 2008, rental expenses included in general
and administrative expenses were $62,593 and $8,748, respectively.





As of
June 30, 2009, and December 31, 2008, 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 has evaluated subsequent events from the balance sheet date through
August 19, 2009 with the date being the date that the financial statements are
issued or are available to be issued. There are no subsequent
events.


41


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





20.
Restatement and reclassification of financial statements





The
Company has restated its consolidated financial statements for the period ended
June 30, 2009 to correct the following errors in the consolidated financial
statements previously filed on August 19, 2009:





1)
            The
      Company erroneously recorded the carrying value instead of fair value of
      assets acquired during the acquisition of Chengsheng. As a result, certain
      assets were understated and goodwill was overstated.  Moreover,
      depreciation and amortization included in general and administrative
      expenses were understated by $33,668 as a result of the higher fair value
      of property, plant and equipment and land use
  right.





2)
            The
      Company applied the incorrect consolidation method to account for its
      subsidiary Chensheng, which resulted in overstatement of non-controlling
      interest of $77,647 on the consolidated balance
  sheet.





3)
            The
      Company did not properly account for the foreign currency translation
      effect when eliminating the investment in subsidiaries accounts during
      consolidation, which resulted in understatement of $862,147 in accumulated
      other comprehensive income.





4)
            The
      Company incorrectly compiled its statement of cash flow. It incorrectly
      included the pre-acquisition cash flow activities of the subsidiary
      Chengseng that was acquired on September 30, 2008 and incorrectly excluded
      the pre-disposal cash flow activities of the subsidiary Hunchun that was
      disposed during the share exchange transaction of the two companies on
      September 30, 2008.  This error affected the individual components
      within net cash provided by operating activities and net cash used in
      investing activities.


42


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





20.
Restatement and reclassification of financial statements -
continued





The
Restatement results from our management’s determination subsequent to the
issuance of our financial statements for the three months ended June 30, 2009,
that was originally filed on August 19, 2009.





The Group
has also reflected the corrections of the following errors and reclassifications
in its consolidated financial statements as of and for the three months ended
June 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 June 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 (i.e. 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 $33,668 in the
      income statement which brought a decrease of $1,209 in exchange effects to
      accumulated other comprehensive income for the increment of the fair value
      of the assets which decreased $25,151 and $7,377 of the property, plant
      and equipment and intangible assets respectively. The Group increased the
      goodwill of $25,942 by the exchange rate
  effects.


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 $450,000 registration right liabilities for the
      six months ended June 30, 2009 and  it resulted in a total of
      $1,350,000 as of June 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 six months ended June 30,
2009.


Ÿ
            The
      Group has recorded a decrease in the derivative financial instruments –
      warrants and the income for change in fair value of warrant liabilities by
      $1,976,044 for the six months ended June 30,
  2009.


43


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





20.
Restatement and reclassification of financial statements -
continued





5)
            The
      Group has reflected the following
  reclassifications.





Ÿ
            The
      Group reclassified $204,715 from cash and cash equivalents to restricted
      cash for cash placed in escrow.


Ÿ
            The
      Group reclassified $1,929,741 of other receivable from current assets to
      long term assets.


Ÿ
            The
      Group reclassified $1,820,733 from property, plant and equipment to
      deposits paid for acquisition of long term
  assets.


Ÿ
            The
      Group reclassified accrued expenses and accruals and other payable-Third
      Party amounting to $77,924 and $297,333, respectively, to accounts payable
      of $375,257.


Ÿ
            The
      Group reclassified other receivable, accrued expenses and accruals and
      other payable-Third Party amounting to $(84,098), $253,084 and $232,150,
      respectively, to  related party payable of
    $401,136.


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 $503,346.


Ÿ
            The
      Group reclassified $303,802 from general and administrative expenses to
      cost of sales from connection services of $111,553, cost of sales of
      natural gas of $77,672 and selling expenses of $114,577 for the six months
      ended June 30, 2009.


Ÿ
            The
      Group reclassified $240,112 from general and administrative expenses to
      cost of sales from connection services of $54,286, cost of sales of
      natural gas of $121,749 and selling expenses of $64,077 for the three
      months ended June 30, 2009.


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





The net
effect of the correction of errors was to:





Ÿ
            Increase
      the Group’s reported total assets as of June 30, 2009 by $454,172 from
      $29,784,269 to $30,238,441.


Ÿ
            Decrease
      the Group’s reported non-controlling interest as of June 30, 2009 by
      $77,647 from $195,841 to $118,194.


Ÿ
            Increase
      the Group’s reported accumulated deficit as of June 30, 2009 by $1,473,690
      from $2,646,872 to $4,120,562.


Ÿ
            Increase
      the Group’s reported accumulated other comprehensive income as of June 30,
      2009 by $862,147 from $735,847 to
$1,597,994.


Ÿ
            Increase
      the Group’s reported net income by $1,519,082 for the six months ended
      June 30, 2009 from $640,410 to
$2,159,492.


Ÿ
            Increase
      the Group’s reported net income attributable to China New Energy Group by
      $1,519,082 for the six months ended June 30, 2009 from $647,313 to
      $2,166,395.


Ÿ
            Decrease
      the Group’s reported comprehensive income attributable to China New Energy
      Group by $1,499,794 for the six months ended June 30, 2009, from $628,438
      to $2,128,232.


Ÿ
            Decrease
      the basic net loss per share from continuing operations by $0.01 from
      $0.02 to $0.01.


Ÿ
            Increase
      the dilutive net earnings per share from continuing operations by $0.01
      from $(0.02) to $(0.01).


44


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


20.
Restatement and reclassification of financial statements -
continued





Condensed
Consolidated Balance Sheet as at June 30, 2009





June
      30
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  June
      302009
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  2009(Reported)
                                  
                                  
                                  Note
      1
                                  
                                  
                                  Note
      2
                                  
                                  
                                  Note
      3
                                  
                                  
                                  Note
      4
                                  
                                  
                                  Note
      5
                                  
                                  
                                  (Restated)ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                                  
                                  $
                                  6,128,037
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (204,715
                                  )
                                  
                                  
                                  5,923,322Restricted
      cash
                                  
                                  
                                  -
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  204,715
                                  
                                  
                                  
                                  204,715Accounts
      receivable
                                  
                                  
                                  2,887,687
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  2,887,687(84,098
                                  )Other
      receivables
                                  
                                  
                                  2,013,839
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (1,929,741
                                  )
                                  
                                  
                                  -Related
      party receivable
                                  
                                  
                                  -
                                  
                                  
                                  
                                  
                                  
                                  
                                  (84,120
                                  )
                                  
                                  
                                  
                                  
                                  
                                  84,120
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Inventories,
      net
                                  
                                  
                                  245,724
                                  
                                  
                                  
                                  3,012
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  248,736Prepaid
      expenses
                                  
                                  
                                  -
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Other
      current assets
                                  
                                  
                                  77,728
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  77,728TOTAL
      CURRENT ASSETS
                                  
                                  
                                  11,353,015
                                  
                                  
                                  
                                  3,012
                                  
                                  
                                  
                                  (84,120
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  84,120
                                  
                                  
                                  
                                  (2,013,839
                                  ))
                                  
                                  
                                  9,342,188Property,
      plant and equipment, net
                                  
                                  
                                  16,596,989
                                  
                                  
                                  
                                  1,036,655
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (25,151
                                  )
                                  
                                  
                                  (1,820,733
                                  )
                                  
                                  
                                  15,787,760Intangible
      assets, net
                                  
                                  
                                  544,787
                                  
                                  
                                  
                                  757,550
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (7,377
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,294,960Other
      receivables
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,929,741
                                  
                                  
                                  
                                  1,929,741Deposits
      paid for acquisition of long term assets
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,820,733
                                  
                                  
                                  
                                  1,820,733Goodwill
                                  
                                  
                                  1,289,478
                                  
                                  
                                  
                                  (1,200,477
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (25,942
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  63,059-TOTAL
      ASSETS
                                  
                                  $
                                  29,784,269
                                  
                                  
                                  
                                  596,740
                                  
                                  
                                  
                                  (84,120
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  25,650
                                  
                                  
                                  
                                  (84,098
                                  )
                                  
                                  
                                  30,238,441LIABILITIES
      AND STOCKHOLDERS’ EQUITYCURRENT
      LIABILITIESAccounts
      payable
                                  
                                  $
                                  44,558
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  375,257
                                  
                                  
                                  
                                  419,815(253,084
                                  )Accrued
      expenses
                                  
                                  
                                  331,008
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (77,924
                                  )
                                  
                                  
                                  -(232,150
                                  )Other
      payables
                                  
                                  
                                  544,120
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (297,333
                                  )
                                  
                                  
                                  14,637Registration
      right penalties payable
                                  
                                  
                                  -
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  900,000
                                  
                                  
                                  
                                  450,000
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,350,000Related
      party payable
                                  
                                  
                                  97,969
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  401,136
                                  
                                  
                                  
                                  499,105Tax
      payable
                                  
                                  
                                  688,629
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  688,629Dividend
      payable
                                  
                                  
                                  518,000
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  518,000Warrant
      liabilities
                                  
                                  
                                  -
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  5,506,143
                                  
                                  
                                  
                                  2,893,996
                                  
                                  
                                  
                                  
                                  
                                  
                                  8,400,139TOTAL
      CURRENT LIABILITIES
                                  
                                  
                                  2,224,284
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  6,406,143
                                  
                                  
                                  
                                  3,343,996
                                  
                                  
                                  
                                  (84,098
                                  )
                                  
                                  
                                  11,890,325Commitment
      and contingencies (Note 12)Preferred
      Stock : 10,000,000 shares authorized, $0.001 par valueSeries
      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 June 30, 2009 and December 31,
      2008
                                  
                                  
                                  100,000
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  100,000Preferred
      shares: (10,000,000 shares authorized, 1,857,373 shares issued and
      outstanding)
                                  
                                  
                                  2,973
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (1,857
                                  )
                                  
                                  
                                  (1,116
                                  )Additional
      paid in capital
                                  
                                  
                                  27,269,162
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (9,982,234
                                  )
                                  
                                  
                                  (7,219,251
                                  )
                                  
                                  
                                  (347,202
                                  )
                                  
                                  
                                  9,720,475(450,000
                                  )(33,668
                                  )26,7061,976,044Accumulated
      deficit
                                  
                                  
                                  (2,646,872
                                  )
                                  
                                  
                                  318,274
                                  
                                  
                                  
                                  (54,196
                                  )
                                  
                                  
                                  (3,453,870
                                  )
                                  
                                  
                                  197,020
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (4,120,562
                                  )Statutory
      surplus reserve fund
                                  
                                  
                                  1,903,034
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (156,144
                                  )
                                  
                                  
                                  1,746,890Accumulated
      other comprehensive income
                                  
                                  
                                  735,847
                                  
                                  
                                  
                                  356,113
                                  
                                  
                                  
                                  (29,924
                                  )
                                  
                                  
                                  
                                  
                                  
                                  32,612
                                  
                                  
                                  
                                  503,346
                                  
                                  
                                  
                                  1,597,994TOTAL
      CHINA NEW ENERGY'S STOCKHOLDERS EQUITY
                                  
                                  
                                  27,364,144
                                  
                                  
                                  
                                  674,387
                                  
                                  
                                  
                                  (84,120
                                  )
                                  
                                  
                                  (13,437,961
                                  )
                                  
                                  
                                  (5,471,653
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  9,044,797Non-controlling
      interest
                                  
                                  
                                  195,841
                                  
                                  
                                  
                                  (77,647
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  118,194TOTAL
      EQUITY
                                  
                                  
                                  27,559,985
                                  
                                  
                                  
                                  596,740
                                  
                                  
                                  
                                  (84,120
                                  )
                                  
                                  
                                  (13,437,961
                                  )
                                  
                                  
                                  (5,471,653
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  9,162,991TOTAL
      LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’
      EQUITY
                                  
                                  $
                                  29,784,269
                                  
                                  
                                  
                                  596,740
                                  
                                  
                                  
                                  (84,120
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  25,650
                                  
                                  
                                  
                                  (84,098
                                  )
                                  
                                  
                                  30,238,441


45


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





20.
Restatement and reclassification of financial statements -
continued





Condensed
Consolidated Statements of Operations and Comprehensive Loss for the Six Months
Ended June 30, 2009





Six months
                                ended
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              Six months
                                endedJune302009
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              June302009Asreported
                              
                              
                              Note1
                              
                              
                              Note2
                              
                              
                              Note3
                              
                              
                              Note4
                              
                              
                              Note5
                              
                              
                              (Restated)Revenue:Connection
      services
                              
                              
                              2,773,982
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              2,773,982Natural
      gas
                              
                              
                              361,625
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              361,6253,135,607
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              3,135,607Cost
      of Sales:Connection
      services
                              
                              
                              693,562
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              111,553
                              
                              
                              
                              805,115Natural
      gas
                              
                              
                              282,210
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              77,672
                              
                              
                              
                              359,882975,772
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              189,225
                              
                              
                              
                              1,164,997Gross
      Profit
                              
                              
                              2,159,835
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (189,225
                              )
                              
                              
                              1,970,610Operating
      Expenses:33,668General
      and administrative expenses
                              
                              
                              1,160,687
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (26,706
                              )
                              
                              
                              (303,802
                              )
                              
                              
                              863,847Selling
      expenses
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              114,577
                              
                              
                              
                              114,577Registration
      rights penalties
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              450,000
                              
                              
                              
                              -
                              
                              
                              
                              450,000Total
      operating expenses
                              
                              
                              1,160,687
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              456,962
                              
                              
                              
                              (189,225
                              )
                              
                              
                              1,428,424Income(Loss)
      from Operations
                              
                              
                              999,148
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (456,962
                              )
                              
                              
                              -
                              
                              
                              
                              542,186Other
      Income (Expenses):Change
      in fair value of warrant liabilities
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              1,976,044
                              
                              
                              
                              
                              
                              
                              
                              1,976,044Interest
      income
                              
                              
                              9,627
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              9,627Interest
      expense
                              
                              
                              (671
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (671
                              )Other
      Income
                              
                              
                              93
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              93Total
      other income (expense)
                              
                              
                              9,049
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              1,976,044
                              
                              
                              
                              -
                              
                              
                              
                              1,985,093Income
      (Loss) From Continuing Operations, Before Income Tax
                              
                              
                              1,008,197
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              1,519,082
                              
                              
                              
                              -
                              
                              
                              
                              2,527,279Income
      Tax
                              
                              
                              (367,787
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (367,787
                              )Income
      (Loss) From Continuing Operations, net of Income Tax
                              
                              
                              640,410
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              1,519,082
                              
                              
                              
                              -
                              
                              
                              
                              2,159,492Income
      From Discontinued Operations, net of Income Tax
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              -Net
      Income
                              
                              
                              640,410
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              1,519,082
                              
                              
                              
                              -
                              
                              
                              
                              2,159,492Less:
      Net Income Attributable to Non-controlling Interest
                              
                              
                              6,903
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              6,903Add:
      Net Income Attributable to China New Energy Group
                              
                              
                              647,313
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              1,519,082
                              
                              
                              
                              -
                              
                              
                              
                              2,166,395Dividend
      and Deemed Dividend on Preferred Stock
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (2,477,807
                              )
                              
                              
                              -
                              
                              
                              
                              (2,477,807
                              )-Net
      Income(Loss) Attributable to Common Stockholders
                              
                              
                              647,313
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (958,725
                              )
                              
                              
                              -
                              
                              
                              
                              (311,412
                              )Other
      Comprehensive IncomeNet
      Income
                              
                              
                              640,410
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              1,519,082
                              
                              
                              
                              
                              
                              
                              
                              2,159,492Foreign
      currency translation gain (loss)
                              
                              
                              305
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (19,288
                              )
                              
                              
                              
                              
                              
                              
                              (18,983
                              )Comprehensive
      Income Attributable to Non-controlling Interest
                              
                              
                              (12,277
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              (12,277
                              )Comprehensive
      Income attributable to the Company
                              
                              $
                              628,438
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              1,499,794
                              
                              
                              
                              -
                              
                              
                              $
                              2,128,232Income
      (Loss) per share  BasicIncome
      (Loss) from continuing operations
                              
                              $
                              (0.02
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              0.01
                              
                              
                              
                              
                              
                              
                              
                              (0.01
                              )Income
      (Loss) from discontinued operations
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              -Total
      income ( loss) per share
                              
                              $
                              (0.02
                              )
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              0.01
                              
                              
                              
                              -
                              
                              
                              $
                              (0.01
                              )Income
      (Loss) per share - DilutedIncome
      (Loss) from continuing operations
                              
                              $
                              (0.02
                              )
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              0.01
                              
                              
                              
                              
                              
                              
                              $
                              (0.01
                              )Income
      (Loss) from discontinued operations
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              -Total
      income (loss) per share
                              
                              $
                              (0.02
                              )
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              0.01
                              
                              
                              
                              -
                              
                              
                              $
                              (0.01
                              )Weighted
      average common shares outstandingBasic
                              
                              
                              100,000,041
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              100,000,041Diluted
                              
                              
                              109,658,379
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              142,264,680


46


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





20.
Restatement and reclassification of financial statements -
continued





Condensed
Consolidated Statements of Operations and Comprehensive Loss for the Three
Months Ended June 30, 2009





Three
      months
                                      ended
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    Three
      months
                                      endedJune 30, 2009
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    June
      302009Asreported
                                    
                                    
                                    Note
      1
                                    
                                    
                                    Note
      2
                                    
                                    
                                    Note
      3
                                    
                                    
                                    Note
      4
                                    
                                    
                                    Note
      5
                                    
                                    
                                    (Restated)Revenue:Connection
      services
                                    
                                    
                                    2,627,230
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    2,627,230Natural
      gas
                                    
                                    
                                    183,360
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    183,3602,810,590
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    2,810,590Cost
      of Sales:Connection
      services
                                    
                                    
                                    656,874
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    54,286
                                    
                                    
                                    
                                    711,160Natural
      gas
                                    
                                    
                                    56,398
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    121,749
                                    
                                    
                                    
                                    178,147713,272
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    176,035
                                    
                                    
                                    
                                    889,307Gross
      Profit
                                    
                                    
                                    2,097,318
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    1,921,283Operating
      Expenses:General
      and administrative expenses
                                    
                                    
                                    752,488
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    16,833
                                    
                                    
                                    
                                    (240,112
                                    )
                                    
                                    
                                    529,209Selling
      expenses
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    64,077
                                    
                                    
                                    
                                    64,077Total
      operating expenses
                                    
                                    
                                    752,488
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    16,833
                                    
                                    
                                    
                                    (176,035
                                    )
                                    
                                    
                                    593,286Income
      (Loss) from Operations
                                    
                                    
                                    1,344,830
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (16,833
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    1,327,997Other
      Income (Expenses):Change
      in fair value of warrant liability
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    13,688,558
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    13,688,558Interest
      income
                                    
                                    
                                    1,270
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    1,270Total
      other income (expense)
                                    
                                    
                                    1,270
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    13,688,558
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    13,689,828Income
      (Loss) From Continuing Operations, Before Income Tax
                                    
                                    
                                    1,346,100
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    13,671,725
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    15,017,825Income
      Tax
                                    
                                    
                                    (366,790
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (366,790
                                    )Income
      (Loss) From Continuing Operations, net of Income Tax
                                    
                                    
                                    979,310
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    13,671,725
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    14,651,035Income
      From Discontinued Operations, net of Income Tax
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Net
      Loss
                                    
                                    
                                    979,310
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    13,671,725
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    14,651,035Less:
      Net Loss Attributable to Non-controlling Interest
                                    
                                    
                                    (14,052
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (14,052
                                    )Add:
      Net Loss Attributable to China New Energy Group
                                    
                                    
                                    965,258
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    13,671,725
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    14,636,983Dividend
      and Deemed Dividend on Preferred Stock
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (2,342,807
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (2,342,807
                                    )Net
      Income (Loss) Attributable to Common Stockholders
                                    
                                    
                                    965,258
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    11,328,918
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    12,294,176Other
      Comprehensive LossNet
      Loss
                                    
                                    
                                    979,310
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    13,671,725
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    14,651,035Foreign
      currency translation gain (loss)
                                    
                                    
                                    11,094
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (35,730
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (24,636
                                    )Comprehensive
      Income Attributable to Non-controlling Interest
                                    
                                    
                                    (8,678
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    (8,678
                                    )Comprehensive
      loss attributable to the Company
                                    
                                    $
                                    981,726
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    13,635,995
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    14,617,721Income
      (Loss) per share BasicIncome
      (Loss) from continuing operations
                                    
                                    $
                                    (0.02
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.14
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.12Income
      (Loss) from discontinued operations
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Total
      income( loss) per share
                                    
                                    $
                                    (0.02
                                    )
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    
                                    -
                                    
                                    
                                    0.14
                                    
                                    
                                    -
                                    
                                    
                                    0.12Income
      (Loss) per share - DilutedLoss
      from continuing operations
                                    
                                    $
                                    (0.02
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.12
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.10Income
      (Loss) from discontinued operations
                                    
                                    
                                    -
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    -Total
      income (loss) per share
                                    
                                    $
                                    (0.02
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    0.12
                                    
                                    
                                    
                                    
                                    
                                    0.10Weighted
      average common shares outstandingBasic
                                    
                                    
                                    100,000,041
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    100,000,041Diluted
                                    
                                    
                                    100,000,041
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    144,453,652


47


CHINA
NEW ENERGY GROUP COMPANY


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008





20.
Restatement and reclassification of financial statements -
continued





For The Six Months EndedJune 302009
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2009As Reported
                        
                        
                        Note1
                        
                        
                        Note2
                        
                        
                        Note3
                        
                        
                        Note 4
                        
                        
                        Note 5
                        
                        
                        As RestatedCash
      flows from operating activitiesNet
      Income
                        
                        $
                        647,314
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,519,141
                        
                        
                        
                        (6,963
                        )
                        
                        $
                        2,159,492(Loss)
      Attributable to non-controlling interest
                        
                        
                        (6,903
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        6,903
                        
                        
                        
                        
                        
                        
                        
                        -Adjustments
      to reconcile net income (loss) to net cash provided by( used in) operating
      activities:Depreciation
      and amortization
                        
                        
                        186,579
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        33,681
                        
                        
                        
                        220,260Change
      in fair value of warrant liability
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,976,044
                        )
                        
                        
                        
                        
                        
                        
                        (1,976,044
                        )Registration
      right liabilities
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        450,000
                        
                        
                        
                        
                        
                        
                        
                        450,000Changes
      in operating assets and liabilities:Accounts
      receivable
                        
                        
                        (703,104
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (703,104
                        )Other
      receivables
                        
                        
                        353,535
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        353,535Inventories
                        
                        
                        9,024
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        9,024Prepayment
                        
                        
                        1,559,165
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,425,487
                        )
                        
                        
                        
                        
                        
                        
                        133,678Other
      current assets
                        
                        
                        (74,377
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (74,377
                        )Accounts
      payable
                        
                        
                        (67,166
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (375,358
                        )
                        
                        
                        (442,524
                        )Accrued
      expense
                        
                        
                        74,772
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -
                        
                        
                        
                        74,772Other
      payables
                        
                        
                        (693,240
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        343,678
                        
                        
                        
                        (349,562
                        )Tax
      payable
                        
                        
                        (4,933
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (4,933
                        )Net
      cash provided by (used in)operating activities
                        
                        
                        1,280,666
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (1,425,487
                        )
                        
                        
                        (4,962
                        )
                        
                        
                        (149,783
                        )Cash
      flows from investing activitiesAddition
      of construction in progress
                        
                        
                        (4,334,824
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,425,487
                        
                        
                        
                        
                        
                        
                        
                        (2,909,337
                        )Increase
      in short-term loan
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Payments
      made to acquire Chensheng
                        
                        
                        (1,838,946
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,838,946
                        )Purchase
      of intangible assets
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Net
      cash provided by (used in) investing activities
                        
                        
                        (6,173,770
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,425,487
                        
                        
                        
                        -
                        
                        
                        
                        (4,748,283
                        )Cash
      flows from financing activitiesIssued
      preferred stock
                        
                        
                        4,752,140
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        4,752,140Contribution
      from non-controlling interest
                        
                        
                        439,060
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        439,060Fund
      deposit as restricted cash
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        16,437
                        
                        
                        
                        16,437Loan
      from related parties
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Capital
      of subsidiaries
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Net
      cash provided by financing activities:
                        
                        
                        5,191,200
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        16,437
                        
                        
                        
                        5,207,637Effect
      of exchange rate changes in cash and cash equivalents
                        
                        
                        (3,567
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        4,962
                        
                        
                        
                        1,395Net
      increase in cash and cash equivalents
                        
                        
                        294,529
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        16,437
                        
                        
                        
                        310,966Cash
      and cash equivalents - beginning of period
                        
                        
                        5,833,508
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (221,152
                        )
                        
                        
                        5,612,356Cash
      and cash equivalents - end of period
                        
                        $
                        6,128,037
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        $
                        5,923,322


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.




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 six months ended June 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
six months ended June 30, 2009, we had sales revenue of $3.14 million of
which $2.78 million, or 88%, was from connection services while $0.36
million, or 12%, was from gas sales.





Our
revenue for the six months ended June 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.





Second
Quarter Financial Performance Highlights





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





Revenues: Our
revenues were $2.81 MM for the second quarter of 2009, an increase of 47%
from the same period of 2008.





Gross
Margin: Gross margin was 68% for the second quarter of 2009 compared
to gross margin of 75% for the second quarter of 2008, representing a
percentage decrease of  7%.


53





Operating
Expenses: Operating expenses (including selling, general
and administrative expenses) were $0.59 MM for the second quarter of 2009,
an increase of 164% from the same period of 2008.





Net Income /
(Loss): A net income of $14.64 MM resulted for the second quarter of
2009, while the net income for the same period of 2008 was $0.20 MM, The
increment of net income was mainly due to changes in fair value of warrant
liabilities of $13.69 MM for the second quarter of 2009.





Fully diluted net
income per share: Fully diluted net income per share was $0.10 for the
second quarter of 2009, as compared to net income per share of $-0.01 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 six months ended June 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 six months ended June 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.




55




Results
of Operations





Comparison
of Three Months Ended June 30, 2009 and 2008





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





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





For the three months endedJune 30,2009
                        
                        
                        2008
                        
                        
                        Change
                        
                        
                        Change%RestatedRevenues:
                        
                        $
                        2,811
                        
                        
                        $
                        1,906
                        
                        
                        
                        905
                        
                        
                        
                        47
                        %Cost
      of Sales:
                        
                        
                        889
                        
                        
                        
                        484
                        
                        
                        
                        405
                        
                        
                        
                        84
                        %Gross
      Profit
                        
                        
                        1,921
                        
                        
                        
                        1,422
                        
                        
                        
                        499
                        
                        
                        
                        35
                        %Total
      operating expenses
                        
                        
                        593
                        
                        
                        
                        225
                        
                        
                        
                        368
                        
                        
                        
                        164
                        %Operating
      income
                        
                        
                        1,328
                        
                        
                        
                        1,197
                        
                        
                        
                        131
                        
                        
                        
                        11
                        %Other
      Income (Expenses):Change
      in fair value of warrant liabilities
                        
                        
                        13,689
                        
                        
                        
                        -910
                        
                        
                        
                        14,599
                        
                        
                        
                        1604
                        %Interest
      income
                        
                        
                        1
                        
                        
                        
                        7
                        
                        
                        
                        (6
                        )
                        
                        
                        -86
                        %Income
      From Continuing Operations, Before Income Tax
                        
                        
                        15,018
                        
                        
                        
                        294
                        
                        
                        
                        14,724
                        
                        
                        
                        5008
                        %Income
      Tax
                        
                        
                        (367
                        )
                        
                        
                        (318
                        )
                        
                        
                        (49
                        )
                        
                        
                        15
                        %Income
      From Discontinued Operations, net of Income Tax
                        
                        
                        -
                        
                        
                        
                        235
                        
                        
                        
                        (235
                        )
                        
                        
                        -100
                        %Non-controlling
      Interest
                        
                        
                        (14
                        )
                        
                        
                        (8
                        )
                        
                        
                        (6
                        )
                        
                        
                        75
                        %Net
      Income (Loss) attributable to China New Energy Group
                        
                        
                        14,637
                        
                        
                        
                        203
                        
                        
                        
                        14,434
                        
                        
                        
                        7110
                        %





Revenues. 
Revenues are derived primarily from connection fees and sales of natural
gas.  Revenues increased $0.91 MM, or 47%, to $2.81 MM for the three months
ended June 30, 2009 from $1.90 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 $0.41 MM, or 84%, to $0.89 MM for the three months ended
June 30, 2009 from $0.48 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 $0.50 MM, or 35%, to $1.92 MM for the three months
ended June 30, 2009 from $1.42 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 June 30, 2009.  The gross profit margin during the same period
in 2008 was 75%. Such decrease in gross profit margin was mainly due to increase
of operating assets and thus increase 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 three months ended June 30, 2009, the total
operating expenses were $0.59 MM while the amount was $0.22 MM for the same
period of 2008, or increased by 164%.  This increase was mainly due to the
fact that we are expanding our company. Management believes that the
relatively high SG&A expenses will continue as we endeavor to expand
our business.


56





Operating incomeOur operating
income increased by $0.13 MM, or 11%, to $1.33 MM for the three months ended
June 30, 2009 from $1.20 MM during the same period in 2008. This increase
in operating income was mainly due to increase in number of connection
households.





Other
Income (Expenses)





Change In Fair Value of
Warrant Liability:For the three months ended June 30, 2009, the change
in fair value of warrant liability was recorded as other income of $13.69 MM
while the one incurred in the same period of 2008 was recorded as other expenses
of $0.91 MM.





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





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





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





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





As at
June 30, 2009, the fair value of the Series A and B Convertible Preferred Stock
were $8.40 MM.  Therefore, the Company recognized a $13.69 MM gain from the
change in fair value for the three months ended June 30, 2009 and a $0.91
MM loss from the change in fair value during the same period in
2008.





IncomeFrom Continuing Operations, Before
Income TaxOur income from continuing operations, before
income tax increased by $14.73 MM, to $15.02 MM for the three months ended
June 30, 2009 from $0.29 MM during the same period in 2008.  Such increase
was mainly due to the fact that the company recorded a $13.69 MM income from the
change in fair value of the warrants which put through according to
EITF 07-05.





Income
(Loss) From Discontinued Operation





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.


57





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 June 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 June 30, 2008.





2009
      (MM)
                          
                          
                          2008
      (MM)Revenue
                          
                          $
                          
                          
                          
                          $
                          0.46Operating
      income
                          
                          $
                          
                          
                          
                          $
                          0.33Income
      before income taxes
                          
                          $
                          
                          
                          
                          $
                          0.33Income
      tax expense
                          
                          $
                          
                          
                          
                          $Income
      from discontinued operations, net of tax
                          
                          $
                          
                          
                          
                          $
                          0.33





NetIncome.
Net income increased by $14.44 MM, to a net income of $14.64 MM for
the three months ended June 30, 2009, from net income of $0.20 MM for the same
period of 2008, which is mainly due to: (1) increase in gross profit by $0.50
MM; and (2) income from the change in fair value of the warrants, $13.69
MM.


58





Comparison
of Six Months Ended June 30, 2009 and 2008





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





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





For the six months endedJune 30,2009
                
                
                2008
                
                
                Change
                
                
                Change%RestatedRevenues:
                
                $
                3,136
                
                
                $
                2,008
                
                
                $
                1,128
                
                
                
                56
                %Cost
      of Sales:
                
                
                1,165
                
                
                
                560
                
                
                
                605
                
                
                
                108
                %Gross
      Profit
                
                
                1,971
                
                
                
                1,448
                
                
                
                523
                
                
                
                36
                %Total
      operating expenses
                
                
                1,428
                
                
                
                471
                
                
                
                957
                
                
                
                203
                %Operating
      income
                
                
                542
                
                
                
                977
                
                
                
                (435
                )
                
                
                -44
                %Other
      Income (Expenses):Change
      in fair value of warrant liabilities
                
                
                1,976
                
                
                
                -910
                
                
                
                2,886
                
                
                
                317
                %Interest
      income
                
                
                10
                
                
                
                6
                
                
                
                4
                
                
                
                67
                %Interest
      expense
                
                
                (1
                )
                
                
                -
                
                
                
                (1
                )
                
                
                -100
                %Income
      From Continuing Operations, Before Income Tax
                
                
                2,527
                
                
                
                73
                
                
                
                2,454
                
                
                
                3362
                %Income
      Tax
                
                
                (368
                )
                
                
                (318
                )
                
                
                (50
                )
                
                
                16
                %Income
      From Discontinued Operations, net of Income Tax
                
                
                -
                
                
                
                217
                
                
                
                (217
                )
                
                
                -100
                %Non-controlling
      Interest
                
                
                7
                
                
                
                (7
                )
                
                
                14
                
                
                
                200
                %Net
      Income (Loss) attributable to China New Energy Group
                
                
                2,166
                
                
                
                (34
                )
                
                
                2,200
                
                
                
                6471
                %





Revenues. 
Revenues are derived primarily from connection fees and sales of natural
gas.  Revenues increased $1.13 MM, or 56%, to $3.14 MM for the six
months ended June 30, 2009 from $2.01 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 $0.61 MM, or 108%, to $1.17 MM for the six months
ended June 30, 2009 from $0.56 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 0.52 MM, or 36%, to $1.97 MM for the six months
ended June 30, 2009 from $1.45 MM during the same period in 2008. 
Gross profit as a percentage of revenues or gross profit margin, was 63% for six
months ended June 30, 2009.  The gross profit margin during the same
period in 2008 was 72%. Such decrease in gross profit margin was mainly due to
increase of operating assets and thus increase the cost allocation of
depreciation.





Total Operating Expenses.The total operating
expenses consist of two components, the first one is registration right
penalties and the other is general and administrative expenses (“SG&A”). For
the six months ended June 30, 2009, the total operating expenses were
$1.43 MM while the amount was $0.47 MM for the same period of 2008, or increased
by 203%.  This increase was mainly due to the fact that we are expanding
our company.    Management believes that the relatively high
SG&A expenses will continue as we endeavor to expand our
business.





Operating income.Our operating
income decreased by $0.44 MM, or 44%, to $0.54 MM for the six months
ended June 30, 2009 from $0.98 MM during the same period in 2008. 
This decrease in operating income was mainly due to increase in registration
right penalties.





Total
Other Income (Expenses)





Change In Fair Value of Warrant
Liability:For the six months ended June 30, 2009, the change in fair
value of warrant liability was recorded as other income of $1.98 MM while the
one incurred in the same period of 2008 was recorded as other expenses of $0.91
MM.





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





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





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





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





As at
June 30, 2009, the fair value of the Series A and B Convertible Preferred Stock
were $8.40 MM.  Therefore, the Company recognized a $1.98 MM gain from the
change in fair value for the six months ended June 30, 2009 and a $0.91 MM
loss from the change in fair value during the same period in
2008.


60





IncomeFrom Continuing Operations, Before Income
Tax.Our income from continuing operations, before income tax
increased by $2.45 MM, to $2.52 MM for the six months ended June 30,
2009 from $0.07 MM during the same period in 2008.  Such increase was
mainly due to the fact that the company recorded a $1.98 MM income from the
change in fair value of the warrants which put through according to
EITF 07-05.





Income
(Loss) From Discontinued Operation





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 June 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 six
months ended June 30, 2008.




2009 (MM)
                      
                      
                      2008 (MM)Revenue
                      
                      $
                      
                      
                      
                      $
                      0.46Operating
      income
                      
                      $
                      
                      
                      
                      $
                      0.31Income
      before income taxes
                      
                      $
                      
                      
                      
                      $
                      0.31Income
      tax expense
                      
                      $
                      
                      
                      
                      $Income
      from discontinued operations, net of tax
                      
                      $
                      
                      
                      
                      $
                      0.31





NetIncome.
Net income increased by $2.20 MM, to a net income of $2.17 MM for
the six months ended June 30, 2009, from net loss of $0.03 MM for the
same period of 2008, which is mainly due to: (1) increase in gross profit by
$0.52 MM; and (2) income from the change in fair value of the warrants, $1.98
MM.


61





Liquidity
and Capital Resources





As of
June 30, 2009, we had cash and cash equivalents of approximately $5.92 million.
 The following table provides detailed information about our net cash flow
for all financial statement periods presented in this report.





Cash
Flow


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





For The Six Months EndedJune 302009
                            
                            
                            2008As RestatedNet
      cash used in  operating activities
                            $
                            (150
                            )
                            
                            $
                            (460
                            )Net
      cash used in investing activities
                            
                            (4,748
                            )
                            
                            
                            (806
                            )Net
      cash provided by financing activities:
                            
                            5,208
                            
                            
                            
                            252Effect
      of exchange rate changes in cash and cash equivalents
                            
                            1
                            
                            
                            
                            (12
                            )Net
      increase(decrease) in cash and cash equivalents
                            $
                            311
                            
                            
                            $
                            (1,026
                            )





Operating
Activities





Net cash
used in operating activities was $0.15 MM for the six months ended June 30,
2009, compared to net cash used in operating activities of $0.46 MM during the
same period of 2008. This decrease in funds used in our operating activities was
primarily due to an increase in accounts receivable and a decrease in
prepayments.





Investing
Activities





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





Net cash
used in investing activities for the six months ended June 30, 2009 was $4.75 MM
which was an increase of $3.94 MM from $0.81 MM for the same
period of 2008.  This increase was due to payment 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 230% as of June 30, 2009.  Net cash provided by financing
activities for the six months ended June 30, 2009 was $5.21 MM, which is an
increase of $4.96 MM from $0.25 MM during the same period of 2008.
This increase was mainly due to the contribution from the private
placement consummated on May 1, 2009.





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


62





Capital
Expenditures, Contractual Obligations, Commitments and Contingences





For the
six months ended June 30, 2009, the company spent about $2.91 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 $0.18 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 June 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;


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·
            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
      furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of
2002.


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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)


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